Capital adequacy

Capital adequacy management is a process intended to ensure that the level of risk which the bank and the Group assumes in relation to the development of its business activities may be covered with its capital, taking into account a specific risk tolerance level and time horizon. The process of managing capital adequacy comprises, in particular, compliance with the applicable regulations of the supervisory and control authorities, as well as the risk tolerance level determined within the Bank and the Bank’s Group and the capital planning process, including the policy concerning the sources of acquisition of capital.

The objective of capital adequacy management is to maintain own funds at a level which is adequate to the scale and profile of the risk relating to the Group’s activities at all times.

The process of managing the Group’s capital adequacy comprises:

• specifying and pursuing the Group’s capital targets;
• identifying and monitoring significant types of risk;
• measuring or estimating internal capital to cover individual risk types of risk and total internal capital;
• determining strategic tolerance limits and thresholds of capital adequacy measures;
• forecasting, monitoring and reporting the level and structure of equity and capital adequacy;
• managing the structure of the balance sheet to optimize the quality of the Bank’s own funds;
• emergency measures with regard to capital;
• stress-tests;
• planning and allocating own funds and internal capital to business areas and customer segments in the Bank as well as individual Group companies;
• assessing the profitability of individual business areas and customer segments.

Capital adequacy measures include:

• total capital ratio (TCR);
• the ratio of own funds to internal capital;
• Tier 1 core capital ratio (CET1);
• Tier 1 capital ratio (T1);
• leverage ratio.

The objective of monitoring the level of capital adequacy measures is to determine the degree of compliance with supervisory standards and to identify cases which require that emergency measures be implemented.

Major regulations applicable in the capital adequacy assessment process include:

• the CRR Regulation;
• the Polish Banking Law;
• the Act of 5 August 2015 on macroprudential supervision over the financial system and crisis management in the financial system (hereinafter referred to as ‘the Act on macroprudential supervision’).

In accordance with Article 92 of the CRR Regulation, the minimum levels of the capital ratios to be maintained by the Group are as follows:

• total capital ratio (TCR) – 8.0%;
• Tier 1 capital ratio (T1) – 6.0%;
• Tier 1 core capital ratio (CET1) – 4.5%.

In accordance with the CRR Regulation and the Act on macroprudential supervision, the Group is obliged to maintain a combined buffer representing the sum of the applicable buffers, namely:

• a capital buffer which applies to all banks. Every year, the capital buffer will be increased to the target level of 2.5% (in 2019). As at 31 December 2017, the systemic risk buffer amounted to 1.25%, and will amount to 1.875% after 1 January 2018.
• the countercyclical buffer imposed to mitigate the systemic risk arising from the credit cycle. The Group calculates the countercyclical buffer at the level specified by the relevant authority of the country where the Group has exposures. Starting from 1 January 2017, the countercyclical buffer is equal to 0% for credit exposures in the Republic of Poland.
• a systemic risk buffer – intended to prevent and mitigate long-term non-cyclical risk or prudential risk which may cause strong negative consequences for the financial system and the economy of a given country. As at 31 December 2017, the systemic risk buffer was equal to 0%. Starting from 1 January 2018, the systemic risk buffer amounts to 3%.
• the buffer relating to the fact that the Bank has been identified as a systemically important institution (‘O-SII’) – on 24 November 2017, on the basis of an assessment of the Bank’s systemic importance in accordance with the Act on macroprudential supervision, the Bank received an individual decision of the Polish Financial Supervision Authority imposing a buffer on the Bank of 0.75% of its total risk exposure calculated in accordance with the CRR Regulation.

In addition, the Group is obliged to maintain own funds to cover an additional capital requirement in order to hedge the risk resulting from mortgage-secured loans and advances to households denominated in foreign currencies (“a discretionary capital requirement”). On 15 December 2017, the Group received a letter from the Polish Financial Supervision Authority concerning an individual recommendation to meet an additional capital requirement (a discretionary capital requirement) for the consolidated capital ratios: the total capital ratio: 0.61 p.p.; Tier 1 capital ratio: 0.46 p.p.; and Tier 1 core capital ratio: 0.34 p.p.

The total value of buffers and additional discretionary capital requirements which the Group was obliged to meet as at 31 December 2017 was 2.61% of the total exposure to risk calculated in accordance with the CRR Regulation. The same values as at 31 December 2016 amounted to 2.79%.

In 2017 and in 2016, the Group maintained a safe capital base in excess of the supervisory and regulatory limits.

Own funds for capital adequacy purpose

In 2017, the Group’s capital adequacy level remained at a safe level, well above the supervisory limits.

An increase in Tier 1 capital before regulatory adjustments and reductions between 31 December 2017 and 31 December 2016 resulted from:

• a decision adopted on 22 June 2017 by the Ordinary General Shareholders’ Meeting on the appropriation of the Bank’s net profit for 2016 by transferring it to supplementary and reserve capital, without distributing any amounts as dividend. The resulting increase in own funds amounted to PLN  1 299 million, and the remaining part of the net profit for 2016 (PLN 1 589 million) had already been included in own funds as at 31 December 2016 since the Bank had received the required permission from the PFSA to include the net profit earned for the three quarters of 2016, less the anticipated charges, in Tier 1 core capital;
• a permission from the PFSA received by the Bank on 21 September 2017 to include the net profit of PKO Bank Polski SA for the first half of 2017, less the anticipated charges (of PLN  1,118 million) in Tier 1 core capital;
• a permission from the PFSA received by the Bank on 15 December 2017 to include the net profit of PKO Bank Polski SA for the third quarter of 2017, less the anticipated charges (of PLN  704 million) in Tier 1 core capital.

Changes in Tier 2 capital between 31 December 2017 and 31 December 2016 resulted from the following:

• having obtained the necessary permissions from the PFSA, the Bank exercised a call option for subordinated bonds of PLN  1 600 million and made an early repayment of a subordinated loan of CHF 224 million (the equivalent of PLN  884 million). As at 31 December 2016, both these instruments were classified as Tier 2 capital. Since the receipt of the said permission, they have no longer been included in the Bank’s own funds;
• the Bank obtained permission from the PFSA to include a new issue of the Bank’s subordinated bonds amounting to PLN  1,700 million in own funds.  

Requirements relating to own funds (Pillar I)

The Group calculates own funds requirements for the following types of risk:

The leverage ratio calculated in accordance with the transitional definition amounted to 10.53% as at 31 December 2017 and 9,62% as at 31 December 2016.

Internal capital (Pillar II)

In 2017, the Group calculated internal capital in accordance with external regulations:

• the CRR Regulation
• the Polish Banking Law;
• the Regulation of the Minister of Finance and Development of 6 March 2017 on the risk management and internal control systems, remuneration policy and the detailed procedure for estimating the internal capital in banks;
• the Act on Macro-prudential supervision;

and the internal regulations of the Bank and the Group.

Internal capital is the amount of capital estimated by the Group that is necessary to cover all of the identified significant risks characteristic of the Group’s activities and the effect of changes in the business environment, taking account of the anticipated risk level.

The estimation of internal capital is aimed at determining the minimum level of own funds which ensures the safety of operations, taking into account changes in the profile and scale of the operations as well as adverse stress conditions.

The internal capital for covering the individual risk types is determined using the methods specified in the internal regulations. In the event of performing internal capital estimates based on statistical models, the annual forecast horizon is adopted and a 99.9% confidence level. The total internal capital of the Group is the sum of the internal capital necessary to cover all significant types of risks to which the Bank and the Group are exposed, taking into account the entities included in prudential consolidation. The correlation coefficient for different types of risk and different Group entities used in the internal capital calculation is equal to 1.

In 2017 and 2016, the relation of the Group’s own funds to its internal capital remained on a level exceeding both the threshold set by the law and the Group’s internal limits.

Disclosures (Pillar III)

The Group annually announces information, in particular, about risk management and capital adequacy in accordance with: the CRR regulation and the implementing acts thereto, Recommendation H, the Polish Banking Law, the Act on Macro-Prudential Supervision, Recommendation M relating to operational risk management in banks and Recommendation P relating to liquidity risk, issued by the Polish Financial Supervision Authority.

Details of the scope of information disclosed, the method of its verification and publication are presented in PKO Bank Polski SA Capital Adequacy Information Policies and other information to be published, which are available on the Bank’s website (www.pkobp.pl).