Capital Market Day, Copenhagen, 29 June 2000
Risk ManagementJesper Ovesen
Chief Financial Officer
Den Danske Bank
Agenda
u Risk Management as an integrated partof our shareholder value philosophy
u Organisation of risk and capitalmanagement
u Future initiatives and thoughts
Den Danske Bank
Risk and return
Theoretical capital ofcost risk
after tax earnings −
In practice capital ofcost capital
loss /expectedprovisions - costs - income−
Regulatory capital
RORCconcept
RAROCconcept
Economic capital
Den Danske Bank
Den Danske Bank Group 1 quarter resultsRORC concept
(DKr million)Retail Wholesale Danske
SecuritiesAsset
ManagementLife &
Pension
Core earnings before provisions 785 580 103 300 197
Risk weighted assets 171,120 199,728 548 5,257 -
Allocated capital (reg.) 11,974 13,981 38 368 5,373
Return on regulatory capital 26,6% 16,8% 1099,3% 330,6% 14,9%
Growth strategy ì î ì ì è
However.... What about risk and the risk adjusted return ?
RAROC
Den Danske Bank
Risk Management
Problems with RORC-conceptu Accounts only credit and market risku Credit risk recognises only four categories of
risk and give very little consideration to thesecurity provided
u Insufficient market risk calculations
RORC RAROCManagement decision
Difficult to use as a “stand-alone-concept” whentrying to optimise the risk/return equation
Den Danske Bank
Risk Management
Why RAROC?u Response to insufficient risk measures in the existing
BIS-rulesu Shareholder value creation
u Return compared to the true economic risku Optimising return through economic capital
allocationu Management of scarce resources
u Response to coming changes in the BIS-rules
Den Danske Bank
REVENUESREVENUES FULLY LOADEDCOSTS
FULLY LOADEDCOSTS
Economic CapitalEconomic Capital
Risk-Adjusted Annual ValueAdded
Risk-Adjusted Annual ValueAdded
+ –
RISKRISK
CreditCredit MarketMarket InsuranceInsurance OperatingOperatingIncludingCapital Benefit
IncludingCapital Benefit
Including ExpectedCredit Loss
Including ExpectedCredit Loss
Cost of Capital
RAROCRAROC
Integration of economic risk and financialperformance management
Den Danske Bank
Cost of capital - how have we estimated it ?
u We have estimated the CoE to 13% pre taxu Capital Asset Pricing model
u long term interest rateu risk premium
u Estimates from external sourcesu Average: 12,9% pre taxu High: 14,1% pre taxu Low: 11,4% pre tax
Den Danske Bank
CREDIT RISKCREDIT RISK
u Credit exposure
u Counterparty quality
u Collateral/ covenants
u Concentrations/ diversification
u Credit exposure
u Counterparty quality
u Collateral/ covenants
u Concentrations/ diversification
MARKET RISKMARKET RISK
u Value at Risk
u P&L volatility
u ALM gap
positions
u Floor risk
u Value at Risk
u P&L volatility
u ALM gap
positions
u Floor risk
INSURANCE RISKINSURANCE RISK
u Mortality/ morbidity histories
u Claims volatility
u One-off catastrophes
u Mortality/ morbidity histories
u Claims volatility
u One-off catastrophes
OPERATING RISKOPERATING RISK
u Business mix
u Revenue volatility
u Cost rigidity
u Potential adverse
events
u Business mix
u Revenue volatility
u Cost rigidity
u Potential adverse
events
ECONOMIC CAPITALECONOMIC CAPITAL
Definition - Required capital to cover potential economic lossesConfidence - Depends on Bank’s debt rating (AA ↔ 1 in 3000 default probability)Time Period - One year
Definition - Required capital to cover potential economic lossesConfidence - Depends on Bank’s debt rating (AA ↔ 1 in 3000 default probability)Time Period - One year
True economic risk captured consistent
Den Danske Bank
Risk Management
Some of you might think.. “If you are so keen on RAROC, whydon’t you publish the numbers?”
We considered it, however... “The RAROC-concept also gives achallenge in many ways”Lots of questions could be aheadè Do we have quality in our historical loss
data?è Do we use the correct parameters?è Do our internal rating system threat our
customers correctly in terms of risk?è Are our calculations of operational risk
in line with best practise?
We implemented the concept in 1999. We will have to get usedto it. Thereafter we will publish the numbers.
Den Danske Bank
The RAROC-concept is a cornerstone inour risk/return management
RetailBanking
WholesaleBanking
DanskeSecurities
AssetManagement
Life &Pension
Risk adjusted return- cost of capital
= Annual Value Added
CustomerA
CustomerB
CustomerC
CustomerD
CustomerE
Risk adjusted return- cost of capital
= Annual Value Added
Capital structure- growth expectations
Equity capital (Tier 1) = 7% Economic capital><=
Dividend policy
Den Danske Bank
Agenda
u Risk Management as an integrated partof our shareholder value philosophy
u Organisation of risk and capitalmanagement
u Future initiatives and thoughts
Den Danske Bank
Organisation of risk and capital management
RetailBanking
WholesaleBanking
DanskeSecurities
AssetManagement
Life &Pension
u Risk and capital management are segregated from those responsible for customer relationships
u Risk are being transferred to centralised unit through transfer pricing
FinanceDepartment
Credit &Market Risk
GroupTreasury
Asset / Liability Committee
Den Danske Bank
ALCO
u Members of ALCO are the members of theexecutive board and the heads of Group Finance,Group Treasury, Danske Markets and the CreditSecretariat
u ALCO meets approximately once every monthu The ALCO Operative Committee meets every
second week and consists of ALCO excluding theexecutive board
Den Danske Bank
The ALCO has the responsibility of:
u The overall development in thebalance sheet
u The funding structure of thebank
u The bank’s market risksu The bank’s credit risksu Internal Transfer Pricing derived
from risks
Den Danske Bank
The ALCO’s responsibilities on the overallbalance sheet cover:
u Goals for the overall growth andcomposition of the balance sheet
u Goals for risk weighted assetsand solvency ratios
u Goals for Economic Capital
Den Danske Bank
Agenda
u Risk Management as an integrated partof our shareholder value philosophy
u Organisation of risk and capitalmanagement
u Future initiatives and thoughts
Den Danske Bank
Future initiatives and thoughts
Positive attitude towards changes in the BIS-rulesu We support the ongoing process and look forward to
a more comprehensive risk frameworku We believe the risk framework should include credit,
market and operational risku On operational risk we take part in several working
groups and will improve the present methodology
è No specific expectations to capital impact fromthe new capital adequacy rules
Den Danske Bank
What drives the future development?
Focus on profitability.....u Willingness to expand and use opportunities in our well
defined business units within Retail banking, Wholesalebanking, Investment banking, Asset Management and Life& Pension if.....”its profitable and meet our target returnlevel”
u Benchmarking, peer group analysis and target setting tovisualise where to go and why!
u Implementation of an overall planning cycle includingstrategic review, action plan and budgets, estimates andmonthly follow-up
Den Danske Bank
Peer Group Analysis
P/B Pay-out1999 C/I value P/E RoE Tier 1 ratio
Peer Group Scandinavia 63% 1.8 10.9 17% 7.7% 42%Peer Group Europe 64% 3.6 19.3 21% 8.3% 38%Cutting Edge 47% 5.1 26.8 47% 11.0% 57%Den Danske Bank 62% 1.4 8.5* 17% 7.3% 26%
* ex. sale of non-life incurance P/E=9.9%
Remarks: Be carecul - C/I-ratio reflects the composition of business units
Den Danske Bank
Future initiatives and thoughtsInvestors and bank analysts demand to Den Danske Bank...apart from producing shareholder valueu Clear and open-minded information in the annual and quarterly
reportu Segmentation and portfolio managementu Targets on Group and business unit levelu Optimal resource allocation
u RORCu RAROC
u Frequent informationu International approved accounting principlesu Capital structure
è We will work very hard to meet your expectations
Den Danske Bank