ING Direct 2008 Annual Report Download - page 202

2.1 Consolidated annual accounts
The risk transfer principle forms the basis of ING Bank’s ALM framework. This refers to the principle whereby the outright interest rate risk
resulting from the commercial business is transferred to the ALM books. The interest rate risk from the commercial business arises from
the fact that own originated assets and liabilities do not reprice simultaneously with respect to interest rate characteristics. The transfer of
the outright interest rate risk is to a large degree based on modelling client behaviour. Within CMRM, extensive research is being done in
order to optimise this modelling. For this purpose, several methods are in place to replicate the interest rate risk, taking into account both
the contractual and behavioural characteristics of demand deposits, saving accounts and mortgages. All models and assumptions are
back-tested regularly and results are presented to the designated ALCO.
For the determination of the interest rate sensitivity of savings accounts and current accounts, several methods depending on the focus
of the risk analysis have been developed, e.g. historical simulation, Earnings at Risk analysis and valuation models. Pricing strategies,
outstanding volumes and the level and shape of the yield curve are taken into account in these models. Based on these analyses,
investment rules are determined for the various portfolios.
The hedging of the embedded prepayment options within mortgage portfolios is based on prepayment prediction models. These models
include the incentive for clients to prepay. The parameters of these models are based on historical data and are regularly updated. The
interest sensitivity of the embedded offered rate options is determined as well for the mortgage portfolio and a hedging process is in
place to minimise the resulting interest rate risk.
After transferring the outright interest rate risk position to the ALM books, the residual interest rate risk that remains in the commercial
banking books is caused by basis risk and optionality. The commercial business units bear responsibility for these residual interest rate
risks that result from banking products of which future cash flows depend on client behaviour (e.g. optionality in mortgages) and from
banking products of which the client rate earned and paid imperfectly correlate with the changing market rates (basis risk). Examples
of products in which these risks are inherent are current accounts, saving accounts and mortgages.
Within ING Direct the interest rate risk is managed and measured at the level of the local ING Direct entities. The interest rate risk
that remains in the ING Direct entities also largely results from basis risk and optionality as the outright interest rate risk is to a large
extent hedged.
The ALM books are managed within ING Wholesale Banking and contain the strategic interest rate risk position of ING Bank. The main
objective is to maximise the economic value of the book and to generate adequate and stable yearly earnings within the risk appetite
boundaries of ING Bank.
In the following sections, the risk figures for interest rate risk in the banking books are presented. In line with the group risk metrics,
ING Bank uses several risk measures to manage interest rate risk both from an earnings and a value perspective. Earnings-at-Risk (EaR)
is used to provide the earnings perspective and the Net Present Value (NPV)-at-Risk and Basis Point Value (BPV) figures provide the value
perspective. Several banking books are governed by the trading risk process and are therefore excluded from the following non-trading
risk tables and are included in the trading risk graph and table under ‘Market Risk in Trading Books’.
Earnings at Risk (EaR)
EaR measures the impact on (pre tax) IFRS earnings resulting from changes of market rates over a time period of one year. Changes in
balance sheet dynamics and management interventions are not incorporated in these calculations. The EaR figures in the table below
are determined on the basis of an instantaneous upward 1% parallel shock in market rates. This shock is assumed to take place at the
beginning of the year and the market rates are assumed to remain stable for the remainder of the year. For the ALM books EaR measures
the potential loss of earnings due to the structural mismatch in interest rate positions. The calculations for the ALM books capture the EaR
resulting from the current positions. For the commercial banking books the EaR captures the interest rate risks resulting from savings,
current accounts and the main mortgage portfolios. The impact of new business is included in the EaR calculations for the savings and
demand deposits portfolios, as it is most relevant for these portfolios. The EaR of the Corporate Line, i.e. the investment of ING Bank’s own
funds, reflects the interest risk profile of the investments only. This is in line with the accounting based definition of (pre tax) EaR.
Risk management (continued)
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