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GRC Professional : GRC Summer 2012
IN DEPTH 22 GRC Professional • Summer 2012 portfolio-specific risk parameters. Others adopt a non-linear modelling approach. Typically, the scenario is first translated into an impact on a systemic factor before linking to losses, with expert judgement playing an important role in this process. APRA’s view is that linear models are likely to underestimate actual non-linear loss profiles.” In other words, the usual links in a chain of cause and effect do not always follow the same pattern that occurs in a crisis situation. Newton explains: “Sometimes, when an event starts, the things we expect to occur don’t occur. The relationships that we expect to be in place may break down under stress. In the markets area, people will say there is a relationship between one market and another, such as equities and interest rates. Over the long term they are right, but under stress that relationship doesn’t hold up. You have to look and see what happens when the proverbial hits the fan.” To do this involves a combination of detailed research and lateral thinking. “Risk people like to play with historic information,” Newton says. “We have this paradigm of predicting the future by looking at the past. If you can observe the past as having significant fluctuations, that is useful. If you don’t have an experience set of your own, you will go and look for experiences where some other environment has had a shock. For example, I might look at the UK house prices in the 90s.” ING Direct’s CRO, Bart Hellemans, says the most critical step in a stress test is at the beginning, when you define the assumptions that you use in your extreme but plausible worst-case scenario. In ING Direct’s case, this involves input from many stakeholders including the CFO, Treasurer and executives from risk and business departments. “You really define an economic scenario,” Hellemans says. “What happens if the crisis in Europe continues and we have Europe go into recession with negative growth Banking crises have happened a dime a dozen. For me, it’s a normal part of life.” Bart Hellemans CRO, ING Direct numbers? What is the impact on growth rates in Asia and particularly China? How will this impact Australia? As a consequence of that, what actions will the Reserve Bank take with respect to interest rates? What will be the impact on unemployment? “Once a scenario is defined by those stakeholders, the next step is to translate that scenario into the input drivers for risk.” This includes using a computer model and expert opinion to determine the likelihood of borrowers defaulting on their loans. For example, a default rate of 14% would be historically high and this would have flow- on effects to savings accounts. “If people are defaulting on their loans, they are going to start drawing on their savings to pay off their debts,” Hellemans says. “And then property prices tumble and growth of your business will be different. “There’s a whole exercise about determining what that scenario does on your balance sheet, including capital base and profitability.” The biggest risks Individual banks will have different exposures to segments of the market that change their risk profiles. For example, ME Bank has a higher exposure to retail banking (consumer products such as mortgages, personal loans, credit cards and term deposits) than the big four banks as a result of its focus on members of industry super funds and unions. Susan Mackenzie, ME Bank’s CRO, says this makes the bank more sensitive to changes in the local market. “For us, (the biggest risk) really sits around liquidity and liquidity shock or loss of liquidity in the market,” she says. Rabobank, which specialises in rural banking, faces a similar challenge on liquidity. As Australia’s second largest rural lender, it is particularly exposed to events such as droughts, natural disasters and commodity price movements. One thing that Australian banks have in common is their exposure to the residential property market. “A substantial part of all of the major
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GRC Autumn 2012