Chapter 11 doubt

[Ekta Mehta]

So:
S iCR = NAV in the unstressed (ie best estimate) balance sheet minus
NAV in the stress scenario for risk i
SC iR is subject to a minimum of 0 (ie there is no ‘negative capital requirement’ in the event that a stress scenario does not represent a risk to the company).
My question was in relation to this section in Chapter 11. I thought the difference should be stressed minus unstressed. This means that we know for a stressed balance sheet how much additional capita will be required - is it not? and only in that difference equation can the lat sentence make sense about negative capita requirement.
HAve I understood it correctly?

 

[Em Francis]

So:
S iCR = NAV in the unstressed (ie best estimate) balance sheet minus
NAV in the stress scenario for risk i
SC iR is subject to a minimum of 0 (ie there is no ‘negative capital requirement’ in the event that a stress scenario does not represent a risk to the company).
My question was in relation to this section in Chapter 11. I thought the difference should be stressed minus unstressed. This means that we know for a stressed balance sheet how much additional capita will be required - is it not? and only in that difference equation can the lat sentence make sense about negative capita requirement.
HAve I understood it correctly?

Hi

A numerical example might help:
SCR = ΔNAV= max (NAV - (NAV l shock), 0)
For example,
if unstressed assets (A0) are 100 and unstressed liabilities (L0) are 80. NAV(0) = 20
Now, after stress, assets (A1) fall to 60 and liabilities (L1) to 50. NAV(1) = 10

SCR = ΔNAV= max (NAV - (NAV l shock), 0) = 20 - 10 = 10.

If, however A1 fell to 60 and liabilities to 20.

ΔNAV= max (NAV - (NAV l shock), 0) = 20 - 40 = 0.

Hope this makes it clearer.

Thanks
Em

 

[Ekta Mehta]

Hi, thanks for the reply - was just thinking - if the NAV in unstressed scenario is higher than that of stressed scenario then why would I require any additional capital with respect to that specific stress?

 

[Lindsay Smitherman]

Taking the example above, we have NAV = 20 in the base position, before the stress is applied, and then NAV = 10 if the stress event happened. So the stress event causes the company to lose 20 - 10 = 10 (unstressed minus stressed) of its NAV.

This means that the Value-at-Risk for that particular event (at that stress confidence level) is 10.

If that event happened, the co would lose NAV of 10, so it needs to make sure that it has capital of 10 available to cover that. Hence the capital requirement (SCR) is based on that difference: need to make sure have that amount of capital available to cover the loss, if that stress event happened.

 

[Ekta Mehta]

got it Lindsay, thank you so much!