ICAAP
CHALLENGES FOR THE
BOARD
Dr David Bobker
Asian Institute of Finance
ICAAP
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Quantified assessment is required
Pillar 1 is just a starting point
Cannot rely on standardised approach
Stress testing key element – in particular
reverse stress testing= inverse risk logic
Challenges for the board
• Understanding the risks
• Setting the risk appetite
• Credible ICAAP and capital adequacy
Understanding the risks
• Cannot wholly delegate to management –
required to sign off on capital
• Regulator placing more responsibility on the
board
• Quantified risk must be the basis of an
ICAAP
• Is the board able fully to understand the
quantum of risk even at a broad level?
• Examples: interest rate risk; concentration
risk
Some questions for the board
• Has the board actually considered its own
ability?
• What can the board do if it believes it
needs additional capability?
• Is board making use of bank’s own
professionals?
Challenge 2 setting appetite
• Understand what is appetite?
• DEFINITION: appetite=decision whether
or not to accept the current situation with
regard to all identified potentially
catastrophic scenarios
• Requires careful consideration of the
meaning of catastrophe AND identification
of the catastrophic scenarios
Inverse Risk Logic
• Process of working backwards from
potential catastrophes to drivers and
associated control failures
• Opposite of usual approach of considering
lots of scenarios and asking what is their
effect
• Focuses only on catastrophe
• But what is catastrophe?
Catastrophe and leverage
• Loss of only a proportion of capital is
catastrophic
• Suppose you can only afford to lose 30%
of capital then YOUR EFFECTIVE
LEVERAGE IS 3 TIMES ACTUAL
• Second – if the “probability” of loss of
capital (per Basel) is 0.1% then the
corresponding probability of losing 30% of
capital is much greater
How much can you lose?
Regulatory
Capital
Safety
margin
8%
RISK
WEIGHTED
ASSETS
RISK ASSET
RATIO
How much can you lose?
Loss of capital
Regulatory
Capital
NON VIABLE
8%
RISK
WEIGHTED
ASSETS
RISK ASSET
RATIO
Leverage principle
Regulatory
Capital
Very small compared
to asset base –
significant compared
to capital
RISKY
ASSET
BASE
Final Challenge
• Board needs to ensure there is a
CREDIBLE ICAAP and ADEQUATE
CAPITAL
• This may put it head on with Executive
Management’s plans
• It is then a matter of choice for board
members
THANK YOU
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