Implications of the Global Financial...

FPDFS – Prudential Oversight Unit

Introduction


Agenda

Background: Why was the FPM created? The FPM Integrating tool Importance of analysis FPM use within dynamic supervision Details: Features/Specs; Structure; Closer look at entry sheets

and results summary sheet

FPM’s wide range of uses Managing Expectations - Caveats FPM’s Portfolio of Work to-date

2


Why was the FPM created?

Update tools to “assess condition/viability” under incertitude/tension

Balance the excesses: little onsite and too much offsite (pre-2007 crisis)

Need to evaluate viability of a bank as a business (flow of earnings)

Need a dynamic perspective on loans (flows, feedback, 2nd round effects)

Focus on solvency rather than static impact of regulatory capital Correct “modeling myopia”: need to look at drivers of bank’s

earnings Internalize knowledge of onsite examiners (CAMEL+RAS) 3


FPM: An Integrating Tool. Simply put…

4…and FPM gives a projection of the financial data

User’s assumptions for the behavior of each BS & PL line and macroeconomic

scenario(s)

The financial data of a bank (or banks or whole banking

system)

Macroeconomic data

FPM can be as basic or comprehensive as your inputs


…Strength Depends on Quality of Inputs

5

…and gives a projection of the financial data

User’s assumptions for the behavior of each BS & PL line:

Macroeconomic data:• Financial Stability Analyses (top-

down systemic perspective)• Impact of Stress Tests

…In easily understandable outputs:• Balance Sheet and Profit/Loss• Proxy Performance Indicators• Operational Cash Flow• PV of Discretionary Dividends• Resolution Costs (as needed)

• Formed from all the analyses

• Supervisory Risk Assessments (bottom-up perspective from Onsite-Exams)

• Functional Cost Analysis

The financial data of a bank (or banks or whole

banking system):


The Inputs: Important Areas for Analysis

6

The FPM requires in-depth analysis of both external and internal variablesaffecting the evolution and viability of the banking firm (or of a group, or the system as a whole):

Macro-EconomicScenarios

Market Banking Financial

RestructuringActions

Risk AssetsReviews

FunctionalActivities

• GDP• Inflation• Exchange rate• Interest rates• Market size• Correlations• NPL regression

• Interest products• Banking spreads• Fee services• Other activities• OpEx &

Overheads• Regulatory regime• Recurrence

• Size of market• Volume growth• Market position• Business lines• Market trends• Reference rates• Competition

• NPLs “Stock”• Future NPLs• PDs, LGDs, or…• Fixed income• Investments• Foreclosed

assets• Related parties

• Pre-provision profits and OCF

• New capital• Carve Outs• Defeasances• Liability

Restructuring• Rightsizing vs.

cost readying


The Inputs: All in the details

This could mean extra work requiring the user to:

• Learn accounting practices: re-aging, restructuring, interest capitalization…• Take stock of existing analysis, examination and audit reports (and detect gaps)...• Special focus on risk asset reviews & segment/income profitability analysis…• Growth patterns, market shares, yields and spreads by main products …

Although it can be quite powerful with robust data, the FPM is only a tool for a dynamic supervision process, not a panacea!


FPM: a Part of a Dynamic Supervision Process

8

1. ANALYTICS:

Build a starting point

Compile and input bank and macroeconomic data

Assess loan quality & determine interest rates

Make assumptions of the Bank’s operations and macroeconomic scenarios

4. CONTINUED SUPERVISION

Execute supervisory

strategy

Remedy gaps of info Institutionalize use of

model Monitor target indicators Deepen risk asset review Clarify business-segment

MIS

3. REPORTING:

Review Scenarios and Sensitivity

Analysis

Assess Confidence Limits

Identify Crucial Variables

Reconsider Risk Profile

2. SIMULATION:

Determine consistency and assess impact

of assumptions

Firm v. Market Data Clarify Abnormal Items Test at “Benchmark” Bank

Identify info gaps & distortions

Feed back new data & assess system reliance


FPM Details: Features/Specifications

9

System of simultaneous equations solved by iteration (Gauss-Seidel method to converge)

12 periods of various frequencies (annual, quarterly, monthly, daily) Up to 3 macroeconomic scenarios to input and choose from 2 currencies (books (Local & Foreign Currencies or two entities)) 8 credit segments with PD/LGD for “A” and “B”-graded clients and default

class “C/D” Scaling factor for PD/LGD and interest performance of “C/D” (suspended or

cash) 7 deposit products with differential reserve requirement and interest cost Nominal GDP as growth driver for system deposits via market share (both

can be scaled)


FPM Details: Features/Specifications, cont.

10

• Separate view of operational cash flow and balance sheet fund flows in each currency

• Discretional fund flow allocation to loans and AFS selected by user (credit share monitored)

• Designated “balancing item” is ELA after settlement between fund flows (cost subsidy)

• Lines to simulate zero/accruing recap bonds and “preferred” non/cumulative shares

• User defined constraints: liquidity and proxy regulatory capital adequacy• Absolute entries to implement/simulate ALM, restructuring, reorganization,

migration, stress • Initial estimation of technical values: book, liquidation, P&A, and NPV of

DCF.


FPM Details: The Structure

11

• Projected BS

• Projected PL

• Summary

• Valuation

• Resolution

Funds Flow

• Deposits, Cash & CB

• Money Markets

• Capital Markets

• Loans

• Other Assets/Liabilities

• Capital

• Basel II

• Operations

Simulation

EN

TRY (B

S/P

L)

Assumptions for BS

Macro Variables

Assumptions for PL

Actions (ALM)

Activities OUTPUTSINPUTS


A Closer Look into FPM

Series of Excel worksheets of data entry, calculations, and grouped results

Screenshot of [FPM

Cover] sheet


FPM Details: Entry Data - [Macro]

13

[Macro] data entry, historical and base year data: (macroeconomic drivers, reference rates, banking sector size and share of ‘target’ bank, etc.)


FPM Details: Entry Data - [Macro], cont.

14

…and up to 3 sets of macro-scenario assumptions for the projection periods, for same macro variables


FPM Details: Entry Data - [Entry]

15

Base year Balance Sheet and Profit & Loss Account data Two ‘books’

local and foreign currency activities possible


FPM Details: Entry Data - [Assumptions-BS]

16

Assumptions for behavior of each BS line for the projection periods…


FPM Details: Entry Data - [Assumptions-PLA]

17

… and assumptions for behavior of each PL line for the projection periods


FPM Details: Summary of Results

18

[Projected BS] & [Projected PL] show results in separate ‘books’ Local currency

activities in LC.CY.; foreign currency activities in FG.CY. and in LC.CY.; & all activities in LC.CY.

• [Summary] sheet shows resulting figures in both currencies, as % of total assets, % growth, and % of internal structures


FPM Uses: What is it for?

19

Identifying & monitoring problem banks Assessing banks’ risk profiles Extrapolating results of supervisory examination/diagnostic of a bank’s financial

condition Assessing the sustainability of a bank going forward Ascertaining consistency & strength of bank mgmt business plans Evaluating resolution options and developing a resolution plan for problem and failed

banks Implementing multi factor sensitivity analysis for developing policy measures against

potential shocks Bank valuation as a concrete starting point for negotiating a price Analyzing cost & subsidies of government or CB support programs Cost-benefit analysis associated with state-owned financial institutions Setting performance targets for management of state-owned banks


Managing Expectations - Caveats

20

• Not a cure-all! – Diagnostic Review: Get out of the dark to find out how large the hole is in the hull

• An integration tool• Results are based on existing diagnostics & assumptions:

• Highly dependent on quality of exams and offsite analysis & data• Can accommodate inputs from bank mgmt and auditing

processes• Suffers from the risk of the “garbage in, garbage out” syndrome• Can be “manipulated” to fit desired “politically correct” story line• Requires sound judgment and best available info (and filling

gaps)• Strengthens the supervision process (exam & analysis), but not

substitute it


FPM: Caveats, continued

21

• Constraints – data availability and reliability, time resources to come up with meaningful level of detail for inputs (starting data and assumptions), understanding of assets/liabilities movements (rates, reference rates (macroecon rates), spreads)

• Can be used in any type of financial institution, but mainly focused on deposit-taking institutions

• Modeling is a dynamic process (not a statistical event)• Depends on the capacity of the supervisory agency - may not reach full

capacity at once but improve steadily as tool & methodology are institutionalized;

• Depends on the “Model Features”: FPM structure is standardized; local templates adapted to FPM via mapping; FPM can accommodate a variety of local features; FPM is a simplification of the complexities of banking; FPM shared complied “as-is” under license


FPM: Portfolio of Work, to-date

22

So far, the FPM has been used in client countries in Africa, Latin America, and East Asia through our different delivery modes: Delivered as a supervisory tool

Method: preliminary contact/desk work, subsequent in-country consultations and training, and follow-ups.

Content: select group of supervisors work through hands-on case studies to be familiarized with the FPM. They also try out a real case alongside the delivery team, and as resources allow, another case with minimal support. These supervisors champion the ultimate integration of the tool into day-to-day work.

Result and Benefits: supervisors, consolidating information from other relevant CB departments, perform diagnostics of possibly problematic banks, to put figures to the depth of the problems, to simulate ‘what-if’ scenarios and test breaking point thresholds. Team may deliver recommendation for improving any gaps in supervision process. Ultimate integration of the tool is up to the Supervisory Department.

(Some projects delivered with funding from Financial Sector Reform and Strengthening (FIRST) Initiative)


FPM: Portfolio of Work, to-date (cont.)

23

• In a modular FSAP, the FPM was used to prepare diagnostic reports on the country’s SME banks. Focusing on baseline projection and costing out resolution alternatives for the Ministry of Finance. Run a baseline scenario and develop two alternatives, restructuring or

shutting down of the bank Support the baseline projection with a sensitivity analysis to cover the

impact of the deviations from the assumptions on loan quality and productivity

Develop the main components of the restructuring plan to limit the cost of supporting SMEs to the tax payers, and

Set quantitative performance criteria for the management to ensure the delivery of desired outcomes.

OTHER uses: Customizable to your needs.*Best use attained when good knowledge on revenues and costs, business lines, and portfolio segments.


Thank you for your interest!

We look forward to discussing how the FPM may assist your work.

Any Questions, please contact us.Y. Carol Lee ([email protected])

24

Implications of the Global Financial...

Documents

Transcript of Implications of the Global Financial...