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Operationalization of Risk Appetite - Balance Sheet Projections of Banks

Hedberg, Johan (2013) FMS820 20132
Mathematical Statistics
Abstract (Swedish)
The financial crisis in 2008 enlightened several shortcomings in the performance
of the banking sector. As a result of this a more rigid regulatory
framework, Basel III, has been developed which raises the requirements of
banks’ capital and liquidity structure and internal capital adequacy processes.
This involves evaluating potential future risks related to the strategy and risk
appetite of a bank. Therefore it is crucial that a bank has an understanding
of how their business plan would affect the balance sheet under different
economic scenarios.
The goal of this study is therefore to demonstrate how this can be implemented
by using quantitative projection methods, incorporating important
risk factors such as yield curves,... (More)
The financial crisis in 2008 enlightened several shortcomings in the performance
of the banking sector. As a result of this a more rigid regulatory
framework, Basel III, has been developed which raises the requirements of
banks’ capital and liquidity structure and internal capital adequacy processes.
This involves evaluating potential future risks related to the strategy and risk
appetite of a bank. Therefore it is crucial that a bank has an understanding
of how their business plan would affect the balance sheet under different
economic scenarios.
The goal of this study is therefore to demonstrate how this can be implemented
by using quantitative projection methods, incorporating important
risk factors such as yield curves, credit spreads and default probabilities. The
projections involve the development of a deterministic mathematical model,
based on credit migrations, under which business plans can be tested and
evaluated under scenarios based on historical downturns such as the recent
financial crisis.
The evaluation is done by incorporating four key risk metrics into the
model followed by a study of the results from the risk metrics using balance
sheet data from an American bank. These risk metrics are considered under
three different scenarios and four proposed business plans. Risk appetite
targets and limits are defined where a breach serves as an indication to the
bank that the business plan should be revised.
The results show potential risks involved in the different business plans
and supports a modest growth of the current balance sheet and a sound
balance between trading and lending activities in order to stay within limits
under severe scenarios. The conclusion is that the model can serve as a base
for setting a risk appetite framework at a bank, but in order to validate key
assumptions and robustness of the results a more thorough investigation with
access to bank data is needed. (Less)
Please use this url to cite or link to this publication:
author
Hedberg, Johan
supervisor
organization
course
FMS820 20132
year
type
H2 - Master's Degree (Two Years)
subject
language
English
id
4017987
date added to LUP
2013-09-06 11:06:04
date last changed
2013-09-06 11:06:04
@misc{4017987,
  abstract     = {The financial crisis in 2008 enlightened several shortcomings in the performance
of the banking sector. As a result of this a more rigid regulatory
framework, Basel III, has been developed which raises the requirements of
banks’ capital and liquidity structure and internal capital adequacy processes.
This involves evaluating potential future risks related to the strategy and risk
appetite of a bank. Therefore it is crucial that a bank has an understanding
of how their business plan would affect the balance sheet under different
economic scenarios.
The goal of this study is therefore to demonstrate how this can be implemented
by using quantitative projection methods, incorporating important
risk factors such as yield curves, credit spreads and default probabilities. The
projections involve the development of a deterministic mathematical model,
based on credit migrations, under which business plans can be tested and
evaluated under scenarios based on historical downturns such as the recent
financial crisis.
The evaluation is done by incorporating four key risk metrics into the
model followed by a study of the results from the risk metrics using balance
sheet data from an American bank. These risk metrics are considered under
three different scenarios and four proposed business plans. Risk appetite
targets and limits are defined where a breach serves as an indication to the
bank that the business plan should be revised.
The results show potential risks involved in the different business plans
and supports a modest growth of the current balance sheet and a sound
balance between trading and lending activities in order to stay within limits
under severe scenarios. The conclusion is that the model can serve as a base
for setting a risk appetite framework at a bank, but in order to validate key
assumptions and robustness of the results a more thorough investigation with
access to bank data is needed.},
  author       = {Hedberg, Johan},
  language     = {eng},
  note         = {Student Paper},
  title        = {Operationalization of Risk Appetite - Balance Sheet Projections of Banks},
  year         = {2013},
}