7.5.3. Market risk
Market risk means the risk of loss or of adverse change in the financial situation resulting, directly or indirectly, from fluctuations in the level and in the volatility of market prices of assets, credit spread, value of liabilities and financial instruments.
Market risk types in the PZU Group include:
Concentration risk and credit spread risk are regarded as an integral part of market risk when measuring risk for the purposes of risk profile, risk tolerance, and market risk ratio reporting. The risk management process has, however, a different set of traits from the process of managing the other sub-categories of market risk and has been described in section 220.127.116.11 along with the process for managing counterparty insolvency risk.
The market risk in the PZU Group originates from three major sources:
A number of documents approved by supervisory boards, management boards and dedicated committees govern investment activity in the PZU Group’s companies.
Risk units take part in the risk identification process, measure, monitor and report on the risks. Market risk is measured using the model of calculating economic capital of market risk based on the value at risk method (VaR) or the standard formula in accordance with the principles defined by the Solvency II Directive. In order to effectively manage market risk, risk limits are adopted in a form of a capital amount allocated to each market risk and limits for individual market risk factors.
In Pekao, the market risk management system forms the structural, organizational and methodological framework, which aims to maintain the balance sheet and off-balance sheet structure in line with the accepted strategic objectives. The market risk management process and the governing procedures include the separation into the banking and trading books.
In managing its trading book’s market risk, Pekao strives to optimize the financial performance and ensure the highest possible quality of service of the bank’s clients in respect to market-making, while remaining within the limits approved by the management board and the supervisory board.
When managing interest rate risk in its banking book, Pekao endeavors to secure the economic value of equity and to achieve its intended net interest income target within the accepted limits.
In Alior Bank, the exposure to market and liquidity risk is restricted by the system of periodically updated limits introduced by the resolution of the supervisory board or the management board that include all risk measures. In Alior Bank, there are three types of limits that differ in respect to their functioning - basic, supplementary and stress-test limits. Market risk management focuses on limiting potential adverse changes in economic value of equity and optimizing the financial result.
Exposure to market risk
|Carrying amount as at 31 December 2018||Note||Assets at Group’s risk||Assets at the client’s risk||Total|
|Including banks’ assets|
|Financial assets and cash exposed to interest rate risk||295,402||252,859||1,303||296,705|
|Fixed-income debt securities||35||52,534||24,169||1,134||53,668|
|Variable-income debt securities||35||31,298||28,333||77||31,375|
|Loan receivables from clients||33||182,054||182,054||-||182,054|
|Term deposits with credit institutions||35||2,679||976||90||2,769|
|Financial assets exposed to other price risk||2,347||816||4,209||6,556|
|Carrying amount as at 31 December 2017 (restated)||Note||Assets at Group’s risk||Assets at the client’s risk||Total|
|Including banks’ assets|
|Financial assets and cash exposed to interest rate risk||280,829||243,736||1,384||282,213|
|Fixed-income debt securities||35||66,973||39,278||1,270||68,243|
|Variable-income debt securities||35||28,128||25,449||23||28,151|
|Loan receivables from clients||33||169,457||169,457||-||169,457|
|Term deposits with credit institutions||35||1,751||851||90||1,841|
|Financial assets exposed to other price risk||3,377||898||4,503||7,880|
The following table presents financial assets of banks and at client’s risk, by the item in which they are classified in the consolidated financial statements:
|Financial assets of banks and financial assets at client’s risk||Note||31 December 2018||31 December 2017 (restated)|
|Pekao and Alior Bank||Financial assets at client’s risk||Pekao and Alior Bank||Financial assets at client’s risk|
|Loan receivables from clients||33||182,054||-||169,457||-|
|Investment financial assets||53,992||5,482||66,494||5,886|
|Measured at amortized cost||18,569||90||n/a||n/a|
|Quoted on a regulated market||738||-||n/a||n/a|
|Not quoted on a regulated market||5,302||-||n/a||n/a|
|Term deposits with credit institutions||976||90||n/a||n/a|
|Measured at fair value through other comprehensive income||34,546||-||n/a||n/a|
|Quoted on a regulated market||44||-||n/a||n/a|
|Not quoted on a regulated market||212||-||n/a||n/a|
|Quoted on a regulated market||4,121||-||n/a||n/a|
|Not quoted on a regulated market||7,660||-||n/a||n/a|
|Measured at fair value through profit or loss||877||5,392||n/a||n/a|
|Quoted on a regulated market||68||358||n/a||n/a|
|Not quoted on a regulated market||27||-||n/a||n/a|
|Participation units and investment certificates||5||3,823||n/a||n/a|
|Quoted on a regulated market||5||61||n/a||n/a|
|Not quoted on a regulated market||-||3,762||n/a||n/a|
|Quoted on a regulated market||9||-||n/a||n/a|
|Not quoted on a regulated market||125||-||n/a||n/a|
|Financial instruments held to maturity||n/a||n/a||4,839||-|
|Not quoted on a regulated market||n/a||n/a||31||-|
|Financial instruments available for sale||n/a||n/a||45,772||-|
|Quoted on a regulated market||n/a||n/a||117||-|
|Not quoted on a regulated market||n/a||n/a||241||-|
|Quoted on a regulated market||n/a||n/a||652||-|
|Not quoted on a regulated market||n/a||n/a||13,278||-|
|Financial instruments measured at fair value through profit or loss – classified as such upon first recognition||n/a||n/a||-||68|
|Quoted on a regulated market||n/a||n/a||-||61|
|Not quoted on a regulated market||n/a||n/a||-||4|
|Financial instruments measured at fair value through profit or loss – held for trading||n/a||n/a||1,817||5,728|
|Quoted on a regulated market||n/a||n/a||5||383|
|Not quoted on a regulated market||n/a||n/a||-||4,055|
|Not quoted on a regulated market||n/a||n/a||80||23|
|Quoted on a regulated market||n/a||n/a||977||-|
|Not quoted on a regulated market||n/a||n/a||11,685||-|
|Term deposits with credit institutions||n/a||n/a||851||90|
|Total financial assets of banks and financial assets at client’s risk||253,675||5,512||244,634||5,887|
In its investing activities, the PZU Group uses derivatives as a tool to mitigate risk (with or without hedge accounting) and to facilitate efficient management of the investment portfolio.
The PZU Group’s exposure to derivatives is presented in section 34.
Exposure to debt securities issued by governments other than the Polish government
|Carrying amount of debt securities issued by governments other than the Polish government||31 December 2018||31 December 2017|
|Other||749 1)||1,316 2)|
1) The Other line item states the countries with respect to which the balance sheet exposure does not exceed the equivalent of PLN 50 million: Albania, Armen ia, Australia, Azerbaijan, Belarus, Belgium, Bolivia, Cameroon, Chile, Columbia, Costa Rica, Denmark, Dominican Republic, Egypt, Ethiopia, France, Germany, Ghana, Guatemala, Honduras, India, Italy, Ivory Coast (Côte d’Ivoire), Jamaica, Jordan, Kazakhstan, Kenya, Morocco, Mexico, Mongolia, Namibia, the Netherlands, Nigeria, Oman, Panama, Paraguay, Peru, Philippines, South Africa, Senegal, Serbia, Slovenia, Sri Lanka, Sweden, Trinidad and Tobago, United Kingdom, Uruguay, Vietnam.
2) The Other line item shows: Azerbaijan, Chile, Dominican Republic, Ecuador, Philippines, Guatemala, Jamaica, Jordan, Kazakhstan, Kenya, Columbia, Costa Rica, Morocco, Mexico, Germany, Nigeria, Oman, Pakistan, Panama, Paraguay, Peru, South Africa, Senegal, Serbia, Slovakia, Slovenia, Sri Lanka, Trinidad and Tobago, Uruguay, United Kingdom, Italy, Ivory Coast, Zambia.
Exposure to debt securities issued by corporations and local government units
|Carrying amount of debt securities issued by corporations and local government units||31 December 2018||31 December 2017|
|Domestic local governments||5,710||6,092|
|National Bank of Poland||2,999||13,097|
|Transportation and storage||1,232||1,904|
|Companies from the WIG-Energy Index||1,183||1,886|
|Public utility services||759||611|
|Companies from the WIG-Fuels Index||748||666|
|Companies from the WIG-Banks Index||452||563|
|Companies from the energy and fuel sector||312||447|
|Mining and quarrying (including companies included in the WIG-Mining index)||130||644|
18.104.22.168. Interest rate Interest rate
The following table presents the sensitivity test of the portfolio of financial instruments for which the PZU Group bears the risk (except for loan receivables from clients and deposit liabilities).
|Change in portfolio value caused by a +/-100 bp shift in the yield curve, by currency of the instrument||31 December 2018||31 December 2017|
The above sensitivity tests do not include the effects of changes in interest rates for technical provisions and liabilities under investment contracts. An analysis of effect of a change in technical rate on measurement of insurance contracts is presented in sections 22.214.171.124 and 126.96.36.199.
Interest rate risk in Pekao
The VaR model is the main tool for measuring interest rate risk of the trading book. This value reflects the level of ten-day loss that may be exceeded with a probability of no more than 1%. VaR is determined through historical simulation, based on a 2-year history of observation of the evolution of risk factors. The set of factors taken into account in the calculation of VaR includes all the relevant market factors that are taken into account in the valuation of financial instruments. The impact of changes in market factors on the current portfolio value is estimated using full revaluation (as a difference between the value of the portfolio after the change in market parameters, by the historically observed changes in those factors, and the present value of the portfolio). In the event of specific credit risk of an issuer, a simplified approach is applied based on an estimated variability of CDS benchmark index. For such a set of probable changes in the portfolio's value (distribution function), VaR is determined as the 1% quantile.
The following table presents VaR for the interest rate risk in Pekao’s trading book.
|31 December 2018||for January-December 2018||31 December 2017||for January-December 2017|
|Trading book – VaR interest rate risk (in thous. PLN)||3,650||1,492||3,425||5,481||2,501||1,568||3,203||6,087|
When managing interest rate risk in its banking book, Pekao endeavors to secure the economic value of equity and to achieve its intended net interest income target within the accepted limits. The financial position in view of the changing interest rates is monitored by using interest rate gap (revaluation gap), duration analysis, sensitivity analysis, stress testing and VaR.
The table below presents the contractual level of sensitivity of net interest income (NII) to a 100 bp decline in interest rates and sensitivity of Pekao’s economic value of equity (EVE) to a 200 bps decline in interest rates. EVE is defined as the present value of future cash flows that will be generated by the entity’s assets, less the present value of the future cash flows necessary to pay the entity’s liabilities. Both analyses assume an immediate change in market rates. The interest rate on bank products changes according to the contractual provisions, whereas in the case of contractual NII, for deposits from retail customers, the declines in interest rates are limited to the zero interest rate level, but not down to negative figures. In the case of EVE sensitivity for PLN- denominated current deposits, a model that ensures realistic revaluation is used.
|Sensitivity in %||31 December 2018||31 December 2017|
Interest rate risk in Alior Bank
The interest rate risk related to Alior Bank’s open positions is linked, first of all, to:
One of the method of estimating exposure to interest rate risk is to calculate BPV, which provides information on the estimated change in the valuation of a transaction/item after a parallel shift in the yield curve by 1 basis point.
BPV estimation for Alior Bank (data in PLN thousand)
|Currency||31 December 2018||31 December 2017|
|Up to 6 months||6 months to 1 year||1 year - 3 years||3-5 years||5 to 10 years||Total||Up to 6 months||6 months to 1 year||1 year - 3 years||3-5 years||5 to 10 years||Total|
For the interest rate risk management purposes, Alior Bank distinguishes trading activity involving securities and derivatives concluded for trading purposes and banking activity involving other securities, own issues, loans, deposits, credits and derivative transactions used to hedge the risk of the banking book. Alior Bank uses the Value at Risk (VaR) model to estimate the level of interest rate risk. The following table presents the economic capital to cover interest rate risk measured using this method at the end of 2018 and 2017 (99% VaR with a 10-day horizon).
|Book||for January-December 2018||for January-December 2017|
Alior Bank conducts scenario analysis that includes, among others, the impact of changes in interest rates on the future net interest income and economic value of equity. Within these scenarios internal limits are maintained, whose utilization is measured daily. Utilization of the limit of change in economic value of equity after a parallel shift of the percentage curve by +/- 200 bps and non-parallel shifts in the +/- 100/400 bps scenarios (for 1M/10Y tenors, the shift between them follows a linear interpolation) is presented in the following table:
|(1M/10Y) scenario||Change in the economic value of equity|
|31 December 2018||31 December 2017|
|+400 / +100||385||189|
|+100 / -400||307||68|
|+200 / +200||281||103|
|- 200 / - 200||(204)||(85)|
|- 100 / - 400||(204)||(43)|
|- 400 / - 100||(219)||(95)|
Exposure to FX risk
|Assets by currency||31 December 2018|
|Loan receivables from clients||153,035||23,458||1,903||3,658 1)||182,054|
|Investment financial assets||88,455||7,796||5,174||240||101,665|
|Measured at amortized cost||42,162||2,580||333||159||45,234|
|Term deposits with credit institutions||1,286||1,250||150||83||2,769|
|Measured at fair value through other comprehensive income||30,788||3,674||4,272||3||38,737|
|Measured at fair value through profit or loss||15,505||1,542||569||78||17,694|
|Participation units and investment certificates||3,556||550||178||14||4,298|
|Cash and cash equivalents||11,741||3,815||778||721 2)||17,055|
1) Of which PLN 2,999 million in Swiss francs and PLN 409 million in British pounds.
2) Of which PLN 261 million in British pounds, PLN 157 million in Swiss francs, PLN 69 million in Swedish kronor, PLN 67 million in Norwegian kroner and PLN 52 million in Danish kroner.
|Assets by currency||31 December 2017 (restated)|
|Loan receivables from clients||143,417||19,602||2,603||3,835 1)||169,457|
|Investment financial assets||99,690||6,080||3,912||364||110,046|
|Held to maturity||20,724||464||13||36||21,237|
|Debt securities – government||20,589||368||13||36||21,006|
|Debt securities – other||135||96||-||-||231|
|Available for sale||43,731||3,058||1,725||5||48,519|
|Measured at fair value – classified as such upon first recognition||5,967||324||252||107||6,650|
|Held for trading||10,904||982||1,608||99||13,593|
|- buy-sell-back transactions||885||-||-||-||885|
|- term deposits with credit institutions||1,606||58||61||116||1,841|
|Cash and cash equivalents||4,877||1,959||492||911 2)||8,239|
1) Of which PLN 3,152 million in Swiss francs and PLN 121 million in Norwegian kroner.
2) Of which PLN 289 million in Czech korunas, PLN 193 million in British pounds, PLN 108 million in Swiss francs, PLN 83 million in Norwegian kroner and PLN 55 million in Swedish kronor.
|Liabilities by currency||31 December 2018||31 December 2017 (restated)|
|Financial liabilities measured at fair value||3,445||374||157||41||4,017||4,199||385||223||149||4,956|
|Derivatives held for trading||1,982||277||150||41||2,450||2,038||285||134||149||2,606|
|Cash flow hedge derivatives||768||3||-||-||771||682||-||-||682|
|Fair value hedge derivatives||43||94||7||-||144||75||100||11||186|
|Liabilities on borrowed securities (short sale)||120||-||-||-||120||672||-||78||750|
|Investment contracts for the client’s account and risk (unit- linked)||266||-||-||-||266||312||-||-||312|
|Liabilities to members of consolidated mutual funds||266||-||-||-||266||420||-||-||420|
|Financial liabilities measured at amortized cost||188,918||28,534||11,528||3,319||232,299||177,591||27,346||10,790||3,867||219,594|
|Liabilities to banks||2,234||3,474||60||276 1)||6,044||2,067||2,559||95||602 3)||5,323|
|Liabilities to clients under deposits||172,162||20,962||11,468||3,043 2)||207,635||163,350||20,853||10,695||3,265 4)||198,163|
|Liabilities on the issue of own debt securities||7,998||4,011||-||-||12,009||5,761||3,849||-||9,610|
|Liabilities on account of repurchase transactions||540||-||-||-||540||1,167||-||-||1,167|
|Investment contracts with guaranteed and fixed terms and conditions||-||-||-||-||-||1||-||-||1|
|Finance lease liabilities||10||-||-||-||10||11||-||-||11|
|Total liabilities by currency||199,017||29,419||11,792||3,495||243,723||189,468||28,685||11,270||4,223||233,646|
1) Of which PLN 226 million in Swiss francs.
2) Of which PLN 1,627 million in British pounds, PLN 584 million in Swiss francs, PLN 174 million in Norwegian kroner, PLN 112 million in Swedish kronor, PLN 89 million in Canadian dollars and PLN 81 million in Czech korunas.
3) Of which PLN 591 million in Swiss francs.
4) Of which PLN 597 million in Czech korunas, PLN 534 million in Swiss francs, PLN 153 million in Norwegian kroner and PLN 129 million in Swedish kronor.
To manage its FX risk, the PZU Group uses also derivatives which allows it to take a selected market exposure in a more efficient manner than by using cash instruments.
The following table presents the sensitivity test of the portfolio of PZU Group’s financial instruments (except for loan receivables from clients and deposit liabilities) in respect to financial instruments for which the PZU Group bears the risk.
Financial assets exposed to exchange risk include investment (deposit) financial assets of the PZU Group and derivative financial assets denominated in foreign currencies.
|Change in portfolio value caused by a +/-20% change of the exchange rate||31 December 2018||31 December 2017|
Both Pekao and Alior Bank use the VaR model to measure currency risk. It allows them to calculate potential loss on currency positions kept by the Bank caused by changes in exchange rates, while maintaining the assumed confidence level (99%) and the period in which the position is kept. The following table presents VaR determined for the trading book FX risk in both banks:
|10-day VaR – fx risk – trading book (PLN thousand)||31 December 2018||31 December 2017|
Level of risk exposure
The value of the portfolio of equity financial instruments is presented in item 35.2.
The following table presents the sensitivity test of PZU Group’s portfolio of quoted equity instruments for which the PZU Group bears the risk.
|Impact of a change in the measurement of quoted equity instruments on equity||31 December 2018||31 December 2017|
|increase in measurement of quoted equity instruments by 20%||190||350|
|decrease in measurement of quoted equity instruments by 20%||(190)||(350)|
188.8.131.52. Liquidity risk
Financial liquidity risk of the PZU Group may result from three types of events:
In the liquidity risk management process, liquidity is controlled in the short, medium and long term, i.e.:
Another objective of the ALM process is to ensure the capability to pay claims and benefits, also in unfavorable economic conditions. The level of liquidity risk is measured by estimating the shortages of cash required to pay liabilities. The estimate is made using a set of analyzes, including among others a liquidity gap analysis (a mismatch of net cash flows) and an analysis of the distribution of expenditures relating to operating activity.
The objective of liquidity risk management is to:
Pekao has a centralized liquidity risk management system in place, which includes regular liquidity management and first level control exercised by responsible units, second level control exercised by a dedicated unit responsible for risk management and independent audit.
Liquidity management in the Pekao Group is planned within the following time horizons:
Due to the specific nature of the liquidity risk management tools and techniques used, the Pekao Group manages its current and medium-term liquidity together with short-term liquidity.
The liquidity risk management policy at Alior Bank consists in maintaining liquidity positions so that it is possible to satisfy payment obligations at all times using the available cash in hand, proceeds from transactions with specified maturity dates or through the sale of transferable assets, while minimizing the costs of maintaining liquidity.
Alior Bank manages its liquidity by using ratios and related limits of the following types of liquidity:
|Carrying amount of debt instruments, by maturity, as at 31 December 2018||up to 1 year||1 – 2 years||2 – 3 years||3 – 4 years||4 – 5 years||Over 5 years||Total|
|Loan receivables from clients||53,823||18,022||13,302||14,537||12,512||69,858||182,054|
|Investment (deposit) debt instruments||16,429||8,028||11,300||15,091||9,231||35,546||95,625|
|Measured at amortized cost||9,485||2,497||2,717||5,005||5,540||19,990||45,234|
|Term deposits with credit institutions||2,532||170||54||-||-||13||2,769|
|Measured at fair value through other comprehensive income||5,923||4,600||5,952||7,791||2,471||11,478||38,215|
|Measured at fair value through profit or loss||1,021||931||2,631||2,295||1,220||4,078||12,176|
|Carrying amount of debt instruments, by maturity, as at 31 December 2017||up to 1 year||1 – 2 years||2 – 3 years||3 – 4 years||4 – 5 years||Over 5 years||Total|
|Loan receivables from clients||47,531||18,362||13,640||11,036||12,321||66,567||169,457|
|Investment (deposit) debt instruments||24,465||9,336||8,330||9,583||12,830||38,274||102,818|
|Held to maturity||229||1,350||1,087||1,243||4,604||12,724||21,237|
|Available for sale||19,457||5,260||2,632||3,756||4,803||11,947||47,855|
|Measured at fair value – classified as such upon first recognition||22||272||771||1,554||444||1,640||4,703|
|Held for trading||263||780||1,587||1,917||1,110||3,319||8,976|
|- buy-sell-back transactions||885||-||-||-||-||-||885|
|- term deposits with credit institutions||1,625||23||76||110||-||7||1,841|
The following table presents future undiscounted cash flow from assets and liabilities as at 31 December 2018.
|Liquidity risk||Up to 1 year||1 – 2 years||2 – 3 years||3 – 4 years||4 – 5 years||5 to 10 years||Over 10 years||Total|
|Cash and cash equivalents||13,195||142||103||85||74||274||3,258||17,131|
|Loan receivables from clients||47,576||23,979||19,287||16,650||13,761||36,998||42,209||200,460|
|Term deposits with credit institutions||2,632||166||141||60||104||49||-||3,152|
The following table presents future undiscounted cash flows from banks’ off-balance sheet liabilities (by contractual terms)
|Off-balance sheet liabilities granted||up to 1 month||1 -3 months||3 months to 1 year||1 – 5 years||over 5 years||Total|
7.5.4. Operational risk
Operational risk is the possibility of suffering loss resulting from improper or erroneous internal processes, human activities, system failures or external events.
Operational risk management has the purpose of optimizing the level of operational risk and operating efficiency in the PZU Group’s operations, leading to a reduction of losses and costs arising from such risks and ensuring adequate and effective control mechanisms. Information on operational risk levels is regularly reported to relevant internal authorities.
Operational risk is identified in particular by:
Operational risk is assessed and measured by:
Monitoring and control of operational risk is performed mainly through an established system of operational risk indicators enabling assessment of changes in the level of operational risk over time and assessment of factors that affect the level of this risk in the business.
Reporting involves communicating the level of operational risk, the effects of monitoring and control to various decision-making levels. The frequency of each report and the scope of information provided therein are tailored to the information needs at each decision-making level.
Management actions involving reactions to any identified and assessed operational risks involve, in particular:
7.5.5. Compliance risk
Compliance risk is the risk of legal sanctions, financial losses or loss of reputation or credibility arising from a failure of PZU Group companies, their employees or entities acting on their behalf to comply with the law, internal regulations or standards of conduct, including ethical standards.
The demarcation of responsibilities with respect to systemic and ongoing compliance risk management is based on internal regulations.
Systemic management entails in particular: developing solutions for implementing compliance risk management principles, monitoring the compliance risk management process and promoting and monitoring compliance with internal regulations and standards of conduct in respect to compliance.
Ongoing compliance risk management entails: identifying, assessing and measuring and adaptation to regulatory requirements.
7.5.6. Model risk
Model risk is the risk of incurring financial losses, incorrectly estimating data reported to the regulatory authority, taking incorrect decision or losing reputation as a result of errors in the development, implementation or application of models. In 2018, model risk was classified as material risk and the formal process of its identification and measurement was started.
At present, the process is implemented at PZU and PZU Życie and aims to ensure high quality of risk management practices applied to this risk.
Model risk is very important for banking sector entities and therefore management of this risk has already been implemented in the course of adaptation to the requirements of Recommendation W issued by the KNF. Both banks have defined standards for the model risk management process, including the rules for developing models and evaluating the quality of their operation and have ensured appropriate corporate governance solutions.