ING Direct 2013 Annual Report Download - page 304

Risk management continued ING Bank
In this context, global and local parameter committees have been set up. Finance, Market Risk Management Product Control and Front
Office are represented in these committees and discuss numerous topics regarding the product valuation and decide on the outcome of
price testing as well as valuation adjustments.
To secure segregation of duties between Front Office and Market Risk Management Product Control, the systems for pricing and price
testing are secured in order to prevent unauthorised access.
Reference is made to Note 46 ‘Fair value of assets and liabilities’ for the basis of the determination of the fair values of the financial
instruments and related sensitivities.
Model disclosure of trading risk measures
Value at Risk
MRM uses the historical simulation 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, equity
prices, foreign exchange rates, credit spreads, implied volatilities) if positions remain unchanged for a time period of one day. Next to
general market movements in these risk factors, VaR also takes into account market data movements for specific moves in e.g. the
underlying issuer of securities. The impact of historical market movements on today’s portfolio is estimated, based on equally weighted
observed market movements of the previous year. ING Bank 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.
Limitations
VaR has some limitations. VaR 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 capital 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. Also, the use
of 99% confidence level means that VaR does not take into account any losses that occur beyond this confidence level.
Backtesting
Backtesting is a technique for the on-going monitoring of the plausibility of the VaR model in use. Although VaR models estimate potential
future results, estimates are based on historical market data. In a backtest, the actual daily result is compared with the 1-day VaR. In
addition to using actual results for backtesting, ING Bank also uses hypothetical results, which measure results excluding the effect of
intraday trading, fees and commissions. When the actual or hypothetical loss exceeds the VaR an ‘outlier’ occurs. Based on ING Bank’s
one-sided confidence level of 99% an outlier is expected once in every 100 business days. In 2013, like in 2012, there was no occurrence
where a daily trading loss exceeded the daily consolidated VaR of ING Commercial Banking. ING Bank reports the results of this
backtesting to DNB on a quarterly basis.
Basel Committee/CRD III
As of 31 December 2011 the Basel requirements on Stressed VaR and the Incremental Risk Charge have come into force in European
legislation (CRD III), complementing the use of VaR. ING follows this framework for its regulatory capital calculations since Q4 2011.
Stressed VaR
The Stressed VaR (SVaR) is intended to replicate a VaR calculation that would be generated on the bank’s current portfolio with inputs
calibrated to the historical data from a continuous 12-month period of significant financial stress relevant to the bank’s portfolio. To
calculate SVaR, ING Bank uses the same model that is used for VaR (historical simulation). The historical data period used includes the
height of the credit crisis around the fall of Lehman brothers, and is reviewed regularly.
Incremental Risk Charge
With the Incremental Risk Charge (IRC) ING Bank calculates an estimate of default and migration risk for unsecuritised credit products in
the trading book over a one-year capital horizon at a 99.9% confidence level. For the calculation of IRC ING Bank performs a Monte Carlo
simulation based on a Gaussian copula model. For all issuers the rating is simulated over the different liquidity horizons (time required to
liquidate the position or hedge all significant risks) within one year. The financial impact is then determined based on the migration to
default (based on LGD), or migration to a different rating category (based on credit spread changes).
The liquidity horizon has been set to the regulatory minimum of three months for all positions in scope. Given the types of products in ING
Bank’s trading portfolio ING considers this horizon to be conservative. We have demonstrated that ING Bank could still actively trade its
positions that are significant for IRC under stressed market circumstances, allowing ING Bank to fully redeem its positions within three months.
Event risk
Event risk is a valuable risk management tool. Event risk evaluates the bank’s financial stability under severe but plausible stress scenarios
and assists in decision-making that assures the bank to remain a financially-healthy on-going concern after a severe event occurs. In
addition to the bank-wide stress test framework as described in the ING Bank risk profile section, MRM performs separate stressed
scenario tests to monitor market risks under extreme market conditions. Since VaR in general does not produce an estimate of the
potential losses that can occur as a result of extreme market movements, ING Bank uses structured stressed scenario tests for monitoring
302 ING Group Annual Report 2013