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May 2015

In this webinar, Moody’s Analytics will discuss practical considerations when unifying regulatory and economic capital in investment decisions and the method for measuring this unified approach.

Related Insights

A Composite Capital Allocation Measure Integrating Regulatory and Economic Capital, and the Impact of IFRS 9 and CECL

We propose a composite capital allocation measure integrating regulatory and economic capital. The approach builds upon the economic framework underpinning traditional RORAC-style business decision rules, allowing for an optimized risk-return tradeoff while adhering to regulatory capital constraints. The measure has a number of depictions, and it can be viewed as a weighted sum of economic and regulatory capital, as economic capital adjusted for a regulatory capital charge, or as regulatory capital adjusted for concentration risk and diversification benefits. Intuitively, when represented as economic capital adjusted for a regulatory capital charge, the adjustment can be represented as the additional top-of-the-house regulatory capital, above economic capital, allocated by each instrument's required regulatory capital. We show that the measure has ideal properties for an integrated capital measure. When regulatory capital is binding, composite capital aggregates to the institution's top-of-the-house target capitalization rate. We find the measure is higher than economic capital, but lower than regulatory capital for instruments with high credit quality, reflecting the high regulatory capital charge for this instrument class. Finally, we address how IFRS 9/CECL impacts the CCM and discuss the broader implications of the new accounting standards.

May 2017 Pdf Dr. Amnon Levy, Dr. Pierre Xu

Measuring and Managing Credit Earnings Volatility of a Loan Portfolio Under IFRS 9

IFRS 9 materially changes how institutions set aside loss allowance. With allowances flowing into earnings, the new rules can have dramatic effects on earnings volatility. In this paper, we propose general methodologies to measure and manage credit earnings volatility of a loan portfolio under IFRS 9. We walk through IFRS 9 rules and the different mechanisms that it interacts with which flow into earnings dynamics. We demonstrate that earnings will be impacted significantly by credit migration under IFRS 9. In addition, the increased sensitivity to migration will be further compounded by the impact of correlation and concentration. We propose a modeling framework that measures portfolio credit earnings volatility and discuss several metrics that can be used to better manage earnings risk.

January 2017 Pdf Dr. Amnon LevyDr. Yanping PanDr. Yashan Wang, Dr. Pierre Xu, Dr. Jing Zhang, Xuan Liang

How to Manage the Impact of IFRS 9 on Earnings Volatility and the Supply and Demand of Regulatory Capital

With the implementation of IFRS 9 underway, institutions want to better quantify the impact of IFRS 9 on provisions, result earnings, and capital buffers. During this video webinar, we discuss the strategic impact of IFRS 9 on earnings, capital, and investment concentration. In addition, we discuss how to incorporate these impacts into a strategic business process to better manage the interplay between supply and demand dynamics for regulatory capital.

December 2016 WebPage Burcu Guner, Dr. Amnon Levy

Risk Chartis IFRS 9 Market Report

International Financial Reporting Standard 9 (IFRS 9) is a high-impact symbolic, operational, IT and organisational transformation event for finance and risk. The Risk Chartis IFRS 9 Market Report focuses on the key challenges for banks implementing IFRS 9, including exclusive content from Moody's Analytics.

October 2016 Pdf Dr. Amnon Levy, Burcu Guner

Managing Earnings Volatility and Uncertainty in the Supply and Demand for Regulatory Capital: The Impact of IFRS 9

This paper presents a novel modeling approach that allows for better management of the interplay between supply and demand dynamics for regulatory capital, combining an economic framework with regulatory capital and new loss recognition rules. The framework is particularly relevant in understanding the extent to which IFRS 9 can lead to more aggressive provisioning, which feeds into earnings volatility. Our approach provides guidance on how organizations can better manage their capital buffer, considering investment concentration, its impact on earnings volatility, and the relationship with regulatory capital requirements. Imperative to portfolio management, the framework recognizes the likelihood of a capital shortfall being significantly impacted by portfolio asset class, geography, industry, and name concentration, as extreme fluctuations in capital supply and demand occur more often for institutions holding more concentrated portfolios. Finally, we discuss integrated investment and strategic decision measures that account for the full spectrum of economic risks and interactions with regulatory and accounting rules, as well as instruments' contribution to earnings volatility and capital surplus dynamics.

September 2016 Pdf Dr. Amnon Levy, Dr. Pierre Xu, Dr. Jing Zhang, Andriy Protsyk

Quantitative Research Webinar Series: Modeling Uncertainty in Regulatory Capital and the Impact of IFRS 9 and CECL

Amnon Levy, Managing Director of Portfolio Research at Moody’s Analytics, discusses a novel modeling approach that allows organizations to better manage the supply and demand dynamics for regulatory capital. The approach marries an economic capital (EC) framework with (RegC) and loss accounting rules.

August 2016 WebPage Dr. Amnon Levy

Investment Decisions and Risk-Based Capital Allocation Under Stress Testing Requirements

Higher capital standards imposed by new stress testing requirements have forced organizations to address how to better manage capital to meet regulatory constraints. While maintaining higher capital levels is indeed mandatory, simply satisfying the requirement does not necessarily align with stakeholders' preferences for optimal capital deployment and investment decisions. CCAR-style stress tests are requirements that organizations must adhere to; however, these exercises likely do not reflect how stakeholders actually trade off risk and return.

May 2016 Pdf Dr. Amnon Levy, Dr. Pierre Xu

Using GCorr® Macro for Multi-Period Stress Testing of Credit Portfolios

This document presents a credit portfolio stress testing method that analytically determines multi-period expected losses under various macroeconomic scenarios. The methodology utilizes Moody's Analytics Global Correlation Model (GCorr) Macro model within the credit portfolio modeling framework. GCorr Macro links the systematic credit factors from GCorr to observable macroeconomic variables. We describe the stress testing calculations and estimation of GCorr Macro parameters and present several validation exercises for portfolios from various regions of the world and of various asset classes.

April 2016 Pdf Noelle Hong, Jimmy Huang, Albert Lee, Dr. Amnon Levy, Marc Mitrovic, Libor Pospisil, Olcay Ozkanoglu

Measuring Required Economic Capital and Parameterizing the Loss Reference Point

When parameterizing an Economic Capital (EC) framework, organizations must consider how losses and gains on principal and coupons/fees are recognized, if they are to ensure appropriate capitalization. The level of loss allowance and capital organizations hold must be sufficient to cover potential losses. This paper outlines how parametrization differs for accrual and securities portfolios. In addition, we relate parametrization approaches with those associated with Basel Advanced-IRB calculations. We conclude that, when measuring an organization's required economic capital buffer, the relevant loss reference point is the accounting value net of loss allowance — losses should be measured in excess of total spread. While seemingly inconsistent with the Basel A-IRB formulation, where losses are measured in excess of expected loss, the difference can be interpreted as loss allowance exactly aligning with expected loss.

March 2016 Pdf Dr. Amnon Levy, Peter Bozsoki, Thomas Tosstorff, Mark Wells

Through-the-Cycle Correlations

In some instances, financial institutions prefer to take longer-term views when assessing the risks of their credit portfolio. While forward-looking or Point-in-Time (PIT) parameters might be more reflective of the current economic environment, their frequent updates may create fluctuations in risk measures, such as economic capital and unexpected loss, which may not be desirable in some applications. This paper outlines two approaches that financial institutions can consider to estimate Through-the-Cycle (TTC) correlation parameters. The first approach averages PIT measures across years to obtain a longer-term TTC average. The second approach calibrates a TTC correlation measure that generates a default distribution in-line with the institution's actual default distribution.

January 2016 Pdf Jimmy Huang, Dr. Amnon Levy, Libor Pospisil, Noelle Hong, Devansh Kumar Srivastava

Credit Risk Management Under Regulatory Capital Constraints

This article outlines recent approaches to managing credit risk when facing regulatory capital requirements. We explore how institutions should best allocate capital and make economically-optimized investment decisions under regulatory capital constraints, such as those imposed by Basel or CCAR-style rules.

December 2015 WebPage Dr. Amnon Levy, Dr. Pierre Xu, Dr. Jing Zhang

Quantifying Risk Appetite for Limit Setting

In this webinar, Moody’s Analytics will discuss practical considerations when unifying regulatory and economic capital in investment decisions and the method for measuring this unified approach.

November 2015 WebPage Dr. Amnon Levy

Practical Considerations When Unifying Regulatory and Economic Capital in Investment Decisions

The degree to which an organization's regulatory capital is constraining impacts an investment's appeal. The more constraint on the organization, the more heavily an instrument's regulatory capital weighs down the investment's appeal, with investments assigned higher regulatory capital impacted more. This paper explores a method for measuring the extent to which an organization's regulatory capital binds and calibrates the model introduced by Levy, Kaplin, Meng, and Zhang (2012), which unifies regulatory and economic capital in investment decisions. We then examine the impact of the regulatory capital requirement on investment decisions based on the calibrated model. We find that the rank order of exposures' risk-return tradeoff in our sample portfolio changes substantially when taking into account the regulatory capital constraint.

August 2015 Pdf Dr. Pierre Xu, Dr. Amnon Levy, Qiang Meng, Andrew Kaplin

Quantifying Risk Appetite in Limit Setting

In this paper, we explore leveraging an organization's economic capital framework to quantify the RAS via risk- and macro scenario-based limits.

June 2015 Pdf Andrew Kaplin, Dr. Amnon Levy, Qiang Meng, Libor Pospisil

Quantitative PPNR Modeling

This paper discusses various quantitative approaches for linking macroeconomic scenarios with PPNR items. Given the broad range of PPNR categories, each item requires special consideration when developing a modeling approach. Modeling approaches range in granularity and depend upon the availability and quality of historical data, statistical properties of the line item, business use and application, and model consistency across balance sheet and income statement items.

January 2014 Pdf Dr. Amnon Levy

Stress Testing Webinar Series: Macroeconomic Conditional Pre-provision Net Revenue (PPNR) Forecasting

This webinar discusses the primary challenges confronting banks when forecasting macroeconomic conditional pre-provision net revenue (PPNR), best practices for forecasting macroeconomic conditional PPNR, and the tools and techniques used by Moody’s Analytics to address the challenges.

October 2013 WebPage Thomas Day, Dr. Amnon Levy, Robert Wyle

Integrating Economic Capital, Regulatory Capital and Regulatory Stress Testing

Amnon Levy, Managing Director and Head of Portfolio Research at Moody's Analytics, shares solutions to integrating the three kinds of stress testing variables for strategic decision making.

October 2013 Pdf Dr. Amnon Levy

A New Approach to Accounting for Regulatory and Economic Capital

In this presentation, which accompanies a recorded Moody's Analytics webinar of the same title, Dr. Amnon Levy discusses Portfolio Research methodology and findings of the new unified measures (RORAC and EVA™) which allow institutions to rank-order their portfolios and potential deals in a way that accounts for both economic risks and regulatory changes.

August 2013 Pdf Dr. Amnon Levy

A New Approach to Accounting for Regulatory and Economic Capital

Learn about Moody's Analytics Portfolio Research methodology and findings of the new unified measures, which allow institutions to rank-order their portfolios and potential deals in a way that accounts for both economic risks and regulatory changes.

August 2013 WebPage Dr. Amnon Levy

A Unified Approach to Accounting for Regulatory and Economic Capital

In this paper, we introduce two new measures that incorporate both RegC and EC: return on risk-adjusted capital (RORAC) and economic value added (EVA™). These measures allow institutions to rank-order their portfolios and potential deals in a way that accounts for economic risk and regulatory charges.

August 2013 Pdf Dr. Amnon Levy, Andrew Kaplin, Qiang Meng, Dr. Jing Zhang

An Overview of Modeling Credit Portfolios

This document provides a high-level overview of the modeling methodologies implemented in Moody's Analytics RiskFrontier™. To address the challenges faced by credit risk or credit portfolio managers, RiskFrontier models a credit investment's value at the analysis date, its value distribution at some investment horizon, as well as the portfolio-referent risk of every instrument in the portfolio. The approach is designed to explicitly analyze a wide range of credit investments and contingencies, including term loans with prepayment options and grid pricing, dynamic utilization in revolving lines of credit, bonds with put and call options, equities, credit default swaps, retail instruments, commercial real estate loans, and structured instruments.

June 2013 Pdf Dr. Amnon Levy

Applications of GCorr™ Macro: Risk Integration, Stress Testing, and Reverse Stress Testing

This research develops an approach to expand the Moody's Analytics Global Correlation Model (GCorr) to include macroeconomic variables. Within the context of this document, macroeconomic variables can include financial market variables, economic activity variables, and other risk factors. The expanded correlation model, known as GCorr Macro, lends itself to several functions that facilitate a cohesive and holistic risk management practice.

April 2013 Pdf Mariano Lanfranconi, Libor Pospisil, Andrew Kaplin, Dr. Amnon LevyNihil Patel

A Unified Decision Measure Incorporating Both Regulatory Capital and Economic Capital

Required economic capital (EC) and regulatory capital (RegC) are two measures frequently used in loan origination and other decisions related to portfolio construction. EC accounts for economic risks such as diversification and concentration effects. When used in measures such as return on risk-adjusted capital (RORAC) or Economic Value Added (EVA™), EC can provide useful insights that allow institutions to optimize risk-return profiles, facilitate strategic planning and limit setting, as well as quantify risk appetite. Meanwhile, when RegC is binding, an institution faces a tangible cost, in that additional capital is needed for new investments that face a positive risk weight. Given these observations, both EC and RegC should influence decision making. After all, a deal with lower RegC but the same EC is favorable, and a deal with lower EC but the same RegC is favorable. In this paper, we formalize RORAC and EVA measures that incorporate both RegC and EC. The new measures allow institutions to rank-order their portfolios and potential deals in a way that accounts for economic risks and regulatory charges.

January 2013 Pdf Dr. Amnon Levy, Andrew Kaplin, Qiang Meng, Dr. Jing Zhang

New Risk Management Techniques that Improve Strategic Planning

New Risk Management Techniques that Improve Strategic Planning

October 2012 WebPage Dr. Amnon Levy, Randy Miller

Moody's Analytics RPC Presentation: Levy Wang on Assessing and Pricing Liquidity Risk

Moody's Analytics RPC Presentation: Levy Wang on Assessing and Pricing Liquidity Risk

January 2011 Pdf Dr. Amnon LevyDr. Yashan Wang

Bulletproofing an Index-Benchmarked Portfolio

Portfolio management problem: Benchmarking portfolio to an index is a common problem. A common approach is to track an index with a smaller number of positions in order to minimize transaction costs. Traditionally, more focus has been on the return; Second-moment-based risk measures such as Unexpected Loss (Standard Deviation) are also used; Less consideration is given to higher-moment, e.g., Tail Risk measures, that are important for credit portfolios.

November 2010 Pdf Dr. Amnon Levy

Analyzing the Impact of Credit Migration in a Portfolio Setting

(This version was written for publication in the Encyclopedia of Quantitative Finance, John Wiley & Sons LTD Publishing) Credit migration is an essential component of credit portfolio modeling. In this paper, we outline a framework for gauging the effects of credit migration on portfolio risk measurements.

September 2010 Pdf Yaakov Tsaig, Dr. Amnon LevyDr. Yashan Wang

Navigating Through Crisis: Validating RiskFrontier® Using Portfolio Selection

Assessing credit risk and ensuring the effectiveness and reliability of credit models are critically important to many risk managers and portfolio managers, especially during financial crises. This validation study examines the measurement accuracy of the portfolio credit risk models employed in Moody's Analytics RiskFrontier.

April 2010 Pdf Zhenya Hu, Dr. Amnon LevyDr. Jing Zhang

Implications of PD-LGD Correlation in a Portfolio Setting

This paper discusses the implications of the Moody's Analytics PD-LGD correlation model on portfolio analysis. We provide numerical results to illustrate the impacts of PD-LGD correlation on risk and return measures of credit portfolios.

February 2010 Pdf Qiang Meng, Dr. Amnon Levy, Andrew Kaplin, Dr. Yashan Wang, Zhenya Hu

Risk Integration: New Top-down Approaches and Correlation Calibration

While the sophistication and adoption of the data, models, and software systems for individual risk types has become more widespread, the tools for consistently measuring integrated risk lag. Typically, individual risk components are aggregated in ways ranging from simple summation to employing copula methods that describe the relationship between risk types. While useful, these “top-down” approaches are limited in their ability to describe the interactive effects of various risk factors that drive loss.

January 2010 Pdf Nan Chen, Andrew Kaplin, Dr. Amnon LevyDr. Yashan Wang