Emerging Practices for Capital Adequacy © Copyright 2003, CCRO. All rights reserved. x 6.4 Mitigation Techniques.................................................................................................................... 40 6.5 Banking Operative Risk Measurement Techniques ................................................................... 40 6.6 Summary .......................................................................................................................................... 42 VII. COMBINING MARKET, CREDIT AND OPERATIVE ECONOMIC CAPITAL ................. 43 7.1 Framework ....................................................................................................................................... 43 7.2 Input Parameters ............................................................................................................................. 44 7.3 Proposed Methodological Solutions ............................................................................................ 44 7.3.1 Simple Sum - Risks Are Assumed to Be Perfectly Correlated ......................................... 45 7.3.2 Modern Portfolio Theory - Risks Are Assessed with Estimated Correlation Structure45 7.3.3 Monte Carlo Simulation - Combined Simulation Approach ............................................ 46 7.4 Summary of Selected Economic Capital Methodology ............................................................. 46 7.5 External Perspectives...................................................................................................................... 47 VIII. LIQUIDITY ADEQUACY ........................................................................................................ 49 8.2 Sources of Liquidity ........................................................................................................................ 50 8.2.1 Cash and Cash Equivalents ................................................................................................... 50 8.2.2 Expected Cash Flow from Operations ................................................................................. 50 8.2.3 Backup Credit Facilities ......................................................................................................... 51 8.3 Fixed Payments ............................................................................................................................... 51 8.4 Contingent Liquidity ...................................................................................................................... 52 8.4.1 Cash Flow at Risk.................................................................................................................... 52 8.4.2 Time Horizon and Confidence Level ................................................................................... 53 8.5 Measuring Liquidity Uses ............................................................................................................. 54 8.6 Trigger Events and Other Contingent Events ............................................................................ 54 8.6.1 Loss or Reduction of Threshold ............................................................................................ 55 8.6.2 Adequate Assurance............................................................................................................... 55 8.6.3 Debt/Equity Trigger .............................................................................................................. 56 8.6.4 Credit/Counterparty Terminations/Defaults .................................................................... 56 8.6.5 Operational/Operations Risk ............................................................................................... 56 8.7 Summary - Liquidity Adequacy ................................................................................................... 57 8.8 Other Considerations ..................................................................................................................... 57 8.8.1 Limits ........................................................................................................................................ 57 8.8.2 Model Review and Back-testing ........................................................................................... 58 IX. CONCLUSION .......................................................................................................................... 59 X. NEXT STEPS ............................................................................................................................ 60 CAPITAL ADEQUACY EXAMPLE ................................................................................................ 61 APPENDIX A: CAPITAL ADEQUACY ISSUES FOR REGULATED UTILITIES ...................... 68 APPENDIX B: DETAILED EXAMPLE OF THE CALCULATION OF THE CREDIT CAPITAL REQUIREMENT ................................................................................................................................ 70 GLOSSARY ....................................................................................................................................... 72 REFERENCES ................................................................................................................................... 76