Capital adequacy

Capital management relates to two areas: capital adequacy management and capital allocation. For both areas, management goals were set.

The goal of capital adequacy management is: (a) ensuring the solvency in normal and stressed conditions (economic capital adequacy/internal capital) and (b) meeting the requirements specified in external regulations (regulatory capital adequacy). Completing that goal, Bank 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.

Group is obliged by law to meet minimum own funds requirements, set in CRR art. 92. At the same time, the following levels, reccomendations 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 reccomendations issued in the end of 2020 in the level of 3.41 p.p. (Bank) and 3.35 p.p. (Group) as for Total Capital Ratio (TCR), which corresponds to capital requirements over Tier 1 ratio of 2.56 p.p. in Bank and of 2.52 p.p. in Group, and which corresponds to capital requirements over CET 1 ratio of 1.91 p.p. in Bank and 1.88 p.p. in Group¹;
• 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 0.25%, and the value is set by KNF every year²;
  • Systemic risk buffer at the level of 0% from March 2020³;
  • Countercyclical buffer at the 0% level.

¹That recomendation replaces the previous one from 2019, to maintain own funds for the coverage of additional capital requirements at the level of 4.96 p.p. (Bank) and 4.87 p.p. (Group) as for TCR, which should have consisted of at least 3.72 p.p. (Bank) and 3.65 p.p. (Group) as for Tier 1 capital and which should have consisted of at least 2.78 p.p. (Bank) and 2.73 p.p. (Group) as for CET1 capital
²In November 2020 KNF informed about identification the Bank as other systemically important institution and imposion other systematically important institution buffer of 0.25%
³Amended in the Regulation of Ministry of Finance and Development as of 18.03.2020

In accordance to binding legal requirements and recommendations of Polish Financial Supervisory Authority (KNF), Bank 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.

The below table presents these levels as at 31 December 2020. The Bank will inform on each change of required capital levels in accordance with regulations.

The Group is completing a project of an implementation of internal ratings based method (IRB) for calculation of own funds requirements for credit risk and calculates its own funds minimum requirements using the IRB and standardise method for credit risk and standardise methods for other risk types.

In the end of 2012, Banco de Portugal (consolidating Regulator) with cooperation of Polish Financial Supervision Authority (PFSA) 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.

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

Since 2018, the Bank Millennium Group has been successively implementing a multi-stage process of implementing changes to the IRB method, related to the requirements regarding the new definition of default. In the first phase, in line with the two-step approach approved by the Tegaulator, the Bank Millennium Group in 2020 successfully implemented solutions for the new definition of default on the production environment. For 2021, it is planned to recalibrate and / or rebuild all credit risk models included in the rating system subject to the current Supervisory approval. These activities are to ensure full adjustment of the Bank Millennium Group to the EBA / GL / 2016/07 guidelines and other guidelines covering the subject of risk parameter modeling. Until the above-mentioned overarching goal is achieved, the Bank Millennium Group is obliged to include an additional conservative charge on estimating the RWA value for exposures classified under the IRB approach. The level of this mark-up, calculated on the basis of the regulatory algorithm, was set at 5% above the value resulting from the IRB method.

Group defines internal capital according to Polish Banking Act, as the estimated amount needed to cover all identified, material risks found in Group’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 Group defined an internal (economic) capital estimation process. To this end, as for measurable 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 2020, 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 utilised 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 evolution of Bank Millennium Group and Bank Millennium SA over the last three years was as follows:

As at 2020 end, capital adequacy in Bank Millennium Group remained on very high and safe level. Total Capital Ratio stayed at year end at 19.49% level for the Group (19.16% for the Bank) and Common Equity Tier 1 Capital ratio (equals T1 ratio) was at 16.50% for the Group (16.15% for the Bank). Therefore, minimum capital levels required by KNF for Bank and Group were achieved with a surplus.

Capital adequacy ratios of the Group decreased during one year period by ca 0.6 p.p. for the Group (by 0.8 p.p. for the Bank). It was caused by a faster risk-weighted assets than own funds growth. In 2020, risk-weighted assets of the Group went up by ca PLN 4 billion (i.e. by 6.3%), mainly as a result of loan portfolio growth. The Group’s Own Funds raised by ca PLN 300 million in 2020 (by 3.1%), mainly as a result of retention of net earnings (net earnings for second half of 2019 amounted to PLN 227 million) and as result of few another factors, of which the increase of revaluation reserve was the most important.

Bank Millennium has a dividend policy of distributing between 35% to 50% of net profit, subject to regulatory recommendations.

On the December 16, 2020, the PFSA adopted a Resolution which presented a position on the dividend policy of banks (and other entities) in 2021, including the recommendation to Bank Millennium:

• suspension of dividend payments (including retained earnings from previous years) in the first half of 2021,
• the Bank’s failure to undertake, in the first half of 2021, without prior consultation with the supervisory authority, other activities beyond the scope of current business and operating activities, which may result in a reduction in the capital base, including buyouts of own shares.

Based on the above recommendations and position of PFSA, considering a uncertainty in business activity due to COVID-19 pandemic, and also seeing the need to assure a reliable capital support for growth of business activity and existing operational/legal risks, the Management Board of the Bank will submit to AGM a proposal of full retention of 2020 net profit in Bank’s own funds.

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

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