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Regulatory Capital

QRM has been working with clients on their Basel compliance processes since 2003. Our consultation applies to all aspects of an enterprise risk management practice, beginning with data modeling, credit parameter estimation, regulatory filings, stress testing, and loan pricing. The engagement not only includes the integrated models and platform upon which clients efficiently comply with Basel, it also increases communication and information sharing across business lines and risk groups.

Operating on a fully integrated enterprise approach, QRM clients create a regulatory model which includes credit, market, and operating risk, as well as capital allocation rules. Models are tested across the institution on either a current or forecasted basis, taking into account changes in credit parameters, economic conditions, and business strategies. Clients produce all of the required regulatory filings, including electronic submissions to the regulator, and publish business unit, legal entity, or other segmentations to facilitate internal audit and control. In addition, QRM consultants assist clients to migrate their Basel model to a full economic capital model capable of calculating transaction-level capital factors or the return on capital attributable to each asset. These calculations take full advantage of Basel’s requirements and provide management the business intelligence necessary to enhance their return on capital.

One Integrated Basel Model for the Entire Institution
QRM clients build regulatory risk models that include credit, market, and operating risk-weighted calculations. Clients are able to apply a single model to the entire balance sheet, or different models to different portfolios within the same process. For example, clients may apply an Advanced Internal Ratings-Based (AIRB) credit model to a portion of the balance sheet and a standardized credit model to the remainder, thus allowing them to transition each portion of their balance sheet to the most sophisticated models as data becomes available.

Our consultants work with clients to build Basel models based on regression equations, scorecards, lookup tables, or even detail-level input of risk parameters. This degree of customization induces fast-activation timetables: some clients have established risk models in one month.

In addition to modeling credit, market, and operating-risk-weighted assets, clients model the equity side of the regulatory balance sheet. They establish appropriate limits on Tier 1, Tier 2, and Tier 3 capital to automatically calculate the regulatory capital ratio. Clients may enter the consolidation structure into the risk modeling process so that appropriate models are calculated for various subsidiaries and regulators.

Enterprise-wide Regulatory Capital Stress Testing
QRM clients conduct regulatory capital stress testing across all regulatory risk models for the current or any future balance sheet position. For current positions, clients conduct simple stress tests—such as two-, three-, or six-sigma shocks—to the probability of defaults, loss given defaults, or other risk parameter estimates, in order to determine the effect on regulatory capital. For future positions, clients create scenario stress tests based on a balance sheet forecast that includes ratings-based migration, credit parameter changes through time, or detailed risk-weighted asset analysis. These forecasts may also include changes in asset mix and growth based on business strategies, changes in asset quality based on economic conditions, or the growth in capital base through retained earnings.

Creating a single stress model consistent across all departments not only embeds the process, it also creates a single enterprise-wide decision variable—the capital ratio. As clients integrate all models within a single-forecast stress test and include business-line-developed pricing and volume strategies, this ratio summarizes the results of the credit, market, and operating risk models, plus the forecast capital base. With the capital ratio, senior management can quickly decide whether its business strategies need to be modified or if contingencies need to be created.

Economic Capital Integration and Loan Pricing Analysis
QRM consultants also assist clients with leveraging their Basel II models to create a full economic capital calculation for the entire organization. Clients selectively remove the various assumptions inherent to the regulatory model, such as single-factor correlation, constant default rates, or non-cyclical recoveries, and replace them with their organization’s underlying business model. As their regulatory and economic capital models are integrated, clients can provide an exact reconciliation between regulatory capital and economic capital based on the modified regulatory model assumptions. This allows the economic capital department to create and reconcile models for Internal Capital Adequacy Assessment Purposes (ICAAP), as well as to calculate the capital factor and return on capital attributable to each of the organization’s assets.

Our clients leverage Microsoft Reporting Services and Online Analytical Processing (OLAP) technologies to drill into and understand the profitability of their organization across key risk dimensions. Reports are created to identify the divisions, regions, credit scores, industries, or other dimensions that are the most profitable. Alternatively, reports may be used to identify the minimum required pricing margin for the underperforming segments of the organization’s portfolio.

Custom Reports and Regulatory Filings
Our consultants work with clients to build customized reports and encourage them to produce Basel II regulatory analyses in both spreadsheet and electronic format. These custom reports provide detailed analysis for client departments, consolidated filings for the regulators, or enterprise-level reporting for the regulatory department.

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