Capital management

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) 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, considering 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 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 banks by KNF every year because 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 the end of 20210 in the level of 2.82 pp (Bank) and 2.79 pp (Group) as for Total Capital Ratio (TCR), which corresponds to capital requirements over Tier 1 ratio of 2.11 pp in Bank and of 2.09 pp in Group, and which corresponds to capital requirements over CET 1 ratio of 1.58 pp in Bank and 1.56 pp in Group*;
• Combined buffer – defined in Act on macro prudential 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 year**;
  • Systemic risk buffer at the level of 0% in force from March 2020, in line with Regulation of Ministry of Development and Finance;
  • 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 capital ratios.

The below table presents these levels as of 31 December 2021. The Bank will inform on each change of required capital levels in accordance with regulations.

* That recommendation replaces the previous one from 2020, to maintain own funds for the coverage of additional capital requirements at the level of 3.41 pp (Bank) and 3.35 pp (Group) as for TCR, which should have consisted of at least 2.56 pp (Bank) and 2.52 pp (Group) as for Tier 1 capital and which should have consisted of at least 1.91 pp (Bank) and 1.88 pp (Group) as for CET1 capital

** In November 2020 KNF issued the decision on identification the Bank as other systemically important institution and imposing OSII Buffer

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 each 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 Group received another decision by Competent 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 Group received the decision of Competent Authorities (ECB cooperating with KNF) on approval the material changes to IRB LGD models and revoking the “Regulatory floor”.

Since 2018, the 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 Competent Authorities, the Group in 2020 successfully implemented solutions for the new definition of default in the production environment. The Group is obliged to include an additional conservative charge on the estimates of the RWA value for exposures classified under the IRB approach. The level of this add-on, calculated based on the supervisory algorithm, was set at 5% above the value resulting from the IRB method.

In 2021, all credit risk models included in the rating system subject to the current regulatory approval were recalibrated and rebuilt. In 2021 the Group also obtained a decision from Competent Authorities to approve significant changes to the IRB models used (LGD, LGD in-default and ELBE) for rating systems subject to the IRB approval.

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, considering 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 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 2021, 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 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*

*Group uses transitional arrangements for IFRS 9 and considers a temporary treatment of unrealized gains and losses on bonds measured by fair value through other comprehensive income (FVOCI) in accordance with Art. 468 of the CRR. As at 31.12.2021, if IFRS 9 transitional arrangements and temporary treatment according to Art. 468 of the CRR had not been applied, capital ratios were as follows:

• TCR: 15.84%
• T1: 12.74%
• CET1: 12.74%
• Leverage ratio: 5.90%

As at 2021 end, capital adequacy, measured by Common Equity Tier 1 Capital ratio and Total Capital Ratio, decreased in one year period by ca 2.53 pp and by ca 2.43 pp respectively.

In 2021, risk-weighted assets (RWA) went down by ca PLN 1.7 billion (by 3.3%). The biggest yearly change was credit risk RWA (fall by ca PLN 2.5 billion, by 5.4%). The second material driver was an operational risk RWA rise (by ca PLN 0.6 billion), what stems from including in calculation higher financial results from the last three years. Changes of market risk and CVA (credit valuation adjustment) RWA were not material.

In 2021 Own Funds fell by ca PLN 1.5 billion (by 15.4%), mainly because of net financial loss caused by legal risk provisions.

Minimum capital levels required by KNF were achieved with a safe surplus.

Leverage ratio stood at the safe level of 6.46%, and it significantly exceeds the regulatory minimum (3%).

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

In November 2021, the Group received a joint decision of the Single Resolution Board (SRB) and the Bank Guarantee Fund, obliging the Group to meet the minimum requirements for own funds and eligible liabilities (MREL). Pursuant to this decision, the Group is required to meet the minimum MREL_trea requirement of 21.41% and the MREL_tem requirement of 5.91% by December 31, 2023. The decision also sets out a gradual path towards reaching the minimum requirements. Their level will be updated annually.

In connection with the above decision, in January 2022, the Supervisory Board of the Bank approved the Eurobond Issue Program with a total nominal value of no more than EUR 3 billion.