Value at risk and bank capital management by Francesco Saita

By Francesco Saita

Whereas the hugely technical size options and methodologies of price in danger have attracted large curiosity, less realization has been concerned with how worth in danger and the risk-adjusted functionality measures reminiscent of RAROC or fiscal profit/EVA"· should be successfully used to enhance a bank?¦s choice making tactics. educational books are usually involved basically with dimension ideas, and commit just a small part to describing the functions, frequently with no discussing the issues that altering organizational tactics in banks can have on company units?¦ behaviour. Practitioners?¦ books are usually in accordance with a unmarried adventure, featuring the process that has been pursued via a unmarried financial institution, yet usually don't effectively overview that technique. In real perform, the alternative of ways to take advantage of price in danger and risk-adjusted functionality measures has no unmarried optimum resolution, yet calls for powerful determination making which can establish the answer that's in line with the bank?¦s variety of administration and coordination mechanisms, and sometimes with features of person enterprise devices in addition. during this ebook, Francesco Saita of Bocconi collage argues that even if chance dimension recommendations have significantly greater in recent times for marketplace, credits and now additionally operational possibility, capital administration and capital allocation judgements are faraway from turning into in basic terms technical and mechanical. On one hand, judgements approximately capital administration needs to reflect on dealing with varied capital constraints (e.g. regulatory vs. monetary capital ) and face amazing problems in offering a degree of ?§aggregated?? price in danger (i.e. a degree that considers the general price susceptible to the financial institution after diversification throughout hazard types). nevertheless, the purpose of utilizing capital extra successfully via capital allocation can't be accomplished in simple terms via a kind of centralized asset allocation method, yet fairly through designing a cost in danger restrict approach and a risk-adjusted functionality dimension process which are designed to supply the ideal incentives to person enterprise devices. This connection among refined and leading edge probability dimension suggestions and useful financial institution choice making approximately capital administration and capital allocation make this booklet distinctive and supply readers with a intensity of educational and theoretical services mixed with sensible and real-world realizing of financial institution constitution, organizational constraints, and decisionmaking techniques. *Contains concise, specialist research of the most recent technical VaR measures yet with no the hugely mathematical component to different books*Discusses useful purposes of those measures within the actual global of banking, targeting powerful determination making for capital administration and allocation*Author relies at Bocconi collage in Milan, Italy, one of many most suitable associations for banking in Europe

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16 CHAPTER ♦ 2 What Is “Capital” Management? 4 The Debate about Basel II Adoption and Implementation Despite the long process that was necessary to define the final Basel II document, starting from the first consultative paper issued by the Basel Committee in 1999, the debate about Basel II is far from over. In particular, since the document has to be translated into national regulation by those states that will be willing to adopt it, the process is at present markedly different between Europe and the United States.

The portfolio normal approach, where historical returns of the current portfolio are recalculated and the return of the whole portfolio is considered as the only underlying variable. , a single-position exposure on a single stock or a spot exchange rate) there is in practice no difference among the three. Even in case of security or currency portfolios, the first two approaches in any case do not differ as far as the treatment of a stock index or a currency is concerned, since the currency rate return may be considered both as a risk factor (as in the delta normal approach) and as a benchmark asset return (as in the asset normal approach).

The ratio between MCaR and current market capitalization could give the risk manager an idea about the percentage of the overall value of the bank that could be destroyed over one year in an adverse scenario within a given confidence level. Yet the concept of MCaR we have introduced is even more relevant from the point of view of internal performance measurement and capital allocation decisions. While these topics are discussed more precisely later; in the book, it is useful now to introduce why and how the existence of multiple concepts of capital might affect banks’ decision-making processes.

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