The basic measurement model used to assess market risk is Value at Risk (VaR), which provides a forecast with a 99% probability of the maximum loss that can be incurred by trading portfolios in a one-day horizon, stemming from fluctuations in equity prices, interest rates, foreign exchange rates and commodity prices. In addition, for certain positions, other risks also need to be considered, such as credit spread risk, basis risk, volatility and correlation risk. The VaR is calculated by using a historical period of 2 years of observation of the risk factors.
Currently, BBVA, S.A. and BBVA Bancomer have been authorized by the Bank of Spain to use their internal model to determine capital requirements deriving from risk positions in their trading book, which jointly accounts for 80-90% of the Group’s trading-book market risk. Furthermore, and following guidelines established by Spanish and European regulators, BBVA has created additional metrics to comply with the regulatory requirements issued by the Bank of Spain. The new market risk measures for the trading book include the calculation of the stressed VaR (to quantify the risk level in extreme historical conditions), the quantification of non-performing risks, and of downgrade risks in the rating of some positions held in the portfolio, such as bonds and credit derivatives; they also quantify securitization and correlation portfolio charges, using the standard model.
The market-risk limits model currently in force consists of a system of VaR (Value at Risk) and economic capital limits and VaR sub-limits, as well as stop-loss limits for each of the Group’s business units. The global limits are proposed by the corporate GRM area and approved by the Executive Committee on an annual basis, once they have been submitted to the Board’s Risk Committee. This limits structure is developed by identifying specific risks by type, trading activity and trading desk. The market risk units maintain consistency between the limits. This system of limits is supplemented by measures of the impact of extreme market movements on risk positions held.
The stress analysis is currently carried out based on historical crisis scenarios. The reference historical scenario today is the collapse of Lehman Brothers in 2008. Economic crisis scenarios are also prepared, which are updated on a monthly basis and drawn up ad hoc for each one of the Group’s trading floors. These scenarios identify the most significant market risk positions and assess the possible impact that fluctuations in market variables may have on such positions.
BBVA continues working to improve and enrich the information provided by the stress tests, drawing up scenarios to detect the possible combinations of impacts on the market variables that might have a significant effect on the performance of trading portfolios, completing the information provided by VaR and the historical scenarios and acting as a warning indicator that supplements the policies for measuring and controlling normal risks.
In order to assess business unit performance over the year, the accrual of negative earnings is linked to the reduction of the VaR limits that have been set. The control structure in place is supplemented by limits on loss and a system of warning signals to anticipate the effects of adverse situations in terms of risk and/or result. All the tasks associated with stress testing, methodologies, scenarios of market variables and reports are coordinated among BBVA Group’s various risk areas.
Finally, the market risk measurement model includes backtesting, or ex-post comparison, which helps to refine the accuracy of the risk measurements by comparing day-on-day management results with their corresponding VaR measurements.