Glossary

A B C D E F G H I J K L M N O P Q R S T U V W X Y Z

AIG
Short for Accord Implementation Group. AIG was set down by the Basel Committee to serve as a forum for discussions on the implementation of the Basel II rules. The AIG discusses issues of mutual concern with supervisors from non-Basel Committee member countries. Discussions take place through regional associations and with the Core Principles Liaison Group, which is a working group of 16 non-member countries, the IMF and the World Bank

AMA (Advanced Measurement Approach) for operational risk
Under AMA, financial institutions can use their internal loss data in combination with external loss data and scenario analyses as input in the estimation of the capital required.

The instituions must use the results of expert assessments to estimate exposure to very serious events (tail value at risk).
Moreover, the approach specifies a number of qualitative requirements for the collection of data and internal controls that must be met by institutions that want to apply AMA.

The AMA is the most sophisticated model for estimating operational risk. Banks who would like to use this method need an approval from their national FSA.

ASA (Alternative Standardised Approach) for operational risk
This operational risk approach is a refinement of the Standardised Approach. The approach is designed for banks active in emerging markets and ensures that these banks get a fair capital requirement. The method is based on lending and not income for retail banking and corporate banking.

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Guidelines on capital adequacy issued by the Bank for International Settlements - BIS

Basic Indicator Approach for operational risk
An operational risk approach that focuses on only one indicator - gross income - for all the activities of a bank. The indicator is multiplied by a fixed percentage, called the "alpha-factor", in order to calculate the required capital requirement.

Business risk
The risk of losses because of changes in external circumstances or events that harm a bank's image or operational earnings. Business risk includes strategic risk and reputational risk, which are types of risk that the regulatory authorities may demand that the bank cover under the new capital adequacy rules.

BIS (Bank for International Settlements)
An international organisation which encourages and supports international monetary and financial cooperation. It also serves as a bank for central banks.

BIS fulfils this task by e.g. being a centre for economic and monetary research and acting as counterparty for central banks in financial transactions.

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The regulators have ensured a gradual capital release by introducing capital floors for those banks choosing advanced methods for credit risk estimation. The capital floors, which depend on the method chosen, are presented in the table below.

Year	Standardised	IRB F	IRB A
2007	-	5	-
2008	-	10	10
2009	-	20	20
2010	-	100	100

The capital floors are based on the bank's capital requirement under Basel I. A bank choosing the IRB Foundation approach can therefore release 5% of its capital requirement under Basel I in 2007, a further 5% in 2008 and a further 10% in 2009. The full benefits from the CRD therefore cannot be enjoyed until in 2010.

CEBS (Committee of European Banking Supervisors)

CEBS's role is to

• serve as an advisory board for the European Commission regarding banking activities
• contribute to consistent implementation of EU directives and to the convergence of member states' supervisory practices throughout the EU
• enhance supervisory co-operation
  

Read more

CF (Conversion Factor)
Definition according to CRD, article 4, paragraph 28: "Conversion Factor means the ratio of the currently undrawn amount of a commitment that will be drawn and outstanding at default to the currently undrawn amount of the commitment, the extent of the commitment shall be determined by the advised limit, unless the unadvised limit is higher."

The revised EU Directive 2000/12 agreed by the Council in October 2005. Builds on the Basel II Accord.

Download the Directive.

Credit risk
The risk of loss because counterparties fail to meet all or part of their obligations. This risk type is normally the largest risk exposure for retail banks. Credit risk includes country risk and settlement risk.

• Country risk is the risk of losses arising from the economic or political circumstances in a country. Country risk also encompasses the risk of nationalisation, expropriation and debt restructuring.
• Settlement risk is the risk arising in connection with the settlement of payments for securities, derivatives and other trades when a bank remits payments before it can ascertain that the offsetting payments have been transferred to one of the bank's accounts.
  
  

CRM (Credit Risk Mitigation)
Definition according to CRD, article 4, paragraph 30: "Credit Risk Mitigation means techniques used by a credit institution to reduce the credit risk associated with an exposure or exposures which the credit institution continues to hold."

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Default
Failure by a borrower to pay interest or principal.

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EAD (Exposure at Default)
The exposure value used in the calculation of RWA using a CF factor. The parameter is also called "Usage given Default" (UGD).

EC (Economic Capital)
The capital required in order to cover losses within the next year with a probability of 99.97 percent. Economic capital consists of credit risk, market risk, event risk, business risk and insurance risk.

EDF (Expected Default Frequency)
The probability of default of a counterparty over a one-year period. The parameter is more often called "Probability of Default" (PD).

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The 13 Basel Committee member countries (Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the UK and the US).

Banks that meet three criteria:

• The bank has a Tier 1 captial in excess of €3 bn
• The bank is diversified
• The bank is internationally active

All the banks which is not included in Group 1-banks

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Haircut
Factor that reduces the estimated value of a given collateral asset. A haircut quantifies costs related to selling the collateral and the risk of value deterioration of the collateral. Haircut is estimated for all types of collateral.

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An important part of Pillar II, which is aimed to go beyond uniform rules capturing the risks of an average institution. The ICAAP ensures that management

• adequately identifies and measures the institution's risks
• maintains adequate internal capital in relation to the institution's risk profile
• uses sound risk management systems and develops them further

Danske Bank uses the ICAAP to determine the extent of the Group's total risk and its capital requirement.

The most advanced regulatory method for estimating credit risk. The model is based on the bank's own internal data for PD, LGD and EAD. The Advanced Internal Ratings Based approach can be used from January 1, 2008 (CRD, article 157)

An advanced regulatory method for estimating credit risk. The model is based on the bank's own internal data for PD and external data for LGD and EAD. This approach can be used from January 1, 2007

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LGD (Loss Given Default)
Definition according to CRD, article 4, paragraph 27: "The ratio of the loss on an exposure due to the default of a counterparty to the amount outstanding at default."

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Market risk
The risk of losses because the market value of a bank's assets, liabilities and off-balance sheet items varies with changes in market conditions. Market risk includes interest rate risk, currency risk and equity market risk.

• Interest rate risk is the risk of losses because of changes in interest rates.
  
• Currency risk is the risk of losses on the Group's positions in foreign currency because of changes in exchange rates.
  
• Equity market risk is the risk of losses because of changes in equity prices.

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Operational risk (event risk)
The risk of losses because of deficient or erroneous internal procedures, human or system errors, or external events.

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PD (Probability of Default)
Definition according to CRD, article 4, paragraph 25: "The probability of default of a counterparty over a one year period. The parameter is also known as "Expected Default Frequency" (EDF)."

The rules in Pillar I can be viewed as the rules capturing the risks of an average bank. The more customised risk adjustments are captured in Pillar II. Pillar I contains rules on estimating three important types of risk:

• Credit risk
• Market risk
• Operational risk

Pillar I also sets the minimum requirement for regulatory capital.

Read more about Pillar I

Pillar II
Pillar II specifies the framework for further capital requirements based on the situation of the individual institution. Pillar II also comprises risk not defined under Pillar I (i.e. concentration and residual risk) as well as stress testing.

Read more about Pillar II.

Pillar III
Pillar III contains requirements to the information to be published. In the future, institutions must give external interested parties far better insight into risk management as well as the quality and composition of portfolios.

Read more about Pillar III.

An estimate based on the current market conditions. A point in time estimate can be compared with a "though the cycle" estimate which is based on a full business or economic cycle. The two concepts are often used in ratings of borrowers. "Through the cycle" estimates are often used by rating agencies.

Procyclicality
In a CRD context the concept of procyclicality captures the rising regulatory capital requirements in an economic downturn and decreasing regulatory capital requirements in economic upswings. This could lead to banks restraining lending in a recession and thereby making matters worse.

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QIS (Quantitative Impact Study)
Studies which have been conducted in order to get an indication of the future capital level of the banking industry. The QIS have also given useful input for further calibration of the Basel II framework. Five QIS have been conducted.

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RAROC (Risk Adjusted Return on Capital)
For several years, the Group's RAROC-based risk management and reporting system has been a core element of its capital and financial management system.

Risk-weighted items (avg.)
Average value of assets and off-balance-sheet items calculated in accordance with the capital adequacy rules of the Danish Financial Supervisory Authority.

Risk-weighted items (ult.)
The value at the end of an accounting reference period of assets and off-balance sheet items in accordance with the capital adequacy rules of the Danish Financial Supervisory Authority.

ROAC (Return on Allocated Capital)
A refinement of the RAROC method. The most important difference between ROAC and RAROC is that ROAC includes concentration and diversification. Concentration on single customers, business sectors and countries will increase the economic capital and thus lower performance. Diversification will have the opposite effect because a diversified portefolio lowers risk. The risk-adjusted return differs from the accounting return insofar as it reflects the average annual loss the Group expects to suffer over a business cycle. The method entails calculating the economic capital needed to absorb the variation in actual losses in relation to expected losses (also known as "unexpected losses"). The parameters used in the model are reviewed on an ongoing basis in relation to loss levels observed in the credit portfolio.

It is also important to note that all capital will be allocated to the different business units under ROAC. There will consequently be no unallocated capital at Group level. The logic behind this is that risk generation and capital allocation should be closer interlinked.

Read more about ROAC

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The most basic approach for measuring credit risk.

The Standardised Approach was introduced in Basel I (1988), and includes four different risk classes: 0%, 20%, 50% and 100%. The CRD replaces all these risk classes with a more sensitive framework based on ratings from an external credit rating agency that is able to fulfil strict criteria. The result is a more comprehensive risk-weighting framework.

Standardised Approach for market risk
This market risk approach was introduced in Denmark in 1996 on the basis of the April 1995 proposal. The approach breaks down into four asset classes:

• interest rate positions
• equity market positions
• currency positions and
• commodity positions

with separate calculation methods for each asset class. The capital requirements for interest rate risk and equity market risk are added only to positions in the trading book, whereas the capital requirements for currency risk and commodity risk are added to the bank's total positions. The capital requirement for interest rate positions is calculated on the basis of the interest rate sensitivity with a standard set of assumed volatilities in the yield curve and added requirements for yield curve risk. The capital requirement is calculated per currency. The capital requirement on equity market risk is calculated on the bank's positions in each individual equity. The currency risk capital requirement is calculated as a percentage of the bank's net open position in each currency. The commodity risk requirement is calculated as a percentage of the bank's open position in each currency plus a requirement for maturity mismatch of the contracts.

This operational risk approach uses one indicator, the same as the one for basis, but different weightings ("beta-factors") for different lines of business, e.g. retail banking and commercial banking. In order to calculate the capital requirement, the bank multiplies a defined indicator by the relevant "beta-factor" for each business line. The sum of the capital requirements for the different lines of business should be used in the calculation of the capital requirement.

Stress test
Stress tests are important tools for analysing a bank's risk profile. Stress tests identify the central risk drivers, and analyse the effect of significant negative shocks to these risk drivers. The effects can be measured in both profit and loss and balance sheet terms. Danske Bank has conducted a number of Group wide stress tests since 2005. The stress tests are conducted at regular intervals. The stress tests show how the Group will fare if it suffers various economic shocks over a period of three to five years. Read more about Danske Bank's stress tests.

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Through the cycle (TTC) estimate
An estimate based on a full business or economic cycle. This type of estimate can be compared with a "point in time" estimate which is an estimate based on the current market conditions. The two concepts are often used in ratings of borrowers. "Through the cycle" estimates are often used by rating agencies.

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Use test
Use test is a crucial issue for banks applying for the IRB approach. It is an absolute requirement from the regulator that the IRB components (PD, LGD and EAD) used in the IRB approaches are also integrated in a bank's daily business. They should be used in the credit approval process, for risk management decisions, in corporate governance and other functions. Some smaller divergences are acceptable, but in general banks should use the same IRB components when calculating their minimum capital requirement and for internal management decisions.

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Last updated/revised on January 31, 2008