ING Direct 2008 Annual Report Download - page 225

MARKET RISK BANK
General
Economic Capital for market risk is the Economic Capital necessary to withstand unexpected value movements due to changes in model
risks and market variables, such as interest rates, equity prices, foreign exchange rates and real estate prices. Economic Capital for market
risk is calculated for exposures both in trading portfolios and non-trading portfolios.
Measurement
Economic capital for market risk is calculated using internally developed methodologies with a 99.95% confidence interval and a horizon
of one year, which represents extreme events and ING’s rating. The Economic Capital for market risk for non trading portfolios is calculated
for each risk type, while for trading portfolios it is calculated on a portfolio level. The calculations for Economic Capital market risk include
real estate risk, foreign exchange rate risk, equity price risk, interest rate risk and model risks.
Real estate price risk includes both the market risks in the investment portfolio and the development risk of ING Real Estate. The real
estate price risk for ING Real Estate is calculated by stressing the underlying market variables. The stress scenarios at a portfolio level
take into account all diversification effects across regions and real estate sectors. Also, the leverage of participations in the real estate
investment funds is taken into account.
For the real estate development process, in addition to price risk, the risk drivers of vacancy rate and construction delays are taken into
account. Furthermore the risk model differs for each development phase (i.e., research, development, and construction) to appropriately
reflect the risk taken in each phase. Using correlations, all risk drivers, and stages are used to calculate a possible market value loss
representing the Economic Capital for market risk for the development portfolio.
For the direct market risks, the actual VaR (measured at a 99% confidence interval, a one day holding period and under the assumption
of an expected value of zero) of the trading and non-trading portfolios is taken as a starting point for the Economic Capital calculations
for market risk. To arrive at the Economic Capital for market risk, a simulation based model is used which includes scaling to the required
confidence interval and holding period. In determining this scaling factor, several other factors are also taken into account like the
occurrence of large market movements (events) and management interventions.
Economic Capital for market risk for the large non-trading portfolios within ING Retail Banking and ING Wholesale Banking is calculated
for embedded option risk (e.g. the prepayment option in mortgages) and model risk. The model risk is calculated by stressing the
underlying assumptions in the models for behavioural assets and liabilities. For example, the hedge for savings portfolios is based on
assumptions with respect to developments of volumes and client rates. Deviations in these assumptions can lead to (ex-post) incorrect
estimation of the typical interest rate maturity of saving deposits. If there is more outflow than initially modelled, the duration of the
savings money may be lower than the duration of the investments, which leads to losses if interest rates go up. The economic capital
figures of ING Direct capture the model risk of the behavioural liabilities in line with the model described above.
For the model applied to mortgage portfolios a similar rationale is employed. The quality of the hedge depends on assumptions with
respect to prepayment behaviour. If these assumptions are wrong, the funding may be either too long or too short term. Similar to the
above, the Economic Capital model for market risk is based on the estimated 99% confidence prepayment model error and the 99%
confidence adverse interest rate change.
While aggregating the different Economic Capital market risk figures for the different portfolios, diversification benefits are taken into
account as it is not expected that all extreme market movements will appear at the same moment.
The nature of market risk Economic Capital, evaluating the impact of extreme stress with a 99.95% confidence level, can sometimes be
difficult to evidence in a statistical sound manner with the available historical data. The Economic Capital figures disclosed by ING Group
are a best effort estimate based on available data and expert opinions.
OPERATIONAL RISK
Operational risk is the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from
external events. It includes the risk of reputation loss, as well as legal risk, whereas strategic risks are not included. While operational risk
can be limited through management controls and insurance, many incidents still have a substantial impact on the profit and loss account
of financial institutions.
The capital model, an actuarial model, consists of a combination of three techniques:
Loss Distribution approach (LDA), which applies statistical analysis to historical loss data;•
Scorecard approach, which focuses on the quality of risk control measures within a specific business unit;•
‘Bonus/Malus’ approach, which focuses on the actual operational incidents of a specific business unit.•
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ING Group Annual Report 2008