Prelims

Half Title Page

Professional Perspectives on Banking and Finance, Volume 1

Series Title Page

Professional Perspectives on Banking and Finance

Editor

Moorad Choudhry

Professional Perspectives on Banking and Finance is a collection of cutting-edge articles written by practitioners for practitioners. Each volume addresses core topics such as risk management, corporate governance and strategy, but with the emphasis on recent developments and their impact on the industry. Articles will not discuss theory: the emphasis is 100% on advice and suggestions reflecting best practice. The content will be accessible, clear and applicable in any commercial bank. All articles in each volume of Professional Perspectives will reflect a diverse global outlook, addressing issues of importance and relevance for all bankers.

Title Page

Professional Perspectives on Banking and Finance, Volume 1

EDITOR

Professor Moorad Choudhry

The BTRM, London

United Kingdom – North America – Japan – India – Malaysia – China

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Emerald Publishing Limited

Emerald Publishing, Floor 5, Northspring, 21-23 Wellington Street, Leeds LS1 4DL

First edition 2024

Editorial matter and selection © 2024 Moorad Choudhry.

Individual chapters © 2024 The authors.

Published under exclusive licence by Emerald Publishing Limited.

Chapter 9: Counterparty Credit Risk: Lessons From Recent Events © 2024 Andreas Ita.

Published here under non-exclusive licence by Emerald Publishing Limited.

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No part of this book may be reproduced, stored in a retrieval system, transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise without either the prior written permission of the publisher or a licence permitting restricted copying issued in the United Kingdom by The Copyright Licencing Agency and in the United States by The Copyright Clearance Centre. Any opinions expressed in the chapters are those of the authors. While Emerald makes every effort to ensure the quality and accuracy of its content, Emerald makes no representation implied or otherwise as to the chapters' suitability and application and disclaims any warranties, express or implied, to their use.

British Library Cataloguing in Publication Data

A catalogue record for this book is available from the British Library.

ISBN: 978-1-83549-335-9 (Print)

ISBN: 978-1-83549-334-2 (Online)

ISBN: 978-1-83549-336-6 (Epub)

About the Contributors

Khaliq Ali has over 18 years of experience in the Insurance and Banking sectors. He currently heads the Centre of Excellence Division at the Trinidad and Tobago Revenue Authority (TTRA), overseeing Analytics, Research, Strategy and Project Management. Before joining the TTRA Khaliq served as the head of the Group Strategic and Corporate Planning Unit at First Citizens Bank Ltd. where he implemented Strategic Management practices including Strategic Risk Management and the Balanced Scorecard system. Khaliq guest lectures at the University of the West Indies and is a member of the faculty of the Certificate of BTRM. He holds Post Graduate Degrees with distinctions in Information Systems Management (University of Greenwich) and Financial Economics (University of the West Indies).

Edward Bace is a senior lecturer and trainer, with over 25 years of experience in financial, economic, risk and credit analysis, as well as treasury, operations and financial management. This experience was gained from a career in banking and lecturing at universities in the United States and London. In addition, he has published numerous articles on these subjects and presented at conferences worldwide. Edward has a Postgraduate Certificate in Higher Education and is a Senior Fellow of the Higher Education Academy. He has an MBA from New York University in Finance and International Business and a PhD from the University of Michigan. He possesses a Bachelor's degree in Chemistry, is a CFA, Chartered MCSI and a Member of the Professional Risk Managers' International Association (PRMIA), where he has represented their Global Ethics and Professional Standards Committee.

Patrick Carey is former Head of Group Market Risk at the Bank of Ireland Group. He is an independent consultant, lecturer and trainer specialising in market risk and IRRBB and is a member of the faculty of the Certificate of BTRM.

Professor Moorad Choudhry is an independent non-executive director at Recognise Bank Limited, and Honorary Professor at University of Kent Business School. He was latterly Treasurer, Corporate Banking Division, at The Royal Bank of Scotland. Moorad is a Fellow of the Chartered Institute of Securities & Investment and a Liveryman at the Worshipful Company of International Bankers. His previous works include The Principles of Banking, 2nd ed., Bank Asset-Liability Management and The Future of Finance.

Peter Eisenhardt is the Secretary General of the International Council of Securities Associations, the global organisation of securities industry associations. ICSA provides a forum for member associations to exchange views and advocate appropriate regulations and initiatives across jurisdictions to promote efficient and well-functioning securities markets (www.icsa.global). He also acts as a consultant for leading investment banks and teaches courses in capital markets and asset liability management. Mr Eisenhardt has over 40 years' experience in banking. He was Head of Short-Term Fixed Income Origination at Bank of America Merrill Lynch in London. He worked for J.P. Morgan in New York, London and Tokyo in treasury, money market trading, bond options trading, repo, credit and origination. Mr Eisenhardt was voted by industry peers to Euroweek's ‘Dream Team of the Global Capital Markets’ in 2004. He is past chairman of the International Capital Markets Association Euro Commercial Paper Committee. Mr Eisenhardt holds a BA from Wesleyan University and an MBA from New York University.

Graham Hillier worked within the RBS and NatWest group for nearly 40 years. He joined a West Sussex branch of NatWest aged 16, prior to transferring to London two years later. He worked in customer-facing functions across the retail, corporate and financial institutions sectors and subsequently in various Risk departments. Graham holds the ACIB banking diploma qualification.

Andreas Ita is co-founder and managing partner of Orbit36, a management consultancy specialising in strategic planning, treasury, capital and risk management for banks. Until 2019, he was Head of Group Economic Performance and Capital Optimization at UBS. Prior to this, he worked for over 10 years as a senior trader in equity derivatives for a global investment bank. Andreas is a member of the BTRM faculty and a regular conference speaker. He holds a PhD in Banking and Finance from the University of Zurich.

Arnau Lopez is an independent senior Treasury Risk Consultant with extensive experience in directing ALM programmes in Tier 1 banks across Europe and the United States, across IRRBB, liquidity risk and FTP disciplines.

Miranda Love is Head of UK Capital Management, Global Treasury at State Street, in London. She is also a Board Director at one of State Street's UK parent holding companies, with subsidiaries in Ireland and the Caymans. Prior to joining Global Treasury in 2018, Miranda worked in State Street's Operational Risk department in Ireland and the United Kingdom, and in the bank's Corporate Audit division in Boston and London. Miranda is a BTRM Alumnus with Distinction and subsequently joined the BTRM Faculty. She obtained a Bachelor's degree in Business Administration from the University of Southern California and a Graduate Diploma in Accounting from Suffolk University.

Beata Lubinska is Head of Treasury at Allica Bank in London. She has over 15 years of experience in this space gained at GE Capital, Deloitte and Standard Chartered Bank both in Milan and London. Beata is a member of the BTRM Faculty.

Trevor Pugh has been involved in finance for over 25 years. For most of that time, he has traded in the UK gilt market and managed trading desks at Barclays and HSBC. Additionally, he engages in academic work, giving lectures and writing about the market.

Periklis Thivaios is a founding partner of True North Partners LLP, a boutique advisory firm headquartered in London. He was previously lecturing on Counterparty Credit Risk and XVA at the Department of Computational and Applied Mathematics, University of the Witwatersrand in South Africa, and is currently an external lecturer and supervisor for the Department of Actuarial Science at the University of Cape Town. He also lectures on ‘Emerging Topics in Fintech’ at the University of Nicosia in Cyprus. Periklis has a doctoral degree in Finance from IE Business School in Spain (with Distinction Cum Laude), a Master’s degree from the London School of Economics (with Distinction) and is a Chartered Financial Analyst (CFA), an accredited Financial Risk Manager (FRM) and a holder of the BTRM accreditation with distinction.

Claire Trythall is Head of Treasury Risk at Newcastle Building Society. She was previously Head of Asset-Liability Management at Hodge Bank and has held positions at Barclays Bank, Tesco Bank and Cumberland Building Society, within the fields of ALM and IRRBB. Claire has a first-class degree in Banking and Finance from the University of Derby, where she earned recognition as the Best International Business Student, and a Higher National Diploma in Business from Staffordshire University.

Preface

A warm welcome to this, the first hopefully in a series of volumes that will address current and emerging challenges and risks in the banking industry. The book's contents are directed at practitioners in banking; the ultimate aim is to encourage debate and discussion at bank boards and asset-liability committees (ALCOs) about how best to address current issues and, if deemed necessary, adjust strategies and business models so as to remain viable and relevant. It goes without saying then that the primary readership this series hopes to attract are senior executives and non-executives in banking.

We have assembled a diverse group of contributing authors, each of them recognised experts in their field, and all either current or recently retired bank practitioners. The chapters are divided into four parts.

Part I: Current and Future Challenges in Banking

In the first chapter, I consider current and emerging future challenges in banking. It being 2023, the implied question in the chapter title was put first to ‘ChatGPT’, an artificial intelligence (AI) programme that generated not inconsiderable comment and debate after it was ‘released’ to the world for use by essentially anyone. Our intention was to determine how effective, and genuinely practically beneficial, the output from ChatGPT was. The reader will draw their own conclusions, of course; ours was that (and only after a number of iterations) the effort of the AI platform merited, at best, a ‘C+’. Our non-AI view considered that the challenges to all banks – whether traditional branch-based or newer digital ‘challenger’ or ‘neo’ banks – were many and varied, ranging from intense competition and geopolitical pressures to the better known ones such as liquidity risk and market risk. It was the latter, after all, that sunk one or two California-based banks in 2023, albeit in a slightly modified form aided and abetted by a new challenge, that of ‘social media risk’.

In Chapter 2, Khaliq Ali presents a comprehensive discussion of strategic risk management in banks and how to approach it. As a risk type, it is recognised by the Basel Committee for Banking Supervision (BCBS) as one that banks should manage, but as Mr Ali states, ‘Strategic Risk is [often] overlooked and is difficult to objectively quantify and manage…’. We hope his chapter helps to fill some gaps in this area.

Claire Trythall presents the first of two chapters authored by herself in this volume in Chapter 3. In an accessible account directed at asset-liability management (ALM) desks in banks, she recommends that ALM managers incorporate a number of key macroeconomic indicators when devising their approach to balance sheet risk management. And we do mean ‘recommends’ – there are 10 value-added recommendations articulated explicitly in this chapter.

Climate change risk management is a current important area of focus in banks, occupying the minds of everyone from the Board of Directors downwards. In Chapter 4, Miranda Love presents what may appear at first sight to be almost a polemic, but on closer reading shows clearly, almost self-evidently, that this is an area that banks all around the world need to take seriously, and not simply because of regulatory fiat. Edward Bace continues the environmental and sustainability theme in Chapter 5, where he discusses the value of including ‘green bonds’ in a bank's non-equity liability structure. As he suggests, there are sound reasons, both ESG and shareholder related, for doing so.

Part II: Regulation and Risk Management

In the second part of the book, we look at regulation and risk management. Fittingly, in the post-2008 crash era of ever more complex regulation and supervision, in the face of ever newer risk types, in Chapter 6 Graham Hillier goes ‘back to basics’ and emphasises that sound principles of traditional, and conservative, risk management in banking remain as important as ever. In essence, if one gets the basics right, everything else will fall into place.

That said, all practitioners in banking will know and appreciate that the industry is a heavily regulated one. Most banks around the world employ a team of people (this team can range in size from one person to several hundred people, depending on the size and complexity of the bank) engaged in what is termed as ‘horizon scanning’. This simply involves watching out for the latest publication from the regulatory authority, dissecting it, disseminating it and suggesting how this regulation will impact the bank's operational procedures and risk management processes. These days, depending on one's jurisdiction, regulatory compliance occupies more senior executive time than any other single activity that said executive will undertake.

In light of this, we include two chapters that will assist the horizon scanning process. In Chapter 7, Peter Eisenhardt asks the question, ‘Where are we going?’ with regards to bank regulation. Periklis Thivaios then hints at an answer to this in the very next chapter. Following the publication by the Basel Committee for Banking Supervision (BCBS) of what is termed ‘Basel III’ bank supervision guidance in 2010, which was followed by the ‘final form’ of Basel III in 2017 (also referred to as ‘Basel IV’ or ‘Basel 3.1’), he suggests that we are heading for ‘Basel V’. All one can say at this stage is, watch this space!

In Chapter 9, Dr Andreas Ita looks at the lessons learnt for risk management from two recent market events, the default of Archegos Capital Management in March 2021 and the unusually large price jumps in energy markets in summer 2022. He finds that the counterparty exposure from margined derivatives transactions exceeded the required initial margin significantly in both cases, so that the exposures were largely uncollateralised when it mattered the most. In addition, the Basel Committee's Standardised Approach on Counterparty Credit Risk (SA-CCR) results in regulatory capital requirements that are insufficient to cover the banks' losses from the unwinding of large and concentrated derivatives exposures. This made it difficult for some banks to identify the high loss potential from their large trades with a single client. Dr Ita's chapter should be required reading for the Board members of banks that run large derivatives trading and prime brokerage operations!

Part III: Best Practice in Interest Rate Risk Management

When soliciting submissions for this book, we were intrigued by the number of authors who wished to cover interest rate risk in the banking book (IRRBB). Possibly this was due to the failure of Silicon Valley Bank, which some have suggested was due to poor (or non-existent, or incompetent – it depends whose views one deems to be the most accurate) IRR management. In any case, the number of chapters on this topic means the subject warrants a whole part to itself.

There are a number of facets to this discipline. Arnau Lopez kicks off in Chapter 10 with a high-level data analytics view, addressing the importance of good management information when addressing regulatory requirements for IRRBB. His chapter is of relevance to any bank, irrespective of size or balance sheet complexity.

In Chapter 11, Beata Lubinska looks in detail at two particularly thorny aspects of the IRRBB discipline: how best to hedge ‘pipeline risk’ and ‘prepayment risk’. Her chapter presents worked examples of the recommended approach to structural hedging of these risk types, which helps ensure that her text remains clear and accessible throughout.

Chapter 12 is the second of Claire Trythall's chapters in the book, and she also looks at prepayment interest rate risk in residential mortgage assets. However, she considers a specific approach to solving this conundrum, the ‘rate incentive’ method.

Patrick Carey rounds out Part III with a chapter that looks at the future of interest rate risk hedging. Considering the future challenges that face banks is clearly a common theme in this book! His chapter should be required reading for every bank's ALCO.

Part IV: Trading and Relative Value Perspectives

We thought we would leave the most technical and arcane subject for last! In Chapter 14, Trevor Pugh looks at the gilt futures basis. By this, we mean the UK Government bond market and the ‘basis’ (difference in price/yield) between the cash bond gilt and the exchange-traded bond futures contract. That one sentence may need explaining for some readers! However, when I first studied this subject, I found that getting to grips with the intricacies of the bond futures basis actually helped in understanding – properly understanding – many aspects of the wider financial markets. Mr Pugh does a fine job in taking the reader through the bond futures basis and explaining why it works as it does and how to interpret what the basis is telling us.

I enjoyed editing this volume, and I hope that you enjoy reading it. I also hope that readers find the contents to be of practical benefit in their ‘day job’. Comments on the text are welcome and should be sent to the Editor via Emerald Publishing.

Professor Moorad Choudhry

Surrey, England

30th September 2023

Disclaimer

The views, thoughts and opinions expressed in this book are those of the Editor and contributing authors in their individual private capacity and should not in any way be attributed to any employing firm or to any of the Editor or contributing authors as a representative, officer or employee of any employing institution or affiliated firm.

While every effort has been made to ensure accuracy, no responsibility for loss occasioned to any person acting or refraining from action as a result of reading any material in this book can be accepted by the Editor or contributing authors, publisher or any named person or corporate entity. Any of the authors may or may not hold, or have held, any security identified in this book.