Download Building a Holistic Capital Management Framework

• Cognizant 20-20 Insights
Building a Holistic Capital
Management Framework
Embedding the strategic use of capital into banks’ internal cultures
will help them gain competitive advantage.
Executive Summary
The 2008 financial crisis induced banks to
rethink their capital planning approach and
identify new ways to extract shareholder value
in an increasingly risk-averse environment.
A lower risk appetite and increased regulatory
capital requirements have imposed new constraints forcing banks to optimize capital allocations, which in turn have required some difficult
business decisions.
We believe capital management is not a onedimensional problem. Developing a holistic capital
management framework is a new imperative for
banks.
In this white paper, we examine key developments and highlight the challenges facing banks
that are looking to develop a holistic capital
management framework. We analyze the impact
of regulations on capital planning decisions. We
also lay out the capital management value chain,
and highlight the need for a strategic transformation of existing processes and systems.
cognizant 20-20 insights | march 2017
Where Does Capital Generate Value?
A Strategy & Performance
Management Perspective
Performance management allows businesses to
decide which product or business lines to direct its
resources to, so as to maximize profitability. ROE1
is a common way to measure the performance of
a bank. However, ROE does not incorporate the
risk element that the equity is exposed to, and
hence it can be misleading. Risk-adjusted performance management is a method to allocate risks
across the business on a consistent basis in terms
of their contribution to capital requirements.
Given the constraints of capital availability and the
cost considerations, banks must assess whether
promoting certain business lines that generate
high returns is indeed generating value for the
business if the investment has to be financed at
a greater cost and by meeting more stringent
regulatory requirements.
To maximize shareholder wealth, banks undertake
capital allocation – a process of planning, allocating
and managing capital for a variety of products to
Holistic Capital Management Framework
2. Economic Capital
1. Strategy & Performance Management
Performance Measures
• Set performance
measures (e.g., ROE) to
drive decision-making.
• Embed risk-adjusted
performance into
decision-making.
Position Risks
(FX, IR, Equity and
Commodity Risks)
Other Risks
(e.g. operational risk)
The potential unexpected
loss in economic value of
the bank’s portfolio of its
positions over a one-year
horizon.
Risks not captured by
the position risks; these
include operational and
pension risks.
Risk Appetite
Definition of the risk
profile needed to
support the bank’s risk
capacity and its overall
strategy.
1. Strategy &
Performance
Management
2. Economic
Capital
Capital
Management
3. Regulatory Capital
Market, Credit and
Operational Risk
Pillar II Requirements
Banks should respond to
regulatory requirements
that have an impact on
their RWAs (e.g. ,CVA
charge, IRRBB, FTRB).
Qualitative and
quantitative assessment
of whether banks have
sufficient capital to
continue operations.
3. Regulatory
Capital
5. Recovery and Resolution Plans
4. Risk-Based
Product Pricing
Measures for Monitoring
Liquidity Distress
Reflecting the Riskiness of the
Product in the Trade
Maintain sufficient liquid assets to
retain depositor confidence and
maintain a buffer over regulatory and
internal assessment of liquidity
requirements.
Figure 1
5. Recovery
and
Resolution
Plans
4. Risk-Based
Product
Pricing
Embedding risk in products’ pricing in
order to ensure that it covers the
costs associated with hedging CVA
capital charge.
ϭ
ensure that the return on investment outstrips the
costs. To achieve success, banks must be able to
appropriately balance growth, risk and return to
remain in line with the interests of investors.
at a specified confidence level, within a chosen
time horizon. Hence, it can be used to gauge the
amount of risk a bank is exposed to and can be
seen as capital that a bank needs to hold on its
balance sheet to support those risks and stay
solvent. Since ECap incorporates not just a bank’s
capital position but also the underlying risk, it is a
very useful tool for capital management.
Clearly, capital management should be increasingly embedded in evaluating decision-making,
costs, performance and incentives per group,
business and product. Performing such an
analysis would require identifying and continuously monitoring a set of metrics that use the
same set of enterprise data and are consistent
and comparable across business groups, lines and
products. However, metrics are often unique to
each business line or product, which makes comparisons difficult. The solution is a standardized
performance management framework.
When considering a performance
management framework that
captures the risk underlying
assets, one way of measuring that
risk is by understanding economic
capital requirements.
How Much Capital? An Economic
Perspective
Banks have had to increasingly focus on two
areas:
When considering a performance management
framework that captures the risk underlying
assets, one way of measuring that risk is by
understanding economic capital requirements.
The capital possessed by a firm protects it against
insolvency in case the difference in value between
its assets and its liabilities decreases. Economic
capital (ECap) represents an estimate of the
worst possible decline in the institution’s capital
cognizant 20-20 insights
• Which risk-driven business area/project should
we channel our capital to?
• Across business areas, is the capital sufficient
to absorb the risk of insolvency?
ECap can support this dual agenda as it can be
used to develop risk-driven profitability measures
to compare businesses but also produce a single
2
Benefits and Challenges of Using Economic Capital Metrics
with Regulatory Capital Metrics 2. Economic Capital
Benefits
Challenges
Complements
regulatory
capital
measures
Allows risk data
to be aggregated
at group level
Allows for
comparison
between
businesses/
products
May require a
rethink of IT
strategy
ECap models
traditionally
difficult to
back-test
Management
complexities
from parallel use
of ECap and
RegCap metrics
ECap is being
increasingly used to
measure capital
buffer. Banks must
maintain it in
addition to
regulatory capital
to avoid falling
short of regulatory
requirements.
ECap metrics are
flexible and can be
calculated across
geographies and
businesses and
hence, can present
the aggregate view
of risk that
regulators seek.
ECap metrics can be
calculated at a
business level. This
allows for
risk-adjusted
performance
measure and
comparison between
different businesses
which helps
management decide
capital allocation for
businesses.
Ecap metrics are to
be calculated both
at a business level
and across
geographies to
obtain an aggregate
view of risk results.
Supporting this
massive risk
architecture change
may require a
rethink of banks’ IT
strategy.
Intensive
back-testing of
models is needed to
ensure the
robustness of the
model, but this could
be challenging due
to unavailability of
data and longer time
horizons.
Regulatory capital is
reported to the
regulator at group
level while ECap
metrics can be used
at business/product
level.
Figure 2
aggregate figure for all risk types, products and
business units.
The risk adjusted return on (economic) capital
(RAROC) is the normative, risk-based leverage
measure that allows comparison between
different business areas and also enables banks
to determine whether high return assets and
Incorporating an ECap analysis into
the capital management framework
will, however, allow banks to gain
a more holistic view of their needs
and generate significant value
in the long run.
investments are contributing toward higher
economic capital. It addresses the shortcomings
of regulatory capital, which is usually calculated
at the company level and doesn’t allow comparative analytics to be performed across business
areas. Executives can use RAROC to make better
decisions on complex problems. It can be used ex
post to decide which investments are generating
target profits or ex ante to set transaction prices
or determine which business lines deserve more
resource injections that could include capital. A
similar performance measure related to ECap is
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economic value added (EVA).2 EVA is positive if
the absolute return on an asset is greater than
the risk-weighted cost of capital needed to fund it.
Hence EVA identifies which projects, products or
business lines create value for shareholders.
An increased focus on risk management and
the regulatory spotlight on banks’ internal risk
management practices have prompted a revival
in ECap model adoption. It also has an important
role under Basel’s Pillar II as it represents a bank’s
view of the amount of capital required to support
its business activities.
ECap metrics bring their own challenges, and
banks are weighing the benefits against the
challenges (see Figure 2).
Incorporating an ECap analysis into the capital
management framework will, however, allow
banks to gain a more holistic view of their needs
and generate significant value in the long run.
A Regulatory Perspective
In contrast to economic capital, the framework
for regulatory capital is laid out by regulators and
is meant to ensure the soundness of the banking
system, protect depositors and prevent financial
crises. Increased capital and funding costs along
with the heavy investment in infrastructure to
3
Regulatory timelines
2. Economic Capital
Overview of Regulatory Timelines
Theme
Capital
Sub-Theme
2016
2017
2018
2019
Core Tier 1
4.5%
4.5%
4.5%
4.5%
Tier 1
6.0%
6.0%
6.0%
6.0%
Tier 2
2.0%
2.0%
2.0%
2.0%
Countercyclical Buffer
0.625%
1.25%
1.875%
2.5%
Conservation Buffer
0.625%
1.25%
1.875%
2.5%
70%
80%
90%
100%
100%
100%
LCR
Liquidity
Leverage
NSFR
Observation period
100%
Liquidity Risk tools
Tools include Concentration of funding, Contractual maturity
mismatch, LCR by significant currency, available unencumbered assets
Leverage ratio
Tracking ratio’s components
3%
3%
3%
Trading Book
FRTB
BIS Consultative Documents were issued in 2012/2014 for FRTB.
Updated Market Risk standards issued in January 2016.
The deadline for this framework to be implemented is in 2019
Banking Book
IRRB
BIS Consultative Documents were issued in 2015 for IRRB Updated
Basel IRRBB standards were issued in April 2016.
Banks are expected to implement the standards by 2018
Pillar 2ϭ
Requirement
ICAAP, ILAAP,
Stress Testing
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PRA expects full compliance of all ILAAP documentation from
October 2016 onwards.
For US IHC’s that meet the asset threshold(total consolidated assets
of $50 billion or greater) are required to submit first capital plan to
Federal Reserve in January 2017
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Figure 3
deal with regulatory changes have put a strain on
profitability and brought capital management to
the forefront.
Despite the extended implementation timeframe,
many financial institutions are tackling the
balance sheet consequences of the new regime
only now. An overview of all regulations that
may affect responses in capital management
is provided in Figure 3. The regulatory initiatives have tried to tackle various elements of
the banking system and their multipolar nature
requires that banks conduct impact analysis on
different fronts.
Basel III and Beyond
Components of Capital
BASEL III has introduced stricter capital
standards by increasing the quality of capital that
banks are to set aside for risk management as
cognizant 20-20 insights
well as a stricter definition of what constitutes
regulatory capital. The total capital ratio3 under
Basel III remains 8% of RWA but its composition
has changed.
Regulatory capital comprises Common Equity
Tier-1 capital (including Core Tier 1) and Tier 2
but common equity requirements have increased.
Basel III also introduced a capital conservation
buffer of 2.5% of RWA as well as a countercyclical
capital buffer in the range of 0 to 2.5% to address
excessive build-up of systemic risk.
Under Basel III, the predominant source of Tier 1
capital is common shares and retained earnings.
In order to qualify as common equity, capital
has to be recognized under both accounting and
insolvency law as “own funds” and must not have
obligatory distributions. Share premium accounts
can be considered common equity only if the
4
shares that gave rise to the premia were eligible
as common equity. As for instruments other than
common equity to be included in Tier 1, specific
criteria have been introduced to ensure these
are loss absorbent on a going-concern basis. In
particular, this means that dated and innovative
Tier-1 instruments will be phased out. Regulatory
adjustments set out in Basel do not apply in fair
value changes of additional Tier 1 and Tier 2
capital instruments that are recognized on the
balance sheet. Guidance from each competent
authority is available on what is considered an
incentive to redeem for additional Tier 1 capital
(e.g., a call option combined with an increase in
the credit spread of the instrument if the call
is not exercised or a call option to convert the
instrument into shares if the call is not exercised).
Deductions from capital (e.g., for goodwill and
intangibles, minority interests, deferred tax
assets, defined benefit pension fund assets,
shortfall of provisions to expected losses for IRB
institutions) and prudential filters have been
harmonized on a global basis and are applied
almost entirely to common equity. Regulations
require that banks deduct investments in capital
instruments of other institutions from the class of
component of capital for which the capital would
qualify if issued by the bank itself.
Tougher capital requirements will
primarily impact areas such as
sales and trading, securitizations,
securities lending and OTC
derivatives.
Basel III has simplified and reduced Tier 2 capital
by eliminating Upper Tier 2 from the capital
structure. Tier 2 capital ensures loss absorption
in case of liquidation (going-concern) since banks
must hold further debt securities that can convert
to equity in times of stress.
Tougher capital requirements will primarily
impact areas such as sales and trading, securitizations, securities lending and OTC derivatives.
Institutions may choose to exit capital-intensive
areas of business (OTCs, commodities) where
levels of return on higher capital levels dilute
shareholder value.
Higher capital costs have forced banks to
reconsider their business models unless they are
able to manage both elements of the capital ratio.
cognizant 20-20 insights
Thus, comprehensive capital management that
incorporates capital planning, calculation and
strategic optimization has become inevitable for
all banks. Banks will need to measure and monitor
the quality of capital defined under the regulatory
initiatives, and this may require an analysis of
data and system requirements to support the
review.
Counterparty Credit Risk (CCR)
During the 2008 crisis, two-thirds of the losses
generated from counterparty risk was due to
credit spread and market variables movements.
So the CCR charge under Basel II, which was not
originally designed to consider market movements
of the exposure, has now been redesigned by
the Basel Committee to adopt a further capital
charge, the CVA charge, to cover for credit spread
volatilities and market volatility of the CCR. The
CVA charge materially increases the capital
requirements for OTC derivatives activities and
has attracted considerable attention from banks
and regulators alike.
Standard and advanced CVA are the two common
methods used by banks to calculate the CVA
capital charge. The standardized approach
allows less flexibility in incorporating market
implied data. It should theoretically result
in a higher capital charge compared to the
advanced approach due to regulatory implied
alignment between risk weights and external
ratings and other more conservative VaR calibrations. However, the standardized approach also
removes complexities associated with market
risk VaR methodologies/IMM approval and
testing. The standardized CVA risk capital charge
methodology requires the development of a
number of heuristic approaches to estimate the
exposure at default, the discounted notional of
single name and index CDS hedges, the effective
maturity of the transaction with the counterparty
and the maturity of the hedges for index CDS.
Calculation of the advanced CVA RWA is a market
risk computation and may be used by institutions
that have regulatory approval to use the internal
model method (IMM) for CCR and specific VaR
model approval for market risk capital. If the
VaR models use a sensitivity-based approach,
the credit spread values in the 1st and 2nd order
sensitivities are the current levels as of valuation
dates for both the stressed and unstressed VaR
capital component of the advanced CVA. Hence,
no additional period of stress may be required for
credit spread parameters in determining future
5
counterparty EE profiles. Calculation of effective
EPE profiles and EAD are common on both
methods and may not have been subject to any
adjustments arising from credit protection that
the bank intends to include as an eligible hedge
in the CVA risk capital charge. However, the use
of other types of credit risk mitigation such as
collateral or netting set that reduce the effective
EPE and EAD amounts in the CCR framework
can be maintained when feeding the risk capital
charge. Also, the VaR model for eligible CDS and
CDS swaptions should capture their nonlinear
risk. Banks will need to assess which model is best
suited and evaluate if legacy systems are capable
of supporting those models.
Market Risk
Interest Rate Risk in the Banking Book (IRRBB)
The post-crisis period witnessed record low
interest rates to boost the economy. Policy
makers are now concerned about the impact
when interest rates rise. Hence banks are being
urged to consider keeping more capital aside
to deal with increases in interest rates. Based
on a set of qualitative principles largely backed
by stress testing and internal audits, banks are
required to manage rate fluctuations. The Basel
Committee was considering bringing interest
rate risk in banking book (IRRBB) under Pillar
1 but it published new standards for IRRBB in
April 2016 and concluded that IRRBB will remain
(will be captured) in Pillar 2. Banks are expected
to implement an enhanced Pillar 2 approach to
identify, measure, monitor and report IRRBB. This
involves adequate procedures, policies, systems
and controls. Banks are also required to assess
and measure IRRBB and the impact of interest
rate shocks on economic value (NPVs of future
cash flows and interest income) of assets, offbalance sheet items and liabilities and on earning-based measures (change to future gains or
losses) of the banks.
Fundamental Review of the Trading Book
(FRTB)
An analysis of FRTB reveals that it:
• Proposes standardized criteria for defining the
boundary between the trading and banking
books.
• Places restrictions on changing this classifica-
tion to provide better alignment in the quantification of capital across the industry as well
as reducing arbitrage between banking and
trading books.
cognizant 20-20 insights
• Argues for a move from VAR to ES for market
risk calculation to capitalize for loss events in
the tail of the P&L distribution.
• Provides validation criteria that banks must use
to approve the soundness of internal models,
and where found inappropriate, banks will be
forced to use standardized models.
• The Basel Committee also proposes a revised,
more risk-sensitive standardized market
approach that includes calculation of the risk
sensitivities based method (delta and gamma),
the default risk charge and the residual risk
add-on.
Banks are being urged to implement
a robust risk management
framework to identify, measure,
monitor and report IRRBB.
Compliance with FRTB would require extensive
interaction between multiple desks – trading,
market risk, analytics, regulatory reporting,
technology, finance, project management and
business analysts. This is both time-consuming
and expensive. Banks will have to invest heavily
in data management, business process reengineering and technology. However, some argue
that FRTB provides an opportunity for banks to
enhance their system capabilities and replace
their legacy IT infrastructure.
Liquidity Risk
The liquidity measures mandated by Basel III aim
to reduce reliance on unstable sources of funding,
highlight the importance of managing funding
costs and encourage banks to review the composition of assets and liabilities on their balance
sheets. Liquidity coverage ratio (LCR)4 and net
stable funding ratio (NSFR)5 will likely drive
banks away from sourcing shorter-term funding
and toward longer-term funding arrangements.
This will also increase the competition for retail
deposits, affect funding costs and margins, and
result in lower RWAs.
LCR reduces complexity but interpretive guidance
is necessary for all banks to follow a consistent
implementation approach. Key examples of high
quality liquid assets (HQLA) implications that
banks will face are as follows:
• Unused
portions of eligible HQLA assets,
already pledged, that are part of the collateral
pool can be used toward the bank’s stock of
HQLA with associated haircuts considered.
6
Where the bank cannot determine which
collateral remains unused it may be assumed
that these assets are encumbered in order of
increasing liquidity value.
• Lower-rated
(BBB+ to BBB-) sovereign and
central bank securities that cannot be included
in the definition of Level 1 assets may be
included in the Level 2B assets with a 50%
haircut but will not constitute more than 15%
of level 2B assets.
The liquidity measures mandated
by Basel III aim to reduce reliance
on unstable sources of funding,
highlight the importance of managing
funding costs and encourage banks to
review the composition of assets and
liabilities on their balance sheets.
• Non-0% risk-weighted sovereign/central bank
debt securities included in the Level 1 assets
and the amounts of foreign currency exposures
should be limited to the jurisdiction of the
issuing sovereign/central bank.
• Common equities, which are exchange-traded
and are part of a major market index within
the home jurisdiction of the bank, should be
denominated in the same currency.
NSFR enables better assessment of funding
risk across on- and off-balance sheet items, and
promotes funding stability by reducing reliance on
short-term wholesale funding. This ratio reduces
the possibility that a disruption at a bank’s
standard source of funding will impact its liquidity
position to cause the bank’s failure and trigger
systemic risk (Basel Committee). The amounts
of available and required funding are calibrated
to reflect the presumed degree of stability of
liabilities and liquidity of assets. The calibration promotes the use of more stable, long-term
sources of funding. This calibration reflects which
stable funding type and counterparty is used (e.g.,
longer term is assumed to be more stable) to fund
the resilient credit creation of the asset side of
the balance sheet.
The Basel Committee has proposed a set of supplementary monitoring tools to assist supervisors
with the analysis of bank-specific and system-wide
liquidity risk trends. Additionally, the committee
has introduced tools to monitor data on the
cognizant 20-20 insights
quantity, type, currency and location of available
unencumbered assets. These include marketrelated monitoring tools that allow monitoring of
market-wide information (e.g., market data from
debt markets or specific products such as securitized products), financial sector information
(to check how the financial sector is reacting to
broader market movements) and bank-specific
information (to gauge market confidence in and
risks associated with specific banks).
Leverage Ratio
Basel III introduced a non-risk-based leverage
ratio to complement the risk-based capital
requirements so as to reduce the excessive
buildup of on- and off-balance sheet leverage.
This will diminish destabilizing deleveraging
exercises during periods of stress. The leverage
ratio measures the relationship between the
capital base and the assets of an institution. The
ratio is designed to put a floor under the buildup
of leverage in the banking system as well as to
introduce additional safeguards against model
risk and measurement errors by supplementing
the risk-based capital requirements with a simple,
transparent measure of risk. In addition, offbalance sheet positions shall be included in the
denominator. In contrast to capital requirement
calculation and accounting, collateral and netting
for derivative and repo transactions will not be
considered. To ensure international comparability
of the ratio, it will be adjusted for differences in
accounting standards.
The exposure measure is the sum of five
components:
• On-balance-sheet exposures, including collateral
for derivatives and securities financing transactions but not the corresponding assets as they
form the next two points.
• Derivative
exposures – accounts for replacement cost, potential future exposure and
adjustment for certain collateral.
• Securities
financing transaction exposures –
accounts for counterparty credit exposure
related to repos, reverse repos, securities
borrowing/lending and margin lending transactions.
• Other off-balance-sheet items.
• Leverage ratio acts as a backstop
measure
to the risk-based capital requirements and
therefore provides added protection against
model risk and measurement error.
7
The implementation of the leverage ratio will
entail changes to regulatory reporting processes
and potentially require system changes.
Revisiting Pillar 2
The purpose of the second pillar under Basel is
to supplement existing regulatory capital requirements for banks’ capital planning process and
risk management. Pillar 2 guidance intends to
help banks better identify, assess, manage and
mitigate risks in their internal capital adequacy
assessment process (ICAAP). Pillar 2 should
exceed Pillar 1 capital requirements so that
all risks are adequately covered. The ICAAP
process should be commensurate with the size
and complexity of the bank’s business as well as
its risk appetite. A supplemental guidance was
issued by the Basel Committee to support their
ICAAP exercise. It addresses the following areas:
• Risk concentrations.
• Off-balance-sheet exposures
with focus on
securitization.
• Valuations.
• Sound stress-testing practices.
ICAAP should incorporate stress testing to
complement other processes such as setting risk
appetite and assessing economic capital so that
the bank has the shock absorption capability to
adequately protect against severe stress events.
The bank’s capital planning should incorporate
rigorous and forward-looking stress testing in
order to withstand uncertain market conditions
and volatility over time. Banks should also assess
their capital adequacy under stress conditions
against a variety of capital ratios (e.g., RWA,
Tier 2).
must be consistent with their risk appetite and
with their overall approach for measuring and
managing liquidity and funding risk. ILAAP
involves a comprehensive stress testing on
variables that affect liquidity risk, assessment of
intraday liquidity risk, the bank’s ability to meet
its intraday liability requirements, assessing its
liquidity risk governance framework and a robust
transfer pricing system in place to ensure that
costs, benefits and risks are fully incorporated
into the bank’s product pricing and incentives.
Banks will be forced to move further
away from holding risky and costly
assets (e.g., OTC derivatives) on their
balance sheet, and will reshape their
strategies toward client businesses.
U.S. intermediate holding companies (IHCs) with
$50 billion or more in total consolidated assets
are subject to assessments by bank regulators to
check if the banks have effective capital planning
processes and sufficient capital to absorb losses
during stressful conditions. The assessment
includes the comprehensive capital analysis and
review (CCAR) and Dodd-Frank Act stress testing
(DFAST).
Banks will be forced to move further away from
holding risky and costly assets (e.g., OTC derivatives) on their balance sheet, and will reshape
their strategies toward client businesses. This
will impact banks’ profitability and require them
to transform their operating models. Capital
management will also require improvements and
upgrades to systems used for stress testing and
back testing.
CCAR evaluates an IHC’s capital adequacy, capital
distributions and capital adequacy processes. For
the annual CCAR submission, IHCs are required to
assess capital adequacy under three supervisory
scenarios provided by the FRB (baseline, adverse
and severely adverse), as well as at least two
internally developed scenarios (baseline, severely
adverse). As part of CCAR, the Federal Reserve
evaluates whether IHCs have sufficient capital to
continue operations through times of economic
and financial market stress and whether they
have robust, forward-looking capital planning
processes that account for their unique risks.
As such, banks have to perform key tasks to
be compliant with CCAR: conduct stress tests
based on relevant scenarios; ensure a control
and governance structure is in place to reduce
risks; and enable accurate and timely reporting of
annual, quarterly and monthly reports.
Similar to ICAAP, Pillar 2 addresses the bank’s
internal liquidity adequacy assessment process
(ILAAP). The bank is required to undertake an
annual assessment of its liquidity and funding
risk across different time horizons in accordance
with existing ILAA and CRDIV rules. Banks’ ILAAP
DFAST is a complementary exercise to CCAR
that assesses whether financial institutions have
sufficient capital to absorb losses and support
operations during adverse economic conditions.
A snapshot of the CCAR taxonomy indicates that
these developments will significantly increase
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8
Snapshot of CCAR Taxonomy
Schedules that need to be submitted as part of the annual FRT-14A report and financials reporting impact
Report
Id
FR Y-14A
Schedule
Constituent Worksheets
Summary
R E L X A+L C
Cover Sheet
Income Statement
Balance Sheet
1. Capital Ǧ CCAR and 2. Capital Ǧ DFAST
Standardized RWA
Retail Balance and Loss Projections
Retail Repurchase
Ǧ
ASC 310 30
Projected OTTI for AFS Securities and HTM by Security
Projected OTTI for AFS and HTM Securities by Portfolio
Legend
OTTI Methodology and Assumptions for AFS and HTM Securities by Portfolio
Projected OCI and Fair Value for AFS Securities
AFS and HTM Fair Market Value Sources by Portfiolio
Trading
Counterparty Risk
Operational Risk Scenario Inputs & Projections
PPNR Projections
PPNR Net Interest Income
PPNR Metrics
Supervisory Baseline Scenario
Supervisory Adverse Scenario
Supervisory Severely Adverse Scenario
BHC Baseline Scenario
Scenario
Regulatory Capital Transitions
Regulatory Capital Instruments
Operational Risk
R
E
Revenue
Expense
L
Loss (impairments,
allowance, charge-offs,
reserves incl.)
X
Risk Exposure
(All eligible assets for
RWA calculations)
A+L
C
Assets and Liabilities
Capital
Additional Scenario
Cover Sheet
Capital Composition
Exceptions Bucket Calculator
Advanced RiskǦWeighted Assets
Standardized RiskǦWeighted Assets
Leverage Exposure
Planned Actions
Schedule C
BHC Operational Risk Historical Capital
Legal Reserves Reporting
Measures used against reporting schedules/worksheets
Measure Name
Equity Delta
Schedule ID Report
Schedule
Q
FR Y-14Q
Trading, PE and Other Fair Value Assets Equity by Geography
Equity Gamma
Profit/(Loss) from % Change in
Country Equity Prices
Q
FR Y-14Q
Trading, PE and Other Fair Value Assets Equity by Geography
Q
FR Y-14Q
Trading, PE and Other Fair Value Assets Equity by Geography
Equity Vega
Q
FR Y-14Q
Trading, PE and Other Fair Value Assets Equity by Geography
Profit/(Loss) from changes in Spot/Vol
Q
FR Y-14Q
Trading, PE and Other Fair Value Assets Equity Spot-Vol Grid
Equity Vega post vol shock
Q
FR Y-14Q
Trading, PE and Other Fair Value Assets Equity Spot-Vol Grid
Equity Delta post spot shock
Q
FR Y-14Q
Trading, PE and Other Fair Value Assets Equity Spot-Vol Grid
Equity Gamma post spot shock
Q
FR Y-14Q
Equity Vega post spot shock
Q
FR Y-14Q
Profit/(Loss) from a -1% change in dividends Q
FX Delta
Q
FR Y-14Q
FX Gamma
Q
FR Y-14Q
Profit/(Loss) From % Change in Spot Price in Q
FR Y-14Q
Measure
NameEquity Spot-Vol Grid
Schedule ID Report
Trading, PE and Other Fair Value
Assets
Common
Equity
Tier 1Spot-Vol
Capital Grid
D.1
FR Y-14A
Trading, PE and Other Fair Value
Assets
Equity
Adjustments and deductions associated with commo D.1
FR Y-14A
Trading, PE and Other Fair Value Assets Other Equity
Conditional AOCI related adjustments
D.1
FR Y-14A
Trading, PE and Other Fair Value
Assets
Spot Sensitivities
Additional
tier FX
1 capital
D.1
FR Y-14A
Trading, PE and Other Fair Value
Assets
FX
Spot
Sensitivities
Other capital instruments (e.g, issuance, repurchase D.1
FR Y-14A
Significant
investments
in the capital of unconsolida D.2
FR Y-14A
Trading, PE and Other Fair Value
Assets
FX Spot Sensitivities
Mortgage
servicing
assets
D.2
FR Y-14A
Trading, PE and Other Fair Value
Assets
FX Vega
Aggregate of items subject To the 15% limit (signifi D.2
FR Y-14A
Trading, PE and Other Fair Value Assets Rates DV01
Advanced Approaches Credit Risk: Credit RWA
D.3
FR Y-14A
Trading, PE and Other Fair Value
Assets
Rates DV01
Advanced
Approaches
Operational Risk: Operational D.3
FR Y-14A
Advanced
Approaches
Operational Risk: Market RW D.3
FR Y-14A
Trading, PE and Other Fair Value
Assets
Rates DV01
Standardised
Weighted
D.4
FR Y-14A
Trading, PE and Other Fair Value
Assets Risk
Rates
Vega Assets: Credit RWA
Standardised Risk Weighted Assets: Market RWA
D.4
FR Y-14A
Trading, PE and Other Fair Value Assets Other Rates
Leverage Exposure for Tier 1 Leverage Ratio
D.5
FR Y-14A
Trading, PE and Other Fair Value
Assets
Other for
Rates
Leverage
Exposure
Supplementary Leverage Ra D.5
FR Y-14A
Trading, PE and Other Fair Value
Assetsto Advanced
Energy
(Applicable
Approaches BHCs Only)
Derivative
exposures
D.5
FR Y-14A
Trading, PE and Other Fair Value
Assets
Energy
Repo
style
transactions
D.5
FR
Y-14A
Trading, PE and Other Fair Value Assets Energy
Other off-balance sheet exposures
D.5
FR Y-14A
Trading, PE and Other Fair Value Assets Metals
Capital and total leverage exposures
D.5
FR Y-14A
Trading, PE and Other Fair Value
Metals
ActionAssets
Description
D.6
FR Y-14A
ActionAssets
Type Metals
D.6
FR Y-14A
Trading, PE and Other Fair Value
Exposure
TypeAgs and Softs
D.6
FR Y-14A
Trading, PE and Other Fair Value
Assets
RWA Type
D.6
FR Y-14A
Trading, PE and Other Fair Value Assets Ags and Softs
Common Equity Tier 1
D.6
FR Y-14A
Trading, PE and Other Fair Value
Assets
Ags
and
Softs
Tier 1
D.6
FR Y-14A
Trading, PE and Other Fair Value
Assets Diversified Commodity Indices
RWA Standardised
D.6
FR Y-14A
RWA Advanced
D.6
FR Y-14A
Trading, PE and Other Fair Value
Assets Diversified Commodity Indices
Total Asset
Leverage Ratio
D.6
FR Y-14A
Trading, PE and Other Fair Value
AssetsforDiversified
Commodity Indices
Total Leverage
D.6
FR Y-14A
Exposure for
Supplementary
Leverage Ratio
Balance Sheet impact
D.6
FR Y-14A
Operational risk capital by BHC unit-of measure
E.1
FR Y-14A
Total Legal Reserve Balance
E.2
FR Y-14A
Total Repurchase Litigation Reserve Balance
E.2
FR Y-14A
Losses associated with loans held for investment at A.1.a
FR Y-14A
Real Estate Loans (in Domestic Offices)
A.1.a
FR Y-14A
A.1.a
FR Y-14A
First Lien Mortgages
Second / Junior Lien Mortgages
A.1.a
FR Y-14A
Loans Secured by Farmland
A.1.a
FR Y-14A
Real Estate Loans (Not in Domestic Offices)
A.1.a
FR Y-14A
FX Lognormal Vega
Q
FR Y-14Q
FR Y-14Q
Directional Risks: DV01
Q
FR Y-14Q
P/(L) from a Parallel Move in Rates (bps)
Q
FR Y-14Q
Basis Risks: DV01
Q
FR Y-14Q
Interest Rate Normal Vegas
Q
FR Y-14Q
Inflation Delta
Q
FR Y-14Q
Cross-Currency vs. USD Basis
Q
FR Y-14Q
Delta
Q
FR Y-14Q
Gamma
Q
FR Y-14Q
Vega
Q
FR Y-14Q
Delta
Q
FR Y-14Q
Gamma
Q
FR Y-14Q
Vega
Q
FR Y-14Q
Delta
Q
FR Y-14Q
Gamma
Q
FR Y-14Q
Vega
Q
Delta
Q
FR Y-14Q
Gamma
Q
FR Y-14Q
Vega
Q
FR Y-14Q
FR Y-14Q
Worksheet
Schedule
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Worksheet
Capital Composition
Capital Composition
Capital Composition
Capital Composition
Capital Composition
Exceptions Bucket Calculator
Exceptions Bucket Calculator
Exceptions Bucket Calculator
Advanced RiskͲWeighted Assets
Advanced RiskͲWeighted Assets
Advanced RiskͲWeighted Assets
Standardized RiskͲWeighted Assets
Standardized RiskͲWeighted Assets
Leverage Exposure
Leverage Exposure
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Regulatory Capital
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Transitions
Leverage Exposure
Leverage Exposure
Leverage Exposure
Leverage Exposure
Planned Actions
Planned Actions
Planned Actions
Planned Actions
Planned Actions
Planned Actions
Planned Actions
Planned Actions
Planned Actions
Planned Actions
Regulatory Capital Transitions
Operational Risk
Operational Risk
Operational Risk
Summary
Summary
Summary
Summary
Summary
Summary
Planned Actions
BHC Operational Risk Historical Capital
Legal Reserves Reporting
Legal Reserves Reporting
Income Statement
Income Statement
Income Statement
Income Statement
Income Statement
Income Statement
Schedule description and data granularity
Report Id Report Description
FR Y-14Q Captures BHC's granular data on various asset classes
and pre-provision net revenue (PPNR) for the reporting
period.
Report Purpose
To capture actual data at the end of each quarter improve the Federal Reserve's ability to perform its
continuous risk-monitoring function by providing
more-timely data.
Frequency
Quarterly
Schedule
Regulatory Capital Instruments
Schedule Description
Captures details about redemptions and issuances
during the quarter and capital instrument positions.
Constituent Worksheets
Regulatory Capital Instruments
Forecasting Horizon
Actuals: Quarterly - from third quarter of the year of submission through third quarter of the following year (e.g. from Q3 2012
through Q3 2013)
Granularity of Data Captured
Repurchases/ Redemptions
Actuals: Quarterly - from third quarter of the year of submission through third quarter of the following year (e.g. from Q3 2012
through Q3 2013)
Captured at Security CUSIP/identifier and Instrument Type level
Issuances
Actuals: Quarterly - from third quarter of the year of submission through third quarter of the following year (e.g. from Q3 2012
through Q3 2013)
Captured at Security CUSIP/identifier and Instrument Type level
Figure 4
cognizant 20-20 insights
9
Captured at Security CUSIP/identifier and Instrument Type level
data and reporting requirements. However, there
are multiple commonalities between CCAR and
DFAST in terms of data, processes and supervision. Hence, there is significant scope for banks to
align processes to gain synergies while ensuring
compliance with both, provided they reassess
their current operating model.
Both regulations should serve to inform the
Federal Reserve and the general public of how
these financial institutions’ capital ratios might
change during a hypothetical set of adverse
economic conditions and the same three FRBprovided supervisory scenarios as under CCAR
are required of the IHCs for the year-end DFAST.
For institutions with significant trading
businesses, extensive data template submissions
are required to support supervisory stress tests
and analysis of the firm’s trading operations.
A thorough understanding of the CCAR
reporting requirements of all regulatory
reporting templates will help banks identify the
level of data granularity in each schedule and
regulatory requirement demand. The regulatory
risk taxonomy analysis in Figure 4 (see previous
page) will also help banks ensure that the
required data is available in an appropriate
structure.
Risk-Based Pricing: A Pressing
Imperative
Risk-based pricing is the alignment of pricing of a
trade by reflecting the riskiness of the product in
the trade. A borrower’s credit risk determines the
price as well as the interest payment, and thus the
higher the perceived risk, the higher the fee that
should be charged on the OTC trade. Risk-based
pricing closely aligns the cost structure with the
real costs by incorporating considerations such
as cost of capital, cost of funding, expected and
unexpected losses, and other allocated expenses
to provide a price that maximizes value.
Along with CVA, rising funding costs that affect a
firm’s P&L should be included in the valuation of
a product – i.e., fair value adjustment (FVA). FVA
incorporates the PV of funding cost into the value
of the product rather than accruing it over the
life of the product. Banks also use fund transfer
pricing (FTP) to charge a lending business or
desk the cost of raising funds. FTP allows a bank
to allocate funding costs to each business unit or
product based on how much capital is required
for that particular product.
cognizant 20-20 insights
Recovery and Resolution Plans (RRPs):
Lessons from the Past
The 2008 global financial crisis resulted in new
regulations aimed at increasing the resilience of
banks; a key focus has been the preparation of
a recovery and resolution plan (RRP). The RRP
determines the operational procedures related
to liquidity crisis solution and thus highlights the
need for more effective tools to resolve financial
distress. The responsibility of the ongoing
monitoring of the emergency liquidity plans lies
under the responsibility of treasury, risk and the
asset liability committee (ALCO). The RRP should
prevent a liquidity crisis from happening, with
its actions mainly dependent on the exposures
and the systemic importance of the financial
institution.
The 2008 global financial crisis
resulted in new regulations aimed
at increasing the resilience of
banks; a key focus has been the
preparation of a recovery and
resolution plan (RRP).
Banks use stress scenarios for recovery planning
purposes. Scenarios range in severity but banks
use both internal and external (usually driven
by macroeconomic indicators) ones for stress
testing in order to estimate the likely future
impacts on income statement, balance sheet,
RWA, regulatory Tier I common equity, economic
capital and liquidity.
RRPs set out what will be expected of banks
with regard to planning for a stressed situation
that will require a bank to take action to recover
or undertake resolution in an orderly manner
without the need for public funded support.
RRP aims to minimize the adverse impact on the
financial system of firms failing to meet their
liabilities when they fall due. All the firms are
required to provide the authorities with sufficient
information to assess the preferred recovery and
resolution strategy.
Challenges and Complexities
Banks are tasked with the dual agenda of meeting
economic and regulatory requirements. They
face challenges on four fronts: governance,
processes, systems and data. The challenges
manifest from these individually, and also due to
inefficient interaction between them. To manage
10
capital effectively, banks need to have stricter
governance and oversight to instill shareholder
confidence in business strategy and performance. The processes have to be streamlined
to reduce complexity and response times, and
achieve synergies while integrating functions
within teams. Systems and data management
need to be overhauled in order to manage capital
accurately and in a timely manner. This will allow
banks to spend more time analyzing the data to
gain insights rather than simply aggregating and
reporting data.
Bringing Order to Chaos: Implementing
Effective Capital Management
Processes
In order to effectively manage the indicated
challenges, it is important to analyze and
fully appreciate the complexity of the capital
management value chain in Figure 6 (see next
page).
Capital planning and supervision is an enterprisewide exercise that encompasses various functions
within a bank, including strategy and business
Key Challenges Related to Capital Planning, Allocation & Management
The Regulatory Agenda
The Economic Agenda
How do I allocate my capital
across assets to ensure
minimal risk and compliance
with regulatory requirements?
How do I allocate my capital
across assets to generate the
highest risk-weighted return on
assets?
Accurately measure quality of
capital to ensure regulatory
compliance both across lines of
business and on an entity level.
Define risk profile needed to
support overall capital planning.
Capital
Management
Decision-Making
Process
Accurately capture and monitor
leverage.
Obtain accurate risk-based
product pricing.
Have accurate view of asset
classification to accurately
forecast regulatory capital
requirements.
Set risk-adjusted performance
measures to drive decisionmaking.
Monitor counterparty credit
exposure.
Compare performance between
different lines of business.
Challenges
Governance
Process
Data
Capital planning not
adequately responsive
due to lack of alignment
between senior
management.
Difficult to fully utilize
capital planning resource
due to lack of synergy
between business and IT,
and between risk and
finance.
Defragmented data
architecture makes it
difficult to capture
performance and risk
measures both across
lines of business and on
an entity level.
Difficult to compare
business lines due to
lack of standardized
metrics or KPIs.
Delayed response to
resolve identified issues
due to absence of
ownership and
accountability.
Decision-making slow
due to fragmented and
poorly defined approval
process.
Processes slow,
inefficient and prone to
human error due to
reliance on manual
processes.
Processes cannot be
adapted during transformational phases.
Processes pose operational risk due to lack of
robust control framework.
Degree of data
granularity between
businesses inconsistent
which makes KPIs
difficult to design and
comparison between
businesses difficult.
Data produced is
inaccurate, incomplete
and out of date and
hence, decisions based
on data are unreliable
and flawed.
Figure 5
cognizant 20-20 insights
11
Systems
Difficult to scale
systems to address
increased modelling
requirements.
Systems incapable of
supporting increased
stress testing requirements.
Lack of real time or
on-demand data due to
system design and
performance
limitations.
planning, risk management, finance, front office,
compliance, executive management and the
board of directors. Capital management requires
data and system interactions within the various
functions. For instance, in planning for an organization’s overall capital needs, its risk appetite
will in part advise an organization – and the risk
appetite, in turn, will be facilitated by extensive
stakeholder discussions and risk calculations.
Similarly, when an organization is monitoring
capital risk associated with a line of business, it
will seek advice from its control framework in
determining how frequently capital needs to be
monitored. The firm will also require significant
firepower from risk management teams that
often make use of sophisticated risk management
platforms. A disparate set of processes and
systems must come together to support and
guide capital management at each step. To enable
a successful framework, firms need to rethink
their enterprise data management strategy and
develop a standardized data dictionary. Banks
will also need to strategize and define the target
operating model for effective capital management
and transform their processes, systems and data
infrastructure.
This transformation has largely been ad hoc,
reactive and tactical to accommodate the
immediate regulatory requirement. Banks need to
Capital Management Value Chain
Goal definition and
strategic planning
Recognition of Stakeholder and
Organisational Goals
Implementation Roadmap
Business & Operating Model
Development
Recovery Resolution Strategies
& Operational Plan
Organisational
target deadlines
Stress testing performance
metrics & BU/ Product focus
Pricing & performance
measurement
Product/BU Strategy Review
Defining Performance Metric
& Monitoring Performance
Sources of finance
for resolution
Planning &
Forecasting
Financing
BU/Product’s
capital
performance
metrics
Risk management
Risk Appetite Setting
Economic
Capital
Risk Reporting and Analysis
Capital
Performance
against Planning
Risk Based Pricing
Regular sources of finance &
market accessibility
Reallocating Resources
Regulatory
Capital
Capital
Allocation &
Usage Limit
Setting
Risk Control Limits
Risk Identification, Modelling
& Measurement
Capital Risk
Measurement & Usage
Limit Monitoring
Resource
reallocation plans
Risk control
limit
definition
XVA metrics
Capital risk
metrics
Limit monitoring
frequency
Governance, policies and
procedures
Monitoring Of Compliance
Set up Control Framework
Design Controls
Policy Development
Figure 6
cognizant 20-20 insights
12
engage in strategic rather than ad hoc enterpriselevel change programs. Our experience suggests
that business and IT transformations are often
disconnected and poorly aligned with enterpriselevel strategy. Hence, a change that can improve
multiple functions often addresses only a few due
to lack of relevant stakeholder involvement in
the early stages. By the time other functions are
involved, implementation deadlines force singular
changes, and firms fail to leverage potential
synergies. Enterprise-wide change management
programs would enable proper integration,
address challenges at the outset and avoid workarounds that often create governance issues.
For instance, embedding a strategic transformation process will help banks successfully optimize
their regulatory capital and hence optimize RWA.
Reviewing current systems and data can help
make granular data available to achieve this.
Based on our analysis of the underlying challenges
within the capital management process, we
propose an efficient IT platform model that facilitates and automates the complex challenges
covered in this paper. At the outset, the model
collates data from multiple disparate systems in
the “enterprise service bus” before transforming
it appropriately in the “warehousing layer.”
The transformed data is ready to support various
processes underlying capital management.
Several of these processes are performed in the
core “computation” layer. In particular, the model
allows the organization to gauge capital demand,
and allows planning and forecasting to be
performed on a “dynamic” basis by incorporating
the changes within the industry and regulatory
landscape.
It is important to recognize that there are various
levers within an organization that influence its
RWA. The allocation module incorporates these
various levers to provide re-optimized capital
allocations across LOBs and products and ensure
a firm’s RWA is minimized. The capital risk materiality module generates relevant capital risk calculations and advises on the materiality of limit
breaches to ensure organizations can be wellprepared. The information must be presented
through function-specific dashboards that
allow stakeholders to monitor risks and control
outcomes.
Roadmap: Strategic Transformation and
Implementation of Target Operating Model
As-is analysis
Activities • Analyze and
document as-is state:
— Review of IT
architecture.
— Analysis of
interdependency
of data and
systems.
— Test robustness of
control framework
(including IT
controls).
• Review and confirm
as-is state with
relevant stakeholders.
Output
Gap identification &
recommendations to address gaps
• Compare work to date with best practice to
identify:
— Gaps.
— Misalignment with as-is state.
Implementation of
optimization
• Define data requirements to
enable the automation of
processes and reporting.
• Assess existing management IT to identify
control weaknesses and process inefficiencies.
• Design future state by mapping
data process based on to-date
recommendations.
• Propose how different units( process, controls,
data and systems) should interact.
• Start implementing optimization
in systems, data and processes.
• Quantify impact of gaps at a high level based
on best practices and market experience.
• Ensure business users are
adequately informed of change.
• Prioritize gaps based on value & delivery
impact.
• Confirmation with relevant
stakeholders that requirements
have been met post
implementation.
• Develop potential options and
recommendations to close high priority gaps.
• Documentation of
as-is state.
• Identification of gaps and weaknesses in
existing structure.
• Approval from
relevant stakeholders.
• List of prioritized gaps and potential impact of
each gap.
• Recommendations and actions to close gaps.
• Cost estimates.
Figure 7
cognizant 20-20 insights
13
• Target state achieved.
• Endorsement of target state
from relevant stakeholders.
Capital Management IT Model
Existing
Client
Systems
Trade Positions, PV
Trading System
Static Trade Data, Historical and
Market Data (e.g., Ratings)
Data Repository
Legal & Compliance
Trading Agreements
Netting Agreements
Collateral Agreements
Enterprise
Service Bus
(Routing,
Messaging,…)
PnL, Tier 1 and Tier 2 Capital,
RAROC, Leverage Ratios
Finance System
PGs, LGDs, EPE, ENE Expected
Shortfall, Stress Tests, Back Testing,
AMA, VaR sensitivities and VaRs,
Risk Limits
Risk System
Other Metrics
Other Relevant
Systems
Risk & Finance Data
Warehousing
Layer
Industry &
Entity
Performance
Metrics
Computation
Layer
Orchestration,
Validation &
Reconciliation
Component
Data Sourcing & Transformation Engine
Scenario
creation
rules
Demand
Forecasting
Model &
Rules
Reporting
Layer
Market
Prices &
Margin
Financing
Costs
...
ROE
Entity Risk
Appetite
Regulatory
Capital &
Economic
Leverage Capital Metrics
Ratio
…
Entity
RAROC
Demand Scenario
Generator
Dynamic Capital
Demand
Forecasting Engine
Exception Manager
Capital
Projections
Planning &
Forecasting
Module
RAROC
Business/
LOB/Product
EVA
…
Performance
Metrics
Credit
exposure
Business/LOB/
Limit
Product Risk &
VaR
Regulatory
Limits Limits
LCR
Limits
…
Adjustments
Rules
Aggregation
Rules
Optimisation
Rules
Aggregation Engine
Allocation Engine
Optimal RWA &
Capital Allocations
Allocation
Module
Achieved
RAROC
Business/LOB/
Product Capital Achieved
RWA
Risk Metrics
Achieved
Leverage
Ratio
…
Credit
Limit
Breaches Business/LOB/
Product Capital
VaR
Usage Metrics
Breaches
…
Materiality
Definition
Materiality
Assessment Engine
Capital Risk
Definition
Capital Risk Engine
Capital Risk Assessment &
Materiality Heatmaps
Capital Risk
Materiality
Module
Performance
Analysis
Dashboard
Reported and Analysed by Line of Business, Product, Geography, etc.
Figure 8
Conclusion
In this increasingly dynamic post-crisis era, banks’
decision-makers will need to work through layers
of complexity when implementing a comprehensive capital management strategy. Banks need to
perform an in-depth assessment of the existing
governance structure, processes, systems and
data. Adopting a holistic approach will not only
allow banks to improve operationally through
streamlined processes, but also help identify
the areas where capital is being inappropriately
cognizant 20-20 insights
allocated. This will help establish greater predictability on capital demand.
In addition to encouraging greater collaboration
between various stakeholders, the change in
approach will enable banks to fully utilize existing
resources and generate greater return on preexisting investments and assets. Ultimately, a
holistic capital management framework will
enable banks to comply with regulations while
also ensuring that they generate sustainable
value for their shareholders.
14
Footnotes
ROE = Net Income / Capital
1
A certain iteration of EVA can be given by EVA = (Revenues – Costs-Expected Loss – Tax) - (Economic
Capital * Cost of Capital Employed)
2
Capital Ratio = Regulatory Capital (Tier 1 + Tier2) / RWA Assets (Credit, Market, Operational)
3
4
Liquidity Coverage Ratio = Stock of high quality liquid assets / Net cash outflows over a 30 day period
≥ 100%
Net Stable Funding Ratio = Available amount of stable funding / Required amount of stable funding)
≥ 100%
5
References
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and What Can Be Done about it?” March 2012. www.imf.org/external/pubs/ft/wp/2012/wp1290.pdf.
• Shearman & Sterling, Basel III Framework: The Credit Valuation Adjustment (CVA) Charge for OTC
Derivative Trades, November 2013. www.shearman.com/~/media/Files/NewsInsights/Publications/2013/11/BaselIIIFrameworkTheCreditValuationAdjustmentCVA-ChargeforOTCDerivativeTradesFIAFR111113.pdf.
• Blackrock, Credit Valuation Adjustment in Europe – Implications for Pension Plans, July 2012. www.
blackrock.com/corporate/en-us/literature/whitepaper/credit-valuation-adjustment-europe-implications-pension-plans.pdf.
• Basel Committee on Banking Supervision, Basel III: the net stable funding ratio, October 2014. www.
bis.org/bcbs/publ/d295.pdf.
• JP
Morgan, Leveraging the Leverage Ratio, 2014. www.jpmorgan.com/cm/BlobServer/is_leveragingtheleverage.pdf?blobkey=id&blobwhere=1320634324649&blobheader=application/
pdf&blobheadername1=Cache-Control&blobheadervalue1=private&blobcol=urldata&blobtable=Mun
goBlobs.
• Sid Verma, Regulation: Banks brace for Basel interest-rate risk push, May 2015. www.euromoney.com/
Article/3450624/Regulation-Banks-brace-for-Basel-interest-rate-risk-push.html.
• Basel
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About the Authors
David Paris is Governance, Risk & Compliance (GRC) head within the Banking and Financial Services
sector for Cognizant Technology Solutions in the UK. He has over 30 years of experience in financial
services management and advisory globally, focused on credit, market, liquidity and operational risk
management. This includes roles at Wells Fargo Bank, First Interstate Bank, Ernst & Young, Reuters
Instinet, IBM and Cognizant. David has an M.B.A. in finance from the American Graduate School of International Management and a degree in Chinese and Russian history from Washington University. He can
be reached at [email protected].
Guruprasad Chavan is an Associate Director (Consulting Senior Manager) within Cognizant Business
Consulting’s BFS Governance Risk and Compliance Practice. He has over 16 years of experience in
business/IT consulting and auditing across various areas such as strategy consulting, enterprise-wide
risk management, accounting policy, SOX compliance, AML, information security and business continuity
management. Guruprasad has in-depth knowledge and experience across various domains within banking
and capital markets. He can be reached at [email protected].
Nick Palamaras is a Senior Manager (Consulting Manager) within Cognizant Business Consulting. He has
over 12 years of experience in risk consulting and investment banking. Nick has significant experience
across the risk, finance and treasury functions, and with regulatory teams of global investment banks.
He has in-depth knowledge of prudential regulation, liquidity risk and Basel (CRDIV and CRR), and has
led assignments in the assessment as well as the design and implementation of treasury and liquidity
risk management frameworks. Nick is a Chartered Accountant (ACCA) and holds a postgraduate degree
in economics and banking. He can be reached at [email protected].
Zareef Anam is an Associate (Business Analyst) within Cognizant Business Consulting. He has worked on
multiple consulting engagements including business transformation, regulatory compliance and operational risk. He can be reached at [email protected].
About Cognizant
Cognizant (NASDAQ-100: CTSH) is one of the world’s leading professional services companies,
transforming clients’ business, operating and technology models for the digital era. Our unique industrybased, consultative approach helps clients envision, build and run more innovative and efficient
businesses. Headquartered in the U.S., Cognizant is ranked 230 on the Fortune 500 and is consistently
listed among the most admired companies in the world. Learn how Cognizant helps clients lead with
digital at www.cognizant.com or follow us @Cognizant .
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