72. Capital adequacy

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 statement of financial position to optimize the quality of the Bank’s own funds;
• emergency measures with regard to capital;
• stress-tests;
• planning and allocating the requirements of 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 actions 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 (as amended), hereinafter referred to as “the Act on macroprudential supervision”.
• 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 internal capital in banks.

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 conservation 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 2018, the cinservation buffer amounted to 1.875%.
• 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 macroprudential risk which may cause strong negative consequences for the financial system and the economy of a given country. As at 31 December 2018, the systemic risk buffer was equal to 3%.
• the buffer relating to the fact that the Bank has been identified as a systemically important institution (‘O-SII’) – on 31 July 2018, on the basis of an assessment of the Bank’s systemic importance in accordance with the Act on macroprudential supervision, the Group received an individual decision of the Polish Financial Supervision Authority imposing a buffer on the Group of 1% 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 29 November 2018, 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: 0.42 p.p.; Tier 1 capital ratio: 0.31 p.p.; and Tier 1 core capital ratio: 0.23 p.p.

In 2018 the Group received the Polish Financial Supervision Authority’s response as to the possibility of applying the 35% risk weight to PLN loans fully and completely secured by mortgage on housing properties. The Office of the PFSA indicated that the provisions of CRR are binding in this respect. The Group treats this position of the PFSA as a possibility to apply the preferential risk weight on a wider basis, including using an extended catalogue of source data on properties for the purpose of assessing the value of the collateral.

In 2018 and in 2017, the Group maintained a safe capital base in excess of the supervisory and regulatory limits.

In 2018, the Group’s capital adequacy level remained at a safe level, well above the supervisory limits.

The increase in the Group’s Tier 1 capital before regulatory adjustments and reductions between 31 December 2018 and 31 December 2017 resulted from:

• a decision adopted on 18 June 2018 by the General Meeting of Shareholders on the appropriation of the Bank’s net profit for 2017 by transferring PLN 2 086 million to supplementary and reserve capital (and, at the same time, allocating PLN 687.5 million for dividends for shareholders). The resulting increase in the Bank’s own funds amounted to PLN 264.5 million, as the balance of the net profit for 2017 (PLN 1 822 million) had already been included in own funds as at 31 December 2017 since the Bank had received the required permissions from the PFSA to include the net profit earned for the three quarters of 2017, less the anticipated charges, in core Tier 1 capital,
• permission from the PFSA received by the Bank on 27 September 2018 to include the net profit of PKO Bank Polski SA for the first half of 2018, less the anticipated charges (of PLN 1 135 million) in Tier 1 core capital;
• permission from the PFSA received by the Bank on 25 December 2018 to include the net profit of PKO Bank Polski SA for the third quarter of 2018, less the anticipated charges (of PLN 500 million) in Tier 1 core capital.
• permission from the PFSA obtained by PKO Bank Hipoteczny SA on 22 October 2018 to treat the company’s net profit for the first half of 2018 as Tier 1 capital after reducing it by the expected charges (of PLN 43 million).

Changes in Tier 2 capital between 31 December 2018 and 31 December 2017 were brought about by the PFSA’s permission for the Bank to include a new issue of its subordinated bonds of PLN 1,000 million in own funds, obtained in March 2018.

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

Without taking into account the transitional arrangements for mitigating the impact of the introduction of IFRS 9 on own funds, as at 31 December 2018, the Group’s own funds would have amounted to PLN 36 992 million, its Tier 1 capital would have amounted to PLN 34 292 million, the total capital ratio would have amounted to 18.534%, and the Tier 1 capital ratio would have amounted to 17.18%.

In 2018, 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 Macroprudential 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 2018 and 2017, 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.

The Group announces, on a six monthly basis, 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).