Market risk in trading activities Market risk is defined as the potential negative deviation from the expected economic value of a financial instrument caused by fluctuations in market prices, i.e. interest rates, exchange rates and equity or com modity prices. Market risk also covers the risk of price fluctuations in negotiable securities as a result of credit risk, country risk and liquidity risk. The interest rate, foreign exchange and equity risks of the non- trading positions in the banking book and of the insurer’s positions are all included in ALM exposure. The objective of market risk management is to measure and report the market risk of the aggregate trading position at group level, taking into account the main risk factors and specific risk. KBC is exposed to market risk via the trading books of the dealing rooms in Western Europe, Central and Eastern Europe, the United States and Asia. The traditional dealing rooms, with the dealing room in Brussels ac counting for the lion’s share of the limits and risks, focus on trading in in terest rate instruments, and activity on the forex markets has traditionally been limited. The dealing rooms abroad focus primarily on providing cus tomer service in money and capital market products, on funding local bank activities and engage in limited trading for own account in local niches. Through its specialised subsidiaries KBC Financial Products (KBC FP) and KBC Securities Group (including KBC Peel Hunt since 1 April 2009), the group also engages in trading in equities and their derivatives. At KBC FP, the proprietary trading and Alternative Investment Management busi ness lines have been closed down and most of the risks eliminated. The remaining business lines are being wound down, i.e. primarily the man agement of the credit derivatives business, the business of providing secured advances to hedge funds, the life insurance business, involve
ment in the US reverse mortgage market (portfolio sold in February 2010) and trading activity in exotic equity derivatives.
Managing market risk The principal tool for measuring and monitoring market risk exposures in the trading book is the Value-at-Risk (VAR) method. VAR is defined as an estimate of the amount of economic value that might be lost on a given portfolio due to market risk over a defined holding period, with a given confidence level. The measurement takes account of the market risk of the current portfolio. KBC uses the historical simulation method, observ ing the relevant Basel II standards (99% one-sided confidence interval, ten-day holding period, historical data going back at least 250 working days). The VAR method does not rely on assumptions regarding the dis tribution of price fluctuations or correlations, but is based on patterns of experience over the previous two years. The VAR model is supplemented by extensive stress tests. Whereas the VAR model captures potential losses under normal market conditions, stress tests show the impact of exceptional circumstances and events with a low degree of probability. The historical and hypothetical stresstest scenarios incorporate both market risk and the liquidity aspects of disruptions in the market. Risk concentrations are monitored via a series of secondary limits, the most important being a three-dimensional scenario limit (based on move ments in spot prices, volatilities and credit spreads). Other secondary limits include equity concentration limits, FX concentration limits and basis-point-value limits for interest rate risk. In addition, risks inherent in options (the so-called ‘greeks’) or the specific risk associated with a par ticular issuer or country are also subject to concentration limits.
Market risk for trading activities
(VAR, 1-day holding period, quarterly averages, in millions of EUR) 24
15
15 11
10 7
9
2Q08
7
3Q08
10
8 6
6
3Q09
4Q09
5
1Q08
15
14
13
4Q08
1Q09
2Q09
KBC Bank (excl. KBC Financial Products)
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
KBC Financial Products
KBC annual report 2009
65