Integrating market and credit risk tends to focus on the mathematics of the methodology. David Goucher, formerly our director of risk policy and development, argues that this misses the point.
Credit and market risk have different time horizons and different ways in which losses are realised: credit default might have to be modelled over several years whereas market risk is much more short term. Also, banks can easily lay off market risk but it is not so easy to liquidate, say, a ten-year swap.
Because of these differences, credit and market risk are best calculated using separate different methodologies. Furthermore, RAROC methodologies already exist to integrate market and credit risk from a capital perspective.
There is therefore little advantage in integrating market and credit risk for purposes of exposure calculation. But what about the advantages in terms of simplicity and system cost?
Market and credit risk management have common transaction data, market rate data, internal MIS hierarchies, etc. Yet most institutions have separate market and credit risk management systems, separate interfaces, separate reconciliation processes, separate limits tracking processes and separate pricing functions.
Less is More
While the strategy of multiple systems and interfaces has served well during a period of rapid growth, banks now tell us that they need cost savings and fewer systems.
In response to this, we have decided to extend the Credient system to manage both market and credit risk. This will be done through using Credient's real-time technology infrastructure and our extensive experience in delivering market and credit risk solutions to provide an integrated risk management solution.
We are concentrating on practical data management and wider systems integration issues rather than a unified measurement of market and credit risk. Using a single transactional database, a single interface to each trading system, common pricing components and a common user interface, Credient users can:
* realise substantial cost savings, through supporting one common system and substantially reducing the number of interfaces required,
* reduce operational risk by reducing the number of processes, reconciliations, valuation models, etc and by utilising a common transaction database,
* benefit from real-time information allowing traders to make informed and accurate decisions,
* gain access to more consistent, comprehensive and accurate management information.
In addition to system benefits and cost savings, Credient's real-time nature allows institutions to take a major step forward in managing and pricing risk. The ability to compute VAR and counterparty credit risk in real time enables institutions to better link the concepts of economic capital and risk adjusted performance measurement for market and credit risk purposes. This is a major advantage to traders when pricing deals.
A technology solution
A single methodology is not appropriate for combined credit and market risk. However, a single system for can deliver cost savings in terms of technology and more pre-deal information for traders. The recent sales to ING and WestLB demonstrate Credient's credentials in this area and we expect to announce more deals soon.
"This article is copyright SunGard Data Systems. It originally appeared in the October newsletter of SunGard Trading and Risk Systems Credient/Infinity business unit - www.risk.sungard.com/credient. For more information contact [email protected]"