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Definition of Internal Capital Requirement – on group and subsidiary level Andreas Green January 27, 2011.

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Presentation on theme: "Definition of Internal Capital Requirement – on group and subsidiary level Andreas Green January 27, 2011."— Presentation transcript:

1 Definition of Internal Capital Requirement – on group and subsidiary level Andreas Green January 27, 2011

2 2 Agenda Internal Capital Requirement – Definition – Group vs. subsidiary level Stress tests – Purpose – Methodology – Group vs. subsidiary level

3 3 Internal Capital Requirement

4 4 Definition of the internal capital requirement (ICR) A key component of the ICR is the stress buffer Pillar 1 risksAdj P1 credit risk Pillar 2 risksAdd'l Capital Buffer Internal Capital Requirement Large Exposures Transition Rules Financial Conglomerate Actual Capital Base Credit RiskMarket RiskOperational RiskCore Tier 1 capitalTier 1 HybridTier 2 capital ICR Economic Capital, exc NLP Additional Capital Constraints

5 5 Group vs. subsidiary level This position has been challenged during the financial crisis and will be further challenged due to the crisis management framework being developed Nordea’s policy has so far been to not include stress test buffers in the definition of Internal Capital Requirement on subsidiary level – The rationale has been to maximize capital transferability within the Group – The capital adequacy has thus been assessed based on a comparison of the actual capital and the ICR excluding stress test buffers

6 6 Stress tests

7 7 The role of stress testing Stress testing is primarily a component of capital forecasting and requires a holistic perspective on risks – Does the bank have enough capital given a serious economic downturn? Given the process of stressing capital requirements, the bank is forced to consider mitigating actions – How can the bank maintain capital targets and/or requirements in periods of stress? – Where might the bank consider reducing exposures? Reducing growth? – Where will the bank find additional capital in periods of economic stress? Economic Cycle Required capital (Regulatory/ Internal) Available capital (Tier 1/ capital base) Capital surplus Capital requirements during economic cycle

8 8 Stress test methodology Exemplified by Credit risk Rating migration – all customers are migrated according to scenarios. Probability of default – stressed to reflect increases in defaults. Collateral coverage – stressed by moving exposures from secured to unsecured. Financial statements – stressed income statements and balance sheets Growth – stressed growth rates are applied to P&L and lending. Loan losses – derived using a historical regression analysis applied to scenarios. Funding costs – increase in the cost of long- and short-term funding Capital RequirementsFinancial Statements

9 9 Group vs. subsidiary level A requirement to maintain stress test buffers on subsidiary level will most likely mean that the sum of the stress test buffers on subsidiary level exceeds the buffer on group level On group level Nordea defines the (ICR) stress test buffer based on the ambition to not fall below a certain threshold – Should the definition be consistent across entities? – Should the severity of the stress scenarios be the same on subsidiary level as on group level? – The stress test methodology needs in general to be adapted to Basel III and the group vs. subsidiary level issue will be impacted by the crisis management framework


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