ING Direct 2008 Annual Report Download - page 223

The Economic Capital calculations reflect known embedded options and the influence of client behaviour in banking products;•
The Economic Capital calculations are on a pre-tax basis and do not consider the effect of regulatory accounting and solvency •
requirements on capital levels;
The framework does not include any franchise value of the business, discretionary management intervention or future business •
volumes and margins.
Further details are provided in the relevant model descriptions for each risk area.
Aggregation model
The main processes executed in the ING Bank Economic Capital aggregation model are depicted in the flowchart below. The white
boxes show the processes performed by the model while the shaded box indicates inputs from other corporate risk departments.
Calculate diversified economic capitalsEconomic capitals per risk type
Calculate diversification ratio per risk type
Determine stressed correlations
Determine correlations
As a foundation the correlations in the risk dashboard are applied based on a 90% confidence level, i.e. they correspond to the
correlations observed in the 10% largest downward movements (a ‘1 in 10’ event). As shown in the flow-chart, these correlation factors
are stressed upwards where necessary to account for potential measurement inaccuracy in extreme events due to limited historic data
observations. For aggregating other risk (business and operational), expert opinion is used.
The Economic Capital for ING Bank involves the aggregation of the underlying Economic Capitals of five risk types, namely credit,
transfer, market, operational and business risks (latter two also referred to as other risks). These risk types are aggregated to provide
a total diversified ING Bank Economic Capital by applying the variance-covariance approach with a 5 x 5 inter-risk correlation matrix.
For allocation of Economic Capital to units and products, diversification factors are calculated for each risk type. These factors are applied
consistently throughout ING Bank. The level of diversification benefit is dependent on both the inter-risk correlations as well as the
relative size of the undiversified Economic Capital exposure for each risk type.
Reporting Framework
For each business unit and product line, the gross Economic Capital for each risk type is delivered to MISRAROC – the financial data
warehouse for RAROC and Economic Capital reporting of ING Bank. The net Economic Capital figures are calculated by taking the
product of the gross Economic Capital and one minus the diversification factor. Total Economic Capital is calculated as the sum of the
net Economic Capital for each risk type at all reporting levels.
CREDIT AND TRANSFER RISK
Economic Capital for credit risk and for transfer risk is the portion of Economic Capital held to withstand unexpected losses inherent in
the credit portfolios related to (unexpected) changes in the underlying creditworthiness of debtors or the recovery value of underlying
collateral (if any). Credit risk and transfer risk capital are calculated on all portfolios which contain credit or transfer risk, including
investment portfolios. The same methodology is used for both the banking and the insurance operations.
Economic Capital for credit risk and for transfer risk are calculated using internally developed models with a 99.95% confidence level
and a time horizon of one year, which represents ING’s desired credit rating.
ING uses a series of credit risk models that can be grouped into three principal categories: Probability of Default (PD) models, which
measure the standalone creditworthiness of individual debtors; Exposure at Default models (EAD) which estimate the size of the financial
obligation at the moment of default in the future; and Loss Given Default Models (LGD), which estimate the recovery value of the
underlying collateral or guarantees received (if any) and the unsecured part. Collectively, ING uses over 100 models for credit risk.
The various models can be grouped into three categories: statistical, expert and hybrid. Each model is individually reviewed and validated
annually by the Model Validation department (MV), in order to determine the continued viability or need to adjust each individual model.
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ING Group Annual Report 2008