Assessing the challenges of P&L attribution and ability to pass the tests

Assessing the challenges of P&L attribution and ability to pass the tests

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Alan Smillie is Head of Capital & Ratings Methodology, part of the Risk Methodology Group in Nomura where he has been since 2010. Before that he worked in Market Risk Methodology at Citi. Amongst other things he worked on the risk models during the subprime crisis, which was one of his most memorable professional experiences, as they tried to respond to once-in-a-generation market shocks.

 

Alan is set to join a panel discussion at the Center for Financial Professionals’ 6th Annual Banking Risk & Regulation Summit in London 9-10 May.

Find out more on the conference here.

 

P&L Attribution is well known to be the most controversial aspect of FRTB. Banks understand the desire to have a more stringent test of model eligibility, but the way the test is designed makes it very hard to pass, without making fundamental system changes which have limited risk management benefit.

 

We asked Alan to explain some of the difficulties in passing the P&L attributions tests. “The key issue is that the test is measuring how well the risk model can predict P&L from front office systems, which is not what the models were designed to do (rather they try to forecast tail losses). And the changes banks have to make to achieve this mean we have to tie the risk system very closely to the Front Office in terms of data and processes, which isn’t always the best approach for managing risk.

 

“This is exacerbated by the design of the test statistic, which is highly sensitive, and the dramatic consequences of failure (removal of IMA, rather than a capital multiplier, for example).”

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