powers to impose specific limits and/or a specific capital charge on market risk exposures, if warranted.
criteria
EC1 The supervisor determines that a bank has suitable policies and processes that clearly articulate roles and responsibilities related to the identification, measuring, monitoring and control of market risk. The supervisor is satisfied that policies and processes are adhered to in practice and are subject to appropriate Board and senior management oversight. Description and
findings re EC1
Policies and procedures for the identification, assessment, monitoring, and control of market risk are defined in Resolution 3464, amended by Resolution 3897, which regulates the implementation of the framework for managing market risk by financial institutions,
establishes its responsibilities and requires its adequacy to the size, nature, complexity and risk of their operations.
The activity of market risk management must be executed by a specific unit, segregated from the business and internal auditing units, and the director responsible for the market risk management is not allowed to execute functions related to asset management and treasury operations.
Market risk management policies and strategies must be approved and revised, at least once a year, by the senior management and board of directors, if it exists. This includes
establishing exposure limits that must be monitored on a daily basis by the market risk management structure.
The market risk unit is responsible for the identification, assessment and control systems of all relevant sources of market risk, evaluation tests on such systems at least annually, and the performance of stress tests and scenario analysis.
During on-site inspections of market risk, supervisory staff verify the adequacy of the given institution’s market risk management structure. This includes review of:
adequacy of policies and strategies and evaluation of how strategies and policies are approved, reviewed, documented and disseminated. Policies must reflect the risk appetite and clearly state: roles, list of authorized financial instruments, hedging strategies, risk measures, limits and report lines.
Role of senior management, communication of strategies, selection of competent personnel, nature of risk profile, risk reporting, and timely correction of deficiencies. Risk identification and management systems commensurate with the complexity of
activities and products, and the identification, development and approval of new products. Mark-to-market process, including evaluation of the independence of personnel
conducting the valuation(s), documentation and auditing.
Market risk limit structure including the review, approval, use, monitoring, and exception process therein.
Methodology and sophistication of the institution’s stress testing process; if it is
commensurate with institutional risk profile and if it addresses all relevant risk factors. The development and approval of scenarios (frequency, officers responsible, risk factors, and granularity) must be considered.
Independence, technical skills, and overall role of risk management.
Reporting by the risk management, if it is timely, reliable, and contains all the relevant information for decision-making.
Internal manuals and procedures and if they adequately address the limit structure, model assumptions, systems adequacy, mark-to-market formula and processes, security and
control procedures, contingency planning, and requirements for data.
Flow of information to and from trading desks, risk management, and senior management functions.
Accuracy of the back testing process and how back testing results are applied to enhance risk models.
Internal and external audit is evaluated through interviews and documents, such as the audit plan, working papers, reports/letters to the bank, frequency of reviews in critical areas, their independence and the follow-up of their recommendations by the bank’s management. In addition, Supervisory staff carries out extensive continuous monitoring activities. See CP 20.
EC2 The supervisor determines that the bank has set market risk limits that are commensurate with the institution’s size and complexity and that reflect all material market risks. Limits should be approved by the Board or senior management. The supervisor confirms that any limits (either internal or imposed by the supervisor) are adhered to.
Description and findings re EC2
See EC 1 above.
EC3 The supervisor is satisfied that there are systems and controls in place to ensure that all transactions are captured on a timely basis, and that the banks’ marked to market positions are revalued frequently, using reliable and prudent market data (or, in the absence of market prices, internal or industry-accepted models). The supervisor requires banks to establish and maintain policies and processes for considering valuation adjustments/reserves for positions that otherwise cannot be prudently valued, including concentrated, less liquid, and stale positions.
Description and findings re EC3
See EC 1 above.
During the inspection process, the supervisor verifies that the bank has a process of mark-to- market that is verifiable and consistent. This process must be carried out by personnel not involved in trading activities, be properly documented and audited.
During continuous monitoring, supervisory staff obtains institutional reports and gathers information from other sources (such as BOVESPA, CETIP, other financial instrument registrars, etc.) in order to assess important issues regarding the risk profile of the entity. The analyses include review and evaluation of market risk exposures and valuation methods for less liquid positions. If necessary, the supervisory staff require response and corrective action by the institution.
Two features of Brazilian financial market minimize the problem of the valuation of less liquid positions: the compulsory registration of all financial instruments and the absence of a secondary market for private instruments. The first brings transparency to the market, on prices, volumes and counterparties. The second means that the great majority of traded instruments are liquid. Less liquid positions and/or instruments are evaluated on a case-by- case basis and institutions’ methodology is checked.
EC4 The supervisor determines that banks perform scenario analysis, stress testing and
contingency planning, as appropriate, and periodic validation or testing of the systems used to measure market risk. The supervisor confirms that the approaches are integrated into risk management policies and processes, and results are taken into account in the bank’s risk- taking strategy.
Description and findings re EC4
The institution must perform stress tests related to market risk, which must include a breakdown of key assumptions, and must consider their results when establishing and reviewing its policies and limits for market risk. Back testing of the results must also be performed. The Supervisor reviews the stress and back testing conducted by the institution
both during onsite activities and through continuous monitoring. See EC 1 also.
Additional criteria
AC1 The supervisor requires that market data used to value trading book positions are verified by a function independent of the lines of business. To the extent that the bank relies on modeling for the purposes of valuation, the bank is required to ensure that the model is independently tested.
Description and
findings re AC1 See EC 3 Assessment of
Principle 13
Compliant Comments
Principle 14 Liquidity risk. Supervisors must be satisfied that banks have a liquidity management