Bank of Montreal 2003 Annual Report Download - page 54

Management’s Discussion and Analysis of Operations and Financial Condition
BMO Financial Group 186th Annual Report 200350
shareholders’ equity, is maintained at a target duration of be-
tween two and three years and embedded options are managed
to low risk levels. Interest rate swaps, options and securities are
the primary tools utilized to manage interest rate risk.
Structural foreign exchange risk arises primarily from trans-
lation risk associated with the net investment in our U.S. opera-
tions, and from transaction risk associated with our U.S. dollar
net income. Translation risk is managed by funding our net
U.S. investment in U.S. dollars. Transaction risk is managed by
entering into foreign exchange forward contract hedges each
quarter that are expected to partially offset the effects of Cana-
dian/U.S. dollar exchange rate fluctuations on the quarter’s net
income. The impact of exchange rate fluctuations on BMO’s
2003 net income is reviewed on page 21.
Structural MVE and EV measures both reflect holding periods
of between one and three months and incorporate the impact
of correlation between market variables. Structural MVE (see
page 48) increased modestly over the past year due to growth in
common shareholders’ equity, while EV continues to be managed
to low levels.
In addition to MVE and EV, simulations, sensitivity analysis,
stress testing and gap analysis, which is disclosed in Table 19 on
page 64, are also used to measure and manage interest rate risk.
Structural interest rate sensitivity to an immediate parallel
increase or decrease of 100 and 200 basis points is disclosed in
Structural Interest Rate Sensitivity ($ millions)*
(After-tax Canadian equivalent) As at October 31, 2003 As at October 31, 2002
Earnings Earnings
Economic sensitivity Economic sensitivity
valueover the next value over the next
sensitivity 12 months sensitivity 12 months
100 basis point increase (202.3) 10.8 (152.7) 1.1
100 basis point decrease 142.7 (17.6) 123.8 (0.1)
200 basis point increase (431.8) 15.7 (354.1) (3.9)
200 basis point decrease 181.2 (61.6) 180.0 (70.7)
*Exposures are in brackets and benefits are represented by positive amounts.
the adjacent table. This sensitivity analysis is performed and
disclosed by many financial institutions and facilitates compar-
ison with our peer group.
Models used to measure structural market risk help forecast
how interest rates and foreign exchange rates may change and
predict how customers would likely react to the changes. These
models have been developed using statistical analysis and are
validated through regular model vetting and backtesting processes
and ongoing dialogue with the lines of business.
For capital calculation purposes, structural market risk capital
at risk is measured using a one-year holding period and a 99.95%
confidence level. Structural market risk capital at risk is allocated
to the lines of business.
Managing liquidity and funding risk is essential to maintaining
both depositor confidence and stability in earnings.
We manage liquidity and funding risk by ensuring that suf-
ficient liquid assets and funding capacity are available to meet
financial commitments, even in times of stress. Our liquidity
and funding risk management framework includes:
▪
oversight by senior governance committees, including the
Liquidity and Funding Management Committee, RMC and RRC;
▪an independent oversight group within Corporate Treasury;
▪an RRC-approved limit structure to support risk management;
▪effective processes and models to monitor and manage risk;
▪strong controls over processes and models and their uses;
▪
a framework of scenario tests for stressed operating condi-
tions; and
▪
contingency plans to facilitate managing through a disruption.
Data provided in this section reflect BMO’s consolidated position.
BMO subsidiaries include regulated and foreign entities and
there fore, movements of funds between companies in the group
are necessarily subject to the liquidity, funding and capital ade-
quacy considerations of the subsidiaries and to tax considerations.
Such considerations do not materially affect BMO’s liquidity
and funding.
BMO’s liquidity and funding position remains sound and there
are no trends, demands, commitments, events or uncertainties
that are reasonably likely to materially impact the position.
We use two primary measures to manage liquidity and funding
risk. The first measure is the cash and securities-to-total assets
ratio. This measure provides an assessment of the extent to which
assets can be readily converted into cash or cash substitutes to
meet financial commitments, as cash resources and securities
are more liquid than loans. The ratio represents the sum of cash
resources and securities as a percentage of total assets. BMO’s
cash and securities-to-total assets ratio at October 31, 2003 was
29.1%, up from 24.9% at October 31, 2002. The increase in the
ratio was primarily attributable to growth in Canadian and U.S.
dollar trading securities.
Cash and securities totalled $74.7 billion at the end of the
year, up from $63.0 billion in 2002, while total assets increased
$3.6 billion to $256.5 billion. In the ordinary course of business, a
Liquidity and Funding Risk
Liquidity and funding risk is the potential for loss if BMO is unable to
meet financial commitments in a timely manner at reasonable prices as
they fall due. Financial commitments include liabilities to depositors and
suppliers, and lending and investment commitments.
20032002200120001999
Core Deposits as a % of
Total Deposits
48.8
56.8
60.0 59.6
57.1
20032002200120001999
Cash and Securities as a % of
Total Assets
29.2
27.8
23.1
24.9
29.1