Bank of Montreal 1997 Annual Report Download - page 50

Bank of Montreal 180th Annual Report 199744
Derivatives
We use financial derivatives to manage position risk, for both trading
and hedging purposes. We offer derivative products to customers for
their own risk management and investment purposes. These contracts
can either be exchange traded (such as futures and some types of
options) or over-the-counter transactions including interest rate and
cross-currency swaps, forward rate agreements (FRAs), caps and
floors, as well as other types of options
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.
The two primary risks arising from the use of derivative products are
credit risk and position risk. These risks are described, managed and
measured as stated earlier.
For regulatory purposes, we also calculate the credit risk equivalent for
our interest rate and foreign exchange derivative contracts on a BIS basis.
This includes the cost of replacing, at current market rates, all contracts
which have positive fair value, plus the potential for future changes based
on a formula using parameters prescribed by the Office of the Superin-
tendent of Financial Institutions (OSFI). Our internal parameters are more
conservative than those prescribed by OSFI. The credit risk equivalent as
at October 31, 1997 was $8.0 billion as compared to $11.2 billion in 1996.
Additional disclosure with regard to derivatives is found in note 20 to
the consolidated financial statements.
Liquidity Risk
The measurement of liquidity risk focuses primarily on the
proportion of liquid assets to total assets. A discussion
of our performance relative to this measure, as well as our
approach to liquidity management, is located on page 50.
Operational Risk
The financial measure of operational risk is actual losses
incurred. No material losses were incurred in 1997 or 1996.
An indirect subsidiary of the Bank has been named as
a defendant in legal actions which we describe on page 82
of the consolidated financial statements.
We are currently managing operational risk relating to the
calendar change for the year 2000. The Opera
tions Group
has overall responsibility for converting systems to accommo-
date the calendar change. A plan to implement the required
changes by the end of 1998 has been developed and is being implemented. A governance structure has been established
which includes a Program Management Office and regular monitoring of progress by the Bank’s Technology and
Infrastructure Committee.
1997 Risk Management Highlights
•Our Interest Rate Risk Program was nominated for the ITX award
sponsored by the Conference Board of Canada and
CIO Canada
magazine. The program was recognized for its value, partnership
of business and technology, and innovation.
•We became the only Canadian co-sponsor of CreditMetrics, a credit
risk management initiative designed to facilitate the creation of
further liquidity in the world loan markets. We were invited to be a
co-sponsor because of our leadership in credit risk management.
•A Risk Management Redesign project was launched in 1997 which is
designed to enable us to increase value delivered to our customers
while maintaining the quality of credit decisions. The process
improvement changes recommended by the project team represent
an evolution in the methodologies that have been introduced in credit
risk management in recent years, and will further lever portfolio
management methodologies, increase differentiation between under-
writing and retention risk and reduce transaction processing time.
Risk Management Continued
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Defined in the Glossary on page 90