ING Direct 2013 Annual Report Download - page 303

Risk management continued ING Bank
Year-on-year variance analysis
In total, real estate market risk exposure in the banking books decreased by EUR 0.7 billion mainly as a result of divestments (EUR 0.54
billion). The rest is due to impairments and negative fair value changes.
Market Risk in trading books
Within the trading portfolios, positions are maintained in the professional financial markets. These positions are often the result of
transactions with clients and may serve to benefit 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, foreign exchange rates and credit spreads.
Governance
The Financial Markets Risk Committee (FMRC) is the market risk committee that, within the risk appetite set by ALCO Bank, sets market
risk limits both on an aggregated level and on a desk level, and approves new products. MRM advises both the FMRC and ALCO Bank on
the market risk appetite of trading activities.
With respect to the trading portfolios, MRM focuses on the management of market risks of Commercial Banking (mainly Financial
Markets) as this is the only business line where trading activities take place. Trading activities include facilitation of client business and
market making. MRM 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. MRM
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 MRM overall down to specific business areas and trading offices.
Fair values of financial trading assets and liabilities
Fair values of financial assets and liabilities that are quoted in active markets are determined by using quoted market prices. Where quoted
prices are not available, other pricing sources and valuation techniques are used to determine fair value.
Other pricing sources can be independent market vendors, brokers or market makers, or recent transactions. The range of prices obtained
from these pricing sources can diverge. The choice of one or the other pricing source can therefore result in different estimates of fair
value. Selecting the most appropriate price within this range requires expertise and judgement.
Valuation techniques range from discounting of cash flows to valuation models. Such models are based on relevant factors such as the
market price of underlying reference instruments, market parameters (volatilities, correlations and credit ratings) and customer behaviour.
Some of these price factors require various assumptions which imply that valuation models are subjective by nature. According to what
valuation technique is used and what assumptions are made, the obtained fair value can be different.
All valuation techniques used are subject to a model governance framework. Model governance refers to a set of policies and procedures
that have to be strictly followed and that cover the complete lifecycle of a model, i.e. its development, validation, approval, implementation
and maintenance. The pillars of model governance are independent validation and periodic review. Such a review aims to determine
whether a model still is appropriate for its intended use. Where models are used for valuation, there can be uncertainty on the
assumptions of the underlying models and/or parameters. In those cases where significant uncertainty on assumptions arises, a model risk
valuation adjustment is applied.
In general, positions are valued taking the bid price for a long position and the offer price for a short position. In cases where positions are
marked at mid-market prices, a fair value adjustment is calculated.
To include credit risk in the fair valuation, ING applies both credit and debit valuation adjustments (hereafter referred to as CVA
respectively DVA). Own issued debt and structured notes that are valued at fair value are adjusted for credit risk by means of a debit
valuation adjustment. Additionally, derivatives valued at fair value are adjusted for credit risk by a credit valuation adjustment. This credit
valuation adjustment is of a bilateral nature; both the credit risk on the counterparty as well as the credit risk on ING are included in the
adjustment. All market data that is used in the determination of the CVA is based on market implied data. Additionally, wrong-way risk
(when exposure to a counterparty is increasing and the credit quality of that counterparty decreases) and right way risk (when exposure to
a counterparty is decreasing and the credit quality of that counterparty increases) are included in the adjustment. ING applies CVA also for
pricing credit risk into new external trades with counterparties. Risk limits and controls are in place to monitor and anticipate CVA risk on a
daily basis. The CVA function operates under a global risk governance, where the risk limits and controls for CVA are managed and monitored
on a global level. Our approach on CVA risk management is driven by increased control, cost efficiency and the global scope of CVA.
Market Risk Management Product Control has the role to identify or challenge market data and pricing sources as well as determining the
parameters that will be used in the valuation models. When using valuation techniques, identified market data and sources used for the
calculations are independently challenged, reviewed and validated on a regular basis, most of it daily. In order to guarantee the highest
quality and consistency in market data inputs, ING started this year migrating these activities into one single source for consistent validated
market data inputs across ING. ING uses an in house developed infrastructure for this purpose and has started to upgrade this application
phase-wise with enhanced validation techniques to apply to the market data obtained from external data vendors (e.g. Bloomberg,
Reuters and others). ING expects to have completed the migration in 2014.
301ING Group Annual Report 2013
1 Who we are 2 Report of the Executive Board 3 Corporate governance 4 Consolidated annual accounts 5 Parent company annual accounts 6 Other information 7 Additional information