Bank Austria Creditanstalt - Annual Report 2004

Market risk management encompasses all activities in connection with Bank Austria Creditanstalt’s treasury operations and management of the balance sheet structure in Vienna and at Bank Austria Creditanstalt’s subsidiaries. Risk positions are aggregated at least daily, analysed by the independent risk management unit and compared with the risk limits set by the Managing Board and the committees (including MACO) designated by the Managing Board. At Bank Austria Creditanstalt, market risk management includes ongoing reporting on the risk position, limit utilisation, and the daily presentation of results of treasury operations.

The Managing Board of Bank Austria Creditanstalt sets risk limits for market risk activities of the entire Bank Austria Creditanstalt Group at least once a year. MACO, which holds a meeting every week, makes limit decisions at the operational level and analyses the risk and earnings positions of the bank’s treasury units. ALCO performs analyses and makes decisions with regard to business activities closely connected with customer business (in particular, balance sheet structure, liquidity, operational risk, and risk management issues arising between sales units and overall bank management). The decisions and results of these committees are reported directly to the bank’s full Managing Board. Strategic Risk Management, an independent unit separate from the business units up to Managing Board level, is in charge of preparing analyses and monitoring compliance with limits. The principles and organisational framework have been laid down in the Treasury Rulebook, the market risk management manual and the ALCO policy of the bank.

Bank Austria Creditanstalt uses uniform risk management procedures throughout the Group. These procedures provide aggregate data and make available the major risk parameters for the various trading operations at least once a day. Besides Value at Risk (VaR; for internal risk measurement on the basis of a one-day holding period and a confidence interval of 99%), other factors of equal importance are stress-oriented volume and position limits. Additional elements of the limit system are loss-warning level limits and options-related limits applied to trading and positioning in non-linear products.

Bank Austria Creditanstalt’s risk model (“NoRISK”) was developed by the bank and has been used for several years. The model is applied and further refined by the Strategic Risk Management unit. Originally implemented with a variance-covariance approach, the system was extended in 2004 to include a simulation approach, which has added key features relating to distribution assumptions and coverage of credit spread risk. Ongoing refinement work includes reviewing the model as part of backtesting procedures, integrating new products, implementing requirements specified by the Managing Board and by MACO, and adjusting the system to general market developments. In this context a product introduction process has been established in which the risk management unit plays a decisive role in approving a new product.

Regular and specific stress scenario calculations complement the information provided to MACO/ALCO and the Managing Board. These calculations were extended in 2004, especially in the area of credit spread. Such stress scenarios are based on assumptions of extreme movements in individual market risk parameters. The bank analyses the effect of these fluctuations and a liquidity disruption in specific products and risk factors on the bank’s results and net asset position. These assumptions of extreme movements are dependent on currency, region and liquidity and are set by Strategic Risk Management on a discretionary basis. The results of these stress tests are taken into account in establishing limits.

In addition to the risk model results, income data from market risk activities are also determined and communicated on a daily basis. These data are presented over time and compared with current budget figures. Reporting covers the components reflected in IFRS-based net income and the marking to market of all investment positions regardless of their recognition in the IFRS-based financial statements (“total return”). The results are available to Bank Austria Creditanstalt’s trading and risk management units via the access-protected Intranet application “ERCONIS”, broken down by portfolio, income statement item and currency.

In Vienna, Bank Austria Creditanstalt uses the “MARCONIS” system to completely and systematically review the market conformity of its trading transactions. HVB Bank Hungary and HVB Bank Biochim in Bulgaria also started to use the system in 2004.

Since 1998 Bank Austria Creditanstalt has used its “NoRISK” risk model, which was approved by the supervisory authorities. In contrast to the internal risk management process, the computation of capital requirements takes into account the statutory parameters (confidence interval of 99%, 10-day holding period) and additionally the multiplier determined as part of the model review is applied. The regulatory model, which is based on the covariance approach used for many years and is applied throughout the Group, currently comprises the categories interest rate risk, exchange rate risk and equity position risk. For regulatory purposes, the model covers the specific equity position risk, and the standard method is currently still used for determining the capital requirements for the specific interest rate position risk. Following the above-mentioned refinement of the “NoRISK” system to include a simulation approach also covering specific risk on interest rate positions, Bank Austria Creditanstalt plans to implement the relevant changes also in its regulatory reports in 2005. After these changes, the internal model will also cover specific interest rate risk.

The results of the internal model based on VaR (1 day, confidence interval of 99%) for 2004 were lower than the previous year’s results despite strong fluctuations. The VaR for the Bank Austria Creditanstalt Group ranged between € 18 m and € 43 m, the average was € 24.6 m (2003: € 33.8 m, 2002: € 37.3 m). For the first time the risk report includes the non-trading driven equity positions of the bank’s investment books and the hedge-fund positions. To ensure comparability, the previous year’s figures are stated for all risk categories (except credit spread).

Interest rate risk and spread risk accounted for most of the total risk of the Bank Austria Creditanstalt Group. Significantly more than half of the amount for interest rate risk related to Bank Austria Creditanstalt’s medium-term to long-term positions resulting from asset/liability management. The increase in VaR in May 2004 was mainly attributable to our positioning in the euro in combination with comparatively high interest rate volatility on an annual average.

VaR of the Bank Austria Creditanstalt Group by risk category (in € m)
Risk category	Minimum	Average	Maximum	Year-end
Interest rate risk	4.7	9.1	23.4	5.2
Credit spread	9.0	12.7	14.8	13.2
Exchange rate risk	0.8	2.6	6.9	2.7
Equity risk/trading	0.8	2.0	3.9	3.3
Emerging markets/high yield	1.4	2.4	3.5	2.4
Hedge funds	3.4	4.0	4.7	3.7
Equity risk/investment	4.0	5.8	8.9	4.5
Diversification	n.m.*⁾	–14.0	n.m.*⁾	–13.2
TOTAL 2004	18.2	24.6	43.0	21.8
Total 2003	23.4	33.8	49.8	25.1
Total 2002	23.2	37.3	58.6	28.4

*)	not meaningful

In addition to VaR, risk positions of the Bank Austria Creditanstalt Group are limited through volume limits, which are set for each pair of currencies, each equity instrument and each country or issuer, and monitored on an ongoing basis. Interest rate positions, which are the predominant factor in the Bank Austria Creditanstalt Group’s risk profile, are managed through the presentation and limitation of “basis point values”, in addition to VaR. For all currencies and maturity bands, the valuation result for a change of one basis point (0.01%) is indicated. As at 31 December 2004, the entire interest rate position of the Bank Austria Creditanstalt Group (trading and investment) for major currencies was composed as follows (the table below shows basis point values > € 500):

Enlarge table

Basis point values of the Bank Austria Creditanstalt Group
		As at 31 December 2004						Annual average, minimum/maximum
in €		Up to 1 month	1 month to 3 months	3 months to 1 year	1 year to 5 years	Over 5 years	Total	Maxi- mum	Mini- mum	Absolute average
Western	EUR	–42,604	–92,536	–596,867	–1,516,105	–1,078,391	–294,293	610,679	–2,508,252	909,329
Europe	CHF	32,048	–6,571	–87,077	–53,928	1,169	–114,358	–58,526	–391,241	229,250
	GBP	–1,597	–12,738	13,866	3,665	–6,420	–3,223	6,838	–137,643	47,309
	DKK	1,304	590	–11,993	–1,334	–	–11,433	–10,521	–30,141	15,404
	SEK	1,348	–396	–15,057	1,133	–	–12,972	–10,209	–24,639	16,411
	NOK	976	–665	–13,695	6	2	–13,375	–4,786	–24,164	13,865
New EU	CZK	1,390	–4,209	–39,803	26,355	–23,297	–39,563	56,235	–54,272	22,152
countries	HUF	167	–1,461	11,454	–50,588	–11,965	–52,392	14,995	–150,864	36,608
	PLN	–6,688	–28,927	32,900	–128,824	–2,762	–134,301	50,690	–210,447	64,782
	SIT	274	–548	–1,239	–28,222	–12,597	–42,332	–8,022	–43,027	23,459
	SKK	–249	–1,464	2,332	–39,741	42,054	2,931	65,371	–11,521	29,749
Central and	BAM	561	–223	–451	–1,743	–14	–1,869	390	–2,696	537
Eastern	BGN	–10	300	1,127	12,337	–44	13,710	15,649	–11,309	9,682
Europe	HRK	–202	383	–550	–5,403	–3,864	–9,636	5,129	–9,636	3,962
	ROL	–577	–1,343	113	–480	–	–2,287	38	–2,800	1,125
	TRL	–	–	827	968	–	1,795	1,884	–243	199
Overseas –	USD	13,741	–39,491	–49,036	71,242	15,823	12,279	531,305	–487,920	147,760
highly	CAD	–363	–776	–440	1,430	8	–140	16,466	–10,379	5,401
developed	AUD	76	–15	–215	–2	903	747	1,836	–2,231	731
countries	NZD	20	–2	13	–	–	31	158	–2,106	281
	JPY	–2,784	–1,575	–22,513	4,911	16,199	–5,762	49,346	–28,498	10,623
Other	SAR	–47	–41	–907	–	–	–995	7	–1,558	985
countries	ZAR	–25	–43	18	194	–	144	1,776	–212	959
	XAU	33	133	–	–	–	166	822	15	283
	BPV<500							270	–420	250
TOTAL		–3,251	–191,826	–777,305	1,328,081	–1,063,195	–707,497			1,591,095

In 2004, the Bank Austria Creditanstalt Group’s positions focused on EUR, CHF and USD. Positions in Central and East European currencies reflect the Group’s activities in this region, with basis-point utilisation levels highest in PLN and HUF, followed by CZK, SKK and SIT. Nevertheless, the entire position in the currencies of the new EU countries is significantly lower than for EUR or USD.

In addition to trading in interest-rate, foreign-currency and equity products, the International Markets business segment also comprises trading and investment in emerging markets bonds (“EMI”) and, since the end of 2003, trading in high-yield corporate bonds below investment grade. At the end of 2004, Russia accounted for 32% of the emerging markets portfolio, Latin America represented 28% of the total volume, CEE countries (incl. Turkey) 21%, Africa 10% and Asia 9%.

As at 31 December 2004, the high-yield portfolio was dominated by positions in the rating category B (62%). Both the high-yield portfolio and the emerging markets bonds portfolio benefited from a tightening of the spread in 2004.

Bank Austria Creditanstalt has invested in hedge funds through its subsidiary Bank Austria Cayman Islands since 1999. In addition to equity investments and debt finance, these investments focus on relatively low-risk convertible arbitrage, as in previous years. While the share of convertible arbitrage has been reduced and the hedge strategies have been more widely diversified, convertible arbitrage still accounts for more than half of the total volume. Investments in multi-manager and distressed-securities strategies amount to another 10% each. In 2004, returns on these investments were adversely affected by the general trend that had an impact on all hedge funds, especially in the first six months. However, very good results from investments in distressed securities in the second half of the year, ongoing portfolio shifts and good returns on multi-manager strategies and in the real estate sector combined to produce a performance for 2004 which continued the successful development of previous years. The investment guidelines define major risk parameters. Compliance with the investment guidelines and daily reviews of valuation results are ensured by the risk management unit at Bank Austria Cayman Islands within central risk management guidelines laid down in Vienna.

In early 2004, Bank Austria Creditanstalt started to invest in hedge funds as part of its equity trading operations. The objective is to better diversify equity-related activities, thereby complementing the focal areas of activity in Austria and the CEE countries. Investment decisions are prepared by a hedge fund research team of CA IB. This business is conducted within guidelines defining standards in respect of maximum investment, investment diversification, relative size of holding in the fund, and strategy. The positions are integrated in the risk calculations of Bank Austria Creditanstalt and are monitored on an ongoing basis.

Capital requirements for market risk
Bank Austria Creditanstalt’s risk model is subjected to daily backtesting in accordance with regulatory requirements. The model results for the securities trading book and the open foreign exchange position (including gold) pursuant to the Austrian Banking Act are compared with changes in value on the basis of actually observed market fluctuations. As the number of backtesting excesses (negative change in value larger than model result) has been within the “green zone” ever since the model was introduced, the multiplier need not be adjusted. In 2004, two backtesting excesses were recorded.

Market risk management in the Group
At Bank Austria Creditanstalt, market risk management covers the activities in Vienna and the positions at the bank’s subsidiaries, especially in Central and Eastern Europe. These subsidiaries have local risk management units with a reporting line to Strategic Risk Management. Uniform processes, methods and limit systems ensure consistent Group-wide risk management adjusted to local market conditions.

The “NoRISK” risk model has been implemented locally at major units (Poland, Czech Republic, Slovakia, Hungary, Croatia), and a daily risk report is made available to the other units. The web application “ERCONIS” was extended in 2004 to record the daily business results of treasury activities in CEE. The timely and continuous analysis of market risk and income is the basis for risk-return management of operations at subsidiaries. In addition, short-term and medium-term liquidity management is performed centrally for subsidiaries through position limits.

Steady business expansion and the acquisition of additional banks in CEE require the permanent adjustment of processes, systems and methods. After the acquisition of Central Profit Banka in Bosnia in the past year, integration in the Group’s market risk position was ensured within a short time.

Market risk limit utilisation remained moderate in 2004. At year-end, the CEE subsidiaries utilised their Value-at-Risk limits to the extent of 22%, which corresponded to about one-quarter of the Group’s market risk.

Management of balance sheet structure
Interest rate risk from customer transactions is attributed to the International Markets (INM) division through a matched funds transfer pricing system applied throughout the Group. This makes it possible to attribute credit, market and liquidity risk and contribution margins to the bank’s business divisions in line with the principle of causation. ALCO ensures that the bank’s overall maturity structure is optimised, with the results from maturity transformation being reflected in the INM division. Factors taken into account in this context include the costs of compensation for assuming interest rate risk, liquidity costs and country risk costs associated with cross-border foreign currency financing.

Products for which the material interest-rate and capital maturity is unclear, such as variable-rate sight and savings deposits, are modelled in respect of investment period and interest rate sensitivity by means of analyses of historical time series, and taken into account in the bank’s overall risk position.

To assess its balance sheet structure, the bank uses the Value-at-Risk approach, complemented by a scenario analysis covering subsequent quarters and years. In this context, simulations of the future development of the bank’s net interest income and market value are based on assumptions regarding volume and margin developments under different interest rate scenarios. In this way, parallel interest rate shocks as well as inversions and low-interest-rate scenarios are analysed to identify their possible impact on the bank’s net interest income and market value. Such analyses focus on modelling customer behaviour in respect of products for which the material interest-rate and capital maturity is unclear. The existing hedge of customer business against interest rate risk significantly reduces the volatility of the bank’s net interest income.

A strong decline in the EUR yield curve would have the strongest impact on the bank’s net interest income. A downward interest rate shock of 2 percentage points would thus depress net interest income in the first year by about € 90 m.

The future New Basel Capital Accord (“Basel II”) will be effective from 2007. For the first time, the new rules establish a relation between “interest rate risk in the banking book” and the bank’s capital by comparing a change in the market value of the banking book after a 2% interest rate shock with the bank’s capital. The complete and automated integration of the Group’s risk position means that Bank Austria Creditanstalt is already well prepared to meet this requirement with its “NoRISK” risk measurement system.

A Basel II recommendation relates to the simulation of future net interest income in different interest rate scenarios (“earnings perspective”). Here, too, the bank has appropriate systems and procedures in place. In addition to the banking book in Austria, such scenario calculations are currently performed for the larger subsidiaries in Poland, the Czech Republic, Slovakia and Hungary.