Setting up a “sound” capital commitment balance is a very important issue in a bank’s current bank management/ALM and governance/compliance. Based on the capital commitment balance, the bank manages the pricing of the customer business (liquidity costs) and the liquidity in ALM; measures the refinancing risk (necessary liquidity buffer) and calculates the liquidity cost risk (ICAAP). Therefore, the board has to make sure that the method employed is accepted throughout the bank, and also vouch for it in front of the regulator.

How to deal with fixed, clearly defined capital commitments is not the issue at hand. Rather, it is the many products without a (clearly) defined term, with multiple clauses and options, with collaterals and requirements as well as the validation requirements in a normal as well as stress case the treatment of which has to be clarified. Our article outlines the currently available methods for modelling capital commitments which would then have to be adapted to the individual product portfolio of each bank.

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