ICAAP: Internal Capital Adequacy Assessment – Sample ICAAP report format and table of content

Here is a sample ICAAP (Internal Capital Adequacy Assessment Process) Document Table of Content and Executive Summary.  While there are a number of designs for the ICAAP submission document, the approach we have taken works through the list of primary risks and highlights the implication for the capital plan of the organization based on risk capital calculations. To download a pdf version of the full report as well as the excel file used to generate this analysis please see the online finance course store.

ICAAP Document – Executive Summary

The primary objective of this document is to assess external and internal capital requirements based on the bank’s core business and the prevailing and projected operating environment for the financial services sector. While there are multiple risk factors a bank is exposed to, the scope of this document is limited to the impact of capital adequacy of a few select factors that have been quantified and translated into risk requirements. These factors are:

  1. Credit Risk
  2. Market Risk
  3. The risk of interest rate mismatch
  4. Liquidity risk
  5. Operational risk
  6. Strategic risk
  7. Concentration Risk
  8. Reputational risk
  9. Legal risk

Methodology

Overview

We have used published balance sheets as at 31st December 2007 and 31st December 2008 and then used detailed account level data from January 2009 till 30th June 2009 to evaluate internal and external capital adequacy for the bank for the next 12-18 months. Given the level of our exposures to credit and market risk a large part of this report is devoted to reviewing the risk profile of these two components of our balance sheet. The essence of our analysis is based on identifying primary drivers of capital requirements for a risk area and then estimating the amount of capital required over the next 12 – 36 months. A more detailed review follows.

Approach – Credit Risk Capital Allocation

Our internal capital adequacy assessment for credit risk includes four primary pieces. The first is capital adequacy calculations using the SBP approved standardized approach. We call this our baseline capital estimate. This is the same as our MCR calculations submitted to the central bank on a quarterly basis. The second is capital requirements on account of factors that have very little expected deviation given the current economic environment. Even though this layer of capital is not currently utilized it is expected that over the next 12 months there is a reasonable chance that it will be allocated. We call this layer expected capital requirement. Our third layer is projected based on recent historical experiences and current infection trends in our portfolio using rating history, transition matrices and current exposures. We call this layer projected capital requirement. Our fourth layer is based on expected best and worst case annualized earnings and profitability analysis by stress testing our credit book. While the second and third layers are provisions based, the last layer is driven by stress on capital caused by expected and unexpected losses. We call this the critical condition capital requirement. Our total capital requirement used for internal capital adequacy analysis is the maximum of the first two layers and the sum of the last two layers. Though it is unlikely that all four layers will be utilized in the near future, the comparison ensures that capital is not double counted.

Approach – Market Risk Capital Allocation

Our internal capital adequacy calculations for market risk also uses five primary pieces. The first is capital adequacy calculations using the SBP approved standardized approach. We call this our baseline capital estimate. This is the same our MCR calculations submitted to the central bank on a quarterly basis. The second is capital requirements on account of factors that have very little expected deviation given the current economic environment. Even though this layer of capital is not currently utilized it is expected that over the next 12 months there is a reasonable chance that it will be allocated and used. We call this layer expected capital requirements and it is based on a Value at Risk (VaR) estimate calculated at 55% level of confidence assuming a 10 day trading horizon using 365 days of historical data. Our third layer is projected based on historical experiences and current trends using the composition and historical volatility of our market risk portfolio. Similar to the second layer, this layer is also driven by a Value at Risk model. The choice of parameters however is more extreme. We call this layer projected capital requirements. It is based on a Value at Risk (VaR) estimate calculated at 99% level of confidence assuming a 10 day holding period using 365 days of historical data. This layer is the same as the capital charge calculated by the Internal Models Approach (IMA) for market risk. Our fourth layer is based on stress testing the third layer. While Value at Risk (VaR) gives a probable threshold beyond which losses are less likely to occur, the fourth layers estimates the capital requirements if this threshold is breached. We call this critical condition capital. Our last and final layer is based on carrying cost analysis of our entire investment inventory in capital markets as well as money markets and a comparison of the historical income generation of our investment portfolio with carrying costs. For Internal Capital Adequacy assessment we use the greater of the regulatory charge and the IMA charge and add on the expected and critical condition capital charges.

Approach – Interest Rate Mismatch Capital Allocation

Our internal capital adequacy calculations for interest rate mismatch risk include the following components. A Capital at Risk charge based on Market Value of Equity calculations that use duration gap estimates to discover the net change in shareholders equity due to interest rate movements on account of balance sheet gaps. We also compare this charge with Earnings at Risk charge based on Net Interest Income at Risk calculations that use the worst case interest rate shock to determine the impact of interest rate movements on the earnings of the bank.

Approach – Liquidity Risk Capital Allocation

We use the cost to close and liquidity gap calculations to assess the overall impact of a liquidity crisis on our balance sheet and capital adequacy levels.

Approach – Concentration Risk Capital Allocation

We use the HHI Index to calculate concentration levels over reporting periods by sectors and counterparties. As the HHI index crosses a ladder of critical threshold we allocate a portion of the overall exposure as supporting capital to offset our concentration risk. In addition to HHI analysis, we also review the distribution of our portfolio across rating grades by products, sectors and amounts. Once again if the skew of the distribution crosses a certain threshold we allocate a portion of the overall exposure to support the unwanted distribution skewness.

Approach – Operational Risk Capital Allocation

We use the basic indicator approach to allocation operational risk capital for our operational risk exposures. However given the nature of our business as a development finance institution and the absence of an extensive branch network, foreign exchange exposure, limited transaction liability products without checking accounts and retail customers, a number of traditional sources of operational risk are absent from our core business.

Approach – Reputational and Legal Risk Capital Allocation

We can borrow funds at KIBOR plus a premium. The primary impact of a “name” crisis is on our funding costs as an institution. We also evaluate our outstanding legal cases instituted by us or against us and the impact as well as likelihood of a judicial judgment against us.

Approach – Strategic Risk Capital Allocation

Under strategic risk, we analyze the following cases:

  1. Restricting our current NPL’s from further downgrade.
  2. Ensuring that no additional non-performing exposure occurs in our core credit portfolio, especially in troubled sectors and industries.
  3. Expansion in other product areas such as venture capital funding and investments.
  4. Ensuring that our carrying cost for our investment portfolio remain within reasonable limits with respect to the expected earning and profitability potential of our investments.

Approach – Other Risk Factors

Risk Aggregation:

Credit Risk:

Credit Risk – Regulatory Risk Weighted Assets Capital Charge
30-Jun-09 18,580,075,509 1,486,406,041
31-Dec-08 20,088,359,023 1,607,068,722
31-Dec-07 24,793,467,817 1,983,477,425
Total for 2009 18,580,075,509 1,486,406,041

Figure 1: Credit Risk – Regulatory

Credit Risk – Internal Assessment Risk Weighted Assets Capital Charge
Layer One – Regulatory Capital 18,580,075,509 1,486,406,041
Layer Two – Expected Transitions 6,047,277,377 483,782,190
Layer Three – Projected Transitions 15,206,060,198 1,216,484,816
Layer Four – P&L impact 25,146,580,508 2,011,726,441
Internal Capital Assessment 33,786,135,707 2,702,890,857

Figure 2: Credit Risk – Internal Assessment

Market Risk:

Market Risk – Regulatory Risk Weighted Assets Capital Charge
30-Jun-09 9,934,561,697 794,764,936
31-Dec-08 12,482,411,341 998,592,907
31-Dec-07 16,481,234,073 1,318,498,726
Total for 2009 9,934,561,697 794,764,936

Figure 3: Market Risk – Regulatory

Market Risk – Internal Assessment Risk Weighted Assets Capital Charge
Layer One – Regulatory capital 9,934,561,697 794,764,936
Layer Two – Expected loss 1,125,000,000 90,000,000
Layer Three – VaR IMA 6,150,012,500 492,001,000
Layer Four – Put premium 1,250,000,000 100,000,000
Total 12,309,561,697 984,764,936

Figure 4: Market Risk – Internal Assessment

Operational Risk

Operational Risk Risk Weighted Assets Capital Charge
Gross Income BIA 5,881,991,987 470,559,359
Total 5,881,991,987 470,559,359

Figure 5: Operational Risk

Liquidity Risk

Liquidity Risk Risk Weighted Assets Capital Charge
Cost to close liquidity gap 6,193,836,170 495,506,894
Total 6,193,836,170 495,506,894

Figure 6: Liquidity Risk

Interest Rate Mismatch Risk

Interest Rate Mismatch Risk Risk Weighted Assets Capital Charge
Fall in MVE @ 99% 3,914,422,545 313,153,804
Total 3,914,422,545 313,153,804

Figure 7: Interest Rate Mismatch Risk

Concentration Risk

Concentration Risk Risk Weighted Assets Capital Charge
Credit Industry Concentration 1,156,109,580 92,488,766
Equity Sector Concentration 1,170,834,722 93,666,778
Money Market Sector Concentration 1,826,565,758 146,125,261
Total 4,153,510,060 332,280,805

Figure 8: Concentration Risk

Aggregation

Capital Adequacy: Regulatory – Pillar I Risk Weighted Assets Capital Charge
Credit Risk 18,580,075,509 1,486,406,041
Market Risk 9,934,561,697 794,764,936
Operational Risk 5,881,991,987 470,559,359
Total 34,396,629,193 2,751,730,335
Eligible Capital 6,000,000,000
Regulatory Adequacy 17.44%

Figure 9: Regulatory

Capital Adequacy for Pillar I

Capital Adequacy: Regulatory – Pillar II Risk Weighted Assets Capital Charge
Credit Risk 18,580,075,509 1,486,406,041
Market Risk 9,934,561,697 794,764,936
Operational Risk 5,881,991,987 470,559,359
Liquidity Risk 6,193,836,170 495,506,894
Interest Rate Mismatch 3,914,422,545 313,153,804
Concentration Risk 4,153,510,060 332,280,805
Total 48,658,397,968 3,892,671,837
Eligible Capital 6,000,000,000
Regulatory Adequacy 12.33%

Figure 10: Regulatory

Capital Adequacy for Pillar II

Capital Adequacy: Internal Assessment Risk Weighted Assets Capital Charge
Credit Risk 33,786,135,707 2,702,890,857
Market Risk 12,309,561,697 984,764,936
Operational Risk 5,881,991,987 470,559,359
Liquidity Risk 6,193,836,170 495,506,894
Interest Rate Mismatch 3,914,422,545 313,153,804
Concentration Risk 4,153,510,060 332,280,805
Total 66,239,458,166 5,299,156,653
Eligible Capital 6,000,000,000
Regulatory Adequacy 9.06%

Figure 11: Internal Capital Adequacy

Table of Contents

1. ICAAP Document review 2. Methodology

  • Overview
  • Approach – Credit Risk Capital Allocation
  • Approach – Market Risk Capital Allocation
  • Approach – Interest Rate Mismatch Capital Allocation
  • Approach – Liquidity Risk Capital Allocation
  • Approach – Concentration Risk Capital Allocation
  • Approach – Operational Risk Capital Allocation
  • Approach – Reputational and Legal Risk Capital Allocation
  • Approach – Strategic Risk Capital Allocation
  • Approach – Other Risk Factors

3. Risk Aggregation:

  • Credit Risk
  • Market Risk
  • Operational Risk
  • Liquidity Risk
  • Interest Rate Mismatch Risk
  • Concentration Risk
  • Aggregation

4. Credit Portfolio Review:

  • Portfolio composition
  • Customer base
  • Maturity
  • Concentration

5. Internal Capital Adequacy

  • Summary of Results
  • Credit Risk Capital Adequacy – Baseline capital
  • Credit Risk Capital Adequacy – Internal ratings and rating transitions
  • Putting it together – rating transitions and profitability analysis
  • Worst case provisioning
  • Infection ratios
  • Using DPD analysis for projections
  • Additional supporting capital required
  • Best case provisions
  • Transition matrices by industry and amount
  • Rating grade transitions
  • ICAAP Assumptions
  • Model Parameter Assumptions
  • Data Sources
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Comments

  1. Syed Shuja Hasan September 21, 2010 at 8:03 am

    Hi,

    I am currently working on ICAAP. Can you please send me a sample of complete ICAAP document

    • Administrator September 24, 2010 at 5:18 am

      Dear Shuja Sahib

      A downloadable edition of our sample ICAAP report will be available shortly on the online finance store. I will go ahead and give you a heads up as soon as its up and running.

      Warm regards

      Jawwad

    • Administrator September 25, 2010 at 4:29 pm

      Dear Shuja Sahib

      The ICAAP Executive summary and draft template has now been added to our online store. You can buy it now from the online finance course store.

      Warm regards

      Jawwad

  2. abdulkareem ersan November 22, 2010 at 4:06 pm

    Hi

    I highly appreciate if you send me a complete ICAAP document.

    regards

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