ING Direct 2009 Annual Report Download - page 245

Model Disclosures
The underlying formulas and models that are used for determining Economic Capital for credit and transfer risk are similar to those used for
determining the level of regulatory capital that is required under Basel II (Pillar 1). Despite the fact that the same underlying formulas are used,
(internal) Economic Capital and regulatory capital are not the same, due to various specific rules imposed by Basel II, such as regulatory caps
and floors, and the use of the standardised approach for certain portions of ING’s portfolio. These differences are permitted under the Basel II
guidelines.
The table below summarises different capital measures used for different purposes and shows the difference in key elements and purposes.
Credit Risk Capital
Measurements Methodology Location Confidence level Inputs Purpose
Regulatory Capital Basel II Formula Vortex Basel Engine
(‘VBE’) in the Central
Risk Database
99.90% Basel II model outputs RWA
Economic Capital Risk Adjusted Capital
(RAC) Closed Algebraic
Formula
Vortex Risk Engine
(‘VRE’) in the Central
Risk Database
99.95% Basel II model outputs
excluding Basel II caps
and floors, maturity,
repayment schedules,
correlation factors,
migration matrix.
Some inputs come from
EC-MC portfolio
calculator but with
99.95% confidence level
country and industry.
Pricing, Economic
Capital for credit at
transactional level and
above
Capital and
earnings at risk
Monte Carlo simulation
based on aggregate
portfolio (‘EC-MC
portfolio calculator’)
Stand alone tool using
same data from Central
Datawarehouse as VRE
90.00% Basel II model outputs
excluding Basel II caps
and correlation factors,
migration matrix
country and industry.
Risk Dashboard at Line
of Business Level and
above
With regard to methodology, the EC-MC Portfolio calculator provides a sophisticated and consistent framework to measure capital
numbers for credit risk. Because of its complexity and required calculation time the EC-MC Portfolio calculator is more suited for portfolio
calculation, rather than to be implemented in an environment requiring real time reporting at a transactional level for day-to-day
management, pricing of new transactions and limit setting. As a result, Economic Capital figures are based on RAC figures that are derived
from the EC-MC Portfolio calculator but are not fully equivalent. The main characteristics are:
RAC is calculated at facility level with closed algebraic formulas rather than from a Monte Carlo Simulation. The RAC algebraic formula •
includes parameters which incorporate the impact of portfolio dynamics, such as correlations and diversification effects. These
parameters are derived through a regression of the outputs of the EC-MC portfolio calculator;
Due to its proprietary nature the inputs in the EC-MC Portfolio calculator are subject to certain technical caps and floors (LGD/EAD is •
constant and PD migration matrix is capped) which are not applicable in RAC. Also, due to the implemented mathematical routines the
EC-MC portfolio calculator is subject to a minimum Probability of default (PD) and maximum tenor, which are not applicable in RAC.
Additionally the banking operations use the RAC model for determining the optimal pricing on (new) lending transactions in order to
ensure that ING meets its desired RAROC returns.
During 2009, the Economic Capital levels for credit and transfer risk were calculated on a daily basis for most of the Commercial Bank and
ING Direct investment portfolios and for the SME portfolios within the Retail banking operations. For consumer loans, residential
mortgages, credit cards, and the insurance portfolios, the calculations are made on a monthly basis. On a quarterly basis, the Economic
Capital for credit risk and transfer risk figures are consolidated with the corresponding Economic Capital components from other
disciplines.
Governance of Economic Capital for Credit and Transfer Risk
All PD, EAD and LGD models are approved by the Credit Risk Committee (CRC) after thorough review of documentation by the Model
Development Steering Committee (MDSG) and MV. In addition, each model is validated on an annual basis by MV. Each model has both a
credit risk and a front office co-sponsor. Both the MDSG and the CRC have participation from both credit risk officers as well as the front
office to ensure maximum acceptance by the organisation.
MARKET RISK BANK
General
Economic Capital for market risk is the Economic Capital necessary to withstand unexpected value movements due to changes in market
variables, such as interest rates, equity prices, foreign exchange rates and Real Estate prices. Economic Capital for market risk is calculated
for exposures both in trading portfolios and non-trading portfolios.
2.1 Consolidated annual accounts
Risk management (continued)
ING Group Annual Report 2009 243