ING Direct 2009 Annual Report Download - page 221

ING Bank
ING Bank’s capital management positions, i.e. the own funds (core capital) and the investments of these own funds, are isolated in the ING
Bank Corporate Line. ALCO Bank determines the target maturity profile over which ING Bank’s own funds must be invested. This maturity
profile reflects the long term nature of the rate of return required by ING Bank’s investors and aims for both earnings maximisation and
stabilisation. ALCO Bank considers a well balanced portfolio of long-dated fixed income investments as the risk neutral position in its internal
risk transfer framework.
The risk transfer principle forms the basis of ING Bank’s ALM framework. This refers to the principle whereby the outright interest rate risk
resulting from the commercial business is transferred to the ALM books. The interest rate risk from the commercial business arises from the
fact that own originated assets and liabilities do not reprice simultaneously with respect to interest rate characteristics. The transfer of the
outright interest rate risk is to a large degree based on modelling client behaviour. Within CMRM, extensive research is being done in order
to optimise this modelling. For this purpose, several methods are in place to replicate the interest rate risk, taking into account both the
contractual and behavioural characteristics of demand deposits, saving accounts and mortgages. All models and assumptions are back-
tested regularly and results are presented to the designated ALCO.
For the determination of the interest rate sensitivity of savings accounts and current accounts, several methods depending on the focus
of the risk analysis have been developed, e.g. historical simulation, Earnings Sensitivity analysis and valuation models. Pricing strategies,
outstanding volumes and the level and shape of the yield curve are taken into account in these models. Based on these analyses,
investment rules are determined for the various portfolios.
The hedging of the embedded prepayment options within mortgage portfolios is based on prepayment prediction models. These models
include the incentive for clients to prepay. The parameters of these models are based on historical data and are regularly updated. The
interest sensitivity of the embedded offered rate options for the mortgage portfolio is determined as well and a hedging process is in place
to minimise the resulting interest rate risk.
After transferring the outright interest rate risk position to the ALM books, the residual interest rate risk that remains in the commercial
banking books is caused by basis risk and optionality. The commercial business units bear responsibility for these residual interest rate risks
that result from banking products of which future cash flows depend on client behaviour (e.g. optionality in mortgages) and from banking
products of which the client rate earned and paid imperfectly correlate with the changing market rates (basis risk). Examples of products
in which these risks are inherent are current accounts, saving accounts and mortgages.
Within ING Direct the interest rate risk is managed and measured at the level of the local ING Direct entities. The interest rate risk
that remains in the ING Direct entities also largely results from basis risk and optionality as the outright interest rate risk is to a large
extent hedged.
The ALM books are managed within ING Commercial Banking and contain the strategic interest rate risk position of ING Bank. The main
objective is to maximise the economic value of the book and to generate adequate and stable yearly earnings within the risk appetite
boundaries of ING Bank.
In the following sections, the risk figures for interest rate risk in the banking books are presented. In line with the group risk metrics, ING
Bank uses several risk measures to manage interest rate risk both from an earnings and a value perspective. Earnings Sensitivity (ES) is used
to provide the earnings perspective and the Net Present Value (NPV)-at-Risk and Basis Point Value (BPV) figures provide the value
perspective. Several small banking books are governed by the trading risk process and are therefore excluded from the following banking
book risk tables. These are included in the trading risk graph and table under ‘Market Risk in Trading Books’.
Earnings Sensitivity (ES)
ES measures the impact on (pre tax) IFRS earnings resulting from changes of market interest rates over a time period of one year.
Management interventions are not incorporated in these calculations; balance sheet dynamics (e.g. new business) only where significant.
The ES figures in the table below are determined on the basis of an instantaneous upward 1% parallel shock in market rates. After the
shock the market rates are assumed to remain stable for the next 12 months. For the ALM books ES measures the potential loss of earnings
due to the structural mismatch in interest rate positions. The calculations for the ALM books capture the ES resulting from the current
positions. For the commercial banking books the ES captures the interest rate risks resulting from savings, current accounts and the main
mortgage portfolios. The impact of new business is included in the ES calculations for the savings and demand deposits portfolios, as it is
most relevant for these portfolios. The ES of the Corporate Line, i.e. the investment of ING Bank’s equity capital, reflects the interest risk
profile of the investments only.
2.1 Consolidated annual accounts
Risk management (continued)
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