global risk management · operational risk credit risk bank risk management agregation portfolio...

Global Risk Management

BB Cartilha Capa ing.indd 10/12/02, 13:481

Table of ContentsIntroduction 03

Market Risk 06 ALM Assets and Liabilities Management 08 Main Mismatches 08 Interest Risk 08 Currency Risk 09 Liquidity Risk 10 Trading 11

Credit Risk 12

Operational Risk 18 Banco do Brasil Operational Risk Management Model 19 Qualitative Approach 20 Quantitative Approach 21 Preceding and Consequent Risks Module 22 Control Environment 23

Corporate Information 24

BB Cartilha ing.indd 10/12/02, 13:341

B a n c o d o B r a s i l2

Banco do Brasil pursues the constant improvement of its global risks management program, adopting state of the art tools and the best market know-how, aiming to comply with the New Basle Accord recommendations.

This represents a set of actions with the purpose of guaranteeing the follow up and effective management of market, credit and operational risks, assuring a more efficient capital allocation, thus helping maximize value to the shareholders.

We attempted to show in this booklet how Banco do Brasil’s global risks management program is structured.

Enio Pereira BotelhoControlling and Investor Relations Vice-President


R i s k M a n a g e m e n t 3

Banco do Brasil’s risk management is based on modern methods aimed at minimizing losses and assisting appropriate capital allocation decisions, besides ensuring observance of legal determinations, banking supervisory requirements and standards, procedures and internal and external controls.

Banco do Brasil takes an overall view of the different kinds of risks - Market / Liquidity, Credit and Operational - as outlined below:

The process is aligned with guidelines set by Brazil’s Central Bank (Bacen) and by the New Basel Accord recommendations, which introduced new concepts and focuses, namely:

Bank RiskManagement

Risk AgregationPortfolio Management

Risk Ranking and Granding

Operational RiskCredit Risk

Market/Liquidity Risk

Valu

e C

reat

ion

Capital A

llocationIntroduction



• emphasis on internal risk management methods: supervision and market discipline;

• incentives to reduce capital requirements for those managing risks better; and

• a multidimensional approach, including information technology, operational processes, adapting to customers needs.

Several steps have been taken with the aim of disseminating and consolidating risk management culture in the Banco do Brasil conglomerate. In this context, a seminar on Integrated Risk Management was held in May 2001 covering Market, Credit and Operational Risk.

The strategy formulated for Risk Management, with an integrated visionof these different types of risk, is centralized by the Global Risk Committee.

This Committee consists of the Board (President and Vice-Presidents),the Directors, and executives from the different departments. Its purposeis to decide on issues related to Risk Management in the ambitof Banco do Brasil and its wholly-owned subsidiaries.

The Global Risk Committee defines the institution’s risk strategies and is responsible for an overall vision of the Bank’s risks and monitoring interdependence between the several classes of risk. It is also responsible for setting risk limits, appropriate liquidity levels, contingency plans,and models for risk measurement.

New Accord

Pillar 1Capital Requirements

Pillar 2Supervisory Process

Pillar 3Market Discipline

• Risk Measurements

• Market Risk

• Credit Risk

• Operational Risk

• Supervisors responsible

for assessing how banks

are matching economic

capital to risks incurred

• Market particpants

should publish data

on their risks and

management



Decisions are communicated to the departments responsible for intervention through resolutions that objectively set out the desired positioning and attempt to speed up procedures.

The management of risk exposure is delegated to three Commissions, which consult on measures to be taken in line with the organization chart below:

The individual actions of the commissions making up the Global Risk Committee, which run risk management procedures for the Conglomerate, are described as follows.

Credit RiskCommission

Global RiskCommittee

Assets and LiabilitiesManagement Commission

Analyzes and proposes measures to global risk committee regarding:

• assets and liabilities risk management commission;

• market and liquidity risk management;

• market and liquidity risk exposure level;

• risk models for market and liquidity risk and assetsand liabilities management;

• appropriate liquidity levels and contingency plans.


• credit risk management;

• credit risk exposure levels;

• credit risk models;

• contingency plans.


• operational risk management;

• operational risk exposure levels;

• operational risk models;

• contingency plans.

Operational RiskCommission

Global Risk Committee



Market Risk

For the purposes of Market Risk Management, Banco do Brasilsegregates commercial and treasury operations (GAP) from trading operations and observes the proper limits and strategies. This separationis designed to ensure that the Bank takes a conservative positioningin managing market risk.

The Bank uses statistical and simulation methodologies to measure market risk for its positions. Among them, we may mention:

• Value at Risk (V@R)

• Scenarios under normal conditions

• Sensitivity indicators (parallel change, inclination and torsion of risk factor curves)

• Stress Scenarios

Value at Risk is a measure of maximum expected loss in monetary terms, under normal market conditions, within a given time horizon,for a given probability level. In the Bank, V@R is measured using historicalsimulation methodology, with 95% probability, for one-day periods.

Valu

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Capital A

llocation

Operational RiskCredit Risk

Bank RiskManagement



Risk strategyCapital allocationCapital matching

Portfolio diversificationLimits systemPerformance monitoring

Measurement modelsPricing for riskEvident processes




Historical methodology assumes that the observation of historical changes in interest rates, market indexes, exchange rates, stock and commodities will reflect possible future changes. New historical analyses are constantly made to define of the best window of opportunity for sampling observations and the last 150 days are currently used for this analysis. The historical methodology allows solid risk measurement for instruments and portfolios. V@R is submitted to back-testing - which consists of comparing the amount calculated with the actual financial outcome as posted. This process calibrates the model. At the confidence interval set by the Bank, it is assumed that the financial outcome will exceed V@R once every 20 days.

In the process of calculating value at risk, scenarios are put togetherbased on statistical analyses and future expectations in the market.These future scenarios may be affected by parallel variations or torsion(not parallel) as a measure of variability of the estimate.

To estimate possible losses, stress scenarios are considered in the eventuality of occurrence of extreme crisis situations. These are based on shocks in scenarios in the same proportions as in previous crisis periods. These scenarios are constantly reviewed and updated to respond to events in the economy. An estimate is made of losses due to a stress situation with the aim of revealing the largest exposure in abnormal market conditions.



ALM Assets and Liabilities Management

The diversity and volatility of the indicators currently used in balances of Brazilian financial institutions require consolidated and tempered management of market risk. The Risk Committee analyzes existing mismatches and examines the probabilities of different scenarios developing. A decision to reduce mismatches is made mainly throughthe use of derivative products.

Lower hedging levels in recent years has made the Bank’s income steadier and reduced its dispersion.

The graph below presents the Bank’s main mismatches on 12/31/2001:

Main Mismatches

CMN Resolution 2692, dated 02/24/2000, established capital reserve requirements for fixed-interest transactions. Measures were taken to raise capital requirements due to the high volatility of Brazilian interest yield curves in July 2001.

Interest Risk

30.0

InterbankFutures

Contract/Average

SELIC Rate

20.0

10.0

-

(10.0)

(20.0)

(30.0) Fixed US$ GeneralPriceIndex

Shareholder´sEquity and

Others

Long-TermInterest

Rate

DemandDeposits

IndexLinked

to SavingDeposits/Reference

Rate

billions of R$



The Global Risk Committee regularly stipulates and reviews limits for the different indicators to which the Bank is exposed.

In this sense, in view of CMN Resolution 2891, dated 09/26/2001,the Global Risk Committee set the Conglomerate’s currency exposureat under 5% (five percent) of Referential Equity, in order to avoid capital requirements associated with positions held in foreign currency.Data on capital requirement for currency exposure for the period January 2001 through December 2001 are shown in the table below:

Currency Risk

Fixed interest

Capital Requirement

12.31.2001

588

12.31.2000

261

Medium

594

Maximum

1,006

Risk Minimum

151

R$ million

Currency exposure

Capital Requirement

12.31.2001

0

12.31.2000

0

Medium

39

Maximum

759

Risk Minimum

0

R$ million

Using the parameters in the previously mentioned Resolution, V@R of R$ 256.6 million was posted at the end of December 2001. The table below shows capital requirements for fixed rate transactions from January 2001 through December 2001:



Liquidity management at the Bank is guided by decisions of the Global Risk Committee, where liquidity risk is treated together with other risks, with decisions on capital allocation and with the participation of all sections of the conglomerate.

Since 1998, the Bank maintains liquidity reserves consisting of federal securities easily converted to cash and a contingency plan to deal with crises in the Brazilian and international finance markets. These reservesare taken into account in preparing the budgeting process and therefore meet daily cash flow needs for the Conglomerate.

In June 2001, CMN Resolution 2804, dated 12/21/2000, on liquidity risk controls, came into effect. Banco do Brasil already had such controls and these - with minor adaptations - enable the bank to fully meet the requirements of the Resolution.

The main variations in liquidity during the year 2001 are shown in the graph below and were derived from the changing profile of Brazilian foreign debt (Brady Bonds) and PESA bonds (Special Asset Purging Program) for government debt bonds (local acronyms of the bonds are LFT and NTN-D),

Liquidity Risk

Daily Liquidity Evolution - 2001

Q1 Q2 Q3 Q4

Cash Balance Liquidity Reserve



Trading

The Global Risk Committee sets limits for the Brazilian and International treasuries in relation to their positions most sensitive to market risks. For evaluation purposes, these operations are segregated from other operations, and their risk is measured and monitored by risk managers subordinated to the Risk Management Unit, who are also responsiblefor controlling limits set by the Global Risk Committee.

Currently, the main limits for the trading portfolio are:a) daily and monthly maximum loss;b) value at risk of 1 day with a 95% confidence level calculated

by the Historical Simulation method;c) stress test.

Due to high volatility in finance markets, the Global Risk Committee decided to reduce the volume of the Bank’s intentional risk, which was reflected directly in the V@R of the trading portfolios. V@R for 2001 is shown in the table below:

Brazil R$International US$

V@R

12.31.2000

2971,192

Medium

6591,276

Maximum

3,9773,061

Trading Minimum

11738

thousands

12.31.2001

1211,498

in the amount of approximately R$ 10.9 billion, in June and July 2001.Since then, the Bank has been optimizing these funds by reducing costof funding and building the portfolio of profitable assets. The reductionof liquidity in late September 2001 was due to the compulsory reserveof 10% on time deposits as of the 28th.



Credit Risk

Banco do Brasil’s credit risk management model is in full compliance with the changes introduced by the “New BIS Accord”. It is also fully integrated with its consolidated management of global risks involved in its trading. Through developing and improving its proprietary models, the Bank aims at enhancing the identification of credit risks associated with the portfolio, in order to allocate funds in a more efficient and effective price-adjusted manner, thus helping maximize value to the shareholders.

The Conglomerate’s vision is that credit risk management should include methods for determining maximum risk exposure, as well as concentration levels, segregated in portfolios (segmented by client, economic sector, region, product, rating, colaterals, etc.), and including individualized determination of properly monitored limits.

Valu

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reat

ion

Capital A

llocation

OperationalRisk

Bank RiskManagement



Risk strategyCapital allocationCapital matching

Portfolio diversificationLimits systemPerformance monitoring

Rating modelsPricing for riskEvident processes


Credit Risk



Banco do Brasil’s credit risk management is governed by the Global Risk Committee, which evaluates proposals from the Credit Risk Commission, whose attribution is to propose measures in the ambit of the Bank and its wholly-owned subsidiaries in relation to the management of credit risk, exposure level to credit risk, credit risk models and contingency plans.

The Commission is composed of eight permanent members with voting rights, working in a collegiate manner and coordinated by the directorfor credit.

AgribusinessDivision

CommercialDivision

CreditDivision

GovernmentDivision

InternationalDivision

RetailDivision

Strategy andOrganization

Division

RestructuringOperationalAssets Unit

Coordination



To ensure excellence in credit risk management, a number of actions are being integrated as in best market practices:

• Risk management model;• Allocation of economic capital;• Risk Portfolio (segments, sections, regions, etc.);• Portfolio management model; • Client rating and operations models;• Pricing model; • Contingency plans;• Backtesting;• Control / auditing points; and• Training.

Methods for setting credit exposure (individual or portfolio) are based on internal systems for dividing clients by class of risk - ratings, determined by statistical models that estimate expected default frequency.

Estimated default frequency indicating loss for a given level of defaults and the equivalent exposure are used to obtain expected loss, and the standard deviation of its distribution is an instrument to determine unexpected loss, the effective value at risk for the credit portfolio, illustrated as follows.



The determination of V@R (Value at Risk) for credit will enable us to evaluate value at risk for the different portfolios and, through RAROC (risk-adjusted return on capital), the return provided by its allocation, thus enabling management to take actions seeking optimization and, consequently, creating more shareholder value.

The model for calculating V@R also enables us to conduct a seriesof stress simulations to project potential impacts of critical situationson credit portfolios and so take early measures to minimize these effects.

Last year, 2001, saw the continuity of development and enhancing of proprietary models based on analytic techniques for clients (individual and corporate, financial institutions, cooperatives and rural businesses), transactions and credit risk management (V@R and RAROC).

Internal training courses were held to disseminate new approaches to credit risk are being accomplished and instruments being developed for portfolio management.

0.01

70

60

50

40

30

20

10

0

0.26

0.51

0.76

1.01

1.26

1.51

1.76

2.012.2

6%2.51

2.76

3.01

3.26

3.51

3.76

4.01

4.26

4.51

4.76

5.01

5.26

5.51

5.76

Expected Loss

99% ConfidenceCredit V@REconomic Capital

Default Rate - %

Prob

abilit

y - %

Hypothetic Data

Capital Structure and Credit Loss Traditional Distribution



The Credit Portfolio Quality Index (local acronym IQC) was also developed as a management mechanism throughout the organization and includedas an item in the 2002 employment contract.

In addition, specific contingency plans for credit risk were in place.

More intensive use of information technology for the credit process(to input proposals, analyze and decide) was backed by reconfiguringin line with the new vision for the Conglomerate’s IT architecture which will provide enhanced speed and flexibility, follow-up, monitoring, and control.

In the operational ambit, there was an audit of the credit process analysis and setting of limits for company credit, which culminated, at the beginning of this year, with the award of ISO 9001/2000 certification, thus ratifying the level of excellence achieved in the credit analysis process, which also applied to the middle (ISO 9002/94) segment.

In relation to provisioning for doubtful credits, the Bank was fully in compliance with legal requirements and improved its flow monitoring. Another highlight was its vision aimed at covering loss in line with expectation of occurrence, based on the distribution curve for probabilityof expected losses.



The New BIS Accord is due to be implemented by 2005 and represents significant progress, since it provides incentives for Banks to strengthen their risk management and measurement procedures. It is innovativein so far as it calls for a sharp focus on operational risk and requirescapital to be provisioned for this kind of risk.

The New Accord poses a flexible structure that can use different models for the identification and measurement of risks in order to make the regulatory minimum capital requirement level more sensitive to banks’ quality and sophistication in global risk management.

With the aim of managing operational risk, Banco do Brasil has developed a management model that enables it to identify, rank, measure and monitor risks involved in its processes. The model is divided in two approaches:the qualitative and quantitative focuses.

Valu

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Capital A

llocation

Bank RiskManagement



Risk strategyExposure limitsScenario analysisCapital allocation

Key risk indicatorsPerformance monitoring

Self-assessment processesDatabaseRating models


Credit RiskOperational

Risk

Operational Risk



Banco do Brasil Operational RiskManagement Model

Phase 1 - Qualitative Module

Phase 2 - Quantitative Module and Integration Capital Allocation Module

Phase 3 - Preceding and Consequent Risk Module

Operational Risk deriving fromSituational Risk (Preceding Risk)

Operational Risk that has generated Legal Riskor Image Risk (Consequent Risk)

DW

Losses IntegratedDatabase

RiskFactors

Quantitative(1)

ModelsManagerialInformationSystem

Capital AllocationCalculation (1)

Quantitative Models

Phase 2

ControlModel

Risk andControls Matrix

Risks Controls Compliance

Self-assessment

MonitoringSelf-assessment

Report

Indicators

Carpis

Losses Report

Compliance

Control Objects

Priority Settings

Methodology

Phase 1

Phase 3

Allocate Capital



The qualitative approach (Phase 1) that has been developed and is being implemented at the Bank includes methodologies, IT systems, management reports and checklists to control the procedures conducted in branches, local managements and administrative units. As the illustration previouslyshowed, this phase consists of the Control Model, the Risks and Controls Matrix, Self-assessment Methodology and the MonitoringProcess, as specified below:

• The “Control Model” provides a unified vision of the “Objects of Control” (processes, products and services susceptible to analysis from the point of view of risks and controls) and constitutes the basis for the application of the Risks and Controls Matrix;

• The Risks and Controls Matrix ranks the criticality levels of control objects to be prioritized and submitted to self-assessment methodology;

• The Self-assessment Methodology applied in the highly critical processes aims to develop action plans to minimize risks and to evaluate and enhance existing controls;

• The Monitoring Process provides management information enabling follow-up of adaptation of controls. Monitoring is based on the Quarterly Control and Compliance Report, the Operational Losses Report, the Self -assessment Report, the management database of the “Control Panel“ System and the Control and Evaluation of Product, Investment and Services Risks (local acronym CARPIS).

Qualitative Approach



The use of measurement models developed from a quantitative focus in Phase 2 attempts to set capital quotas to support expected losses (high frequency and low impact) and unexpected losses (low frequency and high impact) and determine insurance strategies for losses identified as severe (low frequency and high impact). This phase should include the combination of qualitative and quantitative approaches.

The data from this phase provide feedback for the quality of self-assessment, efficiency of controls implemented and the level of risk awareness assimilated by administrators and employees. It enables the Bank to steer toward reducing operational losses and the capital allocated to cover this kind of risk.

As a means of bringing actions implemented into line with the process of quantification and measurement of operational risk, the Bank is implementing a set of initiatives to speed up operational risk management:

• Creation of the Operational Risk Commission for the purpose of analyzing issues involved in Operational Risk management, models and exposure levels, and to promote coordination of actions around the implementation of rules and procedures for internal control and compliance. The issues discussed in the ambit of the Operational Risk Commission are submitted to approval by the Global Risk Committee.

• Implementation of program for analysis of scenarios by detecting and interpreting events external to the Bank that may affect or have consequences for its operational processes, including the new Brazilian Payments System, money laundering, acts of God (floods, droughts and other natural phenomena), and activity peaks;

• Identification of Key Risk Indicators, i.e. factors internal to the Bank that indicate the probable occurrence of operational failure/loss, including Electronic Fraud, Client Complaints and Credit Process Compliance;

• Approval of ‘Exposure Limits’ that express the acceptable level of tolerance for the Key Risk Indicators;

Quantitative Approach



• Development of Operational Risk Rating Model for the chain of branches. The rating is an indicator attributed to branches on the basis of the level of control and compliance observed in their conduct of processes such as credit operations, credit records and limits, trial balances, transitory accounts. This indicator enables the Bank to detect branches with high levels of risk exposure and take steps to improve procedures, hold training courses and improve operational conditions for the branchesas a whole;

• Building a database of main operational losses.

The development of more sophisticated and precise internal models for operational risk management is aimed at situating the Bank on level II or III of the New Accord.

Management of operational losses requires the analysis of factors that preceded them and of their consequences for other risks.

Phase 3, which it is simultaneous to the measurement process, seeksto evaluate relations between Operational, Legal , Image and Conjuncture Risks. It aims to identify the portion of operational risk arising from Conjuncture Risk (Preceding Risk), on the basis of analyzing external factors (Scenarios) and their impacts on operational processes.

In the same way, the phase should evaluate the level of impact of Operational Risk on Legal and Image Risks (Consequent Risks),since the former may boost the effects of certain risks.

Preceding and Consequent Risks Module



Control Environment

The Operational Risk Management Model is part of an environment with a reinforced culture of control and compliance. To consolidate this environment, the Bank took the following steps:

• Self-instruction training program on the issue of “Internal Controls, Operational Risk and Compliance”, aimed at branch staff to induce the development of analytical and critical sensitivity when dealing with risk situations. Around 37,000 employees attended training courses in 2001;

• Preparation of specific training courses for the employees of the Operational Control Centers who are directly involved with controlof the branches, updating them on issues related to “Internal Controls, Operational Risk and Compliance.”;

• Creation of the position of Compliance Agent for every Management and Administrative Unit and organization of courses to assist them in carrying out their duties;

• Determining indicators affecting remuneration of employees in the branches and administrative units with the aim of inducing pro-active behavior in relation to risk identification and control.



Banco do BrasilSBS - Ed. Sede III - 24º andar70073-901 - Brasília (DF) - Brasilwww.bb.com.br

Internal Controls DivisionSBS - Ed. Sede I - 3º andar70073-901 - Brasília (DF) - BrasilTel: (61) 310-4600Fax: (61) 310-4660

Credit DivisionSBS - Ed. Sede I - 20º andar70073-901 - Brasília (DF) - BrasilTel: (61) 310-3250Fax: (61) 310-2454

Risk Management UnitSBS - Ed. Sede III - 16º andar70073-901 - Brasília (DF) - BrasilTel: (61) 310-4300Fax: (61) 310-3985

Marketing and Communication DivisionSBS - Ed. Sede III - 19º andar70073-901 - Brasília (DF) - BrasilTel: (61) 310-3599Fax: (61) 310-2470

Corporate Information


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