## Basel III and Credit, Operational Risk Masterclass

- TBD
- NYC

- Intermediate to advanced
- 14 CPE Credits
- Group-Live
- Prerequisite: none

- US $1,995
- Group discounts available

### INSTRUCTOR

Professor Morton Glantz Read bio

### course overview

Bank institutions are preparing for Basel III, which must be operational by 2019. Banks must show regulatory supervisors, credit agencies and accountants that significant risks are managed properly - that bank policies and procedures are conceptually sound, unequivocally current, empirically validated, and produce capital requirements that are in line with the new capital accords.

This two day program is intensive, interactive and encourages participation. Hands-on exercises, examples and case studies reinforce concepts and ensure delegates have a thorough, genuine understanding of the material covered. Participants use laptops during the workshop and will receive a copy of the author’s recent book (co-authored with Dr. Robert Kissell): Multi asset Risk Modeling: *Techniques for a Global Economy in an Electronic and Algorithmic Trading Era.*

### Key objectives

- Gain knowledge of compliance issues relating to operational risk
- Become familiar with differences between Basel II and Basel III
- Understand essentials of Capital Adequacy Assessment Process (ICAAP)
- Use option theory to extract credit information embedded in the equity markets
- Derive a riskless hedge
- Master migration risk and learn how to use risk matrices to value loans and optimize a loan portfolio
- Advance the principles for effective risk data aggregation and risk reporting
- Determine the best portfolio allocation (diversification) such that the portfolio's bang-for-the-buck, or returns to risk ratio, is maximized under uncertainty conditions
- Reduce operating risk by developing internal rating based approaches provided by the Bank for International Settlements, namely project finance, commodity finance, commercial real estate and object finance internal rating systems compliant with Basel III
- Comprehend the basics of extreme value theory and application to market shocks for stress testing and extreme value at risk
- Understand the quant side of portfolio theory
- Learn the basics of data acquisition and global exposure systems
- Work the basics of Moody’s KMV distance to default model
- Replicate the credit rating of collateralized debt obligations and portfolio credit linked in context with Basel III

### Who should attend?

- Board members with risk responsibilities
- Members of the Risk Management team
- Bank regulators
- Compliance, legal and support staff
- Central bank staff and supervisors
- Rating Agency Analysts
- Investment bankers
- Commercial bankers
- Investment analysts (equity and fixed income)
- Recently qualified accountants
- Recently qualified lawyers
- Financial analysts
- Journalists
- Hedge fund managers
- Academics in finance

### Course Outline

**Introduction to Basel III**

- Brief overview of credit events before and during the banking crisis
- FDIC: bank failures and respective causes
- Lessons from the crisis: Getting fundamentals right
- Where were internal auditors and bank regulators before the debt crisis?
- Basel Committee’s Principles forthe Management of Credit Risk 2000

Discussion: Basel Committee’s Principles for the Management of Credit Risk – “The effective management of credit risk is a critical component of a comprehensive approach to risk management and essential to the long term success of any banking organization”.

**Reforms under Basel III Basel III**

- Differences between Basel II and Basel III
- Numerator capital equation
- Trading book loophole
- Calibration capital ratios
- Distribution policies
- Reinforcement leverage ratio
- Systemically Important Financial Institutions (SIFIs) capital surcharge
- Countercyclical capital charge
- Derivatives issues
- Internal models
- Timing
- Dodd–Frank wall street reform and Consumer Protection Act

**Overview of Capital Adequacy Assessment Process (ICAAP)**

- Regulatory background
- ICAAP overview
- Risk identification and assessment
- Capital planning
- Stress testing and ICCAP
- Governance
- Stress and scenario tests
- The ICAAPdocument

**Capital allocation related to certain loan exposures**

- Standardized approach
- Foundation internal ratings-based (IRB) approach
- Advanced IRB approach

**Overview of Moody’s KMV default model**

- Default probability: three main elements
- Loss given default
- Migration risk
- Expected and unexpected risk
- Equity as a call option
- Distance to default formula
- Converting distance to default methodology to expected default probabilities

**Stochastic stress testing and due diligence**

- Introduction to Monte Carlo computer simulation
- Sensitivity analysis versus Stochastic (simulations) projections
- Defining Assumptions
- Defining Forecasts
- Working with Confidence Levels
- Determining default frequencies
- Adjusting critical assumptions and value drivers
- “Stress testing as an integral part of ICAAP.”
- Understanding an obligor’s financial needs
- Advanced “bankers” cash flow modeling
- Cash flow forecasting equations
- Determining default frequencies

Exercise: Piece of Cake Company. Using simulation software to compare deterministic and stochastic projections:

Case Study: International Drug Corporation. Delegates determine appropriate (stochastic) distributions, the forecast variable, run simulations, select (frequency chart) confidence levels, call up reports and evaluate project managers’ proposal to the bank.

**Portfolio optimization and management of default risk**

- Optimization procedures
- Continuous optimization procedure
- Results interpretation
- Efficient frontier and advanced optimization settings
- Creating an optimal portfolio given allocation of loan exposures across multiple industries
- Illustrative example: portfolio optimization and the effects on portfolio value at risk
- Running static, dynamic, and stochastic optimization with continuous decision variable

Class assignment: given correlations, determine the best portfolio allocation such that the (credit exposure) loan portfolio's bang-for-the-buck, or returns to risk ratio, is maximized under uncertainty conditions

Deal analysis: rating agency analysis of portfolio credit linked note

**Internal Rating Based Approaches provided by the bank for international settlements:**

- Identify three approaches to credit risk measurement
- Project finance, commodity finance, commercial real estate and object finance systems
- Evaluate inputs required for Pillar I approaches
- Evaluate requirements for Standardized Approach
- Interactive corporate risk rating systems
- Supervisor slotting criteria for specialized lending
- Basic structure ,specialized lending:: project finance, object finance commodity finance
- Income-producing, high-volatility real estate exposures, and construction projects
- Determining loss given default (LGD) and loss provisions

Discussion: Basel Principle 10: “Banks should develop and utilize internal risk rating systems in managing credit risk. The rating system should be consistent with the nature, size and complexity of a bank's activities.

**Option theory to reduce FX risk, extract credit information embedded in the equity markets, and employ options analysis in determination of EDF**

- The math behind option theory
- Avoiding value hurting hazards of loan pricing errors
- Factoring volatility estimates into loan pricing
- Volatility & debt/equity values
- Determining the riskless hedge through the N(dl ) component of option pricing
- Finding probabilities that options finish 'in the money' through N(d2) component of the option formula
- Employing options in pricing and valuation decisions
- Quantifying the tradeoff between risk & pricing
- Determining option pricing assumptions, loan yields associated with the volatility of borrowers' percentage returns

**Stress testing systemic risk**

- Extreme value theory and application to market shocks for stress testing and extreme value at risk
- How statistical pricing and risk-forecasting models contributed to the debt crisis
- Volatility models
- Factor models
- Risk hedging techniques

Examples and Case Study

**Basel Committee on Banking Supervision (BCBS): BCBS 239: Principles for effective risk data aggregation and risk reporting**

- Risk data aggregation and risk reporting: will you be compliant with Basel III?
- Objectives
- Scope and initial considerations
- Governance and infrastructure
- Global Exposure Systems (GES), data warehousing and mining
- Robust risk data governance
- Why were banks less than agile in getting a complete, granular, transparent aggregated view of the risks they faced?
- GES basic data
- GES and reports to the board of directors

**Course summary and review**