Aditya Wahyu Setiawan 0849002 Adlin Fathar Siregar0849003 Frida
Unsyiati0849023 Harris Hermawan 0849024 Wiryawan Kuncoro0850094
Enterprise Risk Management at ABN AMRO
Slide 2
ERM Defined: A process, effected by an entity's board of
directors, management and other personnel, applied in strategy
setting and across the enterprise, designed to identify potential
events that may affect the entity, and manage risks to be within
its risk appetite, to provide reasonable assurance regarding the
achievement of entity objectives Source: COSO Enterprise Risk
Management Integrated Framework. 2004. COSO.
Slide 3
Why ERM Is Important Underlying principles: Every entity,
whether for-profit or not, exists to realize value for its
stakeholders. Value is created, preserved, or eroded by management
decisions in all activities, from setting strategy to operating the
enterprise day-to-day.
Slide 4
Why ERM Is Important ERM supports value creation by enabling
management to: Deal effectively with potential future events that
create uncertainty. Respond in a manner that reduces the likelihood
of downside outcomes and increases the upside.
Slide 5
The ERM Framework Entity objectives can be viewed in the
context of four categories: Strategic Operations Reporting
Compliance
Slide 6
The ERM Framework ERM considers activities at all levels of the
organization: Enterprise-level Division or subsidiary Business unit
processes
Slide 7
The ERM Framework Enterprise risk management requires an entity
to take a portfolio view of risk. Management considers how
individual risks interrelate. Management develops a portfolio view
from two perspectives: - Business unit level - Entity level
Slide 8
The ERM Framework The eight components of the framework are
interrelated
Slide 9
ERM Roles & Responsibilities Management The board of
directors Risk officers Internal auditors
Slide 10
Key Implementation Factors 1. Organizational design of business
2. Establishing an ERM organization 3. Performing risk assessments
4. Determining overall risk appetite 5. Identifying risk responses
6. Communication of risk results 7. Monitoring 8. Oversight &
periodic review by management
Slide 11
DETERMINE RISK APPETITE Risk appetite is the amount of risk on
a broad level an entity is willing to accept in pursuit of value.
Use quantitative or qualitative terms (e.g. earnings at risk vs.
reputation risk), and consider risk tolerance (range of acceptable
variation).
Slide 12
Impact vs. Probability PROBABILITY Low High IMPACTIMPACT
Control ShareMitigate & Control Accept High Risk Medium Risk
Low Risk High
Slide 13
Example: Call Center Risk Assessment Credit risk Customer has a
long wait Customer cant get through Customer cant get answers Low
High IMPACTIMPACT PROBABILITY High Risk Medium Risk Low Risk Loss
of phones Loss of computers Entry errors Equipment obsolescence
Repeat calls for same problem Fraud Lost transactions Employee
morale
Slide 14
Overview ABN AMRO: Merger of Algemene Bank Nederland (ABN) and
Amsterdam-Rotterdam Bank (AMRO) in 1991. ABN founded in 1824 AMRO:
Merger of Amsterdam Bank and Rotterdam Bank in 1964. Subsidiaries:
more 800 offices at home and another 2,600 in 75 other countries.
ABN AMRO also had a large presence in Brazil and Malaysia. In 1995,
ABN AMRO lost $124Million. In 1997, Close its diamond office. Ten
Business Principles.
Slide 15
Contd Has three major business segments: private clients and
asset management, consumer and commercial clients, and wholesale
clients. In 1998, ABN AMRO bought Brazils Banco Real and Bandepe
Banks. In 1999, Acquisition BNG. ABN AMRO Key Result 2002 (Exhibit
II). In 2000, ABN AMRO cut 150 branches. In 2001, ABN AMRO sold EAB
to Citigroup.
Slide 16
ABN AMRO: Key Results Exhibit: II (in millions) 2002 2001 Total
revenues 18,280 18,834 Operating expenses 12,823 13,771 Operating
result 5,457 5,063 Provisions 1,695 1,426 Value adjustments to
financial fixed assets 49 24 Operating profit before taxes 3,713
3,613 Source: ABN AMRO Annual Report, 2002
Slide 17
ABN AMRO: Risk Governance Organizational (EXHIBIT III)
Slide 18
Risk Governance Establishing risk philosophy by Supervisory
Board. Responsibility for overall impelemtation of risk policy lay
with CFO. Risk was managed through 2 principal Departement: 1. GRM
(Group Risk Management) 2. GALM (Group Assets and Liabilitity
Management) GRM responsible for management of credit, country,
market, and operational risks and (BASEL II). GALM attempted to
protected the earnings and capital position of the bank from
adverse interest rate and currency movements.
Slide 19
Contd GRC's main responsibilities were to: Determine the risk
policies, procedures and methodologies for measuring and monitoring
risk Set delegated credit authorities for lower committees and
authorized individuals within GRM, C&CC (Consumer and
Commercial Clients) and PC&AM (Private Clients and Asset
Management) Approve credit, market and operational risk associated
with new products Approve risk transactions larger than the
delegated authorities of lower committees Set the overall
value-at-risk (VAR) for the bank's trading products globally
Oversee the bank's overall portfolio for WCS, C&CC and
PC&AM.
Slide 20
The Purpose of Basel 1 In 1988, the Basel I Capital Accord was
created. The general purpose was to: 1. Strengthen the stability of
international banking system. 2. Set up a fair and a consistent
international banking system in order to decrease competitive
inequality among international banks. The basic achievement of
Basel I has been to define bank capital and the so-called bank
capital ratio. In order to set up a minimum risk-based capital
adequacy applying to all banks and governments in the world, a
general definition of capital was required.
Slide 21
Basel Framework & Status January 2001, BCBS published
Consultative Document reviewing the Basel Accord of 1988. 2002,
BCBS delayed publication of New Capital Accord until its
implementation in 2006. Oct 2002, BCBS launched Quantitative Impact
Survey 3, ABN AMRO participated in the survey. ABN AMRO supported
the increased risk-sensitive nature of the proposed New Capital
Accord. The bank has set up a project group, Internal Rating Based
basis for credit risk, and Advanced Measurement Approach for
operational risk.
Slide 22
Credit Risk All commercial activities required prior approval
by authorized individuals or committees. The managing board
delegate approval authority to GRM and further down to SBU.
Decision authority was based on Global One Obligor Exposure,
combined all direct and contingent credit limits. Uniform
Counterparty Rating System, which was the risk rating of the
individual counterparty. UCR was important for decision-making and
portfolio management processes.
Slide 23
The function of UCR Defining appropriate credit authority for
approvals on a risk- based matrix and setting the frequency
reviews. Identifying general trends in the quality of the banks
credit portfolios and consequent adjustment to credit strategies.
Generating key data for Risk Adjusted Return on Capital, economic
capital and expected loss calculations. Rating tools were available
for corporate clients worldwide, SME, project finance, banks and
insurance companies.
Slide 24
The function of UCR UFIRS as effective internal supervisory
tool for evaluating the soundness of financial institutions on a
uniform basis and for identifying those institutions requiring
special attention or concern. Each financial institution is
assigned a composite rating based on an evaluation and rating of
six essential components of an institution's financial condition
and operations: adequacy of capital, the quality of assets, the
capability of management, the quality and level of earnings, the
adequacy of liquidity, and the sensitivity to market risk.
Slide 25
Consumer & Commercial Clients 62,2% of total C&CC loans
outstanding by Netherlands. 32% North America. 2% Brazil. The
relative increase by Netherlands mainly reflected the appreciation
of the Euro agains US$ and Brazilian Real. Consumer business 59% of
total C&CC private loans, commercial loans to middle-market
companies 41%.
Slide 26
Wholesale Clients Mostly located in developed country, Europe
(49%) and North America (30%). Market conditions and exchange rate
movements caused a noticeable shift of WCS total limits. Business
Units clients: Financial Institution & Public Sector (63%)
Country Coverage (13%) Integrated Energy (10%) Telecom, Media,
Technology & Healthcare (9%) Consumer (5%)
Slide 27
Provisioning Policy Provision : Set aside an amount in an
organizations accounts for a known liability. Financial institution
have to provision against loan losses. ABN AMRO had developed
specific provisioning policies for its businesses. Credit officers
continually monitored the quality of the bank's loan portfolios.
Provisioning for consumer loans was made on a portfolio basis, with
specific allowances maintained at a level commensurate with the
portfolio size and loss experience.
Slide 28
Consumer & Commercial Clients In 2002, weaker economic
conditions in the Netherlands were reflected in somewhat higher
provisions C&CC's total provision for 2002 was EUR 881 million,
representing an increase of 10% over total provisions in 2001.
Provisions moved from 51 bps of average RWA (Risk weighted assets)
in 2001 to 58bps in 2002 Of the total provisions in 2002, 37%
related to consumer loans and 63% to commercial loans.
Slide 29
Difficult credit conditions continued in the US through 2002
and resulted in provision levels of 62 bps of average RWA. Most
sectors, including the commercial and asset-based lending
businesses were affected. In Brazil, provisions of EUR 193 million
(unchanged from 2001) were mainly on account of consumer lending
and charges related to discontinued (1999) USD car leasing
portfolios. Provisions moved from 250 bps of average RWA to 265 bps
in 2002.
Slide 30
Credit protection measures instituted by local risk committees
and GRM enabled ABN AMRO to weather the market volatility and
economic turmoil in the region. ABN Amro believed that the quality
of the local C&CC portfolio remained satisfactory.
Slide 31
Wholesale Clients Provisions increased to EUR 742 million from
EUR 543 million in 2001. Provisions were also adversely affected by
corporate governance and disclosure malpractices, which led to
unexpected and specific corporate failures, notably in the US
Slide 32
Country Risk ABN Amro managed emerging market country risk, on
a portfolio basis. ABN AMRO had been monitoring cross-border
exposure for many years by using a VAR model to determine the
cross-border risk on the total portfolio
Slide 33
In absolute terms, cross-border exposure in 2002 fell by 4.3%
compared with 2001. This decline was mostly due to lower exposure
to Latin America, mainly Brazil and Argentina. At end of 2002,
cross-border exposure to Brazil accounted for 18.1% of the total
cross-border risk exposure. Of this amount, 76% was mitigated since
it was trade-related or insured.
Slide 34
Wholesale Clients Individual Industries clients: Utilities
(3,8%) Telecom (3,3%) Manufacture (3,2%) Oil & gas (3,2%) All
industry exposures were controlled under agreed caps and
diversified across geographic markets.
Slide 35
Market Risk Market risk is the uncertainty resulting from
changes in market prices. Affected by other risks such as interest
rate risk and FX risk It can be measured over periods as short as
one day. Usually measured in terms of dollar exposure amount or as
a relative amount against some benchmark.
Slide 36
Market Risk Measurement Back Simulation Analytical Monte Carlo
Stress Testing Back Testing
Slide 37
ABN AMRO market risk principles Simple products, larger limits
Complex products, lower limits Limits are an instrument of
delegation; excesses are possible provided agreed up front
Escalation of any excesses from RMC GRC ALCO
Slide 38
ABN AMRO Market Risk Factors They measured and monitored:
Interest rate sensitivity Open currency position Stock prices
Spread sensitivities Greeks (delta, gamma, vega, rho)
Slide 39
ABN AMRO Market Risk Factors They also make calculation on:
Limitation for VAR Stress Test / Scenario analysis Position
concentration Ageing Monitoring of market risks at different
levels, start from single trading potfolio to key aggregation
levels
Slide 40
Back Testing Backtests: comparison of Profit & Loss versus
Value at Risk Actual backtests Full back office P&L (incl.
fees, commissions, intra-day trading) versus Value at Risk
Hypothetical backtests P&L due to just market movement versus
Value at Risk
Slide 41
Back Testing VAR99 (expected that on one out of every 100
trading days a loss which exceeded the VAR might occur) The results
of the back testing on the actual and the hypothetical P&L were
regularly reported to the Dutch central bank The hypothetical back
testing was also an essential instrument for validation of the
bank's internal models The back-testing result showed that the
hypothetical P&L exceeded the calculated VAR only on two days
in 2002
Slide 42
ABN AMRO: Value Risk versus Hypothetical Profit & Loss for
Trading Portfolios for 2002(in million)
Slide 43
Market Risk Model and Calculation Internal models Fulfill
regulatory requirements Approved by the Dutch central bank for the
calculation of solvency requirements for market risk ABN Amro used
VAR as the primary tool for day-to-day monitoring of
trading-related market risk Historical Simulation, based on four
years of historical data One-day holding period Relative changes of
historical rates and prices 99% confidence level and equally
weighted simulations The VAR was reported daily to the senior
management of the BUs, GRM and members of the Managing Board
Slide 44
ABN AMRO: VAR for Trading Portfolios VaR for trading portfolios
(99% confidence level, one-day holding period) (in million) 31/12
2002 Minimum Maximum Average Average in 2001 Financial Markets 16
13 51 27 33 Global Equity 7 4 15 8 10 Total trading 17 13 49 30
41
Slide 45
Stress Tests and Scenario Analyses Stress Test: Internally
developed To reflect specific characteristics of the bank's
portfolios Scenario Analyses: Based on historical market events
Black Monday (18 - 20 Oct. 87), Bond crash (18 - 21 Feb. 94),
Emerging market crisis (24 - 28 Oct. 97), Financial market crisis
(Jul. - Oct. 98), Czech scenario (May 97) Both are performed daily
for each trading portfolio and at several aggregation levels,
including the bank-wide total
Slide 46
Asset & Liability Management
Slide 47
Group Asset and Liability Management (GALM) Protect the
earnings and capital position of the bank from adverse interest
rate and currency movements and managed the bank's liquidity Group
ALM responsibilities: Governance / policy setting Interest rate
risk Liquidity risk Capital management Profit centre tasks Funding
and capital management structure Currency risk hedging of capital
Overlay portfolios for Group interest positions
Slide 48
Group Asset Management and Liability Committee (Group ALCO)
Members: Finance Treasury Risk management Had global responsibility
across the SBUs It also monitored the activities of local ALCO in
the bank's home markets ALCOs existed in other countries, but their
interest risk came under the market risk management framework
monitored by GRM
Slide 49
ABN AMRO: Distribution of Daily Revenue for FM for 2002
Slide 50
ABN AMRO: Distribution of Daily Revenue for GED for 2002 (in
millions)
Slide 51
Interest Rate Risk Group ALCO set limit to ensure that the
potential adverse impact on trading and non-trading earnings, due
to market movements, was well controlled. Scenario analysis were
used to monitor and limit non-trading interest rate risk.
Simulation models and estimation techniques were used to assess the
sensitivity to movements in the shape and level of the yield curve.
Client behavior also played an important role in interest rate risk
calculation, such as mortgages.
Slide 52
Currency Risk In trading portfolio, exposure to exchange rate
movements were managed through market limits based on VAR. Short
and long position were monitored to ensure compliance with GRCs
limits. Use various hedge strategies to protect itself against the
adverse effects of translating foreign currency into euro. Ratio
hedge the Banks BIS-ratios were protected against fluctuations in
the EUR / USD rate. Capital hedge when the expected currency loss
was larger than the interest rate differential between the two
currencies. Profit hedge to dampen the impact of currency movement
on the P&L.
Slide 53
Liquidity Risk Liquidity risk would arise if, for example, the
bank was unable to fund its portfolio of assets at appropriate
maturities and rates or was unable to liquidate a position in a
timely manner at a reasonable price. ABN Amro managed liquidity on
a daily basis, and Local line management was therefore responsible
for managing local liquidity requirements under the supervision of
Group ALCO. The bank had established group-wide contingency funding
plans that anticipated changes in the bank's structural liquidity
under different scenarios and set out damage-limitation procedures
in case of crises. ABN Amro considered the impact of these
potential changes on the bank's sources of short-term funding and
its long-term liquidity planning horizons.
Slide 54
Interest Rate Risk To mitigate the liquidity risk, the bank had
a liquidity buffer consisting of unencumbered liquid assets, such
as marketable securities and other short-term investments. The size
of the liquidity buffer was linked to the outcomes of these stress
tests. The ability to sell assets (apart from marketable
securities) quickly was an additional source of liquidity for the
bank. Diversity of funding products, market and maturity played an
important role in funding decisions.
Slide 55
Operational Risk ABN Amro defined operational risk as the risk
of loss resulting from inadequate or failed internal processes,
human behavior and systems or from external events. ABN Amro had
established a dedicated Operational Risk Management (ORM)
discipline in 2000 to manage operational risks, was similar to the
credit and market risk function. The Group Operational Risk
Committee was the highest approval authority for operational risk
policy and consisted of members from GRM and the relevant business
lines.
Slide 56
Operational Risk Risk Self Assessment a structured approach,
which assisted line management in identifying and assessing risks
and to take corrective actions. Corporate Loss Database a database
that allowed for the systematic registration of operational risk-
related losses. Risk Approval Process A comprehensive approval
process that included an explicit assessment of the operational,
legal and reputational risks Key Risk Indicators Key risk
indicators were used for trend analysis over time and to trigger
off escalation procedures. Key Operational Risk Control improved
risk awareness and provided inputs for Risk Self-Assessment.