Effective risk management is essential for long-term development and as a strategic safeguard of the success of DZ PRIVATBANK S.A. To direct and monitor the risks arising from banking business, the bank has set up monitoring systems that are constantly upgraded. Risk monitoring applies continuously to the DZ PRIVATBANK Group, which comprises DZ PRIVATBANK S.A., DZ PRIVATBANK (Schweiz) AG, IPConcept (Luxembourg) S.A., and IPConcept (Schweiz) AG.
The Bank’s risk management covers all the actions taken by the responsible divisions for implementing the chosen risk strategies. Such actions comprise mainly conscious decisions to assume or to limit risk. The Risk Control department is responsible, in particular, for ensuring that risks undertaken are transparent in all risk categories. This entails providing an annotated daily risk report to members of the Board of Management and various departments, focusing on the following points:
- Market price risk on a value-at-risk (VaR) basis (group level and various sub-portfolios)
- Credit VaR (group level and various sub-portfolios)
- Daily portfolio performance
- Operating risk and business risk
- Overview of the liquidity position (economic and regulatory)
In addition, various risk reports are submitted to the Supervisory Board, the Board of Management and specific departments on a monthly and quarterly basis. These include stress test presentations and sensitivity matrices.
BASIC PRINCIPLES OF INTEGRATED RISK AND INVESTMENT CONTROL
The risk, capital and liquidity (RCL) strategy set up by the Supervisory Board is used in order to comply with supervision rules on best practice management approaches for financial institutions. The implementation of this strategy is undertaken in line with the risk, capital and liquidity strategy that is approved by the Board of Management.
The purpose of the RCL strategy is to create transparency regarding:
- Basic risk structure
- Appropriateness of the ratio between the identified risk and available funds to hedge unexpected losses (ability to bear risk)
- Risk-adjusted profitability (RAP)
The RCL strategy focuses on combining the following four elements into a single framework concept:
- Risk measurement: an appropriate definition of the Bank’s risk position is the core element of the RCL policy. This involves defining the risk categories in which all material risks are recorded, and setting minimum requirements in relation to the quantifying of those risks
- Ability to bear risk: an analysis of the risk-bearing capacity compares the upper loss limit and the risks measured centrally by DZ Bank AG with the risk cover amount.
- Risk-adjusted profitability: the figures for Economic Value Added (EVA) and Return on Risk Adjusted Capital (RORAC) create transparency regarding the Bank’s added value based on the assumed risks
- Risk, capital and liquidity management: the RCL management strategy is applied through continuous embedding in the planning processes, standardised monitoring of KPIs, and a regular reporting process with clear responsibilities and escalation levels
Value-at-Risk (VaR) and performance changes in stress tests are used for measuring financial risks. VaR indicates the maximum loss within a predefined period according to a defined probability (confidence level). Stress tests denote the analysis of performance changes under suitably defined crisis scenarios. The result of the value-at-risk measurement and of suitable stress tests is defined as the risk capital requirement. All types of risks are measured at individual institution level and at group level.
DEFINITION OF RISK TYPES
RISK MANAGEMENT IN IRKS
In the RCL material, risks are divided into the following types:
- Market price risk
- Credit risk
- Operating and reputational risks
- Business risk
- Investment risk
- Liquidity risk
MARKET PRICE RISK
The Bank assumes market price risks in order to take advantage of business opportunities. A market price risk is defined as the risk of a loss which may arise through changes in interest rates, spreads, ratings (migration risk), exchange rates, share prices or volatilities. Spread and migration risks are measured and limited centrally by DZ BANK AG, both for the Group and for the individual management units. All other market price risks are restricted by means of a local limit, and they are measured and monitored within DZ PRIVATBANK S.A. on the basis of a value-at-risk approach.
The historical simulation approach is based on a confidence level of 99% and an assumed holding period of one trading day over an observation period of 300 days. The limit was applied on the basis of a confidence level of 99.9% and a holding period of one year.
Backtesting is carried out daily in order to check the reliability of the value-at-risk approach. This involves comparing the daily profits and losses with the value-at-risk figures calculated on the basis of risk modelling. Basis point value procedures and stress-test procedures, in which various market movements are simulated, enhance the monitoring of market price risk.
MARKET PRICE RISK DEVELOPMENT OF DZ PRIVATBANK S.A.
Credit risk indicates the risk of unexpected losses caused by counterparty default. The risk capital requirement for the credit risk is quantified by means of a portfolio model (Creditmetrics). This procedure determines the loss distribution on the basis of simulation calculations which can then be used to estimate the unexpected loss and thus the risk capital requirement.
– CONCENTRATION OF CREDIT RISKS
The credit department of DZ PRIVATBANK S.A. has group-wide responsibility for the German cooperative banks' lending business in foreign currencies. It covers the direct refinancing of cooperative banks and the guaranteed lending business of their customers. Other business activities include collateralised loans, money market operations and securities transactions.
In a letter dated 20 July 1994, the Luxembourg regulatory authority (CSSF) approved a request made by DZ PRIVATBANK S.A. to apply an overall weighting of zero to the risks against companies of the DZ BANK Group with regard to limiting major risks.
According to the banking supervision definition, the Bank defines operational risk as the risk of an unexpected loss arising from human actions, process or project management weaknesses, technical failure, or due to external influences. The definition takes legal risk into account, but it does not cover strategic and reputational risks. Operational risks involve their own form of risk and correspondingly require extensive management, controlling and monitoring. The goal is to identify, limit and avoid such risks.
– EARLY WARNING SYSTEM/RISK INDICATORS
Early warning systems are employed to systematically detect and recognise as many of the risks as possible that are involved in banking operations. Risk indicators, which are measured against fixed thresholds, are warning signals that indicate possible operational risks. The Bank can therefore use them as an early warning system to indicate unwelcome trends or developments in banking operations.
– LOSS DATABASE
Data on losses is highly useful for identifying operational risks. The systematic collating and analysis of such data enables weak points to be identified so that measures can be taken to improve them. To comply with the need for completeness, quality and security of auditing, the Bank uses Orc software (Operational Risk Centre) in order to collate loss data. The loss database contains data from 2003 onwards.
The self-assessment of DZ PRIVATBANK S.A. serves as a risk potential analysis; it is conducted as part of the risk self-assessment of the DZ Bank Group. The basic scenarios are specified centrally by DZ BANK AG. The specific scenario descriptions and characteristics are then based on the evaluation of loss frequencies and amounts.
To counter possible risks relating to personnel, the Bank sets great store by the careful selection, training, deploying, fostering and development of its employees. The Bank's structural and procedural organisation is characterised by the strict separation of tasks, the observance of the four-eyes principle, strict access controls, and competency and deputising regulations. All corporate handbooks and work instructions are continually updated.
A standardised procedure ensures that operational and all other risks will be adequately checked when new products or product variants are introduced. The Bank's Legal Compliance and Money Laundering Department is responsible for identifying and processing legal risks. This department also handles the monitoring duties resulting from legal compliance requirements. With its Business Recovery and Disaster Recovery Centres, the Bank's operations can be continued locally at another site in Luxembourg.
The risk capital requirement for operational risk is determined on a quarterly basis at central level by DZ BANK AG. The economic model incorporates both the historical loss data and the risk potential analyses derived from the risk self-assessment.
Business risk means the danger of a loss arising from fluctuations in results due to any particular business strategy and which are not offset by other types of risk. In particular, this includes the risk of losses which it is not possible to offset through the use of purely operative measures due to changes in key parameters, e.g. economic and product environment, customer behaviour, competitive situation.
In accordance with the risk management and risk controlling concepts for other risks, the Bank measures its business risk as value-at-risk (VaR) based on a variance/co-variance approach. The capital required to secure business risks is determined based on the volatility of both of the specified risk drivers, i.e. income and costs, and their correlation.
Investment risks are calculated for investments that are not directly included in the risk management strategy of DZ PRIVATBANK. Since all units of DZ PRIVATBANK are involved in risk management, this approach is not relevant as at the reporting date.
DZ PRIVATBANK S.A. interprets liquidity risk in the stricter sense of the term as meaning the risk of there being insufficient funds available to meet payment obligations; liquidity risk is consequently understood to be insolvency risk. Refinancing risk is the risk of loss that may arise for DZ PRIVATBANK from a deterioration in its own liquidity spread as part of the own-issue spread. Rising liquidity spreads mean that future liquidity requirements can only be met subject to additional costs.
The main sources of liquidity risks are identified on the basis of the Bank’s business strategy and business activities.
The Bank uses an internal liquidity risk model for measuring and controlling liquidity risks. This ensures transparency on a daily basis in relation to expected and unexpected liquidity flows – forward cash exposure – and in relation to the liquidity reserves that can be used to offset liquidity shortages – counterbalancing capacity. Both a normal scenario and several stress scenarios are considered. The objective is a positive cash surplus in all relevant scenarios in the corresponding forecasting period. A liquidity contingency plan is in place in order to allow the bank to respond to a crisis situation quickly and in a coordinated manner.
Luxembourg, 1% February 201)
The Board of Management
Peter Schirmbeck Ralf Bringmann Dr Frank Müller