Capital management

The goal of capital adequacy management is: (a) meeting the requirements specified in external regulations (regulatory capital adequacy) and (b) ensuring the solvency in normal and stressed conditions (economic capital adequacy/internal capital). Completing that goal, the Group strives to achieve internal long-term capital limits (targets), defined in Risk Strategy.

Capital allocation purpose is to create value for shareholders by maximizing the return on risk in business activity, taking into account established risk tolerance.

In a scope of capital management process, there is also a capital planning process. The goal of capital planning is to designate the own funds (capital base that is risk-taking capacity) and capital usage (regulatory capital requirements and economic capital) in a way to ensure that capital targets/limits shall be met, given forecasted business strategy and risk profile – in normal and stressed macroeconomic conditions.

The Group is obliged by law to meet minimum own funds requirements, set in art. 92 of Regulation (EU) No 575/2013 on prudential requirements for credit institutions and investment firms (CRR). At the same time, the following levels, recommendations and buffers were included in capital limits/targets setting:

• Pillar II RRE FX buffer – KNF recommendation to maintain additional own funds for the coverage of additional capital requirements in order to secure the risk resulting from FX mortgage loans granted to households, in line with art. 138.1.2a of Banking Act. A value of that buffer is defined for particular banks by KNF every year as a result of Supervisory review and Evaluation process (SREP) and relates to risk that is in KNF’s opinion – inadequately covered by minimum own funds requirements, set in CRR art. 92. At present, the buffer was set by KNF in recommendations issued in November 2019 in the level of 4.96 p.p. (Bank) and 4.87 p.p. (Group) as for Total Capital Ratio (TCR), which corresponds to capital requirements over Tier 1 ratio of 3.72 p.p. in Bank and of 3.65 p.p. in Group, and which corresponds to capital requirements over CET 1 ratio of 2.78 p.p. in Bank and 2.73 p.p. in Group*;
• Combined buffer – defined in Act on macroprudential supervision over the financial system and crisis management – that consists of:
  • Capital conservation buffer at the level of 2.5%;
  • Other systemically important institution buffer (OSII) – at the level of 0%, and the value is set by KNF every year**;
  • Systemic risk buffer at the level of 3% in force from the beginning of 2018;
  • Countercyclical buffer at the 0% level.

In accordance to binding legal requirements and recommendations of Polish Financial Supervisory Authority (KNF), the Group defined minimum levels of capital ratios being at the same time capital targets/limits. These are OCR (overall capital requirements) as for particular capital ratios.

*That recommendation replaces the previous one from 2018, to maintain own funds for the coverage of additional capital requirements at the level of 6.41 p.p. (Bank) and 6.27 p.p. (Group) as for TCR, which should have consisted of at least 4.81 p.p. (Bank) and 4.70 p.p. (Group) as for Tier 1 capital and which should have consisted of at least 3.57 p.p. (Bank) and 3.51 p.p. (Group) as for CET1 capital
**In August 2019 KNF informed the Bank was not identified as other systemically important institution in 2019

The below table presents these levels as at 31 December 2019. The Bank will inform on each change of required capital levels in accordance with regulations.

Capital risk, expressed in the above capital targets/limits, is measured and monitored in a regular manner. As for all capital targets, there are determined some minimum ranges for those values. Capital ratios in a given range cause a need to take an appropriate management decision or action. Regular monitoring of capital risk relies on classification of capital ratios to the right ranges and then performing the evaluation of trends and drivers influencing capital adequacy.

The Group calculates its own funds requirements using standard methodologies, and is implementing at the same time a project of an implementation of internal ratings based method (IRB) for calculation of own funds requirements for credit risk and obtaining of approval decisions from Regulatory Authorities on that matter.

In the end of 2012, Banco de Portugal (consolidating Regulator) with cooperation of Polish Financial Supervision Authority (KNF) granted an approval to the use of IRB approach as to following loan portfolios: (i) Retail exposures to individual persons secured by residential real estate collateral (RRE), (ii) Qualifying revolving retail exposures (QRRE). According to the mentioned approval, minimum own funds requirements calculated using the IRB approach should be temporarily maintained at no less than 80% (“Regulatory floor”) of the respective capital requirements calculated using the Standardized approach.

In the end of 2014, the Bank received another decision by Regulatory Authorities regarding the IRB process. According to its content, for the RRE and QRRE loan portfolios, the minimum own funds requirements calculated using the IRB approach had to be temporarily maintained at no less than 70% (“Regulatory floor”) of the respective capital requirements calculated using the Standardized approach until the Bank fulfils further defined conditions.

In July 2017 the Bank received the decision of Competent Authorities (ECB cooperating with KNF) on approval the material changes to IRB LGD models and revoking the “Regulatory floor”.

The Group defines internal capital according to Polish Banking Act, as the estimated amount needed to cover all identified, material risks found in the Bank’s activity and changes in economic environment, taking into account the anticipated level of risk in the future.

Internal capital is used in capital management in following processes: economic capital adequacy management and capital allocation. The Bank defined an internal (economic) capital estimation process. To this end, as for measureable risk types, mathematic and statistic models and methods are used.

Maintaining economic capital adequacy means a coverage (provision) of internal capital (that is an aggregated risk measure) by available financial resources (own funds). An obligation to banks to have in place that sort of risk coverage stems from Banking Act. It was mirrored in the Group’s capital targets/limits: economic capital buffer and economic capital buffer in stressed conditions.

In 2019, both above capital targets were met with a surplus. A surplus of own funds over internal capital supports a further increase of banking activity, in particular in areas with a higher risk-adjusted return.

At the same time internal capital is utilized in capital allocation process, to assign an internal capital to products/business lines, calculating risk-adjusted performance measures, setting risk limits and internal capital reallocation.

Capital adequacy of the Group over the last three years was as follows***

*The Group uses transitional arrangements for IFRS 9. As at 31.12.2019, if IFRS 9 transitional arrangements had not been applied, capital ratios were as follows:

• TCR: 19.89%
• T1: 70%
• CET1: 16.70%
• Leverage ratio: 8,00%

As at 2019 end, capital adequacy, measured by Common Equity Tier 1 Capital ratio and Total Capital Ratio, decreased in one year period by ca 2.9 p.p. and by ca 1.6 p.p. respectively.

In 2019, risk-weighted assets went up by ca PLN 11.5 billion (by 31%), mainly as a result of the Euro Bank takeover and loan portfolio growth.

Own Funds raised by ca PLN 1.7 billion in 2019, mainly as a result of retention of net earnings (total net earnings for 2018 and net earnings for first half of 2019), and subordinated debt issue.

Minimum capital levels required by KNF was achieved with a surplus.

Leverage ratio stood at the safe level of 8-9%, with a small quarterly changes and exceeds almost three times a value deemed as safe (3%).

In a long perspective, capital adequacy level of Bank and Group is evaluated as satisfactory.

The Bank received a letter from the Bank Guarantee Fund („BFG”) regarding the minimum level of own funds and liabilities subject to write down or conversion („MREL”)

In accordance with the regulation, the MREL requirement should be achieved by January 1, 2023 and maintained at all times from that date. BFG has determined a linear path to reach the required target. The MREL limit was set on the basis of data as at December 31, 2018 and the value of required buffers valid as at January 1, 2019. As of December 31, 2019, the Bank fulfils the MREL limits set up by BFG.

In order to fulfil and maintain required MREL limits, the Group may issue MREL eligible instruments that could cause increase of financing costs for the Group.