Value at risk var measuring potential changes in

Value at Risk
(VaR)
Measuring potential changes in
market values of traded assets
over a short time horizon (e.g.
overnight)
A measure of financial market risk.
Used to monitor risk profile relative to
tolerance.
Cash Flow at
Risk (CFaR) and
other Causal at
Risk Models
Measuring potential changes in
earnings or cash flows for the
enterprise.
Enterprise wide measure of risk to
financial objectives. Used to monitor
risk profile relative to tolerance on
earnings and cash flow objectives.
Economic
Capital
Measuring the potential changes
in the enterprise value from all
material risks that have a
financial consequences.
Shareholder focus.
Enterprise wide measure of risk to
financial objectives that uses the
outputs of VaR and CFaR. Can be used
for risk criteria, pricing for risk,
performance and remuneration.

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Scenario analysis defined
§ Scenario analysis entails defining one or more business scenarios with
associated key assumptions (sources of uncertainty termed “drivers”) that
determine the severity of the consequences on a key objective.
§ Scenario analysis provides a single “point” estimate for the key objective
and not a range of outcomes.
§ If the scenario has no estimate of likelihood of occurring then usually it
cannot be used to estimate a risk level, unless the appetite is to be never
breached under any scenario, in which case it would signal an excessive
current risk profile. This is the logic for “stress test” scenarios.
§ Advantages of scenario analysis are:
– Historically observed scenarios (eg. GFC or competitor action) can be replayed
through the organisation’s risk profile and the impact can be compared with the
organisation’s actual history.
– It is easily understood by non-quantitative management and stakeholders.
– Useful to test reliance to events.
– Suitable for comparing relative riskiness across different firms for the same
scenario (eg. Regulatory stress tests).

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Illustration of scenario analysis (refer COSO)

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Example:- APRA 2017 regulatory stress test background
§ Like most bank regulators, APRA utilises stress tests to examine the
resilience of the largest banks, individually and collectively.
§ In 2017, APRA conducted an industry stress test by requesting 13 of
the largest banks to estimate the impact of the following scenario.
Each bank was required run the scenario through their balance sheet
and calculate resultant capital adequacy ratios.
ü A significant downturn in the housing market triggered by a downturn in China
and a collapse in demand for commodities.
ü The subsequent downgrade in sovereign and bank debt ratings leads to a
temporary closure of offshore funding markets, a sell-off in the Australian dollar
and widening in credit spreads.
ü Australian GDP falls by 4 per cent, unemployment doubles to 11 per cent and
house prices decline by 35 per cent nationally over three years.