Bank of Montreal 2014 Annual Report Download - page 73

MD&A
MANAGEMENT’S DISCUSSION AND ANALYSIS
and unexpected losses to assess the extent and correlation of risk
before authorizing new exposures. Economic Capital methods and model
inputs are reviewed and/or recalibrated on an annual basis, as appli-
cable. Our Economic Capital models provide a forward-looking estimate
of the difference between our maximum potential loss in economic (or
market) value and our expected loss, measured over a specified time
interval and using a defined confidence level. Both expected and
unexpected loss measures for a transaction or a portfolio reflect current
market conditions and credit quality.
Stress Testing
Stress testing is a key element of our risk and capital management
frameworks. It is linked to our risk appetite and informs our strategy,
business planning and decision-making processes.
Governance of the stress testing framework resides with senior
management, including the Enterprise Stress Testing Steering
Committee. This committee is comprised of business, risk and finance
executives and is accountable to the RMC for the oversight of BMO’s
stress testing framework and for reviewing and challenging stress test
results. Stress testing and enterprise-wide scenarios associated with the
Internal Capital Adequacy Assessment Process (ICAAP), including
recommended actions that the organization would likely take to
manage the impact of the stress event, are presented to senior
management and the Board of Directors. Stress testing associated with
the Comprehensive Capital Analysis and Review (CCAR) and the mid-
year Dodd-Frank Capital Stress Test (DFAST) – which are U.S. regulatory
requirements for BMO Financial Corp. – is similarly governed.
Enterprise Stress Testing
Enterprise stress testing supports our internal capital adequacy assess-
ment and target-setting through analysis of the potential effects of
low-frequency, high-severity events on our balance sheet, earnings,
liquidity and capital positions. Scenario selection is a multi-step process
that considers the enterprise’s material and idiosyncratic risks and the
potential impact of new or emerging risks on our risk profile, as well as
the macroeconomic environment. Scenarios may be defined by senior
management, the Board of Directors or regulators, and are developed in
conjunction with the Economics group. The Economics group translates
the scenarios into macroeconomic and market variables that include but
are not limited to GDP growth, yield curve estimates, unemployment,
housing starts, real estate prices, stock index growth and changes in
corporate profits. The scenarios are then executed by our operating, risk
and finance groups.
Quantitative models and qualitative approaches are utilized to
assess the impact of changes in the macroeconomic environment on our
income statement and balance sheet and the resilience of our capital
over a forecast horizon. Stress test results, including mitigating actions,
are benchmarked and challenged by relevant business units and senior
management, including the Enterprise Stress Testing Steering
Committee.
Ad Hoc Stress Testing
Through our stress testing framework, we embed stress testing in our
strategy, business planning and decision-making. Ad hoc stress testing is
conducted regularly by our operating and risk groups to support risk
identification, business analysis and strategic decision-making.
Credit and Counterparty Risk
Credit and counterparty risk is the potential for loss due to the
failure of a borrower, endorser, guarantor or counterparty to repay
a loan or honour another predetermined financial obligation.
Credit and counterparty risk exists in every lending activity that BMO
enters into, as well as in the transacting of trading and other capital
markets products, the holding of investment securities and the activities
related to securitization. Credit risk is the most significant measurable
risk BMO faces. Proper management of credit risk is essential to our
success, since the failure to effectively manage credit risk could have an
immediate and significant impact on our earnings, financial condition
and reputation.
Credit and Counterparty Risk Governance
The objective of our credit risk management framework is to ensure all
material credit risks to which the enterprise is exposed are identified,
measured, managed, monitored and reported. The RRC has oversight of
the management of all risks faced by the enterprise, including the credit
risk management framework. BMO’s credit risk management framework
incorporates governing principles defined in a series of corporate policies
and standards, which flow through to more specific guidelines and
procedures. These are reviewed on a regular basis and modified when
necessary to keep them current and consistent with BMO’s risk appetite.
The structure, limits, collateral requirements, ongoing management,
monitoring and reporting of our credit exposures are all governed by
these credit risk management principles.
Lending officers in the operating groups are accountable for
recommending credit decisions based on the completion of appropriate
due diligence, and they assume ownership of the risks. Credit officers in
ERPM approve credit decisions and are accountable for providing an
objective assessment of lending decisions and independent oversight of
the risks assumed by the lending officers. All of these experienced and
skilled individuals are subject to a rigorous lending qualification process
and operate in a disciplined environment with clear delegation of
decision-making authority, including individually delegated lending
limits, all of which are reviewed annually. Credit decision-making is
conducted at the management level appropriate to the size and risk of
each transaction in accordance with comprehensive corporate policies,
standards and procedures governing the conduct of credit risk activities.
Corporate Audit Division reviews and tests management processes
and controls and samples credit transactions for adherence to credit
terms and conditions, as well as to governing policies, standards and
procedures.
All credit risk exposures are subject to regular monitoring. Per-
forming accounts are reviewed on a regular basis, with most commercial
and corporate accounts reviewed at least annually. The frequency of
review increases in accordance with the likelihood and size of potential
credit losses, with deteriorating higher-risk situations referred to speci-
alized account management groups for closer attention, when appro-
priate. In addition, regular portfolio and sector reviews are carried out,
including stress testing and scenario analysis based on current, emerging
or prospective risks. Reporting is provided at least quarterly to the Board
and senior management committees, in order to keep them informed of
developments in our credit risk portfolios, including changes in credit risk
concentrations and significant emerging credit risk issues, and to ensure
appropriate actions can be taken where necessary.
Credit and Counterparty Risk Management
Collateral Management
Collateral is used for credit risk mitigation purposes and minimizes
losses that would otherwise be incurred. Depending on the type of
borrower, the assets available and the structure and term of the credit
obligations, collateral can take various forms. For corporate and
Material presented in a blue-tinted font above is an integral part of the 2014 annual consolidated financial statements (see page 77).
84 BMO Financial Group 197th Annual Report 2014