Implementing a Risk-Adjusted Profitability Framework

Transcription

1 Implementing a Risk-Adjusted Profitability Framework Antoine Meouchy April 13, 2018 The 8 th Annual Risk Management Forum - UAB

2 Outline Framework Components Challenges

3 Legal Entity Net Interest Margin Non-interest Income Net Financial Income Expected Credit Loss Operating Expenses Profits Retail Legal Entity Corporate Capital / Equity = Return on Capital/Equity Personal Loans Credit Card 3/

4 Why? Performance in terms of value creation Align goal to optimize performance and risk Business Decisions Cascading 4/

5 Hurdle Rate Framework Other Strategy Profitability & Policies Liquidity Asset Quality Cascading Solvency LoB Segmentation 5/

6 Golden Rules for Top-Down Connect to corporate objectives (ROE, CAR and other) Forward-Looking Risk-Based components are the expected future cash-flows (e.g. EL) at a mediumterm horizon Use risk-sensitive approach and not shortcuts Reliable-Flexible Standalone Fair Hurdle Rates Bridging Evaluate performance at the level of granularity where risk can reliably be estimated Attribute revenues, costs & risks or capital to cover the exact perimeter of a business To estimate value creation, set up a waterfall of hurdle rates at group, legal entity and LoB level Create a strong bridge between risk, finance and business and get buy-in estimations Transparent Communicate on the approach used to reconcile the various metrics 6/

7 Hurdle Rate Framework Other Strategy Profitability & Policies Liquidity Asset Quality Cascading Solvency LoB Segmentation 7/

8 The 5 Pillars of Risk Appetite Profitability Asset Quality New Risk Appetite Framework Solvency Targets Min / Max over 10 years Group / Entity / LOB Liquidity Franchise Value 8/

9 1.10 BANK Risk AUDI* Appetite RAF Framework 2018 Proposal IRRBB * Consolidated Economic Capital Min/Max Charge (over / total Economic Capit Target Group Cascading Responsable body BANK AUDI* RAF 2018 Proposal * Consolidated Group next 10 yrs) Solvency Solvency Profitability Liquidity CET1 Ratio 12.00% 10% Cascaded by CET1/CAR = 75% and CAR ratio Group Finance (Tiering) 1.2 Tier I Ratio 15.00% 13% Cascaded by T1/CAR = 93.75% and CAR ratio Group Finance (Tiering) 1.3 Total CAR 16.00% 15% Cascaded down to LEs Group Finance & Group Risk 1.4 S&P Risk-adjusted Capital (RAC) 4% Not cascaded (Group only) Group Finance 1.5 Economic "internal" capital (ECAP) ratio 80% 100% Cascading down to LEs & LoBs, for capital allocation Group Finance & Group Risk 1.6 Basel III Tier 1 Leverage Ratio > 5% Not cascaded (Group only) Group Risk 1.7 Credit Diversification Benefit / Credit Economic Capital 25%-35% > 20% Not cascaded (Group only) Group Risk 1.8 FC Lebanese sovereign capital charge / total Economic Capital < 25% Not cascaded (Group only) Group Risk 1.9 Real Estate economic capital charge / total Economic Capital < 15% Cascaded down to LEs Group Risk 1.10 IRRBB Economic Capital Charge / total Economic Capital < 15% ECAP & <70% cons. Buffer Cascaded down to LEs Group Risk 1.11 Stressed Cons. Total Reg CAR due to 30% devaluation of either LBP, TRY or EGP > 14% Cascaded down to LEs Group Risk 1.12 Trading Market Risk Capital Charge / total Economic Capital < 2% Cascaded down to LEs & LoBs with trading (e.g. ODEA) 17.5% >14.5% 2.1 = NI / Average Common Equity Cascaded down to LEs (1.20*CoCET1) (CoCET1) Cascading down to LEs, LoBs & Clients after RoACE = NI / Average Common Equity 2.2 Economic 24.3% >22.8% adjustments for overheads (and diversification) 9/ Cost / Income Ratio = Operating expenses / Total Operating Incom Group Risk Group Finance & Group Risk Group Finance & Group Risk 2.3 Economic value growth tbc tbc Cascaded down to LEs Group Finance & Group Risk 2.4 Cost / Income Ratio = Operating expenses / Total Operating Income 45% <50% Cascading down to LEs & LoBs Group Finance 2.5 Gross Operational Estimated Losses / Total Operating Income (YTD) <0.4% Cascading down to LEs Group Risk CET1 Ratio Credit Market Credit Market <50% Cascading down to LEs Group Risk 8% <10% Cascading down to LEs Group Risk Lifetime EL / EAD % <1.5% Cascading down to LEs & LoBs Group Risk (on & off-balance sheet without conversion factors) Asset Quality 3.2 Required Credit Economic Capital/ Credit EL 7 Cascading down to LEs & LoBs Group Risk 4.1 FC Regulatory consolidated LCR 110% >80% Not cascaded (Group only) Group Risk Short-term Liquidity 4.2 Total Regulatory consolidated LCR 110% >80% Cascading same ratio to regulated LEs Group Risk 4.3 FC Economic consolidated LCR 110% >80% Not cascaded (Group only) Group Risk 4.4 Total Economic consolidated LCR 110% >80% Cascading same ratio to regulated LEs Group Risk 4.5 FC Consolidated NSFR tbd tbd Second step: fix at Group and LE Group Risk Structural liquidity Market Tier I Ratio Total CAR Stressed Cons. Total Reg CAR due to 30% devaluation Trading Market Risk Capital Charge / total Economic Ca S&P Risk-adjusted Capital (RAC) Economic "internal" capital (ECAP) ratio Basel III Tier 1 Leverage Ratio Largest exposure per Obligor / Budgeted pre-provision & pretax income (excluding Sovereign and Financial Institutions, weighted for OBS & net of collaterals) Decrease in Net Interest Income due to interest rate shock relative to EOY Net Interest Income Credit Economic Economic value growth Market Credit Diversification Benefit / Credit Economic Capital FC Lebanese sovereign capital charge / total Economic Capital Real Estate economic capital charge / total Economic Capital IRRBB Economic Capital Charge / total Economic Capital Stressed Cons. Total Reg CAR due to 30% devaluation of either LBP, TRY or EGP 4.6 Total Consolidated NSFR tbd tbd Second step: fix at Group and LE Group Risk

10 Hurdle Rate Framework Other Strategy Profitability & Policies Liquidity Solvency Asset Quality Cascading LoB Segmentation 10/

11 for Optimized Capital Allocation across Entities & Lines of Business Group level Group Accounting, market, regulatory and economic performance Entity 1 Entity 2 Entity 3 Legal entity level Regulatory, accounting and economic performance LoB1 LoB2 LoB1 LoB2 LoB1 LoB2 Business Line level: Economic performance Client Product Clients and Products level: Economic performance 11/

12 Hurdle Rate Framework Other Strategy Profitability & Policies Liquidity Asset Quality Cascading Solvency LoB Segmentation 12/

13 nt ent Reconciliation of revenues, costs, EL For information and capital in bucketing Single loan & client Corporate & Commercial Group Corporate Single loan Single client corporate Lebanon SME Personal Banking Retail business Treasury/ MM Central Bank (incl. reserves) Sovereign IR mgt Unit investment TCM Proprietary (excluding trading trading) NIMA (yield above FTP) NIMF Group (FTP - cost of funds) Corporate Retail Treasury/ Sovereign Opex SME Bank (incl. IR mgt Unit FTP (net) corporate Lebanon business MM investment on loans reserves) Non interest income Others LE overheads Included in LoB hurdle rate MtM/ Capital gains Strategic trading Loans & Deposits to staff, RE & PE investments Revenues CP risk on EL on CP EL on CP Default risk EL Average losses (TTC) derivatives risk risk (loans, PE) Average Group overheads capital gains on Market ER Opex Tax Tax Risk costs Components Risk costs Total costs investments Direct costs on loans to clients* LoB costs (excluding loans LE overheads Group overheads Total costs Taxes Taxes Direct costs on loans to LoB Segmentation clients* Corporate & Commercial LoB costs (excluding loans to clients)** Included in LoB hurdle rate Included in LE hurdle rate Included in hurdle rates Treasury and Capital Markets Central to clients)** Capital benefit FTP on economic capital invested Included in hurdle rates Capital benefit Credit Issuer CP risk on Credit Credit risk CP risk of risk to Credit risk on loans and CP risk on derivatives for clients on loans risk on IR & FX central investment swaps bank Prepayment Market spread Capital invested benefit FTP on economic capital Embedded options on loans (drawing, extension, muticurrency, prepayment) Market Pillar II IR option Included on risk in on hurdle MM rates risk above mortgages and FX risk trades (?) FTP invested 15% of Operational 15% of revenues 15% of revenues revenues Cost of capital Capital benefit Personal Banking Included in LE hurdle rate Included in hurdle rates Credit Treasury and Capital Markets BASAL HO Total Group In hurdle In hurdle rate rate In hurdle rate Credit risk Issuer risk Issuer risk on loans to on securities on securities staff Market risk on trading Market risk on trading In hurdle In hurdle rate rate Market risk on investment (PE and RE) 15% of revenues In hurdle rate In hurdle In hurdle rate rate Credit risk TCM (excluding trading) CP risk on derivatives 13/

14 Two Views: Lending Only & All-In Client All-in client Covers all client relationships Deposits Transfers Lending only Covers income and costs for the lending business exclusively FX exchange Trade finance Other fees related businesses 14/

15 Lending Only & All-In Client Current versus Proposed Pilot case 2 (illustration) Q annualized USD 1000 Average liabilities / deposits Economic P&L* Q * 4 Q * 4 Q * 4 Q * 4 Nominal (K USD) bps/exp. Nominal (K USD) bps/exp. Nominal (K USD) bps/exp. Nominal (K USD) bps/exp. Yields received 1,975 1,975 2,100 2,100 Yields above FTP on assets 505 bps 505 bps 555 bps 555 bps FTP paid Fees on assets 0 bps 0 bps 0 0 bps 0 0 bps Coupons paid Yield up to FTP on liablities 0 bps 0 bps 0 bps 0 bps FTP received 0 0 Other fees 0 0 bps 0 bps 0 0 bps 0 0 bps Capital gains Q1 (for 2017 trading and Q Q Q bps 0 0 bps 0 0 bps 0 0 bps investments only) 30,387 Received 0 30,387 0 bps 0 0 bps 30, bps 0 30,000 0 bps FTPs (for ALM only) Paid 0 0 bps 0 0 bps 0 0 bps 0 0 bps Total income (1) 1, bps 1, bps 1, bps 1, bps Expected losses (2) 0 bps - 0 bps 1 0 bps 1 0 bps Direct Costs (3) bps bps 0 bps bps Yearly economic profit (4X) (4) = (1)-(2)-(3) 1, bps 1, bps 1, bps 1, bps Operational ECAP Average ECAP usage (5) bps bps bps bps ECAP Capital benefit at FTP (6) 18 6 bps 18 6 bps 19 6 bps 19 6 bps Standalone Cost of ECAP capital (7) bps bps bps bps Cost of ECAP capital including share in Group and LE overheads (8) bps0 bps bps bps bps Economic performance - 12 months Value Creation to Group *cf. sheet "data definition" Current Proposed Loans only All-in Client New Loan All-in Client Q Q Q Q Average assets / loans 30,387 30,387 30,000 30,000 Average exposure (EAD) 29,586 29,586 30,000 30,000 nal (K USD) bps/exp. Nominal (K USD) bps/exp. Nominal (K USD) bps/exp. Nominal (K USD) bps 1,975 Economic capital absorbed* 1,975 2,100 2,100 Credit ECAP 505 bps 0 bps 505 bps - 0 bps 555 bps 0-0 bps Market ECAP (%) Standalone Value Creation Current bps 0 bps 0 0 bps bps 0 bps 0 bps bps 0 bps 0 0 bps bps 0 Proposed Loans only All-in Client New Loan All-in Client Q * 4 Q * 4 Q * 4 Q * 4 29,586 29,586 30,000 30, bps bps 0 0 bps 0 0 bps 0 0 (4) + (6) / (5) (4) + (6) / (5) (4) + (6) / (5) (4) + (6) / (5) 510.1% 478.0% 674.1% 493.0% (4) + (6) - (7) (4) + (6) - (7) 0 (4) + (6) - (7) (4) + (6) - (7) 0 1, bps 1, bps 1, bps 1, bps (4) + (6) - (8) (4) + (6) - (8) (4) + (6) - (8) (4) + (6) - (8) 1, bps 1, bps 1, bps 1, bps 0 0 bps 0 0 bps 0 bps 0 1, bps 1, bps 1, bps 1, bps - 0 bps 1 0 bps bps bps 0 bps /

16 Additional costs and capital charges view from the Loan to the Group Level Loan Client LoB Funding (FTP), expected loss & loan servicing costs + All revenues and costs at customer level + Operational Risk Capital Aggregation of all framework components Single Loan All-in Client Line of Business 16/

17 Hurdle Rate Framework Other Strategy Profitability & Policies Liquidity Asset Quality Cascading Solvency LoB Segmentation 17/

18 & Value Creation Value Creation + Contribute in meeting Target Rate > Target Rate > Hurdle Rate Target Rate Value Creation > Hurdle Rate Hurdle Rate Value Destruction < Hurdle Rate Value Creation = Economic Profit (Incl. Capital Benefit) - Cost of Capital Consumed 18/

19 Hurdle Rate vs. Target Rate Starting point Definition Hurdle Rate Bank s cost of equity (CoE) In addition to cost of AT1 and Tier 2 instruments Minimum rate that LoBs should meet for value creation Target Rate Bank s target return on equity (x% premium over CoE) In addition to cost of AT1 and Tier 2 instruments Rate that LoBs should meet for Bank to achieve target return on capital Application One hurdle rate across lines of Business Different target rate for different LoBs depending on current performance, market conditions, bank s strategy 19/

20 Hurdle Rate Calculation Costs not directly attributed to a specific LOB Target Capital Structure Cost of Capital Common equity Additional Tier I Tier II Cost of CET1 Cost of AT1 Cost of Tier II Capital buffers Entity Overheads Group Overheads Hurdle Rate Pre-tax basis 20/

21 Hurdle Rate Framework Other Strategy Profitability & Policies Liquidity Asset Quality Cascading Solvency LoB Segmentation 21/

22 Formula Expected margins above FTP + Fees Expected Direct and Indirect LoB costs PD x EAD x LGD Internal FTP for non-deposit funding = Revenues Costs Expected Losses+Capital Benefit Economic Capital Capital consumed for Operational, Credit and Market risk Taxes in Hurdle Rate 22/

23 Economic Capital Journey Ranking Tool Acceptance Tool ECL FTP Cost Allocation

24 Expected Credit Loss PIT=IFRS Rating 9 TTC= PIT=IFRS 9 EL used in is Through The Cycle (TTC) EL used in IFRS 9 is Point-In-Time (PIT) 24/

25 Cost Allocation Direct Cost attributable to the lending facility Costs attributable to the Line of Business. This includes the cost of managing the lending activity and the All-in client Loan LoB Accounted for in profits Costs incurred at the Group Level Group Overhead Legal Entity Overhead Accounted for in Hurdle Rate Costs incurred at the legal entity level but not at the level of the individual LOBs 25/

26 Economic vs. Regulatory Capital: Difference Regulatory Capital (SA) Economic Capital Basis Based on Regulatory rules Based on Bank s own estimations Asset Quality Not risk sensitive (All corporate RW=100%) Based on the Bank s internal ratings Collateral Limited to cash, securities and few other collaterals Include all credit risk mitigants viewed relevant by the bank (including real estate mortgage) Loan Maturity Irrelevant in the capital requirements calculations Function of the maturity of the facility 26/

27 Economic Capital: More Risk Sensitive 27/

28 Key Challenges & Enablers Challenges Business buy-in of framework and its components Data quality issues Market pressure on pricing Complexity of components estimations Cultural challenges Enablers Get the buy-in of each component separately and gradually Establish data governance program and initiatives as a measurement tool and decision support rather than an acceptance criteria Partnership between Risk & Finance is a key Gradual / Iterative roll-out: -From regulatory to economic capital, -From ranking tool to acceptance criteria 28/

29 Q&A 29/