Market Risk Management
- Overview
- Market risk structure and framework
- Market risk governance
- Market risk policy and strategy
- Value at Risk (VaR)
- Stress testing
- Non-Trading Portfolio
- Market risk reporting
1 Overview
Market risk is the exposure to an adverse change in the market value of our trading and investment positions caused by a change in prices and rates.
Such positions result from market making, proprietary trading, underwriting and investing activities.
The market risk factors are foreign exchange rates, commodity price, interest rates, and equity prices.
- Foreign exchange risks arise from exposures to changes in spot and forward rates and volatilities of the exchange rates.
- Interest rate risks result from exposures to changes in the level and shape of the yield curve, the volatility of interest rates and credit spreads.
- Equity price risks result from exposures to the changes in prices and volatilities of individual equities.
2 Market risk structure and framework
The Bank ensures that all the market risk exposures are consistent with its business strategy and within its risk tolerance. The goals of the Bank are principally to:
- define the Bank's market risk appetite;
- ensure that the Bank's overall market risk exposure is maintained at levels consistent with the available capital; and
- ensure that management and individuals responsible for market risk management possess sound expertise and knowledge to accomplish the risk management function which involves establishing stable and reliable methodologies for identifying, measuring, controlling, monitoring and reporting market risk in a consistent manner across the businesses within the Bank.
3 Market risk governance
Regular market risk reports are presented to the Board Audit and Risk Management Committee (BARAC) and the Assets and Liabilities Management Committee (ALCO).
BARAC and the full Board are responsible for the following:
- approval of market risk management framework, policies, strategies, guidelines and philosophy;
- provision of Board oversight for the implementation of market risk management policies; and
- approval of market risks related limits for the Bank and subsidiaries.
The Assets and Liabilities Management Committee, made up of executive directors and other relevant divisional heads, is responsible for the following:
- reviewing policies relating to market risk management;
- recommending market risk policies to the Board;
- providing management oversight for the implementation of policies relating to foreign currency rates, interest rates and equity prices' risks;
- reviewing market risk strategy and recommending same for Board approval;
- developing policies, procedures, tools and systems for identifying, measuring, controlling and reporting market risks;
- evaluating market risk inherent in new products;
- ensuring compliance with statutory and regulatory requirements relating to market risks;
- reviewing and recommending for approval market risks related limits, i.e., position, concentration, currency, dealing gap, total portfolio and counterparty limits; and
- approving appointment of dealers.
The day-to-day implementation of the Bank's market risk management policies, procedures and systems is delegated to the Head of the Market and Liquidity Risk Management Department who reports to the ED/Chief Risk Officer.
The Market and Liquidity Risk Department performs the following functions:
- implementation of the framework and establishment of the market risk policy;
- definition of identification standards and independent measurement, monitoring, control and reporting of market risk;
- definition, approval and monitoring of limits;
- performance of qualitative risk assessments; and
- performance of stress tests and scenario analyses.
FirstBank is committed to managing market risks emanating from the following activities:
- Money market activities.
- Capital market activities.
- Financial intermediation activities.
Some of the Bank's subsidiaries engage in limited proprietary trading in quoted equities but there is control oversight on such exposures. In addition, each subsidiary has a risk management framework and policy that is consistent with the Enterprise Risk Management manual. Apart from the commodity price risks inherent in some of the credits, the Bank is not active in commodity trading.
The Bank maintains a well-articulated market risk policy, which drives the level of market risk exposures on trading and investment activities. The Bank is moving from traditional methods of market risk management (risk mitigation) to risk optimisation by linking the Bank's business strategy to its day-to-day risk exposures.
4 Market risk policy and strategy
FirstBank has put in place a clearly defined market risk management framework that provides the Board of Directors and Management with guidance on market risk management processes. The Bank has also prescribed tolerable market related losses, vis-a-vis the quantum of available capital and level of other risk exposures.
The Bank's market risk policy and strategy are anchored on the following:
- product diversification which involves trading, application and investment in a wide range and class of products such as debt, equity, derivative, foreign exchange instruments, corporate securities and government securities;
- risk taking within well-defined limits with the sole purpose of creating and enhancing shareholder value and competitive advantage;
- effective utilisation of risk capital;
- continuous re-evaluation of risk appetite and communication of same through market risk limits;
- independent market risk management function that reports directly to Management;
- robust market risk management infrastructure reinforced by a strong automated system for controlling, monitoring and reporting market risk, including transactions between the Bank and its subsidiaries;
- deployment of a variety of tools to monitor and restrict market risk exposures such as position limits, sensitivity analysis, ratio analysis and management action triggers;
- setting the internal Open Position Limit (OPL) lower than the CBN prescribed limit (currently 5% of shareholders' funds). The Bank has put in place an approval process for exceeding the internal OPL limit. However, any trading above the CBN regulated OPL limit must be approved by the Central Bank; and
- enforcement of market risk operating limits and other risk management guidelines that will ensure consistent compliance with OPL limit.
5 Value at Risk (VaR)
The Bank, during the year, improved on its use of the VaR model to estimate the potential losses that could occur on risk positions as a result of movements in market rates and prices.
VaR, in general, is a quantitative measure of market risk which applies recent historic market conditions to estimate the potential future loss in market value that will not be exceeded in a set time period at a set statistical confidence level. VaR is calculated for expected movements over a minimum of one business day and to a confidence level of 99% and a 10-day holding period. The confidence level suggests that potential daily losses, in excess of the VaR measure, are likely to be experienced three times per year in every 250 days.
The Bank uses parametric method as its VaR methodology with an observation period of two years obtained from published data from preapproved sources. VaR is calculated on the Bank's positions at close of business.
The Bank has recently deployed SAS risk management systems capabilities for a more robust market risk analysis including VAR models based on Monte-Carlo simulation. The data in the table and graph below comprise the trading VaR of the Bank. The major contributor to the trading VaR is Treasury bill owing to its observed volatility. A typical 3-month Treasury bills volatility during the period peaked at 163.98% while its average volatility during the period was 157.73%. The Bank has not adopted the use of VaR for its equity exposure as a result of low market liquidity. The bank does not trade in commodity and therefore is not exposed to commodity risk except in transactions where commodities have been used as collateral for credit transactions. The latter is covered under credit risk management.
