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Member question: “In counterparty risk assessment models, related to cash in bank accounts, do teams typically manage cash exposure using a percentage of the total or fixed dollar limits (or both)? If dollar-based, how are limits defined (and how much flexibility is employed)?”
Peer answer 1: “We set deposit limits with our banks at fixed dollar limits. It’s not a perfect science, but we use several factors to set the overall dollar exposure limit per bank.
- “These factors include credit rating, CDS spread and country risk. Country risk includes macroeconomic factors and events that can affect the bank’s risk profile.
- “Generally, it is as simple as higher limits are given to banks with higher credit ratings in lower risk countries.”
Peer answer 2: “We set deposit limits at our banks based on dollar limits. The exposure limit includes cash, derivative exposure and direct investments in the bank. The limits are set by our risk management team, primarily based on credit ratings.”
Peer answer 3: “We set our counterparty investment limits based on a combination of a bank’s credit ratings and CDS scores. We set predefined ranges for each metric to break each into four different tiers and then set a predefined dollar limit for each tier.
- “We test the credit ratings and CDS scores on a weekly basis. If a bank moves up or down a tier based on this testing, we require them to remain at the new tier for four consecutive weeks before adjusting their limit. In certain limited cases, we will seek an exception from senior management to increase a bank’s limit beyond what our model suggests.
- “When we set our limits each year, we used a fixed percentage multiplied by enterprise assets to set the top tier counterparty limit. This percentage was set many years ago and there wasn’t too much science to it— just based on what we were comfortable with from a risk appetite perspective.
- “So, the amount of exposure we are willing to take with a counterparty changes year to year as our enterprise assets change.”