Bank of Montreal 2008 Annual Report Download - page 79

MD&A
BMO Financial Group 191st Annual Report 2008 | 75
The newly created operating group CRO positions help manage
risk on an integrated basis at the business unit level. The operating
group CROs also participate in the senior management leadership team
meetings for each of our businesses.
Stress testing and scenario analysis assist in measuring the impact
on our operations of extreme but plausible operational, political, eco-
nomic, credit and market events. Scenarios designed in collaboration
with our economists, equity research department and risk management
groups are based on historical or hypothetical events, a combination
thereof, or significant economic developments such as a rapid increase
in the value of the Canadian dollar, a real estate downturn or higher
energy costs. These tests and analyses are then applied to all significant
and relevant risk-taking portfolios across the enterprise. As stipulated by
the Basel II Capital Accord, BMO also conducts stress testing of regula-
tory credit capital across all material portfolios using the Advanced
Internal Ratings Based (AIRB) Approach calculation methodology.
We also conduct ongoing stress testing and scenario analysis
designed to test BMO’s credit exposures to a specific industry, to several
industries or to specific products that are highly correlated. These tests
attempt to gauge the effect of various scenarios on default probabilities
and loss rates in the portfolio under review. This provides senior
management with significant insight into the sensitivity of our exposures
to underlying risk characteristics of specific industries.
Basel II
Framework
BMO adopted the Basel II framework effective November 1, 2007.
The framework promotes the adoption of stronger risk management
practices, provides more risk-sensitive regulatory capital requirements,
and promotes the use of an enterprise’s internal estimates. Under
the framework, there are three increasingly risk-sensitive approaches
to the calculation of regulatory capital requirements for credit and
operational risk. The approaches available for the computation of
credit risk are: Standardized, Foundation IRB and IRB Advanced (AIRB).
For operational risk the approaches that may be followed are: Basic
Indicator, Standardized or Advanced Measurement.
BMO has chosen to apply the most advanced AIRB approach for
calculations related to credit risk in our portfolio, except for our sub-
sidiary Harris Bankcorp, Inc., which currently uses the Standardized
Approach. We have adopted the Standardized Approach for calculations
related to operational risk.
BMO Financial Group conducts business through a variety of
corporate structures, including subsidiaries and joint ventures, and
the Basel II framework applies across the entire enterprise.
BMO Financial Group calculates regulatory capital requirements
at the enterprise level, and for the following subsidiaries: Bank of
Montreal Mortgage Corporation and BMO Trust Company. All of BMO’s
subsidiaries must meet the regulatory and legislative requirements
of the jurisdictions in which they operate, which may affect the
deployment of capital within each operating group. A framework is in
place to ensure that subsidiaries and their parent entity have access to
capital and funding as required to support their ongoing operations
under both normal and stressed conditions.
Under the AIRB Approach, risk-weighted assets (RWA) are calculated
based on the internal risk ratings assigned to each exposure (asset).
Parameters used are model-driven, based on historical experience and
other metrics. Models are recalibrated as required, and are subject to
periodic validation and regulatory review and approval.
Under the Standardized Approach, risk weightings are determined
based on the Basel Asset Class and the risk rating of the counterparty.
Basel II Risk-Based Parameters
Exposure at Default (EAD) represents the outstanding amount of
a credit exposure, adding back any specific provisions taken or any
amounts partially written off. For off-balance sheet amounts and
undrawn amounts, EAD includes an estimate of any further
amount that may be drawn at the time of default.
Loss Given Default (LGD) is the amount that may not be recov-
ered in the event of a default, presented as a proportion of the
exposure at default. LGD takes into consideration the amount and
quality of any collateral held.
Probability of Default (PD) represents the likelihood that a credit
obligation (loan) will not be repaid and will go into default. A PD
is assigned to each account, based on the type of facility, the
product type and customer characteristics. The credit history of the
counterparty/portfolio and the nature of the exposure are taken
into account in the calculation of a PD.
Reporting under Basel II is generally by Basel Asset Class and
exposure type. For the calculation of credit risk, BMO’s portfolio can be
broken down into wholesale, retail and non-counterparty managed
assets. Within the wholesale portfolio, the asset classes are: corporate,
specialized lending, banks, sovereign, small and medium enterprises
treated as corporate, securitization and equity. Within the retail portfolio,
the asset classes are: residential mortgages, home equity lines of credit,
qualifying revolving retail (which includes lines of credit and credit
cards), small and medium enterprises treated as retail, and other retail.
The amount of RWA is reflective of risk ratings, risk parameters
and product mix. Table 22 on page 101 provides details by Basel Asset
Class and Risk Type for RWA calculation under the Basel II methodology.
The table below provides a high-level overview of our balance
sheet and corresponding Basel II Asset Class View.
Balance Sheet Accounts
As at October 31 ($ millions) 2008
Cash and other assets 100,917
Securities 100,138
Net loans and acceptances 214,995
Total Assets 416,050
Basel II View of the Balance Sheet
As at October 31 ($ millions) 2008
Non-Counterparty Managed Assets 82,428
Counterparty Managed Assets
Credit assets
Wholesale (AIRB and Standardized) 141,620
Retail (AIRB and Standardized) 91,879
Equity 1,330
Securitization 6,200
Repo style transactions 28,033
Market risk assets subject to specific risk only 64,121
Deconsolidated subsidiary assets 439
Total Assets 416,050