9780071407632

Risk Management and Capital Adequacy

by
  • ISBN13:

    9780071407632

  • ISBN10:

    0071407634

  • Edition: 1st
  • Format: Hardcover
  • Copyright: 2003-04-11
  • Publisher: McGraw-Hill Education
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Summary

Under the new Basle Guidelines, all financial institutions subject to local banking laws will soon be required to operate under dramatically different risk exposure rules.Risk Management and Capital Adequacyprovides details on the key risk approaches under these new guidelines and is the first book to analyze if and how they can be integrated. From conceptual frameworks to analyses of models and approaches, it provides a solid reference source for the information that everyone in risk management will soon need to know.

Author Biography

Reto Gallati, Ph.D., is deputy chief risk officer at Putnam Investments. A visiting professor at MIT's Sloan School of Management, Dr. Gallati has also worked in risk management at KPMG, Goldman Sachs, and Crédit Suisse and has been an instructor at Boston University, Harvard, and the University of Zurich.

Table of Contents

Acknowledgments viii
Introduction xvii
Risk Management: A Maturing Discipline
1(32)
Background
1(4)
Risks: A View of the Past Decades
5(2)
Definition of Risk
7(1)
Related Terms and Differentiation
8(2)
Degree of Risk
10(1)
Risk Management: A Multilayered Term
11(11)
Background
11(1)
History of Modern Risk Management
11(2)
Related Approaches
13(9)
Approach and Risk Maps
22(1)
Systemic Risk
22(6)
Definition
22(4)
Causes of Systemic Risk
26(1)
Factors That Support Systemic Risk
26(1)
Regulatory Mechanisms for Risk Management
27(1)
Summary
28(2)
Notes
30(3)
Market Risk
33(96)
Background
33(1)
Definition of Market Risk
34(3)
Conceptual Approaches for Modeling Market Risk
37(2)
Modern Portfolio Theory
39(15)
The Capital Asset Pricing Model
41(2)
The Security Market Line
43(2)
Modified Form of CAPM by Black, Jensen, and Scholes
45(1)
Arbitrage Pricing Theory
46(1)
Approaches to Option Pricing
47(7)
Regulatory Initiatives for Market Risks and Value at Risk
54(6)
Development of an International Framework for Risk Regulation
56(1)
Framework of the 1988 BIS Capital Adequacy Calculation
56(2)
Criticisms of the 1988 Approach
58(1)
Evolution of the 1996 Amendment on Market Risks
58(2)
Amendment to the Capital Accord to Incorporate Market Risks
60(2)
Scope and Coverage of Capital Charges
60(1)
Countable Capital Components
61(1)
The de Minimis Rule
62(1)
The Standardized Measurement Method
62(33)
General and Specific Risks for Equity- and Interest-Rate-Sensitive Instruments
65(1)
Interest-Rate Risks
66(13)
Equity Position Risk
79(4)
Foreign-Exchange Risk
83(1)
Commodities Risk
84(4)
Treatment of Options
88(6)
Criticisms of the Standard Approach
94(1)
The Internal Model Approach
95(12)
Conditions for and Process of Granting Approval
95(2)
VaR-Based Components and Multiplication Factor
97(1)
Requirement for Specific Risks
98(1)
Combination of Model-Based and Standard Approaches
98(1)
Specification of Market Risk Factors to Be Captured
99(2)
Minimum Quantitative Requirements
101(1)
Minimum Qualitative Requirements
102(5)
The Precommitment Model
107(1)
Comparison of Approaches
108(1)
Revision and Modification of the Basel Accord on Market Risks
109(1)
The E.U. Capital Adequacy Directive
109(1)
New Capital Adequacy Framework to Replace the 1988 Accord
110(1)
Regulation of Nonbanks
110(4)
Pension Funds
111(1)
Insurance Companies
111(1)
Securities Firms
112(1)
The Trend Toward Risk-Based Disclosures
113(1)
Disclosure Requirements
113(1)
Encouraged Disclosures
114(1)
Market Instruments and Credit Risks
114(2)
Summary
116(1)
Notes
117(12)
Credit Risk
129(154)
Background
129(1)
Definition
130(1)
Current Credit Risk Regulations
130(1)
Deficiencies of the Current Regulations
131(2)
Deficiencies of the Current Conceptual Approaches for Modeling Credit Risk
133(2)
Conceptual Approaches for Modeling Credit Risk
135(5)
Transaction and Portfolio Management
136(4)
Measuring Transaction Risk-Adjusted Profitability
140(1)
Measuring Credit Risk for Credit Portfolios
140(10)
Economic Capital Allocation
141(5)
Choice of Time Horizon
146(1)
Credit Loss Measurement Definition
146(3)
Risk Aggregation
149(1)
Development of New Approaches to Credit Risk Management
150(55)
Background
151(1)
BIS Risk-Based Capital Requirement Framework
152(2)
Traditional Credit Risk Management Approaches
154(5)
Option Theory, Credit Risk, and the KMV Model
159(8)
J. P. Morgan's CreditMetrics and Other VaR Approaches
167(11)
The McKinsey Model and Other Macrosimulation Models
178(5)
KPMG's Loan Analysis System and Other Risk-Neutral Valuation Approaches
183(7)
The CSFB CreditRisk+ Model
190(3)
CSFB's CreditRisk+ Approach
193(4)
Summary and Comparison of New Internal Model Approaches
197(8)
Modern Portfolio Theory and Its Application to Loan Portfolios
205(21)
Background
205(3)
Application to Nontraded Bonds and Credits
208(1)
Nonnormal Returns
209(1)
Unobservable Returns
209(1)
Unobservable Correlations
209(1)
Modeling Risk-Return Trade-off of Loans and Loan Portfolios
209(16)
Differences in Credit Versus Market Risk Models
225(1)
Backtesting and Stress Testing Credit Risk Models
226(3)
Background
226(1)
Credit Risk Models and Backtesting
227(1)
Stress Testing Based on Time-Series Versus Cross-Sectional Approaches
228(1)
Products with Inherent Credit Risks
229(21)
Credit Lines
229(2)
Secured Loans
231(2)
Money Market Instruments
233(4)
Futures Contracts
237(3)
Options
240(3)
Forward Rate Agreements
243(2)
Asset-Backed Securities
245(2)
Interest-Rate Swaps
247(3)
Proposal for a Modern Capital Accord for Credit Risk
250(13)
Institute of International Finance
251(1)
International Swaps and Derivatives Association
252(1)
Basel Committee on Banking Supervision and the New Capital Accord
253(10)
Summary
263(2)
Notes
265(18)
Operational Risk
283(58)
Background
283(2)
Increasing Focus on Operational Risk
285(4)
Drivers of Operational Risk Management
286(2)
Operational Risk and Shareholder Value
288(1)
Definition of Operational Risk
289(4)
Regulatory Understanding of Operational Risk Definition
293(3)
Enforcement of Operational Risk Management
296(3)
Evolution of Operational Risk Initiatives
299(3)
Measurement of Operational Risk
302(1)
Core Elements of an Operational Risk Management Process
303(1)
Alternative Operational Risk Management Approaches
304(17)
Top-Down Approaches
305(9)
Bottom-Up Approaches
314(5)
Top-Down vs. Bottom-Up Approaches
319(2)
The Emerging Operational Risk Discussion
321(1)
Capital Issues from the Regulatory Perspective
321(3)
Capital Adequacy Issues from an Industry Perspective
324(13)
Measurement Techniques and Progress in the Industry Today
327(3)
Regulatory Framework for Operational Risk Overview Under the New Capital Accord
330(5)
Operational Risk Standards
335(1)
Possible Role of Bank Supervisors
336(1)
Summary and Conclusion
337(1)
Notes
338(3)
Building Blocks for Integration of Risk Categories
341(100)
Background
341(1)
The New Basel Capital Accord
342(10)
Background
342(1)
Existing Framework
343(2)
Impact of the 1988 Accord
345(1)
The June 1999 Proposal
346(2)
Potential Modifications to the Committee's Proposals
348(4)
Structure of the New Accord and Impact on Risk Management
352(4)
Pillar I: Minimum Capital Requirement
352(1)
Pillar II: Supervisory Review Process
353(1)
Pillar III: Market Discipline and General Disclosure Requirements
354(2)
Value at Risk and Regulatory Capital Requirement
356(10)
Background
356(1)
Historical Development of VaR
357(2)
VaR and Modern Financial Management
359(5)
Definition of VaR
364(2)
Conceptual Overview of Risk Methodologies
366(2)
Limitations of VaR
368(21)
Parameters for VaR Analysis
368(5)
Different Approaches to Measuring VaR
373(7)
Historical Simulation Method
380(2)
Stress Testing
382(7)
Summary of Stress Tests
389(1)
Portfolio Risk
389(15)
Portfolio VaR
390(3)
Incremental VaR
393(2)
Alternative Covariance Matrix Approaches
395(9)
Pitfalls in the Application and Interpretation of VaR
404(27)
Event and Stability Risks
405(1)
Transition Risk
406(1)
Changing Holdings
406(1)
Problem Positions
406(1)
Model Risks
407(2)
Strategic Risks
409(1)
Time Aggregation
409(5)
Predicting Volatility and Correlations
414(1)
Modeling Time-Varying Risk
415(8)
The RiskMetrics Approach
423(4)
Modeling Correlations
427(4)
Liquidity Risk
431(5)
Summary
436(1)
Notes
437(4)
Case Studies
441(54)
Structure of Studies
441(1)
Overview of Cases
441(4)
Metallgesellschaft
445(16)
Background
445(3)
Cause
448(9)
Risk Areas Affected
457(4)
Sumitomo
461(5)
Background
461(1)
Cause
461(3)
Effect
464(1)
Risk Areas Affected
464(2)
LTCM
466(13)
Background
466(2)
Cause
468(4)
Effect
472(1)
Risk Areas Affected
473(6)
Barings
479(11)
Background
479(1)
Cause
480(5)
Effect
485(1)
Risk Areas Affected
486(4)
Notes
490(5)
Glossary 495(24)
Bibliography 519(20)
Index 539

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