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In the first video of this two-part video series, Elisa introduces us to sustainability. She begins by looking at the difference between sustainability and corporate social responsibility, two terms that can be easily confused.

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Banking Essentials - Part I

This pathway will walk us through the basics of banks, starting with some of the different types and their main functions, then starting to look at the regulation faced by the banks, both before and after the Global Financial Crisis.

Greenwashing

Greenwashing is the act of distributing false information about something being more environmentally friendly than it actually is.

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Expert led content

+1,000 expert presented, on-demand video modules

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Gain CPD / CPE credits and professional certification

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Build, scale and manage your organisation’s learning

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Tackling the Cost of Living Crisis

In this video, Max discusses the cost-of-living crisis currently enveloping the UK. He examines its impact on households as well as the overall economy.

CSR and Sustainability in Financial Services

In the first video of this two-part video series, Elisa introduces us to sustainability. She begins by looking at the difference between sustainability and corporate social responsibility, two terms that can be easily confused.

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Book a demo

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Managing Capital Risk and Reporting

Managing Capital Risk and Reporting

David McDonald

20 years: Treasury in Capital Management

A bank must determine if it has enough capital for the future, even if it has enough capital to handle its risks today. Unsurprisingly, regulators are very curious in the same question. Join David as he covers how banks should manage capital risk going forward.

A bank must determine if it has enough capital for the future, even if it has enough capital to handle its risks today. Unsurprisingly, regulators are very curious in the same question. Join David as he covers how banks should manage capital risk going forward.

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Managing Capital Risk and Reporting

11 mins 6 secs

Key learning objectives:

  • Outline how banks determine whether they have enough capital for future risks

  • Understand the importance of stress testing

Overview:

Even if a bank has enough capital to manage its risks today, it needs to know whether it has enough capital to manage future risks. They do this by creating detailed risk assessment plans as well as assessing what could go wrong under certain conditions through stress testing.

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Summary

How does a bank ensure it has enough capital for future risks?

To ensure enough capital for future risks it needs to create a detailed risk assessment. It starts with developing a strategic plan starting with an economic base case forecast for 3-5 years, or a capital allocation plan. Businesses and finance departments then forecast how the bank could best take advantage, or protect against, forecast economic conditions. Risk departments run their models for each point (at year end, for example) in that plan to estimate what internal and regulatory capital requirements could be. However, to ensure the plan is robust enough the bank also needs to undertake stress testing, i.e. determining what happens if it all goes wrong. 

Why are stress tests so important?

Following the GFC, Board and regulators’ risk appetites now typically include limits for what could happen to a bank’s capital or liquidity should things not go according to plan, known as stress testing. A Board’s risk appetite statement will include a limit on how much the capital position could be eroded should things go wrong, and they would be advised not to approve a strategic plan if this appetite is breached. 

A stress scenario is run in the same way as a base case strategic plan.  Businesses forecast what would happen to balance sheet growth and margins; risk departments calculate impairments and capital requirements for each risk type and, additionally, might add on downside impacts for current and forecast operational events.  A revised forecast capital plan is constructed for the board to consider formally as part of its strategy deliberations.

Stress tests should be extreme but plausible and should have a clear purpose, most likely with a defined pass/fail threshold. 

The severity of the scenario may be determined in-house or be prescribed by the regulator, although regulators do tend to provide indications of the appropriate degree of stress expected in its Internal Capital Adequacy Assessment Process, or ICAAP.

One of the key outcomes of the stress testing process relates to the actions that the bank could take to mitigate the impact of the given stress scenario. The actions it could take would be documented in its recovery plan. 

Regulatory stress tests started to evolve in 2009 and are typically run annually in the US and UK and every two years in the EU. 

 

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David McDonald

David McDonald

David McDonald is the Head of Regulatory Reporting at Close Brothers Plc. Close Brothers is a leading UK merchant banking group providing lending, deposit taking, wealth management services and securities trading. He has served for 32 years in the banking sector, working his way up from a filing clerk in 1990 to senior positions in risk and finance at HSBC and Santander.

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