2008 General MeetingAssemblée générale 2008

Toronto, Ontario

2008 General MeetingAssemblée générale 2008

Toronto, Ontario

Canadian Institute

of Actuaries

Canadian Institute

of Actuaries

L’Institut canadien desactuaires

L’Institut canadien desactuaires

Economic Capital Model

Organization Structure, Model Governance and Strategic Usages at the Bank of Nova Scotia

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Outline

1. Economic Capital• A Definition and Description• Organizational Ownership• Economic Capital in Context• Composition of Economic Capital• Risks Currently Covered

2. Enhancements to Economic Capital• Risk Coverage• Enhancements to Existing Risks

3. Economic Capital Usages within Scotiabank

4. Summary

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Economic Capital: A Definition and Description

Economic capital is a measure of potential losses, which would flow to retained earnings, inherent in the Bank’s business activities.

• Losses from business activities are, in part, random so economic capital is derived from an estimated loss distribution built up from several sub models. It estimates a loss amount that will be exceeded with only a small probability.

• Economic Capital is calculated at the all-Bank level inclusive of its subsidiaries.

• All sub-models are calibrated to a forecast horizon of one year.

• Economic capital is used to determine whether the Bank’s actual capital is sufficient to cover its risk at the desired risk rating level.

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Economic Capital: Organizational Ownership

• Economic Capital stewardship usually resides with some combination of Risk, Corporate Finance and Treasury.

• Following this general structure, the Bank centrally manages the overall framework of the economic capital model.

• The Bank has a distributed approach to the model calculation.

• Specialized groups create, develop and maintain specific components of the economic capital model.

• The various components of the economic capital model are then aggregated by a centralized group.

• Economic Capital is then allocated to the business lines in accordance with their usage for performance measurement purposes.

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CreditCredit

MarketMarket

OperationalOperational

Business

Business

Real Estate

Real Estate

OtherOther

Economic Capital in Context

Economic capital is a fundamental component of the Bank’s capital management strategy.

Economic Capital

Risk Appetite

Actual Equity• The Bank’s risk appetite is partially

cast in terms of economic capital relative to equity.

• In the future, business line risk parameters may be even more closely tied to economic capital.

This results in a direct linkage of business line risk parameters and the Bank’s risk appetite.

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Economic Capital: Risks Currently Covered

The following risk types are explicitly included in the model:

Pillar 1 Risks: – Market Risk

• Standard• Trading

Portfolio– Credit Risk– Operational

Pillar 2 Risks: – Market Risk

• Interest Rate Risk in Banking Book• FX Structural Risk• Pipeline Risk• Equity Investment Risk

– Business– Strategic– Insurance Risk– Others

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Enhancements to Economic Capital

•Risk Coverage and Potential Inclusion of New Risk Types:

–Annually the Bank undertakes an assessment of risks not included in the economic capital model.

• A set of risks not currently included in the model are evaluated for potential inclusion

• If a major risk is not included in the model, then the rationale for the exclusion and mitigating controls and policies are outlined in the report. (e.g. liquidity and reputational risks).

• Periodically this will result in the inclusion of a new risk type which was not previously included in the model (e.g. insurance risk).

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Enhancements to Economic Capital

•Periodically risk types currently in the model are reviewed and enhanced:

–The Bank has recently enhanced the models for several of the included risk types:

• One such example is the improvement of the Operational risk model which leverages a loss distribution approach.

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Economic Capital Usages within Scotiabank

Consistent Risk Measure:– Economic capital provides a consistent risk measure

across different risk types, enabling aggregation (e.g. roll-up to different levels) and comparison (e.g. across industries and business units).

Performance Measurement:– Economic capital forms the basis of the Bank’s return

on economic equity measure. ROEE is a key performance measurement for business lines as well as in profitability measurement for loan origination or renewal.

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Economic Capital Usages within Scotiabank

Capital Planning:– Given business strategy, what are the economic capital

requirements likely to be in future years?– Does the Bank need to build up additional capital to

accommodate increased risks?– What is the economic capital impact of acquisitions or

divestment?

Stress Testing:– Examine the impacts of stress events on: income, regulatory

capital requirements and economic capital.

Internal Capital Adequacy Assessment Process:– Economic capital is an important component of the Bank’s

ICAAP.

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Summary

– The estimation of economic capital is an ongoing process that is actively managed to ensure accuracy and coverage of material risks to the Bank.

– Economic Capital is a central component of the Bank’s management strategy.

• Capital management

• Risk management

• Business line performance management