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Risk Management in the Chilean Banking Industry: The VaR Revolution

  • Economics


C:\WINNT\Profiles\asaguez\Perso 752 CUADERNOS DE ECONOMIA (Vol. 40, Nº 121, diciembre 2003) RISK-MANAGEMENT IN THE CHILEAN BANKING INDUSTRY: IMPLEMENTING THE VaR REVOLUTION JOSÉ MIGUEL CRUZ* 1. INTRODUCTION Almost a decade ago, a major change in the risk-management industry was in its way: J.P. Morgan, the well-known international bank, released to the general public a detailed document describing a simple technique to measure market risks for trading portfolios –Value at Risk (VaR) (J.P. Morgan 1995). The document soon became an industry standard. Among other qualities, it fully addressed the quantitative recommendations issued by the Group of Thirty (1993), which aimed at strengthening an industry challenged by major financial scandals (Jorion 1997). Most of the financial problems that institutions experienced during these years were related to the lack of appropriate risk-disclosure policies (specially in relation to derivatives), lack of involvement of senior management, and poor internal procedures and risk-management controls. In January 1996 the Basle Committee of Banking Supervision issued the Market Risk Amendment (BIS 1996), which captured the major concerns of regulators and senior management, by recommending that regulatory capital be assigned according to market risk (in contrast to the 1988 Capital Accord, with a focus on credit risk), and by defining a set of qualitative requirements that incorporate the best practices for risk-management1. All banks would be required to allocate capital to prevent balance sheet and off-balance sheet adverse changes caused by unforeseen movements in interest rates and market prices. For larger institutions, it also suggested that capital should be assigned on a regular basis according to the trading portfolio’s market risk. As for best practices, in general terms the Amendment established the need for ongoing improvements in risk control and risk disclosure, focusing on a more technical measurement of market risks (dai

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