MORNBFI Vol. 1 - Planters Development Bank

APP. Q-4308.12.31simulation, a comparison to Boardapproved limits and a qualitativediscussion regarding the appropriatenessof the FI’s current exposures.Sophisticated simulations should be usedcarefully so that they do not become“black boxes” producing numbers thathave the appearance of precision but maynot be very accurate when their specificassumptions and parameters are revealed.Market limits structureThe FI’s board of directors should setthe institution’s tolerance for market riskand communicate that tolerance to seniormanagement. Based on these tolerances,senior management should establishappropriate risk limits, duly approved bythe Board, to maintain the FI’s exposurewithin the set tolerances over a range ofpossible changes in market risk factorssuch as interest rates.Limits represent the FI’s actualwillingness and ability to accept reallosses. In setting risk limits, the board andsenior management should consider thenature of the FI’s strategies and activities,past performance, and managementskills. Most importantly, the board andsenior management should consider thelevel of the FI’s earnings and capital andensure that both are sufficient to absorblosses equal to the proposed limits. Limitsshould be approved by the board ofdirectors. Furthermore, limits should beflexible to changes in conditions or risktolerances and should be reviewedperiodically.An FI’s limits should be consistentwith its overall approach to measuringmarket risk. At a minimum, FIs usingsimple gap should establish limits onmismatches in each time bucket on astand-alone and cumulative basis. Inaddition, limits should be adopted tocontrol potential losses in the investmentportfolio to a pre-set percentage of capital.Larger, more complex FIs shouldestablish limits on the potential impact ofchanges in market risk factors on reportedearnings and/or the FI’s economic valueof equity. Market risk limits may includelimits on net and gross positions, volumelimits, stop-loss limits, value-at-risk limits,re-pricing gap limits, earnings-at-risk limitsand other limits that capture either notionalor (un)expected loss exposures. Inassigning interest rate risk limits under theearnings perspective, FIs should explorelimits on the variability of net income aswell as net interest income in order to fullyassess the contribution of non-interestincome to the interest rate risk exposureof the FI. Such limits usually specifyacceptable levels of earnings volatilityunder specified interest rate scenarios.For example, interest rate risk limitsmay be keyed to specific scenarios ofmovements in market interest rates suchas an increase or decrease of a particularmagnitude. The rate movements used indeveloping these limits should representmeaningful stress situations taking intoaccount historic rate volatility and the timerequired for management to addressexposures. Limits may also be based onmeasures derived from the underlyingstatistical distribution of interest rates, suchas earnings at risk or economic value-atrisktechniques. Moreover, specifiedscenarios should take account of the fullrange of possible sources of interest raterisk to the FI including re-pricing, yieldcurve, basis, and option risks. Simplescenarios using parallel shifts in interestrates may be insufficient to identify suchrisks. This is particularly important for FIswith significant exposures to these sourcesof market risk.The form of limits for addressing theeffect of rates on an FI’s economic valueof equity should be appropriate for the sizeand complexity of its underlying positions.For FIs engaged in traditional bankingManual of Regulations for Non-Bank Financial InstitutionsQ RegulationsAppendix Q-43 - Page 13