Financial and
ESG report 2020

Market risk and interest rate risk

The market risk encompasses current and prospective impact on earnings or capital, arising from changes in the value of the Group’s portfolio due to adverse movement in interest rates, foreign exchange rates or prices of bonds, equities or commodities.

The interest rate risk arising from Banking Book activities (IRRBB) encompasses current or prospective impact to both the earnings and the economic value of the Group’s portfolio arising from adverse movements in interest rates that affect interest rate sensitive instruments. The risk includes gap risk, basis risk and option risk.

The framework of market risk and interest rate risk management and its control are defined on a centralized basis with the use of the same concepts and metrics which are used in all the entities of the BCP Group.

The Group’s market risk measurement allows monitoring of all of the risk types, which are generic risk (including interest rate risk, foreign exchange risk, and equity risk), non-linear risk, specific risk and commodity risk. In 2020 the nonlinear risk and commodities risk did not exist in the Group. The equity risk assumed to be irrelevant since the Group’s engagement in equity instruments is immaterial.

Each market risk type is measured individually using an appropriate risk models and then integrated measurement of total market risk is built from those assessments without considering any type of diversification between the four risk types (the worst case scenario).

The main measure used by the Group to evaluate market risks (interest rate risk, foreign exchange risk, equity risk) is the parametric VaR (Value at Risk) model – an expected loss that may arise on the portfolio over a specified period of time (holding period) and with specified probability (confidence level) from an adverse market movement.

The Value at Risk in the Group (VaR) is calculated considering the holding period of 10 working days and a 99% confidence level (one tail). In line with regulatory requirements of CRDIV / CRR, since April 2014 the volatility associated with each market risk vertex considered in the VaR model (and respective correlation between them) has been estimated by the equally weighted changes of market parameters using the effective observation period of historical data of last year. Previously applied EWMA method (exponentially weighted moving average method) with effectively shorter observation period is now only justified by a significant upsurge in price volatility.

In order to monitor and limit the positions in instruments, for which it is not possible to properly assess market risk with the use of the VaR model (non-linear risk, commodity risk and specific risk), the appropriate assessment rules were defined. The non-linear risk is measured according to internally developed methodology which is in line with the VaR methodology – the same time horizon and significant level is used. Specific and commodities’ risks are measured through standard approach defined in supervisory regulations, with a corresponding change of the time horizon considered.

The market risk measurement is carried out daily (intra-day and end-of-day), both on an individual basis for each of the areas responsible for risk taking and risk management, and also in consolidated terms for Global Bank, Trading and Banking Book considering the effect of the diversification that exists between the particular portfolios. In addition, each Book is divided into the risk management areas.

To ensure that the VaR model adopted is appropriate for the evaluation of the risks involved in the open positions, a back-testing process has been instituted and is carried out daily.

All reported excesses are documented. This includes an explanation of their causes and their incorporation in one of the three classes of excess explanation: adequacy of the model, insufficient model accuracy or unanticipated market movements.

Parallel to the VaR calculation the portfolios are subject to a set of sensitivity analysis and stress scenarios, in order to:

  • Estimate the potential economic loss resulting from extreme variations in market risk factors,
  • Identify the market risk movements, possibly not captured by VaR, to which the portfolios are more sensitive,
  • Identify the actions that can be taken to reduce the impact of extreme variations in the risk factors.

The following types of market scenarios are being applied:

  • Parallel shifts of the yield curves;
  • More steep or flat shape of the yield curves;
  • Variations of the exchange rates;
  • Historical adverse scenarios;
  • Customized scenarios based on observed, adverse changes of market risk parameters.

 

The global VaR limit is expressed as a fraction of the consolidated Own Funds and then limit is divided into the books, risk management areas and various types of risk, which enables the Group for full measurement, monitoring and control of market risk. The market risk exposure (VaR) together with the limit utilization is reported daily to all areas responsible for management and control of market risk in the Group.

The market risk limits are revised at least once a year and in order to take into account, inter alia, the change of the consolidated Own Funds, current and projected balance sheet structure as well as the market environment. The current limits in place have been valid since 1st January 2020 and the nominal levels were confirmed to be valid also in 2021 by the annual revision carried out and approved by the Risk Committee in December 2020.

Within the current market environment, the Group continued to act very prudently. The strong market volatility in connection with the global COVID-19 pandemic resulted in increase of the Group’s market and interest rate risk.

In 2020, the VaR for the Group that is jointly Trading Book and Banking Book, increased due to market volatility caused by the COVID-19 pandemic but still were below maximum limits in place. In 2020 the VaR indicators for the Group remained on average at the level of PLN 72.5 million (29% of the limit) and PLN 96.9 million (39% of the limit) as of the end of December 2020. The low level of diversification effect is connected with the fact that the Group’s market risk is mainly the interest rate risk. The figures in the Table below include also the exposures to market risk generated in subordinated companies, as the Bank manages market risk at central level. The diversification effect applies to the generic risk and reflects correlation between its constituents.

The market risk in terms of VaR for the Group (‘000 PLN):

VaR measures for market risk (‘000 PLN) VaR (2020)
31.12.2019 Average Maximum Minimum 31.12.2020
Total risk 33 225 72 530 130 866 30 776 96 894
Generic risk 31 039 70 533 128 701 28 593 95 256
Interest Rate Risk 31 038 70 537 128 744 28 588 95 227
FX Risk 12 133 1 522 15 190
Diversification Effect 0.0% 0.2%
Specific risk 2 186 0 0 0 1 638

The corresponding exposures as of 2019 respectively amounted to (‘000 PLN):

VaR measures for market risk (‘000 PLN) VaR (2019)
31.12.2018 Average Maximum Minimum 31.12.2019
Total risk 29 098 27 259 34 247 18 513 33 225
Generic risk 27 337 25 324 31 925 16 646 31 039
Interest Rate Risk 27 349 25 322 31 923 16 648 31 038
FX Risk 78 76 607 7 12
Diversification Effect 0.3% 0.0%
Specific risk 1 761 1 935 2 767 1 591 2 186

The market risk exposure divided into Trading Book and Banking Book together with risk type division is presented in the table below (‘000 PLN):

Banking Book:

VaR measures for market risk (‘000 PLN) VaR (2020)
31.12.2019 Average Maximum Minimum 31.12.2020
Total risk 31 263 71 467 132 279 29 842 95 897
Generic risk 29 080 69 472 130 116 27 659 94 261
Interest Rate Risk 29 080 69 472 130 116 27 659 94 261
FX Risk 0 0 0 0 0
Diversification Effect 0.0% 0.0%
Specific risk 2 184 0 0 0 1 636

VaR measures for market risk (‘000 PLN) VaR (2019)
31.12.2018 Average Maximum Minimum 31.12.2019
Total risk 28 825 26 338 33 616 18 160 31 263
Generic risk 27 067 24 434 31 749 16 463 29 080
Interest Rate Risk 27 067 24 434 31 749 16 463 29 080
FX Risk 0 0 0 0 0
Diversification Effect 0,0% 0,0%
Specific risk 1 758 1 903 2 375 1 588 2 184

Trading Book:

VaR measures for market risk (‘000 PLN) VaR (2020)
31.12.2019 Average Maximum Minimum 31.12.2020
Total risk 2 455 2 514 6 162 762 1 239
Generic risk 2 452 2 511 6 160 759 1 237
Interest Rate Risk 2 451 2 497 6 118 758 1 190
FX Risk 11 132 1 524 11 183
Diversification Effect 0.4% 11.0%
Ryzyko szczególne 2 0 6 0 2

VaR measures for market risk (‘000 PLN) VaR (2019)
31.12.2018 Average Maximum Minimum 31.12.2019
Total risk 478 1 785 5 464 446 2 455
Generic risk 475 1 754 5 461 443 2 452
Interest Rate Risk 470 1 746 5 435 359 2 451
FX Risk 81 77 620 7 11
Diversification Effect 16.0% 0.4%
Ryzyko szczególne 3 31 1 070 2 2

In 2020, risk limits in terms of VaR were not breached – neither for the whole Group nor for the Banking Book and Trading Book, separately.

All eventual excesses of market risk limits are always reported, documented and ratified at the proper competence level.

Open positions mostly included interest-rate instruments and FX risk instruments. The FX risk covers all the foreign exchange exposures of the Group. According to the Risk Strategy approved in the Group, the FX open position is allowed, however should be kept at low levels. For this purpose, the Group has introduced a system of conservative limits for FX open positions (both Intraday and Overnight limits) and allows keeping FX open positions only in Trading Book.

In 2020, FX position generated in the Banking Book was fully transferred to the Trading Book where it was managed on a daily basis. During 2020 the FX open position remained on average at the level of PLN 7.6 million (8.5% of the limit) with maximum of PLN 37.6 million (44.1% of the limit). In 2020, the FX Total open position (Intraday as well as Overnight) remained below 2% of Own Funds and well below the maximum limits in place.

Evolution of the total FX open position (Overnight) in Trading Portfolio (PLN thousand):

Total position Period Average Period Minimum Period Maximum The Last Day of Period
2020 7 590 2 353 37 584 4 954
2019 7 557 1 760 38 983 7 181

In addition to above mentioned market risk limits, the stop loss limits are introduced for the financial markets portfolios. The aim is to limit the maximum losses of the trading activity of the Group. In case the limit is reached, a review of the management strategy and assumptions for the positions in question must be undertaken.

In the back-testing calculation for VaR model in Global Bank, nine excesses were detected during the last twelve months (see table below, PLN thousand).

Reporting Date VaR
(generic risk)
Theoretical change in the value of the portfolio
(absolute values)
Number of excesses
in last 12 months *
2020-12-31 94 903 44 353 9
2019-12-31 31 039 3 324 5
* The excess is said to happen whenever the difference between the absolute change in portfolio value and VaR measure is positive.

In 2020, all excesses in the process of VaR model back testing were caused by unanticipated market movements caused by the COVID-19 pandemic uncertainty, of which strong changes in Polish government bonds yields and short term interest rates in March 2020 had the most impact on VaR model performance. In consequences, due to the number of excesses detected, the assessment of VaR model performance felt into yellow zone: 9 – 14 excesses acceptable. It forced immediate action in VaR calculations, including model parameters calibration to most recent market observation and temporary volatility method changed from equal weights to EWMA method, which is better suited during periods of significant upsurge in price volatility. It allowed stopping further excesses in VaR back testing. Due to one year monitoring period, higher number of excesses will be present for foreseeable future (yellow zone is expected at least in 1Q 2021 reporting).

VaR assessment is supplemented by monitoring the market rate sensitivity to the above-mentioned stress tests scenarios of portfolios carrying market risk.

The results of market risk sensitivity and customized stress tests were regularly reported to the Capital, Assets and Liabilities Committee. After a series of interest rate cuts in Poland, the thresholds for market risk exposure under customized stress scenarios were temporary exceeded, in particular under stress test scenario that assumes strong Polish government bonds yield increase (2-years by more than 222 bps). In the low interest rate environment in Poland, the probability of scenario occurrence was assessed as very low. The Capital, Assets and Liabilities Committee has approved the breach and carried out revision of customized scenarios. In December 2020, the market stress tests scenarios were adjusted to the most recent changes of the market risk parameters. It allowed adopting new set of market risk stress scenarios that are severe but still possible to occur. Results under revised scenarios are again kept under defined boundaries

In case of the Banking Book, the main component of the market risk is interest rate risk.

Exposure to interest rate risk in the Banking Book are primarily generated by the unbalance between assets and liabilities (including equity) that have fixed rate (or zero rate) and also, to a lower extent, by the different repricing dates of assets and liabilities as well as its reference indexes, if contractually existing. Additionally, due to specificity of the polish legal system, the interest rate of consumer credits is limited (it cannot exceed two times Reference Rate of the National Bank of Poland increased by 7 percentage points). In situations of decreasing interest rates, the impact on Net Interest Income is negative and depends on the share of the loan portfolio that is affected by the new maximum rate.

The results of COVID-19 pandemic and its negative impact on the economic environment, as well as the reductions of the reference rates by the Monetary Policy Council at its meetings on 17th March 2020, 8th April 2020 and 28thMay 2020 had a negative impact on the activity and financial results of the Group. Before above mentioned three interest rate cuts, the NBP Reference rate was set at 1.5%, so that the maximum interest rate for loan portfolio could not exceed 10% annually. On March the maximum interest rate dropped immediately to 9%, in April to 8% and then in May to 7.2%.

Regarding the interest rate risk in Banking Book, the following principles are in place:

  • The market risk that results from the commercial banking activity is hedged or transferred on the monthly basis to areas that actively manage market risk and that are measured in terms of risk and profit and loss,
  • The Bank primarily uses natural hedging between loans and deposits as well as fixed rate bonds and derivatives to manage interest rate risk with the main purpose of protecting the net interest income.

The variations in market interest rate have an influence on the Group’s net interest income, both under a short and medium-term perspective, affecting also its economic value in the long term. The measurement of both is complementary in understanding the complete scope of interest rate risk in Banking Book.

For this reason, apart from daily market risk measurement in terms of value at risk, the scope of the additional measurement of interest rate risk covers both earnings-based and economic value measures, which are quarterly:

  • the impact on the economic value of equity (EVE) resulting from different shocks with upward/downward yield curve movements, including scenarios defined by the supervisor (standard, supervisory test assuming sudden parallel +/-200 basis points shift of the yield curve as well as supervisory outlier test, SOT with set of six interest rate risk stress scenarios).

and monthly:

  • the interest rate sensitivity in terms of BPVx100, that is the change of the portfolio’s value for the parallel movement in the yield curve by 1 basis point multiplied by 100,
  • the impact on net interest income over a time horizon of next 12 months resulting from one-off interest rate shock of 100 basis points.

The interest rate risk measurement is carried for all the risk management areas in the Bank, with the particular attention on Banking Book.

For the purpose of  interest rate risk management for non-maturing assets and liabilities or for the instruments with Client’s option embedded, the Group is defining specific assumptions recently revised in December 2020, including:

  • Due date for balances and interest flows arising from non-maturing deposits are defined on the basis of historical data regarding customer behaviour, taking into account the stability of the volumes and with assumption of a maximum maturity of 3 years,
  • The tendency to faster repayment of receivables than contractually scheduled is taken under consideration by calculating a prepayment rate in respect to all relevant Banks’ loan portfolios on the basis of historical data. It should be noted, that mortgage loans that are the Group’s loan product with a dominant share, are indexed to floating interest rate. This causes that the tendency to early repayment is less important for the interest rate risk.
  • The equity, fixed and other assets that are assumed to have repricing period of 1 year. However to understand the impact of the chosen maturity profile the IRRBB measurement is carried out without inclusion of the equity capital to isolate the effects on both EVE and earnings perspectives.

The results of the above mentioned analysis for BPVx100 and economic value measures in 2020 did not exceed neither supervisory nor internally defined limits. The supervisory stress tests results of December 2020 show that even under the most severe outlier test scenario, the decline of EVE for Banking Book is far below supervisory limit of 15% of Tier 1. Similarly, decline of EVE under standard scenario of sudden parallel +/-200 basis points shift of the yield curve also stayed far below supervisory maximum of 20% of Own Funds.

The results of the sensitivity of the Banking Book to changes of interest rates in terms of BPVx100 as well as EVE are presented in Table below (PLN thousand).

Sensitivity of the Banking Book to changes of interest rates was as follows (‘000 PLN):

31.12.2020 31.12.2019
BPVx100 BPVx100
PLN (24 537) (157 480)
CHF 16 864 11 099
EUR 97 308 44 677
USD 29 892 14 256
Other 4 946 3 359
TOTAL 124 471 (84 089)
Equity, fixed and other assets 77 253 73 352
TOTAL 201 725 (10 738)

Sensitivity of EVE to changes of interest rates (*) 31.12.2020 31.12.2019
Standard, supervisory test (parallel yield curve +/-200 b.p. % Own Funds) (0.28%) (2.36%)
Supervisory outlier test (the most severe scenario, % CET1) (1.94%) (3.71%)
(*)The principles listed in section 115 of the EBA IRRBB Guidelines were applied to calculate the change in EVE. The most severe decline of EVE is presented.

The above-mentioned decisions of the Monetary Policy Council to reduce interest rates to its historical minimum (decrease reference rate to 0.10% and the Lombard rate to 0,50%) as well as the decision regarding change in the parameters of the obligatory requirement, had altogether a significant negative impact on the Group’s net interest income. The cumulative decrease in net interest income for 2020 compared to the annualized level of 4Q 2019 amounted to a total of PLN 223 million or 8%. Mainly due to the quick remedial actions taken by the Bank, the negative impact was eventually smaller than already disclosed estimates published on the Current Report published on 14th April and 2nd June 2020 (PLN 240 million to PLN 285 million) but nonetheless it resulted, ceteris paribus, in lower NII than would otherwise have been achieved.

In such a low interest rate environment in Poland, the results of sensitivity of NII for the next 12 months after 31st December 2020 and for position in Polish Zloty in Banking Book in a scenario of further decrease of interest rates by 100 bps, is negative and equal to -16.7% of the annualized 4Q 2020 net interest income (+9.9% for a 100 bps increase). The asymmetrical impact is connected mainly with the specificity of the polish legal system mentioned above with simultaneous limitation on further decrease on deposits side (minimum interest rate set at 0%).The NBP Reference rate is currently set at 0.10%, so that in case of decrease by 100 bps the maximum interest rate for loan portfolio could not exceed 5.2% annually in comparison to currently valid 7.2%. In order to limit negative impact on NII sensitivity in case of further interest rate decrease, the interest rate swaps were concluded in 4Q 2020.

Sensitivity of NII for PLN to changes of interest rates 31.12.2020 31.12.2019
Parallel yield curve increase by 100 b.p. +9.9% +1.2%
Parallel yield curve decrease by 100 b.p. (16.7%) (3.4%)

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