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Setting Counterparty Limits

Setting Counterparty Limits

Risk models only have value if they are used effectively in combination with a limit management and control process. While a control function requires and relies on reports, the key is not generation of quantitative numbers, formatted in ten different variations and cuts; it is the interpretation and application of that analysis that matters.

The objective of a risk function is to not just gather data, run reports, submit and analyze them; it is to ensure that unpleasant surprises and their impacts are limited. While you can’t control the timing and magnitude of such surprises, a well managed and well run risk function can help manage expectations as well as plan ahead for unexpected shocks. Limits play a major role in achieving that objective.

 

Topics covered:

  1. Core principles of limit setting
  2. Risk limits and control process
  3. A brief overview of the various categories of limits
  4. Hierarchy of limits
  5. Reporting and exception review process, including early warning indicators, exception reports and management action triggers
  6. Categories of limit exceptions
  7. An illustration of capital loss and stop loss limits
  8. An illustration of VaR limits
  9. An illustration of VaR-based regulatory approach limits
  10. Illustrations of duration, convexity and PVBP limits
  11. Credit Risk Limits such as Pre-settlement risk and Financial institution and concentration limits
  12. Application of limits to various money market, forex market and capital market products
  13. Limits for Liquidity Risk
  14. Limits for Interest Rate Risk
  15. Exception handling and Sample action plan for trigger zones

 

The Calculating Value at Risk (VaR) course is a pre-requisite to some of the measures mentioned above. It is therefore included in the PDF note as an annexure.

This pre-package study note also includes a sample credit appraisal and counterparty limit proposal document for a local bank. The document covers the following topics:

  1. Financial Institution Credit Appraisal summary showing capital adequacy ratios and rating agency ratings and the recommended credit limit proposed
  2. Executive summary giving an overview of the bank analysis, peer group analysis and sovereign analysis conducted
  3. Bank’s Profile
  4. Bank’s Shareholding and Management structure
  5. Credit Ratings from Rating Agencies including their reasoning for assigning these rating
  6. Sovereign ratings including the reasoning for assigning this rating
  7. Financial analysis including an analysis of the financial statements (auditor’s report, balance sheet analysis by amount and % of Total Assets, trend in balance sheet items, earnings analysis by amount and % change over last period, trend in P&L statement items), and peer group and banking sector analysis
  8. Commentary to financial analysis for total assets, liabilities and equities, advances-to-deposits ratio, contingent liabilities, related party transactions, capital adequacy, net income for the year, returns on assets and equity
  9. Advances and Non-performing assets analysis including trends in NPL, industry wise share of NPL, NPL provision coverage, net NPL to advances ratios, and sector, geographical, foreign exchange exposures/ concentrations in total advances
  10. Business plans of and recent news regarding the bank
  11. Sovereign outlook including socio-political outlook and macroeconomic indicators
  12. Conclusions – Key risks identified for the bank after the analysis
  13. Annexure – Board of directors and key management personnel profiles, past and projected balance sheets and profit and loss statements, credit exposure details, country/ sovereign outlook details, peer group and banking sector analysis details

EXCEL file:

The pre-packaged deal also includes one EXCEL file that demonstrates the calculation/ setting of the Pre-settlement Risk (PSR) counterparty limit.

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