Internal capital

The Group and the Bank carry out the internal capital adequacy assessment process (ICAAP) in reliance on the models of internal (economic) capital.

The Group and the Bank define economic capital as the amount of capital which is needed to cover all the unexpected economic losses that may occur during a specified future period and that are estimated with specific probability, without jeopardizing interests of the Group’s depositors/creditors. Internal capital calculations incorporate all the material risk types to which the Group is exposed and are based on a set of parameters developed on the basis of the individual features and characteristics of the Polish market. The models quantify the value of expected and unexpected losses on account of the risk types considered to be material, at the assumed confidence level and in a 1-year time horizon.

Internal capital is calculated and maintained as to every risk type evaluated as a material one and as to risk types, to which own funds requirements are maintained, according to CRR.

The Group and the Bank defined the below risk types as material, presented together with methods of internal capital estimation. The last risk materiality assessment was completed in December 2019.

Completing riks materiality assessment in 2019, 11 main risk categories were defined in total, and within them 69 types of risk, including many types of non-financial and hard-to-measure risks. Defined risk categories include:

1. Credit risk
2. Concentration risk
3. Liquidity risk
4. Market risk
5. Real estate risk
6. Operational risk
7. Interest rate risk in banking book
8. Business risk
9. Reputational risk
10. Other risk types
11. RRE FX risk – all aspects and areas of risk of loan portfolio secured by residential real estate in foreign currency

In internal capital calculation, the Group and the Bank have taken a conservative approach to the correlation between individual risk types (the fact that different risk types do not convert to losses simultaneously) and calculates the effect of diversification on the entire loss distribution.

In addition to the above risk types considered as material (Table 12), the Group and the Bank also prudently maintain internal capital for risk types covered by regulatory capital requirements or when it is required in a specified supervisory guidelines. It regards the following risk types:

• Market risk in trading book
• Interest rate risk in banking book
• Risk of equity in banking portfolio
• Credit Valuation Adjustment risk.

In line with the recommendations issued by the banking supervision authority, individual risk types and the diversification effect are subjected to stress tests. The total diversified internal capital is subject to economic assessment of capital adequacy, by a comparison with „risk bearing capacity” (available financial resources). The Group conservatively assumes that the available financial resources are equivalent to regulatory own funds which form the basis for calculating the total capital ratio.

The internal capital adequacy assessment process following the Group’s approach is closely linked to the risk, capital and business management processes in place in the Group. It consists of the following stages:

1. Classification and assessment of materiality of risk types, to determine the method for incorporating them in the risk management process and in the ICAAP process,
2. Measurement (quantification) of risk,
3. Aggregation of internal capital to secure material risk of operations, while taking into account the effect of correlation between risk types,
4. Assessment of capital adequacy by comparing the Bank’s economic risk (internal capital) to its capacity to cover the risk,
5. Allocation of internal capital to business lines/areas of operation,
6. Use of allocated internal capital to measure risk-based efficiency, set risk limits, reallocate capital while taking into account risk-weighted returns.
7. Control and monitoring of the risk level, available financial resources, capital limits and objectives.

Capital adequacy assessment carried out at the end of 2019 indicates a high level of this adequacy, which is shown in a significant surplus of capital resources (equivalent to regulatory own funds) as compared to economic risk (internal capital value) and risk calculated on the basis of supervisory regulations (the value of minimum capital requirements to cover risk).

Both the Bank and the Group meet the statutory requirements regarding the level of own funds and the internal capital set forth in Article 128 of the Banking Law Act and in the CRR.