ING Direct 2011 Annual Report Download - page 235

Risk management continued
ING Bank
Economic Capital for market risk for the mortgage portfolios within ING Retail Banking (Benelux, Direct and International Banking) and ING
Commercial Banking is calculated for embedded option risk (e.g. the prepayment option and offered rate option in mortgages). The embedded
options are hedged using a delta-hedging methodology, leaving the mortgage portfolio exposed to convexity and volatility risk.
Real estate price risk includes the market risks in both the investment portfolio and the development portfolio of ING Real Estate. The real
estate price risk for the investment portfolio is calculated by stressing the underlying market variables. The stress scenarios at a portfolio
level take into account all diversification effects across regions and real estate sectors. Also, the leverage of participations in the real estate
investment funds is taken into account. For the Real Estate development process, in addition to market sale price risk, the risk drivers of
market rent, investor yield and construction delays are taken into account. Furthermore the risk model differs for each development phase
(i.e., research, development, and construction) to appropriately reflect the risk taken in each phase. Using correlations, all risk drivers, and
stages are used to calculate a possible market value loss representing the Economic Capital for market risk for the development portfolio.
While aggregating the different Economic Capital market risk figures for the different portfolios, diversification benefits (based on stressed
correlations) are taken into account as it is not expected that all extreme market movements will appear at the same moment.
The nature of market risk Economic Capital, evaluating the impact of extreme stress with a 99.95% confidence level, can sometimes be
difficult to evidence in a statistical sound manner with the available historical data. The Economic Capital figures disclosed by ING Bank
area best effort estimate based on available data and expert opinions.
Economic and Regulatory Capital (Bank diversified only) by risk type
Economic Capital (1) Regulatory Capital
2011 2010 2011 2010
Market risk 8,262 7,233 1,124 364
(1) this includes model risk
The market risk Economic Capital is higher than the Regulatory Capital primarily due to the inclusion of the interest rate risk banking books
in Economic Capital. The market risk Regulatory Capital includes a stressed VaR charge, while Economic Capital does not. The main drivers
for the increase in market risk Economic Capital are methodology updates. The increase in market risk Regulatory Capital is due to the new
market risk framework Basel 2.5 containing an additional capital charge for Stressed VaR and Incremental Risk.
ING Bank Market Risk in Trading Books
Governance
Within the trading portfolios, positions are maintained in the professional financial markets for the purpose of benefiting from short-term
price movements. Market risk arises in the trading portfolios through the exposure to various market risk factors, including interest rates,
equity prices, foreign exchange rates and credit spreads.
The Financial Markets Risk Committee (FMRC) is the market risk committee that, within the risk appetite set by ALCO Bank, sets market
risk limits both on an aggregated level and on a desk level, and approves new products. MRM advises both the FMRC and ALCO Bank
on the market risk appetite of trading activities.
With respect to the trading portfolios, MRM focuses on the management of market risks of Commercial Banking (mainly Financial
Markets) as this is the only business line where trading activities take place. Trading activities include facilitation of client business, market
making and proprietary position taking in cash and derivatives markets. MRM is responsible for the development and implementation of
trading risk policies and risk measurement methodologies, the reporting and monitoring of risk exposures against approved trading limits
and the validation of pricing models. MRM also reviews trading mandates and limits, and performs the gatekeeper role in the product
review process. The management of trading market risk is performed at various organisational levels, from MRM overall down to specific
business areas and trading offices.
Model Disclosure
Value at Risk
MRM uses the historical simulation Value at Risk (VaR) methodology as its primary risk measure. The VaR for market risk quantifies, with a
one-sided confidence level of 99%, the maximum overnight loss that could occur due to changes in risk factors (e.g. interest rates, equity
prices, foreign exchange rates, credit spreads, implied volatilities) if positions remain unchanged for a time period of one day. Next to
general market movements in these risk factors, VaR also takes into account market data movements for specific moves in e.g. the
underlying issuer of securities. The impact of historical market movements on today’s portfolio is estimated, based on equally weighted
observed market movements of the previous year. ING Bank uses VaR with a 1-day horizon for internal risk measurement, control and back
testing, and VaR with a 10-day horizon for determining regulatory capital.
1 Who we are 2 Report of the Executive Board 3 Corporate governance 4 Consolidated annual accounts 5 Parent company annual accounts 6 Other information 7 Additional information
233ING Group Annual Report 2011