Canada Bank Says Software Trims Reserve Requirements

Credit risk management software that Royal Bank of Canada Dominion Securities installed five months ago is paying off.

The bank is using Carma from MKIRisk Inc. to measure counterparty credit risk in its interest rate and foreign exchange derivatives portfolios.

The software is helping it to reduce its use of credit by 20% to 30% while holding down the capital held in reserve for credit risk, said William Tabin, vice president of Dominion's credit analytics group.

Carma, which uses the Monte Carlo simulation method, calculates credit exposures more accurately than the previous, in-house system, Mr. Tabin said. The benefits began appearing immediately, he said.

Malcolme Warne, vice president of MKI Risk, said that with more accurate calculations "you don't have to be so conservative in your capital reserve estimates."

He said he expects Carma to be among the first credit risk systems approved by regulators under a revised capital accord that the Basel Committee of the Bank for International Settlements is scheduled to release this month.

The accord would allow banks to use internal or vendor-supplied systems for credit-risk reserve calculations, provided they meet certain criteria.

As a firmwide calculation engine, Carma nets offsetting risks and accounts for collateral, thereby permitting trading with lower-rated counterparties, Mr. Warne said.

Previously, Dominion calculated credit risk exposure product by product, he said. The risks were then aggregated, not accounting for offsets and collateral.

Carma is better at handling collateral than competing systems, said Deborah Williams, a risk researcher at Meridien Research, Newton, Mass.

She said that a recent regulatory recommendation by the Bank for International Settlements calls for banks to disclose management of collateral for credit risk. She added, however, that banks should be more focused on creditworthiness than collateral and credit exposures.

"One of the faults of currently available credit risk exposure systems is that they do not calculate counterparty creditworthiness," she said. "Banks must inject a counterparty rating into the credit risk calculation engine, resulting in a figure that assumes ratings remain static."

Carma is a product of Cats Software Inc., which was acquired for $60 million in January by Misys PLC of the United Kingdom. Misys integrated Cats with its own risk division to form MKI Risk under its banking software umbrella, Midas-Kapiti International.

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