Basel II implementation at Absa: A case study
Presented by:
André Blaauw
GM: Enterprise-wide Risk Management
Absa, South Africa
andrebl@absa.co.za
Risk Management Workshop Colombia: From Theory to Implementation
Cartagena, Colombia
16-19 February 2004
Agenda
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
About the SA financial system
About Absa
Risk management history at Absa
To B2 or not to B2?
B2 implementation strategy
Current B2 implementation status
Delivering the B2 solution
B2 / IFRS alignment
Early results
Local supervisor’s influence
Industry collaboration
Remaining issues and challenges
Conclusion
SA:
South Africa
B2:
Basel II Capital Accord
IFRS: International Financial Reporting Standards
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 2
1. About the SA Financial System
JSE:
SAFEX:
OTC:
FSB:
Johannesburg Stock Exchange
South African Futures Exchange
Over-The-Counter
Financial Services Board
• Sophisticated by emerging market standards:
– Well developed capital and money markets.
– Listed equities market (JSE) – total market capitalisation of approx 200 Billion USD.
– Large and liquid listed fixed income market (Bond Market Exchange).
– Formal equity and commodity futures and options markets (SAFEX).
– Large domestic interest rate- and FX OTC derivatives markets.
• Banking industry:
– Dominated by 5 large banks – combined holds more than 90% of assets.
– Financial conglomerates – retail, commercial, investment banking, insurance, asset
management, etc.
• Regulatory environment:
– Banks are regulated by the central bank.
– Insurance, securities trading, asset management, etc. – regulated by the FSB.
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 3
2. About Absa
Who is Absa?
• Absa Group Ltd.:
– Domiciled in South Africa (SA)
– Listed on Johannesburg Stock Exchange (JSE)
– Controlling company of major banking and financial services group in SA
– Formed about nine years ago by merging four major South African financial services
groups (Amalgamated Banks of South Africa Ltd.)
• Absa Bank Ltd.:
– One of the 4 largest domestic banks in SA
– Market leader in retail banking: mortgages and electronic banking
• Geographical footprint:
– Represented in 11 countries:
South Africa, Europe, Asia, Americas, Other sub-Saharan African countries
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 4
2. About Absa
Absa Group Activities
Absa Bank
•
•
•
•
•
Retail banking
Commercial banking
Corporate & Merchant banking
International operations
Africa banking operations
Absa Financial Services
•
•
•
•
•
Life insurance
Short-term insurance
Insurance broking
Trust & Investment services
Employee benefits
Other Activities
• Asset management
• Property development
• Pension payments
Contribution by Activity
(% of Headline Earnings) *31-Mar-2003
Personal banking
28.5%
Commercial banking
30.4%
Wholesale domestic banking
20.4%
International banking
3.2%
African operations
2.6%
Insurance and financial services
17.6%
Other
-2.7%
100%
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 5
2. About Absa
Salient features
*31-Dec-2003
Return on assets (ROA):
1.5%
Assets:
> ZAR 284 billion (>USD 50 billion)
*30-Sep-2003
Return on equity (ROE):
> 20%
*31-Mar-2003
Capital adequacy range:
11% to 12%
*31-Mar-2003
Permanent staff complement:
> 32,000
*31-Mar-2003
Customers:
± 6 million
Branches & agencies:
± 1,200
Non-performing loan (NPL) ratio:
± 4%
Bad debt ratio:
0 .85%
Recent events in SA
•
•
•
•
•
1994 first democratic elections: Ending SA's isolation
from international community; Rapidly growing trade
between SA and other African countries
Tier 2 Banks liquidity crisis
Micro-lending shake-up
Mergers & acquisitions, and new market players
Currency volatility
•
•
•
•
•
Black Economic Empowerment
•
Basel II Capital Adequacy Requirements
Financial Services Charter
Banking the unbanked/unbankable
King II report on Corporate Governance
AC133 Accounting Standard (1 Jan 2003)
(IAS 39 / FAS133 equivalent)
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 6
3. Risk management history at Absa
1996
ALCO process fully established.
1997
Trading book VaR implementation.
1998
Active hedging programme for IRR commenced.
1999
ERM approach initiated.
2000
Earnings-at-Risk (EaR) framework implemented.
2001
Re-engineering of credit decisioning platform completed.
2002
Basel 2 programme initiated.
2003
Basel 2 implementation gains momentum.
ALCO:
VaR:
IRR:
ERM:
EaR:
Asset & Liability Committee
Value-at-Risk
Interest Rate Risk
Enterprise-wide Risk Management
Earnings-at-Risk
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 7
4. To B2 or not to B2? – Internal considerations
4.1
INTERNAL CONSIDERATIONS
4.1.1
Resource implications:
– Significant investment in IT systems would be required.
– Data availability challenges.
– Complex model requirements.
– Ownership, co-ordination of efforts (Finance, IT, Risk).
4.1.2
B2 implementation cost and risk:
– Estimated at 2.8% of annual Operating Expenditure, expensed over 5 years.
– Capital saving benefits uncertain.
– High risk of rework, due to regulatory process uncertainty.
4.1.3
Change management:
– Changes to IT systems and business processes, policies and procedures.
– Challenge to manage required change effectively.
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 8
4. To B2 or not to B2? – Internal considerations
4.1.4
Other compliance requirements:
– AC133 (IFRS), AML, etc.
4.1.5
Business benefits:
– Enhanced reputation.
– Improved control environment, information integrity, etc.
– Tools to improve operational and process efficiencies.
4.1.6
Enhancing risk management framework:
– Opportunity to further embed risk-reward management culture in decision making.
AC133:
Accounting standard AC133, “Financial Instruments:
Recognition and Measurement”, a recent addition to South
African GAAP and local equivalent of IAS39 / FAS133.
IFRS:
International Financial Reporting Standards
AML:
Anti-Money Laundering
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 9
4. To B2 or not to B2? – External considerations
4.2
EXTERNAL CONSIDERATIONS: EMERGING MARKETS ACCEPTANCE
4.2.1
Cross border capital flows:
– Improved transparency of SA banks’ risk profiles and best practices benchmark compliance
could improve ratings.
– Improved capital inflows could result.
4.2.2
Unintended consequences:
– Higher capital requirements volatility in emerging markets.
– More challenging for banks to maintain profitability due to combined impact of AC133 and B2.
4.2.3
Benefits to banking and financial system:
– Improved risk management practices could lead to reduced systemic risk and
improved market perception.
–
–
–
–
–
More efficient utilisation of capital employed in the banking system.
Growth in risk transfer instruments promoted.
Industry consistent disclosure.
Improved corporate governance through board and senior management oversight requirements.
Complements supervisor’s risk based approach.
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 10
4. To B2 or not to B2? – Conclusion
4.3
CONCLUSION
– Reputational risk of non-compliance too high.
– Large retail base should lead to reduced capital requirements.
– Positive spin-offs.
– Benefits outweigh costs.
– B2 should be viewed as an opportunity to enhance competitive position.
B2
No B2
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 11
5. B2 Implementation Strategy
• Absa’s goal:
To be fully B2 compliant by January 2007
• B2 approach aspirations:
– Retail credit exposures:
IRB Advanced
– Corporate credit exposures:
IRB foundation
– Operational Risk:
Advanced measurement approach
Some subsidiaries will be excluded from Group adopted approach based
on materiality and will follow standardised approach.
IRB:
Internal Ratings Based
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 12
6. Current B2 Implementation Status
CP2
May
CP1
Jan
01
OIS3
Dec
02
Final
Accord
Jun
CP3
Apr
Legislative
Process
04
03
Parallel
Run
05
Full
Implementation
Jan
06
07
Planning/mobilisation
Gap/Impact Analysis
Programme Timeline
Pre requisite systems
Methodologies and data
Measurement Models
B2/IFRS alignment
Systems integration
Process and organisation
Operationalisation
Programme Management
Awareness/Communication
Change Enablement
Quality & Compliance Assurance
2001
2002
2003
2004
2005
2006
2007
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 13
7. Delivering the B2 solution
Planning, programme mobilising and governance
•
•
•
•
•
•
•
Oversight by Board
Group program SteerCo
Work stream structures with clearly defined outputs
Programme sponsorship
Budgeting, priority setting, etc.
IT strategy alignment
Subject expertise
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 14
7. Delivering the B2 solution
Programme management: Governance Structure
Group Risk Committee
B2 Programme
SteerCo
ACMB
B2 SteerCo
CRMO
B2 SteerCo
B2 Credit Risk
Work Streams
(Board Risk Committee)
(Chairman: FD)
ERM
B2 SteerCo
Group Finance
B2 SteerCo
B2 Capital &
Disclosure
Work Streams
B2 Credit
Risk Project
Management
B2 Market Risk
Work Streams
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
B2 Operational
Risk
Work Streams
Slide 15
7. Delivering the B2 solution
Communication and Awareness
•
•
•
•
•
•
•
•
Ongoing
Board member training programmes
Interpreted B2
External training
Core group with requisite expertise
Training material
B2 knowledge base
Ongoing impact analysis and communication of results
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 16
7. Delivering the B2 solution
Models: Credit Risk
• PD:
– Corporates:
– SMEs:
– Retail:
– Specialised lending:
– Banks and sovereigns:
KMV
Moody’s RiskCalc (SA default database)
Own development based on internal default experience
related to application and behavorial scoring (TRIAD)
Slotting criteria
Derived from internal to external rating mappings
• LGD Retail:
– Own development based on internal recovery experience
• EAD Retail:
– Own development based on internal draw down experience
• Capital measurement:
– Pillar 1:
– Pillar 2:
SAP Bank Analyser
Own development in SAS
PD:
SMEs:
LGD:
EAD:
Probability of Default
Small and Medium sized Enterprises
Loss Given Default
Exposure At Default
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 17
7. Delivering the B2 solution
Models: Operational Risk
• Quantitative operational loss modeling:
• Qualitative measurement – self-assessment surveys:
Algorithmics
Horizon (JP Morgan)
Models: Market Risk
• Trading book:
• Equity investments:
• IRR in banking book:
Algorithmics
Algorithmics
Kamakura (being evaluated)
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 18
7. Delivering the B2 solution
Data Collection Strategy
• Retail credit loss data:
• SME credit loss data:
– Data collection efforts commenced some time ago.
– Four years of historical data available already.
– Data pooling arrangement with peer group initiated.
• Corporate, sovereign, banks credit loss data:
– Insufficient data availability in local market.
– Statistical model approach to be followed.
– Calibrated to international default experience.
• Operational risk:
– Historical data available for frauds and some loss events.
– Data collection efforts for remaining loss types have commenced.
– Data pooling arrangement with peer group under discussion.
• Centralised financial transaction database:
– Development in progress.
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 19
7. Delivering the B2 Solution
Integrated Credit Risk System
R
O
CAPITAL
ALLOCATION
engine
PORTFOLIO engine
DI Formatter
Simulators
R
A
EL-UL
Engine
BIS CAPITAL engine
C
EAD
PRICING
engines
Recovery
Rating
Economic
Scenario
Generator
PROVISIONING
engine
STRATEGY optimiser
Interface Layer
LGD engine
EAD engine
Haircut
Engine
Banking Book
Trading Book
Credit
conversion
Factors
LGD Estimators
PFE
Calculators
Fixed Property
Moveable Property
Finance Securities
Concurrent Creditors
Loan valuation engine (AC133)
PD Estimators
Retail
Corporate Client
Sovereign
External
Business Client
Financial Institution
Unlisted
Ratings Calibrator
Recovery Statistics
Limits/Exposure
Retail Client
Business Client
Corporate Client
Collateral
Management
Fixed Property
Moveable Property
Finance Securities
Concurrent Creditors
Rating Systems
Application Scoring
Behavioral scoring
 Judgmental
 FES
Customer/Product Systems
Slide 20
7. Delivering the B2 solution
Integrated Operational Risk System
OPRISK CAPITAL allocation
OPRISK PERFORMANCE management
Operational Risk Analysis and
Modeling
INTEGRATED OPRISK
PROFILE dashboard
Interface Layer
Indicator
Monitoring
Indicator
Identification
Sourcing
Business Units
ERM
QUANTITATIVE
OPRISK data
Industry
Database
Sourcing
Business Units
ERM
Economic
Crime Profile
2
3
QUALITATIVE
OPRISK data
2
Loss/Events
Database
Loss/Event
Capturing
RISK
1
INDICATORS
1
Loss/event
Validation
1
Operational Risk Profile
Integration
3
Profile Alignment
Assurance Compliance
Qualitative Operational Risk
Sourcing
Business Units
ERM
Enterprise Operational Risk Framework Version 3.1
Slide 21
7. Delivering the B2 solution
Risk Management Framework Enhancement– Credit Risk
Compliance
assessment
Oversight
Audit
reports
Assurance
Board and
Senior Management
Oversight
Disclosure
Compliance
Risk appetite
Approved capital
SBUs
SBU
Strategies
Capital
Measurement
Capital
Allocation
Portfolio
Performance
Set Concentration
Limits
Portfolio Optimization
Support
Enterprise Credit
Portfolio Risk
Management
Concentration limits
Segment Credit
Policies
Credit
Ratings
Underwriting
Segment
Monitoring
Credit Portfolio
Management
Credit Risk
Mitigation
Segment
Credit Risk
Management
Collateral Values
Approval requests
Loan
Origination
Limits
Prices per rating
Collateral
Management
Provisions
Workout
Recovery
Debt
Recovery
Origination
Legend:
Significant enhancement required to existing processes for B2
Minor enhancement required to existing processes for B2
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 22
7. Delivering the B2 solution
Risk Management Framework Enhancement– Operational Risk
Compliance
assessment
Audit
reports
Oversight
Assurance
Compliance
Disclosure
Risk appetite
Approved capital
Profile Alignment
Capital
Measurement
Modeling
Capital
Allocation
Indicator
Database
Sources
• Business Units
Board and Senior
Management Oversight
Performance
Management
Loss Event
Database
Sources
• Industry Database
• Public Sources
• External Research
Mitigation
Strategies
Qualitative
Database
Sources
• Business Units
• Fraud Related Events
Sources
• Control Self-Assessments
• Compliance profiles
Performance
Management
BU Strategies
Reducing
operational losses
Legend:
Effective and efficient
internal control
Enterprise Operational
Risk Management
Information Sourcing
BU Operational Risk
Management
Business process
reengineering
Significant process changes in progress
Minor process changes in progress
Slide 23
7. Delivering the B2 solution
Risk Management Framework Enhancement– Market Risk
Compliance
assessment
Oversight
Audit
reports
Assurance
Compliance
Disclosure
Board and
Senior Management:
Oversight
Capital
Allocation
Set and
enforce limits
Set
Policies
Risk Management Unit:
Measure, Monitor, Control,
Report
Portfolio
Management
Risk
Mitigation
Risk appetite
Capital +
Risk
Measurement
Legend:
Position taking
functions
Significant enhancement required to existing processes for B2
Minor enhancement required to existing processes for B2
•
•
Existing Risk Management Framework unchanged.
•
Computation of capital for position risk in the trading book: Compliance with Capital Adequacy Requirement
(1998) represents compliance to Basel II. Absa had its internal model approved for the computation of position
risk capital in the trading book in 1998.
•
Capital requirements for equity risk: Equities in the banking book under the internal models approach (VaR).
Interest Rate Risk in the Banking Book does not attract a minimum Pillar 1 capital charge, but supervisory review
process requires disclosure of economic value sensitivities relative to capital.
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 24
7. Delivering the B2 solution
Capital adequacy management framework
Set
Risk Appetite
Capital
Management
Models &
Methodologies
Set
Risk
Policies
Risk
Assessment
Strategic
Planning
Allocate
Risk
Ratings
Portfolio Risk
Measurement
Risk
Pricing
Market
Segmentation
and Targeting
Obtain Assurance
& Ensure
Compliance
Regulatory
Reporting
Public
Disclosure
Risk-Adjusted
Performance
Measurement
Capital
Requirement
Projections
Portfolio
Limit
Monitoring
Group
Risk Profile
Reporting
Quantitative
Risk
Measurement
Deal
Origination
Monitor
Risk Profiles
Risk
Mitigation
Service
Delivery
Exposure
Monitoring
Board Risk Committees
Group Finance
Collateral
Management
Operations
Management
Enterprise RM
Structuring
Provisioning
IT / Information
Management
Recovery
Risk
Management
Customer
Relationship
Management
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Risk
Underwriting
SBUs
Slide 25
8. B2 / IFRS alignment
•
Overlap between IFRS and B2.
•
Common data requirements.
•
Common valuation models.
•
Provisioning / capital interrelationship.
•
Capital adequacy implications of fair value adjustments.
•
B2 / IFRS development strategy to ensure consistency in risk and financial
performance measurement.
•
Common validation needs.
•
Ownership.
B2:
Basel II Capital Accord
IFRS: International Financial Reporting Standards
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 26
9. Early results
Capital impact
• Ongoing capital impact measurement.
• As of December 2003:
Overall:
Retail credit portfolios:
SMEs:
Corporate :
Banks:
Operational risk capital:
Estimated 5% capital saving
Significant (30%+) capital saving
Slight increase
Increase
Significant increase
7% increase (preliminary AMA)
• Early indication of further capital relief from EL / UL amendment.
AMA:
EL / UL:
Advanced Measurement Approach
Expected Loss / Unexpected Loss
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 27
9. Early results
Strategic implications
•
•
•
•
•
•
•
Protecting the Retail base.
Increased focus on Wealth Management services.
Increased focus on CRM.
Reviewing LTV lending criteria for some Mortgage segments.
Reviewing speculative grade Corporate lending criteria.
Increased focus on customer retention.
Consider risk-based product re-pricing (declining capital needs over loan
life).
CRM: Customer Relationship Management
LTV:
Loan-To-Value
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 28
10. Local Supervisor’s Influence
Accord Implementation
SteerCo
Risk Management
•
•
•
•
Disclosure
• Senior Bank Executives
• Bank Supervision Heads
Compliance
Economic Impact
Data issues
Model validation
Consolidated response to BIS proposals
Co-ordinated QIS
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 29
11. Industry Collaboration
Industry has taken initiatives …
Credit loss data pooling
•
SME default data
(in progress)
•
SME LGD data
(next phase)
Operational loss data pooling
•
•
Still under discussion
Issues: context,
confidentiality, etc.
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 30
12. Remaining issues and challenges – Pillar 2 clarity
•
Judgmental approach to Pillar 2 – strong reliance on supervisor expertise.
•
Economic capital measurement assumptions for interest rate risk in
banking book.
•
Measurement issues and assumptions for risks not covered under Pillar 1
– eg. Liquidity risk.
•
Capital stress testing methodology.
•
Capital buffer requirements.
•
Credit concentration risk measurement approaches.
•
Risk diversification treatment in buffer determination.
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 31
12. Remaining issues and challenges – Pro-cyclicality
B2 Credit Capital Risk Weight Curve
450%
400%
350%
250%
200%
150%
100%
D
C
CC
CCC-
CCC
CCC+
B-
B
B+
BB-
BB
BB+
BBB-
BBB
BBB+
A-
A
A+
AA-
AA
0%
AA+
50%
AAA
Risk Weight
300%
S&P Rating
•
•
Static LGD, EAD and term assumptions.
Non-linear sensitivity to credit quality changes.
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 32
12. Remaining issues and challenges – Pro-cyclicality
•
Absa’s capital requirement would have increased by over 30% under a
B2 regime in the aftermath of the 1998 Emerging Markets Crisis.
•
Problem exacerbated by dynamic internal rating systems.
•
Capital stress testing/planning simulation model capability.
•
Buffer management.
•
Ongoing capital attribution analysis.
•
Hedge capital fluctuations.
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 33
12. Remaining issues and challenges – Model validation
•
Supervisory approach to model validation.
•
Statistical validation (backtesting, out of sample testing, etc.)
not feasible in all areas.
•
Benchmarking.
•
Mapped ratings.
•
Methodology reviews.
•
Pragmatic approach.
•
Ongoing validation strategy.
•
Rating agents.
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 34
12. Remaining issues and challenges – Capital level & Ratings
Long-term Impact of Basel II on Bank Ratings
“
• Higher CAR won’t necessarily lead to upgrade,
and cutting capital because of a higher CAR could lead to a
downgrade.
• But better data on risk profile will be considered,
and better risk management a positive:
– Better asset allocation
– Better risk-adjusted pricing.
”
Moody’s Investors Services
CAR:
Capital Adequacy Requirements
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 35
13. Conclusion
•
B2 benefits outweigh costs.
•
Plethora of model tools and data availability is improving.
•
Strong programme management required for successful implementation.
•
Industry collaboration critical.
•
Communication and education – bank management, investors,
stakeholders, etc.
•
Key role of Regulator: To be pro-active on issues - reduce uncertainties.
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 36
Victor Hugo
B2 implementation at Absa: A case study, AJ Blaauw — Cartagena, 18 February 2004
Slide 37