Key changes in the risk management area in 2016

mBank Group is continuously improving risk control and management process with a focus on a streamlining integrated risk management from the perspective of concentration on a customer.

Selected projects realized in 2016 are described below:

• Adaptation works to the requirements of Recommendation W concerning model risk management in banks (published in July 2015 by the Polish Financial Supervision Authority) were completed. The abovementioned works resulted, among others, in the update of Model Management Policy, which was supplemented with provisions addressing requirements of the Recommendation W. The model risk tolerance level was also defined. In addition, Model Risk Committee responsible for supervising model risk management process was appointed. The Committee performs information, discussion, decision and legislative functions. In particular, the Committee:
  • approves the new and redesigned models, as well as amendments thereto, deciding also about the resignation from the application of the model;
  • takes decisions on the scope of application of the group and external models, including central models, in banking processes;
  • recommends the tolerance level for model risk and submits its findings to the decision of the Management Board and the Supervisory Board;
  • takes the final decision regarding approval of the significance assigned to a given model;
  • approves preventive and remedial measures indicated within the results of monitoring;
  • accepts the schedule for validation of models and the results of each model validation.
• Implementation of the Internal Control System Self-assessment was completed in mBank Group subsidiaries. In the Bank, the Self-assessment was implemented in 2015. Thus, the process covers the whole activity of the Group. Self-assessment process is carried out on an annual basis and it aims at a comprehensive assessment of operational risk.
• “Credit policy of financing residential developers projects by mBank Group” was adopted. A framework for the risk appetite and development of acquisition in this market was determined, the definition of residential developer’s project was developed, risks were identified and their mitigants were introduced, and the limit for the portfolio of residential developers’ projects was implemented.
• Continuation of the program – launched in 2015 - of continuous increase of effectiveness of work in the risk management area based on the principles of Lean Management with an emphasis on implementing a culture of responsibility and mechanisms for continuous improvement of processes. The aim of the program is to enable the absorption of the increasing number of tasks resulting from the business development and increasing regulatory requirements, without necessity to enlarge significantly the available resources.
• The Bank carried out IFRS 9 implementation project, including, among others, analytical work in assessing the impact of IFRS 9 on the methodology for calculation of provisions in the Group; implementation of the necessary changes was also started. IFRS 9 changes the requirements for classification and evaluation of financial assets and implements the impairment model based on the expected losses calculated for certain instruments over the lifetime of the asset. IFRS 9 will take effect starting from January 2018.

Main risks in the mBank Group’s business

The Management Board of mBank takes measures necessary to ensure that the Bank manages all material risks arising from the implementation of the adopted strategy of mBank Group, in particular, through approving strategies and processes for managing material risks in the Group.

The following risks were recognized as material in the operations of the Group as of the end-2016:

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mBank monitors all the aforementioned risks. The following section presents the rules of monitoring credit, market, liquidity and operational risk in mBank Group using risk measures applied by mBank and taking into account differences in the profile and scale of business of the Group.

The detailed information on managing the abovementioned risks as well as information concerning the management of other types of risk, that is business risk, reputational risk, model risk and capital risk are included in the Consolidated Financial Statement of mBank Group in the chapter 3. Risk Management.

Capital adequacy

Maintaining an adequate level of capital is one of the main tasks of the Bank. The Management Board of mBank ensures consistency of the capital and risk management process by means of a system of strategies, policies, procedures and limits for the management of particular risks which constitute the ICAAP architecture. Furthermore, in line with the Capital Management Policy applicable at mBank, the Bank maintains an optimum level and structure of own funds, guaranteeing maintenance of the total capital ratio at a level higher than the supervisory requirement, at the same time covering all significant risks identified in the Bank’s operations and key risk concentrations resulting from applied business strategy. The assessment process comprises determination of the appropriate capital surplus required to cover potential losses resulting from materialization of particular risk factors related to the existing portfolios and planned activity. New regulatory requirements as well as possible adverse macroeconomic changes are also taken into account in the capital management process.

The Capital Management Policy at mBank is based on two main pillars:

• maintenance of an optimal level and structure of own funds, with the use of available methods and means (retained net profit, issue of shares, subordinated bonds, etc.);
• effective use of the existing capital among others by applying a system of capital utilisation measures resulting in reduction of the activity that is not generating the expected return and development of products with lower capital absorption.

The capital ratios of mBank Group in 2016 were driven by the following factors:

• inclusion in Common Equity Tier 1 capital the remaining part of the net profit of mBank Group for the year 2015, not included in Common Equity Tier 1 capital on the basis of the PFSA decision obtained in 2015;
• inclusion in Common Equity Tier 1 capital the verified net profit of the mBank Group for the first, second and third quarters of the year 2016, net of expected charges and dividends, on the basis of the PFSA decisions from June 21, 2016, September 7, 2016 and December 14, 2016 respectively;
• classification of capital instruments issued within incentive programs in the period from January 1, 2016 till July 31, 2016 as instruments in Common Equity Tier 1 capital;
• change of calculation methodology for the additional value adjustments deducted from Common Equity Tier 1 capital;
• change of the limit for unrealized gains measured at the fair value included in the own funds calculation from 40% in 2015 to 60% in 2016;
• change of the limit for grandfathered subordinated instruments included in the own funds;
• adjustment of the application of the regulatory floor to the requirements of article 500 of the CRR Regulation, also complying with the provisions of the ITS Regulation. The adjustment was implemented to ensure a full comparability, transparency and compliance of the Bank's capital position presented in the financial statement and regulatory reporting with the approach used by the EU parent institution (Commerzbank AG) and observed in other EU member states. The method used by the Bank in the past followed the local authorities' approach to the issue at hand. The PFSA within correspondence conducted by the Bank on the subject of the abovementioned adjustment, stated that it is not coherent with the local regulatory approach to own funds assessment which has been used so far and is still expected to be used;
• extensions of the AIRB approach and the changes of the AIRB models:
  • the implementation of the material change to the internal corporate LGD model (having satisfied the suspensive conditions) for which the Bank obtained the joint consent of the European Central Bank and of the PFSA on September 15, 2016;
  • the receipt on July 26, 2016 of an official confirmation from the European Central Bank and the PFSA regarding the Bank's fulfilment of the high significance conditions stipulated in the conditional consent to apply the internal rating based approach to the calculation of the capital charge for credit risk for the credit exposures of the subsidiary mLeasing;
• expansion of the mBank Group business activity;
• depreciation of the Polish currency against the foreign currencies.

 
From 2016 banks are obliged to maintain additional own funds to cover the capital buffers implemented as a result of the Act on Macro-prudential Supervision over the Financial System and Crisis Management in the Financial System that entered into force in 2015 and transposed the CRD IV provisions to the Polish prudential regulations. As of December 31, 2016, Bank was obliged to ensure adequate own funds to meet conservation capital buffer of 1.25% of the total risk exposure amount.

As of the end of 2016 the countercyclical capital buffer rate set for relevant exposures in Poland according with the article 83 of the Act amounted to 0%. mBank Group specific countercyclical capital buffer calculated in accordance with the provisions of the Act as the weighted average of the countercyclical buffer rates that apply in the countries where the relevant credit exposures of the Group are located, amounted to 0% as of December 31, 2016.

In Q4 2016, the Bank received an administrative decision of the PFSA that identified mBank as other systemically important institutions (O-SII) and imposed a capital buffer of 0,5% of the total risk exposure amount, calculated in accordance with article 92(3) of the Regulation, to be maintained on individual and consolidated levels.

Consequently, the combined buffer requirement set for the mBank Group as of the end of 2016 amounted to 1.75% (of the total risk exposure amount).

Additionally, as a result of risk assessment carried out by the Polish Financial Supervision Authority within the supervisory review and evaluation process, in particular with regard to the evaluation of risk related to the portfolio of foreign exchange retail mortgage loans, mBank Group received an individual recommendation to maintain own funds on the consolidated level to cover additional capital requirement of 3.25% in order to mitigate the risk and 2.44% for Tier 1 capital (on individual basis: 3.81% at the level of own funds and 2.86% at the level of Tier 1 capital)

High level of additional capital requirement in Pillar II was due to the fact that the Polish Financial Supervision Authority applied one methodology to all banks in Poland. This failed to take into account the results of internal models applied by mBank to the calculation of capital requirements for credit risk. According to this methodology, the calculation of the additional capital requirement for each and every bank uses the risk weight under the standardised approach (100%) as a starting point. Consequently, more than half of the additional capital requirement calculated by the PFSA for mBank Group comes from “aligning” the capital requirement to the requirement calculated under the standardised approach. The second important component with effect on an additional capital requirement within Pillar II was related to the BION score quantifying the risk of foreign exchange retail mortgage loans portfolio, taking into account the specific nature of the Group portfolio, the following factors were taken into account:

• the share of loans with LTV >100% in total FX lending portfolio;
• the level of margin realised in the Group on FX lending portfolio;
• sensitivity of total capital ratio to exchange rate and interest rate changes;
• Group’s readiness to absorb losses of a potential portfolio currency conversion.

The level of the required capital ratios encompasses:

• the basic requirement of PFSA addressed to banks in Poland to maintain the total capital ratio of 12% and the Tier 1 ratio of 9%;
• the combined buffer requirement of additional 1.75%;
• the additional capital charge in Pillar II – 3.25% (consolidated level) and 3.81% (individual level).
  
  

At the end of 2016 mBank Group comfortably met the PFSA’s required levels: its capital ratios on consolidated basis and individual basis were above the required values.

Capital ratios on individual level and consolidated Common Equity Tier 1 ratio together with Tier 1 ratio stayed above the required values during whole 2016. From the beginning of January 2016 consolidated total capital ratio of mBank Group should amount to at least 16.97% according to requirements in force at that time. Untill March 24, 2016, i.e. the day on which the Ordinary General Meeting of mBank approved consolidated financial statements of mBank Group and decided not to pay a dividend from 2015 profit, consolidated total capital ratio of mBank Group stayed slightly below the required value. From March 24, 2016 till the end of 2016 consolidated total capital ratio of mBank Group stayed above the required value.

With a considerable surplus of own funds mBank Group comfortably meets the additional own funds requirement related to Pillar II and the combined buffer requirement

Without adjustment of the approach to the application of the regulatory floor to the requirements of article 500 of the CRR Regulation, capital ratios of mBank Group as of December 31, 2016 would amount to as follows: Total capital ratio – 18.35%, Common Equity Tier 1 ratio – 15.66%. Additionally, had the Group adjusted the approach to the application of the regulatory floor as of December 31, 2015 the capital ratios of mBank Group would not change.

Without adjustment of the approach to the application of the regulatory floor to the requirements of article 500 of the CRR Regulation, mBank capital ratios as of December 31, 2016, would amount to as follows: total capital ratio – 21.93%, Common Equity Tier 1 ratio – 18.76%. Additionally, had the Bank adjusted the approach to the application of the regulatory floor as of December 31,2015 the mBank capital ratios would increase respectively: by 0.33% in case of total capital ratio and by 0.27% in case of Tier 1 ratio and Common Equity Tier 1 ratio.

The second component of the adequacy assessment of Group’s capital base, alongside the calculation of capital ratios and their comparison with the required levels (taking account of the combined buffer requirement and the additional capital chargé within Pillar II), is verification whether Group meets requirements resulting from article 500 of the CRR. To this end, own funds are compared to the value of the „regulatory floor” accounting for 80% of the comparable standardised-driven total capital requirement. This parallel calculation is to ensure that the Group’s own funds calculated under the internal rating based approach are sufficient and they do not fall below 80% of own funds that the Group would have to maintain under the standardised approach. mBank Group’s own funds are well above the level determined by the regulatory floor.

The consolidated leverage ratio calculated in accordance with the provisions of CRR Regulation and Commission Delegated Regulation (EU) 2015/62 of October 10, 2014, amending Regulation (EU) No 575/2013 of the European Parliament and of the Council with regard to the leverage ratio, including provisions regarding transitional period, amounted to 8.23%.

Stress tests

In order to ensure compliance with regulatory requirements under normal and stress conditions the Group and the Bank carry out sensitivity analyses for key concentration risks. These analysis are used among others for calculation of the capital surplus above the level of regulatory requirements.

Additionally integrated stress tests are conducted based on scenario of unfavourable economic conditions that may adversely affect the Bank’s financial position in at least a full two-year time horizon (for liquidity risk - a one-year time horizon). The risk scenario, i.e. the most plausible (in at least a full two-year time horizon) scenario of negative deviations from the base scenario, expressed in terms of macroeconomic and financial ratios, is common for all risk types, applied at Group level and aligned with the corresponding scenario accepted by the consolidating entity.

Reverse stress tests are conducted in order to identify events that might potentially pose a risk to the functioning of the Group and the Bank.

The Group and the Bank take part in regulatory stress tests conducted by the Polish Financial Supervision Authority in order to determine the impact of assumed macroeconomic stress scenarios on the Group’s balance sheet and P&L as well as on prudential norms.

Explanatory note - risk management

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