Bank of Montreal 2010 Annual Report Download - page 87

MD&A
Translation risk is managed by funding our net U.S. investment in U.S.
dollars. Transaction risk is managed by assessing at the start of each
quarter whether to enter into foreign exchange forward contract hedges
that are expected to partially offset the pre-tax effects of Canadian/U.S.
dollar exchange rate fluctuations in the quarter on the expected
U.S. dollar net income for the quarter. The Canadian dollar equivalents
of BMO’s U.S.-dollar-denominated results are affected, favourably or
unfavourably, by movements in the Canadian/U.S. dollar exchange rate.
The size of the impact on the Canadian dollar equivalents depends on
the level of U.S.-dollar-denominated results and the movement in the
exchange rate. If future results are consistent with the range of results
for the past three years, each one cent decrease in the Canadian/U.S.
dollar exchange rate, expressed in terms of how many Canadian dollars
one U.S. dollar buys, would be expected to change the Canadian dollar
equivalents of U.S.-dollar-denominated net income (loss) before income
taxes by between –$6 million and $10 million. An increase of one cent
would have the opposite effect.
Structural MVE and EV measures both reflect holding periods of
between one month and three months and incorporate the impact of
correlation between market variables.
Structural MVE and EV are summarized in the following table.
Structural MVE increased from the prior year primarily due to growth in
common shareholders’ equity. Structural EV continues to be managed
to low levels.
Structural Balance Sheet Market Value Exposure and
Earnings Volatility ($ millions)*
As at October 31
(Canadian equivalent) 2010 2009
Market Value Exposure (pre-tax) (564.1) (543.2)
12-month Earnings Volatility (after-tax) (63.8) (69.0)
*Measured at a 99% confidence interval.
In addition to MVE and EV, we use simulations, sensitivity analysis, stress
testing and gap analysis to measure and manage interest rate risk.
The interest-rate gap position is disclosed in Note 19 on page 143 of the
financial statements.
Structural interest rate sensitivity to an immediate parallel
increase or decrease of 100 and 200 basis points in the yield curve is
disclosed in the table below. This sensitivity analysis is performed and
disclosed by many financial institutions and facilitates comparison with
our peer group. The change in economic value sensitivity from the
prior year reflects capital growth and higher interest rates. The asset-
liability profile at the end of the year results in a structural earnings
benefit from interest rate increases and structural earnings exposure
to interest rate decreases.
Structural Interest Rate Sensitivity ($ millions)*
Canadian equivalent As at October 31, 2010 As at October 31, 2009
Economic 12-month Economic 12-month
value earnings value earnings
sensitivity sensitivity sensitivity sensitivity
pre-tax after-tax pre-tax after-tax
100 basis point increase (380.5) 20.9 (353.2) 11.0
100 basis point decrease 322.3 (70.3) 254.2 (75.6)
200 basis point increase (815.1) 33.4 (779.2) (10.6)
200 basis point decrease 738.2 (12.8) 392.8 (62.9)
*Exposures are in brackets and benefits are represented by positive amounts.
Models used to measure structural market risk project how interest
rates and foreign exchange rates may change and predict how customers
would likely react to the changes. For customer loans and deposits
with scheduled maturity and repricing dates (such as mortgages and
term deposits), our models measure how customers are likely to use
embedded options to alter those terms. For customer loans and deposits
without scheduled maturity and repricing dates (such as credit card
loans and chequing accounts), our models assume a maturity profile
that considers historical and forecasted trends in balances. 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. Models used to predict customer
behaviour are also used in support of product pricing and performance
measurement.
Liquidity and Funding Risk
credit and liquidity lines, purchase collateral for pledging and fund asset
growth and strategic investments. Liquidity and funding requirements
are assessed under expected and stressed economic, market, political
and enterprise-specific environments, which determine the minimum
required amount of liquid assets to be held at all times.
Our liquidity and funding risk management framework includes:
• oversight by senior governance committees, including the Balance
Sheet Management Committee, Risk Management Committee and
Risk Review Committee;
• an independent oversight group within Corporate Treasury;
• a Risk Review Committee-approved limit structure to support the
maintenance of a strong liquidity position;
• 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 conditions; and
• contingency plans to facilitate managing through disruption.
In December 2009, the Basel Committee on Banking Supervision (BCBS)
published for consultation an International framework for liquidity
measurement, standards and monitoring. The framework contains two
new liquidity measures, Liquidity Coverage Ratio (LCR) and Net Stable
Funding Ratio (NSFR), and four monitoring tools (contractual maturity
Managing liquidity and funding risk is essential to maintaining both
depositor confidence and stability in earnings. It is BMO’s policy to ensure
that sufficient liquid assets and funding capacity are available to meet
financial commitments, even in times of stress.
We actively manage liquidity and funding risk across the enterprise
by holding liquid assets in excess of established minimum requirements
at all times. Liquid assets include unencumbered, high-quality assets
that are marketable, can be pledged as security for borrowings, and
can be converted to cash in a time frame that meets our liquidity
and funding requirements. Liquid assets are held both in our trading
businesses and in supplemental liquidity pools that are maintained for
contingencies. Liquidity and funding requirements consist of expected
and stressed cash outflows. These arise from obligations to repay deposits
that are withdrawn or not renewed, fund drawdowns on available
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,
investment and pledging commitments.
Material in blue-tinted font above is an integral part of the 2010 annual consolidated financial statements (see page 75).
BMO Financial Group 193rd Annual Report 2010 85