ING Direct 2008 Annual Report Download - page 198

2.1 Consolidated annual accounts
Within ING Bank, market risk (including liquidity risk) falls under the supervision of the ALCO function with ALCO Bank as the highest
approval authority. ALCO Bank determines the overall risk appetite for market risk. The ALCO function is regionally organised with the
exception of ING Direct, which has a separate ALCO. The business lines Retail Banking and Wholesale Banking are represented within the
respective regional and local ALCO’s. The ALCO structure within ING Bank facilitates top-down risk management, limit setting and the
monitoring and control of market risk. This ensures a correct implementation of the ING Bank risk appetite.
The Corporate Market Risk Management department (CMRM) is the designated independent department that is responsible for the
design and execution of the bank’s market risk management functions in support of the ALCO function. The CMRM structure recognises
that risk management to a large extent occurs at the regional/local level. Bottom-up reporting allows each management level to fully
assess the market risk relevant at the respective levels.
CMRM is responsible for determining adequate policies and procedures for managing market risk and for monitoring the compliance with
these guidelines. An important element of the market risk management function is the assessment of market risk in new products and
businesses. Furthermore CMRM maintains an adequate limit framework in line with ING Bank’s risk appetite. The businesses are responsible
for adhering to the limits that ultimately are approved by ALCO Bank. Limit breaches are reported to senior management on a timely
basis and the business is required to take the appropriate actions to reduce the risk position.
Market risk in trading portfolios
Organisation
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 and foreign exchange rates.
The Financial Markets Risk Committee (FMRC) is a market risk committee that, within the guidelines set by ALCO Bank, sets market risk
limits both on an aggregated level and on a desk level, and approves new products. CMRM advises both the FMRC and ALCO Bank on
the market risk appetite of Wholesale Banking activities.
CMRM Trading focuses on the management of market risks in the trading portfolios of Wholesale Banking (mainly Financial Markets)
as this is the only business line where significant trading activities take place. Trading activities include facilitation of client business,
market making and proprietary position taking in cash and derivatives markets. CMRM Trading 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. CMRM 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 CMRM
Trading overall down to specific business areas and trading offices.
Measurement
CMRM uses the 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, foreign exchange
rates, equity prices, credit spreads, implied volatilities) if positions remain unchanged for a time period of one day. The impact of historical
market movements on today’s portfolio is estimated, based on equally weighted observed market movements of the previous year. ING
uses VaR with a 1-day horizon for internal risk measurement, control and backtesting, and VaR with a 10-day horizon for determining
regulatory capital. ING’s VaR model has been approved by the Dutch Central Bank to be used for the regulatory capital calculation of its
most important trading activities.
Market risk management for the fixed income and equity markets is split into two components: general market risk and specific
market risk. The general market risk component estimates the VaR resulting from general market-value movements (e.g. interest rate
movements). The specific market risk component estimates the VaR resulting from market-value movements that relate to e.g. the
underlying issuer of securities in the portfolios. This specific risk relates to all value movements not related to general market movements.
The VaR for linear portfolios is calculated using a variance – covariance approach. The market risk of all the important option portfolios
within ING is measured by Monte Carlo and historical simulation methods.
Limitations
VaR as a risk measure has some limitations. VaR quantifies the potential loss under the assumption of normal market conditions. This
assumption may not always hold true in reality, especially when market events occur, and therefore could lead to an underestimation of
the potential loss. VaR also uses historical data to forecast future price behaviour. Future price behaviour could differ substantially from
past behaviour. Moreover, the use of a one-day holding period (or ten days for regulatory calculations) assumes that all positions in the
portfolio can be liquidated or hedged in one day. In periods of illiquidity or market events, this assumption may not hold true. Also, the
use of 99% confidence level means that VaR does not take into account any losses that occur beyond this confidence level.
Risk management (continued)
ING Group Annual Report 2008
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