IBRC annual report for 2011 - Irish Bank Resolution Corporation ...

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Notes to the financial statements continued50. Risk management continuedLiquidity and funding risk continuedThe Group evaluates its longer term liquidity mismatch or structural liquidity risk on a regular basis. The management ofstructural liquidity risk is important in identifying future funding requirements.Risk mitigationIt is accepted that the current liquidity and funding risk position is significantly outside the risk appetite parameters. The Bankwill continue to manage and monitor this risk, whilst acknowledging that opportunities to reduce it are limited due to thecurrent position of the Bank.Holding a portfolio of highly liquid assets has always formed part of the Group's liquidity management policy, assisting theGroup in receiving and placing cash in the repo market during periods of market volatility. Given the stressed funding andliquidity position of the Bank virtually all of the liquid asset portfolio is currently under repurchase agreements as outlined innote 24.Regulatory liquidityThe Central Bank of Ireland introduced regulatory liquidity requirements in 2007, replacing the liquid stock approach with amore advanced cash flow mismatch approach. Irish banks are required to report coverage in the 0 to 8 day and 9 to 30 dayperiods against which regulatory limits are set with conservative assumptions for certain cash flow types. In addition, theCentral Bank of Ireland sets qualitative requirements regarded as best practice for liquidity risk management.Due to the Bank's reliance on central bank funding, it is not in full compliance with a number of regulatory liquidityrequirements.Market riskDefinitionMarket risk is the risk of a potential adverse change in the Group’s income or financial position arising from movements ininterest rates, exchange rates or other market prices.ObjectiveThe Group aims to have effective systems and methodologies for the identification and measurement of market risks in itsbalance sheet. These risks are then managed within strict limits and in the context of a conservative risk appetite level that isconsistent with the support provided to the Group by the Irish Government.PoliciesThe Group's exposure to market risk is governed by policies approved by the Risk and Compliance Committee, and overseen byALCO. All risk limits are approved by ALCO and the Risk and Compliance Committee.Strategies and processesThe Group’s Restructuring Plan provides for market risk to be minimised in the context of the winding down of the loan bookand the derivatives book. Market risk is managed centrally by the Financial Markets team and GBSM. Market risk throughoutthe Group is measured and monitored by Group Risk, operating independently of the business units.Risk mitigationThe Group has limited ability to engage in risk reducing transactions in the market and therefore aims to manage the winddownprocess in a manner that keeps market risk within approved limits.Trading book riskDefinitionThe trading book consists of positions arising from legacy client transactions in a range of financial instruments as well asrelated interbank hedging transactions. It includes interest rate swaps, currency swaps, interest rate futures, forward rateagreements and options. There are no unhedged exposures in equities or commodities.ObjectiveThe Financial Markets team was well advanced at 31 December 2011 in winding down legacy positions in the trading book inaccordance with the Group’s Restructuring Plan. This process will continue in 2012. Management of existing balance sheet riskpositions takes place within a detailed framework of approved limits. The general aim in the reduction of the portfolio is toretain corporate derivatives until the swap matures or until the associated loan is sold/repays and to retain only sufficientinterbank deals to hedge the market risks arising from these retained corporate exposures.126
Irish Bank Resolution Corporation LimitedAnnual Report & Accounts 2011PoliciesThe Bank's Group Treasury Policy prescribes valuation models and risk measurement methodologies that ensure closemonitoring and clear reporting of all trading book risks.The primary trading book market risk measure is a Value at Risk ('VaR') model that is based on a historical simulationmethodology. It is implemented using a 99% confidence level, a 1 day holding period and two years of historic data. Thestandard risk factors capture the risks in interest rates, exchange rates, option sensitivities and interest basis. The methodologytakes into account inter-relationships between different market variables, for instance between interest rates and foreignexchange rates, and captures the risks associated with option positions in interest rate and foreign exchange instruments.Although an important and industry standard measure of risk, VaR has its limitations as a result of its use of historical data,frequency of calculation and holding periods. Additionally, the use of confidence intervals does not give any information aboutpotential losses when the confidence level is exceeded. For these reasons, the Group also uses a variety of other methodologiesin measuring market risk. These include, but are not limited to, stress testing and sensitivity analysis.Reporting and measurement systemsGroup Risk provides daily reporting of trading book risk positions against all approved VaR, Present Value of a Basis Point('PVBP'), option sensitivity and stop-loss limits. It provides monthly reporting to ALCO on trading book activity with analysis ofall significant risk positions, including stress testing of positions against a range of extreme market scenarios. There is alsomonthly reporting to the Risk and Compliance Committee on compliance with risk limits.Risk mitigationThe Group Treasury Policy outlines a rigorous control environment that includes prescribing a specific range of approvedproducts. It also provides for a structure for the management of legacy trading book risk positions through a detailed set oflimits that covers all of the risk sensitivities associated with the approved products. The wind-down of the trading book involvesidentifying offsetting risk positions that can be closed out at the same time to avoid any increase in market risk positioning.The table below summarises the VaR levels of the Group’s trading book for the period using a 99% confidence level.1 Day TimeHorizon10 Day TimeHorizon2011 2010 2011 2010€m €m €m €mAt end of year 0.3 0.5 1.0 1.7Average 0.3 0.4 1.0 1.2Minimum 0.2 0.1 0.5 0.4Maximum 0.5 1.0 1.7 3.0The average and maximum VaR figures for the year ended 31 December 2011 were lower than for the previous period. Riskpositions were reduced during the year as the wind-down of the trading book was implemented.Banking book risk - interest rate riskDefinitionInterest rate risk is the risk of a potential adverse change in the Group's income or financial position arising from movements ininterest rates. It arises from the structure of the balance sheet and from the execution of customer and interbank business.Banking book positions are those acquired with the intention of holding them to maturity in the normal course of business.Interest rate risk in the banking book arises from a combination of lending, funding and non-trading treasury activities. TheFinancial Markets team manages the market risk associated with all of these activities on a consolidated basis.The Group's financial assets and liabilities have interest rates that are reset at different times or under different bases. There is apotential impact on earnings and value that could occur when liabilities cannot be repriced as quickly as assets in a fallinginterest rate environment or when assets cannot be repriced as quickly as liabilities in an environment of rising rates.At 31 December 2011, the Group held Irish Government promissory notes with a total principal value of €28.5bn. As thepromissory notes are fixed rate instruments which create significant interest rate risk exposure, which in turn leads to potentialearnings volatility, the Bank has hedged a portion of the exposure. The Bank has hedged a total of €4.3bn of the notes usingamortising interest rate swaps, and a further €5.7bn of economic hedges exist in the form of the Group’s capital and fixed ratedebt issuance. However, significant fixed rate exposure remains, with limited capacity to hedge further amounts with marketcounterparties. Further details on the promissory notes are set out in note 25.127
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ContentsIrish Bank Resolution Corpo
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Chairman’s statementIrish Bank Re
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Group Chief Executive’s reviewIri
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Business review continuedIrish Bank
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Board of DirectorsIrish Bank Resolu
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Corporate Responsibility continuedI
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Principal risks and uncertainties c
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Report of the DirectorsIrish Bank R
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Corporate governance statementIrish
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OpinionIn our opinion:• the Group
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Consolidated statement of comprehen
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