HSBC 2011 Annual Report Download - page 219

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Overview Operating & Financial Review Corporate Governance Financial Statements Shareholder Information
completing the satisfactory settlement of the transaction. Three approaches to calculating counterparty credit risk
and determining exposure values are defined by Basel II: standardised, mark-to-market and internal model
method. These exposure values are used to determine capital requirements under one of the credit risk
approaches: standardised, IRB foundation and IRB advanced.
We use the mark-to-market and internal model method approaches for counterparty credit risk. Our longer-term
aim is to migrate more positions from the mark-to-market to the internal model method approach.
• Securitisation
Securitisation positions are held in both the trading and non-trading book. For non-trading book securitisation
positions, Basel II specifies two methods for calculating credit risk requirements, these being the standardised
and IRB approaches. Both approaches rely on the mapping of rating agency credit ratings to risk weights, which
range between 7% and 1,250%. Positions that would otherwise be weighted at 1,250% are deducted from capital.
Within the IRB approach, we use the Ratings Based Method for the majority of our non-trading book
securitisation positions, and the Internal Assessment Approach for unrated liquidity facilities and programme-
wide enhancements for asset-backed securitisations.
Following the implementation of Basel 2.5, the majority of securitisation positions in the trading book are treated
for capital purposes as if they are held in the non-trading book under the standardised or IRB approaches. Other
traded securitisation positions, known as correlation trading, are treated under an internal model approach
approved by the FSA.
Market risk capital requirement
The market risk capital requirement is measured using internal market risk models where approved by the FSA, or
the FSA’s standard rules. Following the implementation of Basel 2.5, our internal market risk models comprise VAR,
stressed VAR, incremental risk charge and correlation trading under the comprehensive risk measure.
Operational risk capital requirement
Basel II includes a capital requirement for operational risk, again utilising three levels of sophistication. The capital
required under the basic indicator approach is a simple percentage of gross revenues, whereas under the standardised
approach it is one of three different percentages of gross revenues allocated to each of eight defined business lines.
Both these approaches use an average of the last three financial years’ revenues. Finally, the advanced measurement
approach uses banks’ own statistical analysis and modelling of operational risk data to determine capital
requirements. We have adopted the standardised approach in determining our operational risk capital requirements.
Pillar 2 capital requirements
We conduct an Internal Capital Adequacy Assessment Process (‘ICAAP’) to determine a forward looking assessment
of HSBC’s capital requirements given its business strategy, risk profile, risk appetite and capital plan. This process
incorporates the risk management processes and governance of the firm. A range of stress tests are applied to our
base capital plan. These coupled with our economic capital framework and other risk management practices are used
to assess HSBC’s internal capital adequacy requirements.
The ICAAP is examined by the FSA as part of the FSA’s Supervisory Review and Evaluation Process, which occurs
periodically to enable the FSA to define the Individual Capital Guidance or minimum capital requirements for
HSBC.
Pillar 3 disclosure requirements
Pillar 3 of Basel II is related to market discipline and aims to make firms more transparent by requiring them to
publish specific, prescribed details of their risks, capital and risk management under the Basel II framework. Our
Pillar 3 disclosures for the year ended 31 December 2011 are published as a separate document on the Group Investor
Relations website.