BankingBook Analytics (BBA)’s model-based ICAAP solution is now accredited by Canadian regulatory authorities. Our solution is developed in compliance with the local and international regulatory requirements. It comprises of the following two distinct enterprise-wide applications:
- ECAP Leader, includes coverage of material risks by Economic Capital models, Enterprise-wide Risk Management and Risk Adjusted Performance Measurement of loan book
- Scenario Frontier: Scenario-based stress testing of material risks, including stress testing of current and projected financials; and IFRS 9/CECL model
The fundamental question that any capital management framework needs to address is, “what should be the quantum of capital that needs to be held?” This becomes even more challenging, when an institution uses the Standardized Approach, i.e., application of prescriptive risk weights to determine the Pillar 1 capital requirement.
ICAAP requires that the amount of capital that an organization must hold should be directly proportional to the amount of risk that it faces, at its desired safety level (or target credit rating). The following graphic provides summary snapshot of the principle based on which BBA’s ICAAP solution is developed:
Framework-based ICAAP Solution
An important element of BBA’s ICAAP solution is that it addresses ‘procyclicality risk’ by assigning capital buffer to ensure capital remains adequate even through an economic downturn.
By adding buffer capital to Pillar 1 capital (Standardized Approach) and the modelled Ecap, BBA’s solution develops oscillating view of capital: a floor (ECAP model + buffer) and a ceiling (Standardized Approach Capital + buffer). It then compares capital utilization with available capital (current and projected) to determine surplus/deficit.
BBA’s ICAAP system, along with the associated documentation forms the basis for the supervisory review process.
Our applications ensure compliance with the Principle 1 of Supervisory Review Process. Principle 1 states that Credit Institutions should have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital levels.
The cost of holding excess capital is in the region of 7%, being the spread between the average hurdle rate (say 12%) and the capital benefit rate of 5%. BBA’s capital management strategy focuses on intelligently reducing baseline capital by using sophisticated models, assuring the regulators about the adequacy of capital using two distinctly different lenses, i.e., through-the-cycle and point-in-time.
The following are some of the key business benefits:
- Transition from approximations-based capital requirements - leaving credit unions exposed to ‘unattended’ event risk and also forcing regulators to apportion higher capital – to a more robust, measurement-based capital framework
- Refined understanding of credit portfolio’s price performance (above or below breakeven threshold)
- Automation and loss data warehousing
In conclusion, for every $10MM in capital savings afforded by BBA's solution, the benefits far outweigh the cost of solution. Book your demo today!
Author - Sohail Saad