FirstCaribbean International Bank (Bahamas) Limited
FirstCaribbean International Bank (Bahamas) Limited FirstCaribbean International Bank (Bahamas) Limited
Notes to Consolidated Financial StatementsFor the year ended October 31, 2009(Expressed in thousands of Bahamian dollars)26. Financial Risk Management (Continued)E. Market risk (continued)Risk measurement: (continued)Sensitivity: (continued)The CSDV01 sensitivity was a new measure introduced in 2008 at the Parent Group as a way to monitor the risk of thespreads between the growing USD denominated, locally issued bond portfolio and the benchmark USD interest ratecurve widening or narrowing as well as to look at the effect of that same type of credit spread move impacting the valueof the USD structural hedge.Value at risk:The Parent Group’s Value at Risk (“VaR”) methodology utilizes the tested and validated CIBC parent models. It isa statistical and probability based approach that uses volatilities and correlations to quantify risk into dollar terms.VaR measures the potential loss from the adverse market movements that can occur overnight with a less than onepercent probability of occurring under normal market conditions, based on equally weighted historical data. VaR usesnumerous risk factors as inputs and is computed through the use of historical volatility of each risk factor and theassociated correlations among them, evaluated over a one year period and updated on a regular basis. The use ofthese historical measures do cause a degree of limitation to its accuracy as it assumes that future price movements willfollow a statistical distribution and thus may not clearly predict the future impact. The fact that VaR is an end of daymeasure and thus does not take into account intra-day moves is not a significant issue for the Parent Group as neitherthe trading nor non-trading portfolios are that active and the FX is controlled via trade and volume size limits. A furtherweakness of the VaR measure is that it does not estimate the effects of market variable moves outside of the ninety-ninepercent parameter and hence may underestimate losses. To counter this, the Parent Group has various stress measuresto calculate potential tail event losses.Stress testing & scenario analysis:Stress testing and scenario analysis are designed to add insight to possible outcomes of abnormal (or tail event) marketconditions and to highlight where risk concentrations could be a concern.The Parent Group has two distinct approaches to this. For the hard currency testing it sends its position sensitivityto CIBC and utilizes the suite of measures that the parent company has developed. The stress testing measures theeffect on our hard currency portfolio values over a wide range of extreme moves in market prices. The stress testingmethodology assumes no actions are taken or are able to be taken during the event to mitigate the risk, reflecting thedecreased liquidity that frequently accompanies market shocks. The scenario analysis approach again for the ParentGroup’s hard currency exposures simulate an impact on earnings of extreme market events up to a period of onequarter. Scenarios are developed using actual historical data during periods of market disruption, or are based uponhypothetical occurrence of economic or political events or natural disasters and are designed by our parent company’seconomists, business leaders and risk managers. Examples of these would include the 1998 Russian led crisis, FedReserve tightening of 1994 and potential effects of revaluation of the Chinese currency. These tests are run on ourbehalf on a weekly basis.The local currency stress tests are designed on a similar but smaller scale. For interest rate stresses, Market Risk inconjunction with Treasury Sales & Trading consider the market data over approximately the last ten years and identifythe greatest curve or data point moves over both sixty day and single day periods. These are then applied to theexisting positions/sensitivities of the Parent Group. This is performed and reported on a monthly basis as they do nottend to change rapidly. For foreign exchange stresses the Parent Group considers what the effect of a currency comingoff a peg would have on the earnings of the Bank. This is largely judgmental as it has happened so infrequently inthe region and it is supplemented by some historical reviews both within the region and in other areas where peggedcurrency regimes have or do exist.60
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Notes to Consolidated Financial StatementsFor the year ended October 31, 2009(Expressed in thousands of Bahamian dollars)26. Financial Risk Management (Continued)E. Market risk (continued)Risk measurement: (continued)Sensitivity: (continued)The CSDV01 sensitivity was a new measure introduced in 2008 at the Parent Group as a way to monitor the risk of thespreads between the growing USD denominated, locally issued bond portfolio and the benchmark USD interest ratecurve widening or narrowing as well as to look at the effect of that same type of credit spread move impacting the valueof the USD structural hedge.Value at risk:The Parent Group’s Value at Risk (“VaR”) methodology utilizes the tested and validated CIBC parent models. It isa statistical and probability based approach that uses volatilities and correlations to quantify risk into dollar terms.VaR measures the potential loss from the adverse market movements that can occur overnight with a less than onepercent probability of occurring under normal market conditions, based on equally weighted historical data. VaR usesnumerous risk factors as inputs and is computed through the use of historical volatility of each risk factor and theassociated correlations among them, evaluated over a one year period and updated on a regular basis. The use ofthese historical measures do cause a degree of limitation to its accuracy as it assumes that future price movements willfollow a statistical distribution and thus may not clearly predict the future impact. The fact that VaR is an end of daymeasure and thus does not take into account intra-day moves is not a significant issue for the Parent Group as neitherthe trading nor non-trading portfolios are that active and the FX is controlled via trade and volume size limits. A furtherweakness of the VaR measure is that it does not estimate the effects of market variable moves outside of the ninety-ninepercent parameter and hence may underestimate losses. To counter this, the Parent Group has various stress measuresto calculate potential tail event losses.Stress testing & scenario analysis:Stress testing and scenario analysis are designed to add insight to possible outcomes of abnormal (or tail event) marketconditions and to highlight where risk concentrations could be a concern.The Parent Group has two distinct approaches to this. For the hard currency testing it sends its position sensitivityto CIBC and utilizes the suite of measures that the parent company has developed. The stress testing measures theeffect on our hard currency portfolio values over a wide range of extreme moves in market prices. The stress testingmethodology assumes no actions are taken or are able to be taken during the event to mitigate the risk, reflecting thedecreased liquidity that frequently accompanies market shocks. The scenario analysis approach again for the ParentGroup’s hard currency exposures simulate an impact on earnings of extreme market events up to a period of onequarter. Scenarios are developed using actual historical data during periods of market disruption, or are based uponhypothetical occurrence of economic or political events or natural disasters and are designed by our parent company’seconomists, business leaders and risk managers. Examples of these would include the 1998 Russian led crisis, FedReserve tightening of 1994 and potential effects of revaluation of the Chinese currency. These tests are run on ourbehalf on a weekly basis.The local currency stress tests are designed on a similar but smaller scale. For interest rate stresses, Market Risk inconjunction with Treasury Sales & Trading consider the market data over approximately the last ten years and identifythe greatest curve or data point moves over both sixty day and single day periods. These are then applied to theexisting positions/sensitivities of the Parent Group. This is performed and reported on a monthly basis as they do nottend to change rapidly. For foreign exchange stresses the Parent Group considers what the effect of a currency comingoff a peg would have on the earnings of the <strong>Bank</strong>. This is largely judgmental as it has happened so infrequently inthe region and it is supplemented by some historical reviews both within the region and in other areas where peggedcurrency regimes have or do exist.60