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 market movement (prices).
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 main measure used by the Group to evaluate market risks 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) with a required probability (confidence level) due to an adverse market movement. The market risk measurement is carried out daily, 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, Banking Book and Trading Book considering the effect of the diversification that exists between the particular portfolios.
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, open positions included just interest-rate instruments and FX risk instruments. 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 PLN72.5 million (29% of the limit) and PLN96.9 million (39% of the limit) as of the end of December 2020. FX open position (Intraday as well as Overnight) remained below 2% of Own Funds and well below the maximum limits in place.
In 2020, the total market risk exposure in terms of VaR as well as FX open position was kept within limits in place (no excesses were detected).
All eventual excesses of market risk limits are reported, documented and ratified at the proper competence level.
Apart from daily measurement at the level of each book and market risk area, the VaR model is mainly applicable and analysed at the Trading Book level, where the policy intention is to trade positions on the regular basis (mostly daily). On contrary, following the supervisory guidelines, the interest rate risk in Banking Book is additionally covered by both earnings-based and economic value measures, in particular by measuring:
- the impact on the net interest income over a time horizon of next 12 months resulting from one-off interest rate shock of upward/downward yield curve shift by 100 basis points,
- the impact on the economic value of equity (EVE) resulting from different upward/downward basis points shocks, including scenarios defined by the supervisor (standard, supervisory test assuming sudden parallel +/-200 basis points shift of the yield curve as well supervisory outlier test – SOT with set of six interest rate risk stress scenarios).
The supervisory stress tests results as at 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 impact of interest rate change on Net Interest Income is asymmetrical and it is negative in case of decreasing interest rates. This is due to the Polish legal system and the fact that the interest rate of consumer loans and credit cards is limited (it cannot exceed twice Reference Rate of the National Bank of Poland increased by 7 percentage points). The strength of impact on net interest income in face of decrease of the interest rate depends, among other factors, on the percentage 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, 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%.
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 4Q19 amounted to a total of PLN223 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 Reports published on 14th April and 2nd June 2020 (PLN240 million to PLN285 million) but nonetheless, ceteris paribus, it resulted 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 100bps, is negative and equal to -16.7% of the annualized 4Q 2020 net interest income (+9.9% for a 100bps 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 100bps 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.
The impact on net interest income in the next 12 months after 31st December 2020 (based on annualized 4Q 2020 net interest income), in a scenario of immediate parallel yield curve decrease for position in Banking Book in Polish Zloty, is the following:
|Sensitivity of NII for PLN interest rate change||31.12.2020||31.12.2019|
|parallel yield curve increase by 100bp||+9.9%||+1.2%|
|parallel yield curve decrease by 100bp||-16.7%||-3.4%|
More information on market risk and interest rate risk management can be found in chapter 9.4 of the Annual Consolidated Report of the Bank Millennium S.A. Capital Group for the 12-month period ending 31st December 2020.