Barclays 2007 Annual Report Download - page 89

1
Business review
Barclays PLC Annual Report 2007 87
Stress testing
As part of the annual stress testing process, Barclays estimates the impact
of a severe economic downturn on the projected demand and supply of
capital. This process enables the Group to assess whether it could meet its
minimum regulatory capital requirements throughout a severe recession.
The Risk Appetite numbers are validated by estimating the Group
sensitivity to adverse changes in the business environment and to include
operational events that impact the Group as a whole using stress testing
and scenario analysis. For instance, changes in certain macroeconomic
variables represent environmental stresses which may reveal systemic
credit and market risk sensitivities in our retail and wholesale portfolios.
The recession scenarios considered incorporate changes in
macroeconomic variables, including:
– Weaker GDP, employment or property prices
– Higher interest rates
– Lower equity prices
– Interest rate curve shifts
Such Group-wide stress tests allow senior management to gain a better
understanding of how portfolios are likely to react to changing economic
and geopolitical conditions and how the Group can best prepare for and
react to them. The stress test simulates the balance sheet and profit and
loss effects of stresses across the Group, investigating the impact on profits
and the ability to maintain appropriate capital ratios. Insights gained are
fully integrated into the senior management process and the Risk Appetite
framework. This process of analysis and senior management oversight
also provides the basis for fulfilling the stress testing requirements of
Basel II.
Group-wide stress testing is only one of a number of stress test analyses
that are performed as part of the wider risk management process.
Specific stress test analysis is used across all risk types to gain a better
understanding of the risk profile and the potential effects of changes in
external factors. These stress tests are performed at a range of different
levels, from analysis covering specific stresses on individual sub-portfolios
(e.g. high value mortgages in the South East of England), to portfolio level
stresses (e.g. the overall commodities portfolio).
Managing capital ratio sensitivity to foreign exchange
rate movements
The Group’s regulatory capital ratios are sensitive to foreign exchange
movements in reserves, goodwill, minority interests and other non Sterling
debt capital as well as non Sterling risk weighted assets. For material
currencies, the Group seeks to hold capital in currencies to match the risk
weighted assets transacted in those currencies, in the same proportion
as the Group capital ratio targets, also taking into account the impact of
hedging net investments.
Achieving the planned performance in each business is dependent upon
the ability of the business to direct, assess, control, report, and manage
and challenge the risks in the business accurately. Group Risk supports the
planning process by providing robust review and challenge of the business
plans to ensure that:
– The figures relating to risk are internally consistent and accurate
– The plans are achievable given the risk management capabilities
of the businesses
– The plans efficiently utilise, but do not exceed, the Group’s risk appetite.
This review and challenge is achieved through Risk Executive Dialogues
involving among others, the Group Risk Director and the business
risk directors.
Economic capital management
Economic capital is an internal measure of the minimum equity and
preference capital required for the Group to maintain its credit rating
based upon its risk profile.
Barclays assesses economic capital requirements by measuring the
Group risk profile using both internally and externally developed models.
The Group assigns economic capital primarily within the following risks:
Credit Risk, Market Risk, Business Risk, Operational Risk, Insurance Risk,
Fixed Assets and Private Equity. Group Risk owns the methodology and
policy for economic capital while the businesses are primarily responsible
for the calculation.
The Group regularly enhances its economic capital methodology and
benchmarks outputs to external reference points. The framework reflects
default probabilities during average credit conditions, rather than those
prevailing at the balance sheet date, thus removing cyclicality from the
economic capital calculation. Economic capital for wholesale credit risk
includes counterparty credit risk arising as a result of credit risk on traded
market exposures. The framework also adjusts economic capital to reflect
time horizon, correlation of risks and risk concentrations.
Economic capital is allocated on a consistent basis across all of Barclays
businesses and risk activities. A single cost of equity is applied to calculate
the cost of risk. Economic capital allocations reflect varying levels of risk.
The total average economic capital required by the Group, as determined
by risk assessment models and after considering the Group’s estimated
portfolio effects, is compared with the average supply of capital resources
to evaluate economic capital utilisation.
The Group’s economic capital calculations form the basis of its Internal
Capital Adequacy Assessment Process (‘ICAAP’) submission to the FSA
under Pillar 2 of Basel II.