Strategic Asset Liability Management

Day One

Risk Measurement and Management in ALM

Overview of ALM

• ALM’s expanding role in managing risks and returns across the bank
• ALM organization overview
• Key risks managed – interest rate, liquidity, FX, and credit risks
• Strategic ALM – Use of funds transfer pricing, full transfer pricing, and economic value added (EVA) to steer the balance sheet
• ALM as a constrained optimization problem – maximizing profit subject to compliance with all regulatory and internal constraints holistically

Interest Rate Risk

• Earnings and economic value of equity (EVE) impacts of interest rate risk (IRR)
• Earnings-based IRR measurement models – repricing gap, maturity-adjusted repricing gap, marginal and cumulative gaps, standardized gap
• EVE IRR measurement models – duration gap, cash flow mapping, duration intervals, modified residual life, clumping
• IRR measurement in the trading book – VAR and expected shortfall; FRTB treatment
• Behavioral and financial options – non-maturity deposits, pre-payments, term deposits, automatic interest rate options

Case Study 1: Deposit modeling at Barclays Plc

Case Study 2: Modeling pre-payments at Barclays Plc

• Basis risk
• Yield curve twist and curvature risk
• Dynamic analysis of net interest income risk
• Managing net interest income risk across currencies
• Estimating asset and liability volatilities and correlations
• IRR stress-testing and earnings-at-risk
• IRR hedging techniques using interest rate swaps, swaptions, caps/floors/collars, futures, swap futures, forward rate agreements

Case Study 3: Use of interest rate derivatives to hedge interest rate risk on residential mortgage book

• New BCBS standards for Interest Rate Risk in the Banking Book (IRRBB)
• Estimating deposit interest rate elasticities

Workshop 1: Dynamic analysis of net interest income risk for a bank balance sheet and design of hedging strategy

Liquidity Risk

• Key sources of liquidity risk – maturity mismatch, collateral posting requirements, and off-balance sheet
• LCR and NSFR
• Liquidity stress-testing
• Key behavioral options – deposits (demand and time); pre-payable/revolving loans; liquidity/credit facilities
• Deposit modeling under stress – deterministic, historic, and stochastic factor models

Case Study 4:  Deposit modeling under stress at Barclays Plc

• Stressing liquidity/credit facility drawdowns – deterministic, historic, and stochastic factor models

Case Study 5:  Modeling stressed liquidity/credit facility drawdowns at Deutsche Bank AG

• Collateral management – CSAs, initial margin requirements, central clearing
• Funding Value Adjustment (FVA) and Margin Value Adjustment (MVA)

Case Study 6: Calculating FVA and MVA

• Stressed derivative collateral posting requirements – modeling for ratings triggers and stressed financial market conditions

Case Study 7: Stress testing collateral posting requirements for a derivatives portfolio

• Contingency funding plan

Credit Risk

• Key sources of credit risks – loans, bonds, and counterparty credit risk
• Expected and unexpected credit losses, including expected credit loss measurement and dynamics under IFRS 9
• Credit value at risk
• Using credit derivatives to manage loan book credit risk

Case Study 8: Use of CDS at Nordea to manage loan book credit risk and benefit from capital efficiency

• Use of securitization for credit risk transfer, funding and/or capital efficiencies

Case Study 9: Use of securitization at Lloyds Banking Group Plc

• Options for NPL management – outsourced collections; sale; creation of non-core units; securitization; EVA approach as best practice

Case Study 10: What strategies are European banks using to deal with their NPLs?

• Counterparty credit risk – Credit value adjustment (CVA); CVA hedging; use of proxies for counterparty credit curves; new standardized approach for CVA (SA-CVA) and how best to arrange derivatives activities for CVA capital efficiency

Day Two

Strategic ALM

ALM Optimization

• Recap of key regulatory requirements within which ALM must be conducted – Basel 3 Pillar 1 capital requirements; LCR and NSFR; leverage ratio; Pillar 2 capital and liquidity requirements; total loss absorbency capacity (TLAC) and minimum requirement for eligible liabilities requirement (MREL); various “Basel 4” components including revised standardized approach for credit risk, SMA (operational risk), SA-CVA, new market risk standard (FRTB), IRRBB and capital output floor
• How should banks think of ALM as a constrained optimization problem to maximize earnings subject to these various regulatory requirements as well as internal risk limits

Case Study 11:  Model for ALM optimization for a hypothetical bank, compliant with all regulatory requirements and making recommendations for strategy for the constituent business units

Workshop 2: Simulating the ALM-optimized balance sheet for new business development and market risk shocks. What actions should be taken?

Collateral Management

• Understanding Credit Support Annexes (CSAs)
• New regulatory requirements for initial margin
• Central clearing
• Collateral management – rehypothecation vs. segregation; “cheapest to deliver” collateral optionality; managing the liquidity buffer composition in different stress scenarios
• Funding Value Adjustment (FVA) as a measure of the net cost of variation margin collateral posting

Case Study 12: Calculating FVA

• Margin Value Adjustment (MVA) as a measure of the cost of initial margin collateral posting

Case Study 13: Calculating MVA

• Stressed derivative collateral posting requirements – modeling for ratings triggers and stressed financial market conditions
• How should we manage the liquidity buffer?

Risks and Returns in Fair Value Portfolios

• Strategic use of trading book and investment/available for sale portfolios
• VAR, stressed VAR, and expected shortfall frameworks for monitoring risk

Case Study 14: Fundamental Review of the Trading Book (FRTB). What does the ALCO need to be aware of?

• Measuring returns on risks taken in fair value portfolios
• Risk limit setting
• ALM oversight of market risks to control capital and funding impacts

Funds Transfer Pricing. Full Transfer Pricing and Economic Value Added

• Accurate business unit performance measurement as key to capital allocation
• Transfer pricing broadly as the way to achieve accurate performance measurement and to steer the balance sheet
• The need for liquidity risk pricing and funds transfer pricing (FTP) as the mechanism to do this
• Options for calculating the FTP curve
• Effective maturity measurement for FTP on assets and liabilities with significant behavioral elements
• Pricing contingent liquidity risk – deposits, liquidity/credit facilities, derivatives collateral posting

Case Study 15: Implementing FTP at a predominantly retail bank

• FTP for investment banking operations – behavioral holding periods and high contingent liquidity risks

Case Study 16: Implementing FTP at a universal bank with significant investment banking operations

• Full transfer pricing and economic value added (EVA)

Case Study 17: What does a complete EVA framework look like?

• Should Treasury make a profit from transfer pricing?

Day Three

Strategic ALM (Cont.)

ALM and Capital Management

• Role of ALM in capital management
• Regulatory vs. economic capital
• Budgeting by business unit and firm-wide
• Forming the capital plan in conjunction with the business plan and stress testing it for ICAAP or other purposes. What target capital range should we have?
• Setting risk appetite and limits across the group
• Optimizing capital issuance – capital composition choices (equity, Additional Tier 1, Tier 2, and other loss absorbency capacity) and implications for earnings and balance sheet resilience

Case Study 18: Capital planning at Barclays Plc

• Target ratings considerations
• Performance measurement and capital allocation across business units – EVA; returns on risk-adjusted capital; diversification; and strategic considerations

Case Study 19: EVA and capital allocation at Nordea

• Deleveraging transactions
• Measuring ALM performance
• Role of ALM in capital efficiency

Derivatives Hedging in ALM

• Derivatives hedge accounting under IFRS 9. What place for non-designated hedges with economic benefit?
• Review of key interest rate and FX derivatives used in ALM
• Level 2 vs. Level 3 valuation
• Using interest rate derivatives to manage net interest income, fair value portfolios, and funding management
• Standard vs. non-standard derivatives
• Operational and liquidity implications
• Enhancing income through use of derivatives
• ALM impact of clearing derivatives through central clearers vs. bilateral margining
• Collateral and capital implications of new derivatives regulations
• Impacts on capital and financial performance from derivatives applications

Case Study 20: Use of cross currency interest rate swaps to hedge non-base currency own debt issuance

ALM and Funding

• Review of funding instruments, their behavior, costs, risks, and benefits – deposits (retail, SME, large corporates); interbank; commercial paper and certificates of deposits; secured financing transactions; covered bonds; securitization; senior unsecured debt
• Optimizing the funding mix for the business model

Case Study 21: Reconfiguring the funding mix at Paragon Banking Group Plc

• Where is the line between capital and funding?
• Target ratings and financial flexibility considerations
• Developing and maintaining market access
• Managing funding maturity profile
• Use of derivatives in financing strategies
• Securitization – which assets; what risk retention; tranching; capital requirements; cash flow considerations
• Structured financing products and strategies
• Off-balance sheet and special purpose vehicle financing

Insurance Company ALM

• Solvency 2 efficient investment portfolio construction under the standard formula and internal model options
• Managing interest rate risk, taking account of guarantees (at maturity, annual, and clique), volatility adjustment, risk margin, and transitional measures on technical provisions – the problem of the ultimate forward rate
• Reinsurance program design under Solvency 2
• Balancing returns and risks in product design and mix under Solvency 2 – how to measure economic value of new business (VNB)

Case Study 22: VNB measurement at Allianz SE

• Derivatives in insurance ALM
• Setting the Solvency 2 ratio target range, ladder of intervention, and composition of own funds

Case Study 23: Implementing Solvency 2 efficient ALM across product design, investment portfolio construction, interest rate risk management, and reinsurance