TD Bank 2003 Annual Report Download - page 38

TD BANK FINANCIAL GROUP ANNUAL REPORT 2003 • Management’s Discussion and Analysis36
Provision for credit losses
The provision for credit losses is the amount added to the specific,
general and sectoral allowances to bring them up to a level that
management considers adequate to absorb all probable credit-relat-
ed losses in the loan portfolio. The net provision for the year is
reduced by any recoveries from loans previously written-off.
The Bank recorded a provision for credit losses of $186 million
in 2003, including a $80 million release of the sectoral allowance
and a $157 million release of the general allowance, compared
with $2,925 million in 2002. This level of provision for credit losses
represents .15% of net average loans and customer’s liability
under acceptances compared with 2.24% in the prior year.
See Notes to Consolidated Financial Statements page 63, Note 3
See Supplementary information page 52, table 14
Net impaired loans
The Bank monitors the level of net impaired loans in its portfolio,
which it defines as the gross amount of impaired loans less the
total of all specific, general and sectoral allowances for credit
losses. For the year ended October 31, 2003, the total of all
the above allowances exceeded gross impaired loans, resulting
in excess allowances of $641 million, compared to an excess of
$975 million a year ago.
See Supplementary information page 51, table 12
MARKET RISK
Market risk is the potential for loss from changes in the value
of financial instruments. The value of a financial instrument
can be affected by changes in:
•Interest rates;
•Foreign exchange rates;
•Equity and commodity prices; and
•Credit spreads.
We are exposed to market risk in both our trading and invest-
ment portfolios and through our non-trading activities. In our
trading and investment portfolios, we are active participants in
the market and seek to realize returns for the Bank from the
careful management of our positions and our inventories. In our
non-trading banking activities, we are exposed to market risk
through the transactions our customers execute with us.
Market risk in our trading activities
We are exposed to market risk when we enter into financial
transactions through our four main trading activities:
•Market-making. We provide markets for a large number of
securities and other traded products. We keep an inventory of
these securities to buy from and sell to investors. We profit
from the spread between bid and ask prices. Profitability is
driven by trading volume.
•Sales. We provide a wide variety of financial products to meet
the needs of our clients. We earn money on these products
from price mark-ups or commissions. Profitability is driven by
sales volume.
•Arbitrage. We take positions in certain markets or products
and offset the risk in other markets or products. Our knowl-
edge of various markets and products and how they relate
to each other allows us to identify and benefit from pricing
anomalies.
•Positioning. We aim to make profits by taking positions in
certain financial markets in anticipation of changes in those
markets. This is the riskiest of our trading activities and we
use it selectively.
Who manages market risk in our trading activities
Wholesale Banking has primary accountability for managing
market risk while the Market Risk Group within Risk Management
oversees their activities. Operational support for the market risk
monitoring and regulatory capital calculations is provided by
Wholesale Banking’s Finance and Operations department.
The Market Risk Group is not accountable for trading rev-
enues. Its responsibilities include:
•Designing methods for measuring and reporting market risk;
•Determining market risk policy, which includes designing and
setting all trading limits for Wholesale Banking’s businesses;
•Enforcing approved market risk limits;
•Approving all new trading products from a market risk
perspective;
•Independent testing of all pricing models, risk models, and
trading systems;
•Approving all market rates and prices used in valuing the
Bank’s trading positions and estimating market risk;
•Stress testing the portfolio to determine the effect of large,
unusual market movements; and
•Designing and validating the models used to calculate
regulatory capital required for market risk.
The Market Risk and Capital Committee meets every two
weeks for a peer review of the market risk profile of our trading
businesses, to approve changes to risk policies, to review under-
writing inventories, and to review the usage of capital and assets
in Wholesale Banking. The committee is chaired by the Senior
Vice President, Market Risk and includes members of senior
management of Wholesale Banking and Audit. Significant market
risk issues are escalated to the Credit and Market Risk Committee,
which is chaired by the Bank’s President and CEO, and includes
senior management of Wholesale Banking and the EVP and Chief
Risk Officer. The Risk Committee of the Board oversees the
management of market risk and approves all major market risk
policies periodically.
How we manage market risk in our trading activities
Managing market risk is a key part of our business planning
process. We begin new trading operations and expand existing
ones only if:
•The risk has been thoroughly assessed and is judged to be
within our risk capacity and business expertise; and
•We have the infrastructure in place to monitor, control and
manage the risk.
We manage market risk primarily by enforcing trading limits
and by “stress testing” our trading activities.
Trading limits
We set trading limits that are consistent with the approved
business plan for each business and our tolerance for the
market risk of that business. When setting these limits, we
consider market volatility, market liquidity, trader experience
and business strategy.
Our primary measure for setting trading limits is Value at Risk
(VaR). VaR measures the adverse impact that potential changes
in market rates and prices could have on the value of a portfolio
over a specified period of time. We use VaR to monitor and
control overall risk levels and to calculate the regulatory capital
required for market risk.
We may also apply specialized limits, such as notional limits,
credit spread limits, yield curve shift limits, loss exposure limits,
stop loss limits and other limits, if it is appropriate to do so.
These additional limits reduce the likelihood that trading losses
will exceed VaR limits.