Main risks of mBank Group’s business

Credit risk inherent in financing of mBank Group clients is assessed based on shared statistical models developed for the AIRB (Advanced Internal Rating-Based) approach and uniform tools, and is based on common definitions of terms and parameters used in the credit risk management and rating process. The bank ensures their cohesion at the Group level.

The Group uses different models for particular client segments. The rules governing clear assignment of clients to a system are defined in the bank and the Group subsidiaries internal regulations.

In their credit risk management process, the bank and the Group subsidiaries use the core risk measures defined under the AIRB approach:

• PD – Probability of Default (%);
• LGD (Loss Given Default) – estimated relative loss in case of default (%);
• EAD (Exposure at Default) – estimated exposure at the time of default (amount);
• EL – Expected Loss taking into account the probability of default (amount);

and related measures including:

• RD (Risk Density) – relative expected loss defined as EL to EAD (%);
• LAD (Loss at Default) – estimated loss (amount) in case of default (the product of EAD and LGD).

In the decision-making process, for reporting and communication with business units, PD and EL are expressed in the language of rating classes whose definitions (Masterscale) are uniform across Commerzbank Group.

In its credit risk management process, the bank also attaches great importance to the assessment of unexpected loss. For this purpose, the bank uses the RWA (Risk Weighted Assets) measure, which is applied, under the AIRB approach, to calculate regulatory capital required to cover credit risk (unexpected loss).

In managing mortgage-secured credit exposures the Group uses the LtV ratio (Loan to Value), i.e. the value of the loan to the market value (or mortgage banking calculated value) of the real estate which secures the loan.

Stress testing is an additional tool of credit risk assessment. Stress testing of the regulatory capital and economic capital required to cover credit risk is carried out quarterly.

In addition to the tools listed above, which are applied both in the corporate and in the retail credit risk measurement, the Group uses tools specific to these areas.

For corporate credit risk the Group defines maximum exposure to a client/group of related clients using the following credit risk mitigating measures:

• MBPZO (Maximum Safe Total Exposure), which defines the maximum level of financial debt of an entity from financial institutions calculated under the bank’s methodology, approved by the bank’s competent decision-making body. An alternative measure used by the bank to clients applying for small exposure is Borrowing Capacity (BC);
• LG (General Limit), which defines the level of credit risk financial exposure to a client/group of related clients acceptable to the Group, approved by the bank’s competent decision-making body. LG includes a structured limit and products granted outside the structured limit.

In order to minimise credit risk, the Group uses a broad range of collateral for credit products, which also enable active management of the capital requirement. In the assessment of the quality of collaterals for risk products, mBank and mLeasing use the MRV ratio (Most Realistic Value) reflecting the pessimistic variant of debt recovery from the collateral through forced sale. The RORAC ratio (Return on Risk Adjusted Capital) is applied in the decision-making process and the assessment of profitability of a client in the CRM system.

Retail credit risk measures are constructed to reflect the characteristics of this customer segment and, in the case of portfolio measures, the high granularity of the loan portfolio:

• DtI (Debt-to-Income) – i.e. monthly credit payments to the net income of a household (used for individual customers);
• DPD (Days-Past-Due) – a family of portfolio risk measures based on the number of days past due date (e.g. share of contracts which are from 31 to 90 days past due date in the total portfolio by number or by value);
• Vintage ratios, which present the quality of cohorts of loans grouped by disbursement time at a different phase of their lifetime;
• COR (Cost of risk) – cost of risk for a loan portfolio (segment), i.e. ratio of provisions result and changes in valuation of contracts based on fair value approach to the exposure;
• Roll-rates, which measure the migration of contracts between days-past-due brackets (1-30, 31-60, 61-90 DPD, etc.).

Corporate and Investment Banking

In accordance with the Corporate Credit Risk Management Strategy in mBank Group, the main goal in this area is defining a safe level of risk appetite in sales of risk-bearing products to the Group clients and use synergies by integrating the offer of the bank and Group subsidiaries. The Strategy is realised by credit risk policies, limits reducing the risk and the principles of risk assessment of business entities applying for financing. The bank manages credit risk both at the single entity level and the consolidated level.

The Group actively manages credit risk aiming to optimise profitability taking into account the cost of risk. In its current credit risk management and determination of concentration risk, the bank performs quarterly portfolio analyses using a Steering Matrix which incorporates PD rating and LAD.

The bank monitors credit portfolio on a quarterly basis including an analysis of the dynamics of change in size and (sector) segmentation of the credit portfolio, client risk (analysis of PD rating), quality of collateral against credit exposures, the scale of change in EL, Risk Density, and default exposures.

The Group strives to avoid concentration in industries and sectors where credit risk is considered excessively high. The bank uses internally defined industry limits for day-to-day management of the sector concentration risk.

In compliance with the Recommendation S of the Polish Financial Supervision Authority (PFSA), the bank has identified a mortgage-secured credit exposure portfolio in retail and corporate banking and applies the Mortgage-Secured Credit Exposure Risk Management Policy. The bank manages the mortgage-secured credit exposure portfolio risk with a focus on defining an optimised portfolio structure in terms of quality (rating), currencies, country regions, tenors, and types of properties.

For international companies, non-banking financial institutions and biggest corporate clients, mBank Group promotes innovative products with low capital consumption, in particular products of investment banking, transactional banking and financial markets instruments.

mBank offers financing alternative to banking loans by arranging public and private programmes and club deals for bonds issued by clients with a stable financial position.

Retail Banking

Lending in retail banking is a key segment of the Group’s business model, both in terms of the share in total assets and the contribution to its profits.

As credit exposures are highly granular (more than 2.5 million active loans), the retail banking credit risk management process is based on a portfolio approach. This is reflected in the statistical profile of risk rating models including the models which fulfil the regulatory requirements of the Advanced Internal Ratings-Based approach (AIRB). The AIRB parameters (PD, LGD and EL) are used widely in order to estimate credit requirements, to determine acceptance criteria and terms of transactions, and to report risks.

Furthermore, the Retail Banking credit risk management has the following characteristics:

• high standardisation and automation of the credit process, including decision-making, both in acquisition, post-sale services, and debt collection;
• little (as compared to Corporate Banking) discretionary competences in the decision-making process (e.g. no discretionary adjustment of clients’ ratings);
• extensive risk reporting system based on portfolio analysis of credit exposure quality, including vintage analysis and roll-rates analysis.

The main point of reference in the retail banking credit risk management process is risk appetite defined in correlation with the strategy of mBank Group. The general principle underlying the lending strategy of the Group in terms of sales of retail loans is to address the offer to clients who have an established relationship with the bank or to address it to new clients for whom the loan is a product initiating a long-term relationship of highly transactional nature. Thereby, the bank continues to focus its non-mortgage loans policies on lending to existing clients with a high creditworthiness while systematically growing the acquisition of external clients. As part of these activities, the bank increasingly participates in financing customers making purchases via Internet. To reduce risks of accepting new clients, the bank develops its credit policy using, among others, credit testing and is actively developing its fraud prevention system.

The new acquisition focuses on products which may be financed with issue of mortgage bonds. Those exposures will then be transferred to mBank Hipoteczny in the pooling process to enable the issue of mortgage bonds. The conservative policy of assessing borrowers’ reliability and creditworthiness is applied; taking into account, inter alia, current, historically lowest, levels of interest rates, the Group attaches special attention to the application of long-term estimates of interest rate while assessing creditworthiness.

In order to mitigate the risk associated with a decrease in the value of mortgage collateral in relation to the value of credit exposure, the Group’s credit offer is (and will be) directed mainly to clients who buy standard properties within large urban areas.

As of December 31, 2019, the share of impaired exposures in the total (gross) amount of loans and advances granted to clients (NPL) decreased to 4.5% from 4.8% at the end of 2018. The change of the indicator applies mainly to retail banking and is caused by the realization of debt collection processes, as well as the increase of the retail loan portfolio.

In accordance with the EBA guidelines on management of non-performing and forborne exposures, which came into force from June 30, 2019, Banks are obliged to monitor and manage the NPL portfolio. Banks should strive to maintain the value of the NPL portfolio below the threshold set by the regulator at 5%. As of December 31, 2019, the NPL_REG radio (ratio calculated according to EBA guidelines) was at 4.0%.The difference between NPL and NPL_REG ratios results mainly from inclusion of central banks’ receivables.

Provisions (defined as credit risk costs for loans and advances to customers, i.e. provisions for loans and advances at amortised cost and fair value change of loans and advances mandatorily at fair value through profit or loss) increased from PLN 3,437.4 million at the end of December 2018 to PLN 3,574.2 million at the end of December 2019.

The coverage ratio (with provisions as defined earlier) decreased in the analysed period from 62.5% in December 2018 to 60.7% in December 2019. The change of the ratio is caused by the sale of the loan portfolio highly covered provisions.

The manner of identifying evidence of default is based on all available credit data of a given client and encompasses all of the client’s liabilities towards the bank.

The table below presents the quality of mBank Group loan portfolio as at the end of December 2019 and as at the end of December 2018.

Non-performing loans and advances – loans and advances at amortised cost with impairment (basket 3 and POCI) and loans and advances mandatorily at fair value through profit or loss in default

NPL ratio – loans and advances at amortised cost with impairment (basket 3 and POCI) and loans and advances mandatorily at fair value through profit or loss in default in the whole portfolio

Provisions for non-performing loans – provisions for loans and advances at amortised cost with impairment (basket 3 and POCI) and fair value change of loans and advances mandatorily at fair value through profit or loss in default

Provisions for performing loans – provisions for loans and advances at amortised cost without impairment (basket 1 and 2) and fair value change of non-default loans and advances mandatorily at fair value through profit or loss

Coverage ratio – coverage ratio of loans and advances related to the portfolio in default.

In its operations, the bank is exposed to market risk, which is defined as a risk resulting from unfavourable change of the current valuation of financial instruments in the bank’s portfolios due to changes of the market risk factors, in particular:

• interest rates;
• foreign exchange rates;
• stock share prices and indices;
• implied volatilities of relevant options;
• credit spreads (to the extent reflecting market fluctuations of debt instruments prices, reflecting credit spread for corporate bonds, and spread between government yield curve and swap curve – for government bonds).

In terms of the banking book, the bank distinguishes the interest rate risk, which defines as the risk of an adverse change in both the current valuation of the banking book position and the net interest income as a result of changes in interest rates.

For the purpose of internal management, the bank quantifies exposure to market risk, both for banking and trading book, by measuring:

• the Value at Risk (VaR);
• expected loss under condition that this loss exceeds Value at Risk (ES – Expected Shortfall);
• the Value at Risk in stressed conditions (Stressed VaR);
• economic capital to cover market risk;
• stress tests scenario values;
• portfolio sensitivities to changes of market prices or market parameters (IR BPV – Interest Rate Basis Point Value, CS BPV – Credit Spread Basis Point Value).

For the banking book, the bank also uses the following measures (described in more detail in the chapter on interest rate risk):

• sensitivity of the economic value of capital (delta EVE);
• sensitivity of net interest income (delta NII);
• repricing gap.

Measurement and analysis of market risk takes place in two perspectives (including and without taking into account the modelling of stable parts of equity capital and current accounts, insensitive to changes in interest rates), which allows controlling the impact on the market risk level of the applied strategy for stabilising the net interest income.

The implementation of market risk management strategy involves managing the bank’s positions in a way enabling to maintain market risk profile within the risk appetite defined by the bank.

The market risk profile is derived from the strategic goals of business units, the decisions of dedicated committees and the limits on market risk exposures established at the level of the bank’s organisational units, the mBank Group and the Group entities. The limit system reflects the defined risk appetite in a quantitative manner.

The bank is focused on meeting customers’ business needs, while reducing trade in derivatives in terms of currency, currency pairs, nominal values and tenors of transactions, as well as applying the principle of lack of commodity open positions. mBank has limited appetite for currency risk, which is expressed through market risk limits. The bank conducts trading activity on well-known markets using financial instruments the bank has adequate expertise in and that have been approved for trading.

The bank stabilises interest income using long-term fixed-rate assets and derivatives and assuming – for equity capital – the maximum modelled maturity of 10 years and for current accounts – the maximum modelled maturity of 5 years. The management of interest rate risk of the banking book takes into account the economic and accounting perspectives, and the financial instruments used for hedging are adequate to the bank’s expertise and have been approved for trading.

The main principle stipulates separation between the market risk monitoring and control functions and the functions related to opening and maintaining open market risk positions. In addition, the bank applies the rule of organisational separation between managing banking book and trading book positions.

The mBank’s positions constitute the main source of market risk for the mBank Group.

In 2019, the market risk exposure, as measured by the Value at Risk (VaR for a 1-day holding period, at 97.5% confidence level), remained at a moderate level in relation to the established VaR limits.

The table below presents VaR and Stressed VaR for the Group’s and mBank’s portfolios (including modelling of equity capital and current accounts):

The Value at Risk (VaR) was largely influenced by the portfolios of instruments sensitive to the interest rates and the separate credit spread – mainly the portfolios of the Treasury bonds (in the banking and trading books) and positions resulting from interest rate swap transactions.

The table presents the values of IR BPV and CS BPV (+1 b.p.) for the Group’s and mBank’s portfolios, broken down into the banking and trading books (including modelling of equity capital and current accounts):

The credit spread sensitivity (CS BPV) for the mBank’s banking book, results in c.a. 40% from the positions in debt securities valued at amortised cost. Changes in market price have no impact on the revaluation reserve or the income statement for these positions.

In 2019, in order to expand the existing portfolio of measures to assess the interest rate risk of the banking book, mBank introduced a new risk measure to quantify net interest income volatility in line with the EBA guidelines. The volatility of net interest income is calculated and monitored over a five-year horizon in the bank’s base scenario assuming a normal situation and in more than 20 defined stress-test scenarios. The table below presents the volatility of the net interest income within 12 months horizon, assuming an unfavourable 100 bps change of market interest rates (parallel shift of the curves by 100 bps with floor on product level) and based on a stable portfolio over the period.

In its operations, mBank is exposed to liquidity risk, i.e. the risk of being unable to honour its payment obligations, arising from the bank’s balance-sheet and off-balance-sheet positions, on terms favourable to the bank and at a reasonable price. In terms of its sources, liquidity risk may result from internal factors (reputational risk resulting for instance in excessive withdrawal of cash by bank clients, materialisation of credit risk) and external factors (turbulences and crises in the financial markets, country risk, turbulences in the operation of clearing systems).

The bank has defined a set of liquidity risk measures and a system of limits, buffers and warning thresholds which protect the bank’s liquidity in the event of unfavourable internal or external conditions. Independent measurement, monitoring and controlling of liquidity risk is performed daily by the Balance Risk Management Department. The main measures used in liquidity risk management of the bank include measures based on liquidity gap calculation in LAB methodology, the regulatory measures (M3, M4, LCR) and also NSFR (Net Stable Funding Ratio) for analysis only. LAB measures reflect the projected future cash flow gap of assets, liabilities and off-balance-sheet commitments of the bank, which represent potential risk of being unable to meet liabilities within a specific time horizon and under a certain scenario.

The methodology for measuring the liquidity gap (LAB) includes normal conditions scenario (LAB Base Case) describing the situation under normal conditions, i.e. without specific, negative occurrences. For the purpose of this scenario, no continuation of activity is assumed (the so-called run-off scenario) and stress scenarios, of which the following are limited:

• LAB Bank Stress (short-term) – short-term scenario (up to 2 weeks) of the idiosyncratic stress;
• LAB Market Stress (long-term) – long-term scenario (up to 2 months) of the market crisis;
• LAB Combined Stress I – combined stress scenario that presents the effects of the simultaneous occurrence of short-term idiosyncratic stress and long-term market related stress.

Cash flow projections used in LAB measures are based on crisis scenarios, which include among others excessive withdrawal of cash by the bank’s clients and being unable to liquidate some assets due to an external crisis occurring to various extent dependent on assumed scenario.

Moreover, the bank has a process of reporting and monitoring of intraday liquidity position including crisis scenario for intraday liquidity. The reverse stress scenario is the complement of the liquidity stress testing system.

In order to support the process of liquidity risk management, the bank has a system of early warnings indicators (EWI) and recovery indicators. It is composed of indicators monitoring the level of regulatory and internal limits and additionally, indicators monitoring significant changes of market factors, as well as changes in the bank’s balance sheet. Exceedance of thresholds by defined indicators may be a trigger for the launch of the Contingency Plan or the Recovery Plan for mBank Group.

LCR calculation and reporting is carried out in accordance with the Delegated Commission Regulation (EU) 2015/61 of October 10, 2014, which has been in force since October 2015. With the respect of NSFR, the bank reports to the NBP according to the standards established by EBA in 2014, and reports to the PSFA in the form of a dedicated questionnaire.

The liquidity strategy is pursued by active management of the balance sheet structure and future cash flows as well as maintenance of liquidity reserves adequate to liquidity needs depending on the activity of the bank and the current market situation as well as funding needs of the Group subsidiaries. The bank manages liquidity risk at two levels: strategic (within committees of the bank) and operational (Treasury Department).

Liquidity risk limiting covers supervisory (M3, M4, LCR) and internal measures. The liquidity risk internal limit system is based mainly on defining acceptable level of gaps in stress conditions in specific time horizons and for different liquidity risk profiles (for all currencies in aggregate converted to PLN and for individual foreign currencies).

The bank has a centralised approach to the Group’s funding management in order to increase the efficiency of liquidity resources used. The subsidiaries are financed by mBank through the Treasury Department. Additionally, mBank Hipoteczny raises funding in the market by issuance of covered bonds and short-term debt securities and mLeasing raises funding by issuance of short-term debt securities.

The bank has the Contingency Plan in case of a threat of losing financial liquidity, which sets the strategy and procedures to be implemented in the event of a situation connected with the risk of losing liquidity by mBank Group and aimed at neutralising this threat. The document defines the division of responsibility for monitoring and identifying threats, and actions during the emergency situation. The Contingency Plan is tested at least annually.

The bank limits the volume and term concentration of foreign currency funding of mBank with FX swaps and CIRS. In addition, the limit is decomposed into individual limits for CIRS and FX swaps as well as limits for funding in EUR and CHF. The structure of these limits reflects the bank’s preferences for funding structure in those currencies.

The liquidity of mBank remained at a safe level in 2019, as reflected in the high surplus of liquid assets over short-term liabilities in LAB measures and in the levels of regulatory measures.

The table below presents the LAB gaps for tenors up to 1M and 1Y and the regulatory measures M3, M4, LCR in 2019:

The Group’s liquidity risk measurement includes in addition mBank Hipoteczny and mLeasing. mBank monitors liquidity risk of the subsidiaries to protect liquidity also at the Group level in the event of adverse events (crises).

The Group’s liquidity was at a safe level in 2019, as reflected in the high surplus of liquid assets over short-term liabilities in the LAB measures and the LCR calculated at the Group level.

The table below presents the LAB gaps for tenors up to 1M and 1Y and the LCR at mBank Group level:

In order to effectively manage operational risk, the bank applies quantitative and qualitative methods and tools, which intend to cause-oriented operational risk management.

The basic qualitative tool is the Internal Control System Self-Assessment carried out by the bank’s organisational units and the Group subsidiaries. The Self-Assessment process aims to provide communication about the need to change and improve control processes, and thus a more pro-active approach to operational risk management and increasing operational risk awareness in mBank Group. The end result of the Self-Assessment is the evaluation of risks, control mechanisms and independent monitoring of control mechanisms as well as the creation of corrective action plans aimed at changing the structure or the optimization of the control mechanisms and their independent monitoring.

The bank also prepares scenario analyses describing risks associated with rare operational risk events with potentially very serious consequences.

In accordance with the requirements of Recommendation M, the bank has a process for identifying threats associated with operational risk in all relevant areas of the bank’s operations and for creating new and modifying existing products, processes and systems, as well as for changes in the organisational structure.

Quantitative tools include mainly collection of data on operational events and effects. With the use of the database available at mBank Group, data on operational risk losses are recorded with an emphasis on the cause. Recorded data are analysed by the Integrated Risk Management Department and at organisational units. This approach allows organisational units to carry out ongoing monitoring of their current risk profile. mBank has an access to external operational loss databases and applies them to analyse operational risk and potential threats, that institutions operating in the financial sector are exposed to.

The key risk indicators (KRI) are another tool. Ongoing monitoring of risk factors recognized as key at the given moment allows for prediction of an increased level of operational risk and adequate response by the organisational units in order to avoid the occurrence of operational events and losses.

The organisation of the operational risk control and management system is aimed at enabling effective control and management of this risk at every level of the bank’s organisational hierarchy. The structure of operational risk control and management covers in particular the role of the Management Board of the bank, the Business and Risk Forum, the Chief Risk Officer, the Integrated Risk Management Department, and the tasks assigned to persons managing operational risk in particular organisational units and business areas of the bank. The operational risk control and management process at the bank is developed and coordinated by the central operational risk control function while operational risk management takes place in every organisational unit of the bank and in every subsidiary of mBank Group. It consists in identifying and monitoring operational risk and taking actions aimed to avoid, mitigate or transfer operational risk. The operational risk control process is supervised by the Supervisory Board of the bank through its Risk Committee.