Exceptions to the rule

Regulators have traditionally seen value-at-risk exceptions as an early warning of weaknesses in bank risk models. However, the financial crisis has shown VAR exceptions cannot be used to predict bank failures or distress.

Banks back-test their daily value-at-risk every day by comparing it with the corresponding daily trading revenue (see footnote 1). A backtesting VAR exception occurs when trading losses exceed the daily VAR estimate. Nevertheless, banks calculate VAR using a confidence interval that allows for such exceptions. European banks calculate VAR at a 99% confidence interval, which means they should expect two or three days of exceptions a year (see footnote 2). Most US banks calculate VAR at a 95%