Bank of Montreal 2013 Annual Report Download - page 77

MANAGEMENT’S DISCUSSION AND ANALYSIS
Linkages between Balance Sheet Items and Market Risk Disclosures ($ millions)
Below are parts of our consolidated balance sheet that are subject to market risk, showing balances that are mainly subject to traded risk and non-
traded risk measurement techniques.
Market risk measure
2013 2012 Main risk factors for
Traded Non-traded Traded Non-traded non-traded risk
As at October 31 Total risk (1) risk (2) Total risk (1) risk (2) balances
Assets Subject to Market Risk
Interest bearing deposits with banks 6,518 1,511 5,007 6,341 2,226 4,115 Interest rate
Securities
Trading (3)(4) 75,159 69,393 5,766 70,109 62,599 7,510 Interest rate
Available for sale 53,067 27,817 25,250 56,382 31,029 25,353 Interest rate
Held to maturity 6,032 – 6,032 875 – 875 Interest rate
Other 723 – 723 958 – 958 Equity
Securities borrowed or purchased under resale agreements 39,799 39,799 – 47,011 47,011 – Interest rate
Loans and acceptances (net of allowance for credit losses) 279,095 – 279,095 253,835 – 253,835 Interest rate,
foreign exchange
Derivative instruments 30,259 29,484 775 48,071 46,575 1,496 Interest rate,
foreign exchange
Other assets (4) 8,971 828 8,143 10,338 1,525 8,813 Interest rate
Liabilities Subject to Market Risk
Deposits 366,821 5,928 360,893 323,702 4,301 319,401 Interest rate,
foreign exchange
Derivative instruments 31,974 31,184 790 48,736 48,163 573 Interest rate,
foreign exchange
Acceptances 8,472 – 8,472 8,019 – 8,019 Interest rate
Securities sold but not yet purchased 22,446 22,446 – 23,439 23,439 – Interest rate
Securities lent or sold under repurchase agreements 28,884 28,884 – 39,737 39,737 – Interest rate
Other liabilities (4) 42,212 2,176 40,036 46,596 3,981 42,615 Interest rate
Subordinated debt 3,996 – 3,996 4,093 – 4,093 Interest rate
Capital trust securities 463 – 463 462 – 462 Interest rate
MD&A
(1) Includes BMO’s balance sheet items subject to the trading and underwriting risk management framework.
(2) Includes BMO’s balance sheet items subject to the structural balance sheet and insurance risk management framework.
(3) Includes securities designated at fair value through profit or loss.
(4) Includes balances relating to our insurance business.
Trading and Underwriting Market Risk
To capture the multi-dimensional aspects of market risk effectively, a
number of metrics are used, including VaR, SVaR, stress testing, sensitiv-
ities, position concentrations, market and notional values and revenue
losses.
VaR and stress testing are estimates of portfolio risk, but have
limitations. Among the limitations of VaR is the assumption that all
positions can be liquidated within the assigned one-day holding period
(ten-day holding period for regulatory calculations), which may not be
the case in illiquid market conditions, and that historical data can be
used as a proxy to predict future market events. Generally, market
liquidity horizons are reviewed for suitability and updated where appro-
priate for relevant risk metrics. Scenario analysis and probabilistic stress
testing are performed daily to determine the impact of unusual and/or
unexpected market changes on our portfolios. As well, historical and
event stresses are tested on a weekly basis, including tests of scenarios
such as the stock market crash of 1987 and the collapse of Lehman
Brothers in 2008. Ad hoc analyses are run to examine our sensitivity to
low-frequency, high-severity hypothetical scenarios. Scenarios are
amended, added or deleted to better reflect changes in underlying
market conditions. The results are reported to the lines of business, RMC
and RRC on a regular basis. Stress testing is limited by the number of
scenarios that can be run, and by the fact that not all downside
scenarios can be predicted and effectively modelled. Neither VaR nor
stress testing is viewed as a definitive predictor of the maximum
amount of losses that could occur in any one day, because both meas-
ures are computed at prescribed confidence levels and their results
could be exceeded in highly volatile market conditions. On a daily basis,
exposures are aggregated by lines of business and risk type and moni-
tored against delegated limit levels, and the results are reported to the
appropriate stakeholders. BMO has a robust governance process in place
to ensure adherence to delegated market risk limits. Amounts exceeding
established limits are communicated to senior management on a timely
basis for resolution and appropriate action.
Within the Market Risk group, the Valuation Product Control (VPC)
group is responsible for independent valuation of all trading and
available-for-sale portfolios within Capital Markets Trading Products and
Corporate Treasury, to ensure that they are materially accurate by:
‰ developing and maintaining valuation adjustment policies and proce-
dures in accordance with regulatory requirements and IFRS;
‰ establishing official rate sources for valuation of all portfolios; and
‰ providing an independent review of portfolios where trader prices are
used for valuation. This would include instruments accounted for on a
trading and AFS basis.
VPC processes include all OTC and exchange-traded instruments that are
booked, including both trading and AFS securities.
Trader valuations are reviewed to determine whether they align
with an independent assessment of the market value of the portfolio. If
the valuation difference exceeds the prescribed tolerance threshold, a
valuation adjustment is recorded in accordance with our accounting
policy and regulatory requirements. Prior to the final month-end general
ledger close, meetings are held between key stakeholders from the
lines of business, Market Risk, Capital Markets Finance and the Chief
Accountant’s Group to review all valuation adjustments that are estab-
lished by the Market Risk group.
The Valuation Steering Committee is BMO’s senior management
valuation committee. It meets at least quarterly to address the more
challenging material valuation issues in BMO’s portfolios and acts as a
key forum for discussing positions categorized as Level 3 for financial
reporting purposes and their inherent uncertainty.
Material in blue-tinted font above is an integral part of the 2013 annual consolidated financial statements (see page 77).
88 BMO Financial Group 196th Annual Report 2013