(51a) Market risk

Market risk management encompasses all activities in connection with our Markets & Investment Banking operations and management of the balance sheet structure in Vienna and at Bank Austria Creditanstalt’s subsidiaries. Risk positions are aggregated at least daily, analysed by the independent risk management unit and compared with the risk limits set by the Management Board and the committees (including MACO) designated by the Management Board. At Bank Austria Creditanstalt, market risk management includes ongoing reporting on the risk position, limit utilisation, and the daily presentation of results of Markets & Investment Banking operations.

Bank Austria Creditanstalt uses uniform risk management procedures throughout the Group. These procedures provide aggregate data and make available the major risk parameters for the various trading operations at least once a day. Besides Value at Risk, other factors of equal importance are stress-oriented volume and position limits. Additional elements of the limit system are loss-warning level limits and options-related limits applied to trading and positioning in non-linear products.

Bank Austria Creditanstalt’s risk model (“NoRISK”) was developed by the bank and has been used for several years. The model is applied and further refined by Strategic Risk Management. Ongoing refinement work includes reviewing the model as part of backtesting procedures, integrating new products, implementing requirements specified by the Management Board and by MACO, and adjusting the system to general market developments. In this context a product introduction process has been established in which risk managers play a decisive role in approving a new product. The “NoRISK” risk model, approved by the supervisory authorities since 1998, is used for computing capital requirements; in contrast to the internal risk management process, the computation of capital requirements takes into account the statutory parameters (confidence interval of 99 %, 10-day holding period) and additionally the multiplier determined as part of the model review is applied. In 2006, the banking supervisory authorities approved an extension of the model in the area of commodities position risk. This means that the internal “NoRISK” model now also covers this area in the reporting of capital resources. Thus the system comprises all major risk categories: interest rate risk and equity position risk (both general and specific risk), exchange rate risk and commodities position risk.

Regular and specific stress scenario calculations complement the information provided to MACO/ALCO and the Management Board. In 2006, the stress scenarios were extended to include macro scenarios with a view to taking better account of global developments. Stress scenarios are based on assumptions of extreme movements in individual market risk parameters. The bank analyses the effect of such fluctuations and a liquidity disruption in specific products and risk factors on the bank’s results. These assumptions of extreme movements are dependent on currency, region, liquidity and the credit rating, and are set by Strategic Risk Management on a discretionary basis.

In addition to the risk model results, income data from market risk activities are also determined and communicated on a daily basis. These data are presented over time and compared with current budget figures. Reporting covers the components reflected in IFRS-based profit and the marking to market of all investment positions regardless of their recognition in the IFRS-based financial statements (“total return”). The results are available to Bank Austria Creditanstalt’s trading and risk management units via the access-protected Intranet application “ERCONIS”, broken down by portfolio, income statement item and currency. Strategic Risk Management strongly supports efforts to implement the new regulatory approach to prudent valuation in the trading book.

In Vienna, Bank Austria Creditanstalt uses the “MARCONIS” system developed by the bank itself to completely and systematically review the market conformity of its trading transactions. This tool is also used by all CEE banking subsidiaries with market risk activities.

The results of the internal model based on VaR (1 day, confidence interval of 99 %) for 2006 moved in a range between € 15 m and € 25 m for the BA-CA Group, with minor fluctuations during the year. The average VaR was € 19.8 m, slightly higher than the comparative figure for the previous year and significantly lower than in 2004 (2004: € 24.6 m, 2005: € 16.8 m). As in previous years, the risk report includes the non-trading driven equity positions of the bank’s investment books and the hedge-fund positions. Credit spread risk continued to account for most of the total risk of the Bank Austria Creditanstalt Group.

Corporates and financials of investment grade account for the largest part of the Bank Austria Creditanstalt Group’s credit spread positions. Within investment grade positions, financial services companies with comparatively good ratings and ABS and MBS positions with excellent ratings predominate. In Treasury-near sectors, core EU countries and municipals (including German Jumbo issues) account for the highest proportion, followed by Treasuries of the new EU member states.

Trading in high-yield bonds, which has been part of Markets & Investment Banking for several years, is not included in the above table. Trading in high-yield bonds comprises emerging markets investments and corporate high-yield bonds below investment grade. Trading in these two portfolios is managed through general VaR limits and a multi-stage limit system limiting positions in individual corporates, industries, rating classes and countries. At the end of 2006, Russia (and neighbouring CIS countries) accounted for 57 % of the emerging markets portfolio, Latin America represented 20 % of the total volume, CEE countries (incl. Turkey) 17 %, Asia 6 % and Africa 1 %. As at 29 December 2006, the high-yield portfolio was dominated by positions in rating category B (61 %).

Bank Austria Creditanstalt has invested in hedge funds through its subsidiary Bank Austria Cayman Islands since 1999. Market-neutral and event-driven strategies account for the highest proportion of total volume, most of which is invested in funds of funds. The proportion of directional strategies is low compared with the industry average, and the applied leverage is also limited at a comparatively low level. The investment guidelines, which define major risk parameters, are an important management tool in this sector. Compliance with the investment guidelines and daily reviews of valuation results are assured by the risk management unit at Bank Austria Cayman Islands within central risk management guidelines laid down in Vienna.

In addition to the hedge fund activities in the Cayman Islands, Bank Austria Creditanstalt invested in hedge funds as part of its equity trading operations. With these investments, which were primarily driven by equity long/short strategies, the BA-CA Group aims to better diversify equity-related activities, thereby complementing the focal areas in Austria and the CEE countries. Investment decisions are prepared by a hedge fund research team of CA IB. This business is conducted within guidelines defining standards in respect of maximum investment, investment diversification, relative size of holding in the fund and strategy, approach to due diligence and fund selection. The positions are integrated in the risk calculations of Bank Austria Creditanstalt and are monitored on an ongoing basis. In almost all cases, investment volume per fund is a single-digit million euro amount.

Capital requirements for market risk
Bank Austria Creditanstalt’s risk model is subjected to daily backtesting in accordance with regulatory requirements. The model results are compared with changes in value on the basis of actually observed market fluctuations. As the number of backtesting excesses (negative change in value larger than model result) has been within the “green zone” ever since the model was introduced, the multiplier need not be adjusted. In 2006, no backtesting excess was recorded.

Market risk limit utilisation in CEE remained moderate in 2006. On average, the CEE subsidiaries utilised their Value-at-Risk limits to the extent of just under 30 %, which corresponded to about one-quarter of the Group’s market risk.

In addition, short-term and medium-term liquidity management is performed centrally for subsidiaries through position limits. On the whole, the restrictions placed on liquidity transformation at subsidiaries were observed in 2006.

Liquidity management of subsidiaries and of the Group is supported by “ALVIS”, a web application developed by the bank itself.

Steady business expansion and the acquisition of additional banks in CEE require the permanent adjustment of processes, systems and methods. In 2006, the integration of Tiriac Bank (Romania) and of Nova banjalucka banka (Bosnia and Herzegovina) in the global market risk system was ensured. Work to integrate the CEE subsidiaries of UniCredit and of HVB in the BA-CA Group started in the middle of 2006. This ensures uniform rules, processes and risk measurement methods in the now larger group.

The Bank Austria Creditanstalt Group has gained strong integration expertise through numerous integration projects carried out over the past years. Integrated market risk systems enable BA-CA to integrate additional units within the BA-CA Group’s risk management framework in the future.

Management of balance sheet structure
Interest rate risk and liquidity risk from customer transactions is attributed to Bank Austria Creditanstalt’s treasury operations through a matched funds transfer pricing system applied throughout the Group. This makes it possible to attribute credit, market and liquidity risk and contribution margins to the bank’s business divisions in line with the principle of causation. ALCO ensures that the bank’s overall maturity structure is optimised, with the results from maturity transformation being reflected in the Markets & Investment Banking Division. Factors taken into account in this context include the costs of compensation for assuming interest rate risk, liquidity costs and country risk costs associated with foreign currency financing at CEE subsidiaries.

Products for which the material interest-rate and capital maturity is not defined, such as variable-rate sight and savings deposits, are modelled in respect of investment period and interest rate sensitivity by means of analyses of historical time series, and taken into account in the bank’s overall risk position. Interest rate sensitivities are determined and taken into account in hedging activities, which results in a positive contribution to profits from customer business.

To assess its balance sheet structure, the bank uses the Value-at-Risk approach, complemented by a scenario analysis covering subsequent quarters and years. In addition to the banking book in Austria, such scenario calculations are performed for the larger subsidiaries in the Czech Republic, Slovakia and Hungary. The bank thus also follows the Basel II recommendation concerning the simulation of future net interest income under different interest rate scenarios (“earnings perspective”).

In the earnings perspective analysis, simulations of the future development of net interest income and of the market value of the banking book are generally based on assumptions regarding volume and margin developments under different interest rate scenarios. Parallel interest rate shocks as well as inversions and low-interest-rate scenarios can be analysed to identify their possible impact on the bank’s net interest income and market value.

The analyses performed as at September 2006 show that a strong decline in the EUR yield curve would have the strongest impact on the bank’s net interest income. A downward interest rate shock of 1 percentage point would depress net interest income in the first year by about € 150 m if all other factors (volume, margins, maturities) remain constant.

The rules of the New Basel Capital Accord (“Basel II”) will have to be observed from 2008. For the first time, the new rules establish a relation at Group level between “interest rate risk in the banking book” and the bank’s capital by comparing a change in the market value of the banking book after a 2 % interest rate shock with the bank’s net capital resources. In the event that such an interest rate shock absorbs more than 20 % of a bank’s net capital resources, the bank supervisory authority could require the bank to take measures to reduce risk.

The complete and automated integration of the Group’s risk position means that Bank Austria Creditanstalt is already well prepared to meet this requirement with its “NoRISK” risk measurement system. A 2 % interest rate shock would absorb about 1 % of the Group’s net capital resources; this calculation also includes the current investment of equity capital as an open risk position. This means that the figure for Bank Austria Creditanstalt is far below the outlier level of 20 %.