55. Credit risk management

Credit risk is defined as the risk of losses being incurred as a result of a customer’s default on its liabilities towards the Group or the risk of a decrease in the economic value of amounts due to the Group as a result of deterioration of a customer’s ability to repay the customers’ liabilities.

The objective of credit risk management is to minimize losses on the loan portfolio as well as to minimize the risk of occurrence of loans at risk of impairment, while keeping the expected level of profitability and value of loan portfolio.

The Bank and the Group subsidiaries are guided mainly by the following credit risk management principles:

• every loan transaction is subject to comprehensive credit risk assessment, which is reflected in an internal rating or credit scoring;
• credit risk relating to loan transactions is measured at the stage of examining a loan application and on a regular basis, as part of the monitoring process, taking into consideration changes in external conditions and in the financial standing of the borrowers;
• credit risk assessment of exposures is separated from the sales function by ensuring an appropriate organizational structure, independence in developing and validating tools supporting an assessment of credit risk and independence of decisions approving deviations from the suggestions resulting from using these tools;
• terms and conditions of a loan transactions offered to a customer depend on the assessment of credit risk level generated by the transaction;
• credit decisions may be taken solely by persons authorized to do so;
• credit risk is diversified, in particular, in terms of geographical areas, industries, products and customers;
• an expected credit risk level is mitigated by collateral received by the Bank, margins from customers and impairment allowances (provisions) for expected credit losses.

The above-mentioned principles are implemented by the Group through the use of advanced credit risk management methods, both at the level of individual credit exposures and of the entire loan portfolio of the Group. These methods are verified and developed to ensure compliance with the requirements of the internal rating-based method (IRB), i.e. an advanced credit risk measurement method which may be used to calculate the capital requirements for credit risk, subject to an approval by the Polish Financial Supervision Authority.

The Group entities which have significant credit risk levels (the KREDOBANK SA Group, the PKO Leasing SA Group, PKO Bank Hipoteczny SA and Finansowa Kompania “Prywatne Inwestycje” sp. z o.o.) manage their credit risk individually, but the methods used for credit risk assessment and measurement are adjusted to the methods used by PKO Bank Polski SA, taking into account the specific nature of activities of these companies.

Any changes to the solutions used by the Group’s subsidiaries must be agreed every time with the Bank’s units responsible for risk management.

The PKO Leasing SA Group, the KREDOBANK SA Group, and Finansowa Kompania “Prywatne Inwestycje” sp. z o.o. and PKO Bank Hipoteczny SA measure their credit risk regularly and the results of such measurements are submitted to the Bank.

Within the structures of PKO Bank Hipoteczny SA, the KREDOBANK SA Group and the PKO Leasing SA Group, there are organizational units in the risk management areas which are responsible, in particular, for:

• developing methodologies for credit risk assessment and recognition of provisions and allowances;
• control over and monitoring of credit risk in the lending process;
• quality and efficiency of the restructuring and debt collection processes;

In these companies, the credit decision limits depend primarily on: the amount of the exposure to a given customer, the amount of an individual credit transaction and the duration of the lending period.

The process of credit decision-making in PKO Bank Hipoteczny SA, the KREDOBANK SA Group and the PKO Leasing SA Group is supported by credit committees which are involved in the process for credit transactions which generate an increased credit risk level.

Relevant organizational units of the Risk Management Area participate in managing the credit risk in the Group entities by consulting projects and periodically reviewing internal regulations of these entities relating to the assessment of credit risk, and by making recommendations for amendments to such internal regulations. The Bank supports implementation of the recommended changes in credit risk assessment policies in the Group entities.

Credit risk forecasting and monitoring involves preparing risk level forecasts and monitoring deviations from the forecasts or the adopted benchmarks (e.g. limits, thresholds, plans, prior period measurements, recommendations and instructions issued by external supervisory and regulatory authority), and performing (specific and comprehensive) stress tests. Risk level forecasts are subject to backtesting.

Credit risk is monitored at the level of individual credit transactions and at portfolio level.

Credit risk monitoring at the individual loan transaction level is governed, in particular, by the Group’s internal regulations concerning:

• assessment of the credit risk related to customer financing;
• method of assessing customers;
• identification of groups of related entities;
• evaluation of collateral and inspection of investments;
• recognition of allowances for expected credit losses;
• Early Warning System;
• operating procedures.

In order to accelerate the response to the warning signals noted reflecting an increased credit risk level, the Group uses and develops an IT application, the Early Warning System (EWS).

Credit risk monitoring at the portfolio level consists in:

• supervising the level of the portfolio credit risk on the basis of the adopted tools used for measuring credit risk, taking into consideration the identified sources of credit risk and analysing the effects and actions taken as part of system management;
• recommending preventive measures in the event of identifying an increased level of credit risk.

Credit risk reporting includes periodical reporting of the loan portfolio risk exposure.

The Group prepares monthly and quarterly credit risk reports. Credit risk reporting covers regular information on the scale of the risk exposure of the loan portfolio. In addition to information for the Bank, the reports also include information on the level of credit risk in the Group entities where a material level of credit risk was identified (e.g. the KREDOBANK SA Group, the PKO Leasing SA Group, PKO Bank Hipoteczny SA).

The purpose of management actions is to shape and optimize the credit risk management system and credit risk level at the Group.

The credit risk management actions include particularly:

• issuing internal regulations governing the credit risk management system at the Group;
• issuing recommendations, guidelines for conduct, explanations and interpretation of the Group’s internal regulations;
• taking decisions regarding the acceptable level of credit risk, including in particular lending decisions;
• developing and improving credit risk control tools and mechanisms which make it possible to maintain the credit risk level within the limits acceptable to the Group;
• developing and monitoring the operation of credit risk management controls;
• developing and improving credit risk assessment methods and models;
• developing and improving IT tools used in credit risk management;  planning actions and issuing recommendations.

The main credit risk management tools used by the Group include:

• minimum transaction requirements (risk parameters) determined for a given type of transaction (e.g. minimum LTV value, maximum loan amount, required collateral),
• the principles of defining credit availability, including cut-offs – the minimum number of points awarded in the process of creditworthiness assessment with the use of a scoring system (for retail customers and SMEs) or the customer’s rating class (for corporate clients), which a client must obtain to receive a loan;
• concentration limits – limits defined in the Regulation of the European Parliament and the Council (EU) No. 575/2013 on prudential requirements for credit institutions and investment firms (CRR Regulation) and the Polish Banking Law, or internal limits defining concentration risk appetite;
• industry-related limits – limits which reduce the risk level related to financing institutional customers conducting business activities in industries characterized by high level of credit risk;
• the limits defining the appetite for credit risk resulting from, among other things, Recommendations S and T;
• credit limits defining the Group’s maximum exposure to a customer or a country in respect of wholesale market transactions, settlement limits and limits for exposure duration;
• authorization limits – limits defining the maximum level of credit decision-making powers with regard to the Group’s customers; the limits depend primarily on the amount of the Bank’s exposure to a given customer (or a group of related customers) and the lending period; authorization limits depend on the level (in the Bank’s organizational structure) at which credit decisions are made;
• minimum credit margins – credit risk margins relating to a given credit transaction concluded by the Group with a given corporate customer, where the interest rate offered to the customer should not be lower than the reference rate plus an appropriate credit risk margin. If the reference rate achieves a value equal to or lower than zero, the zero value should be adopted to determine the interest rate.

The collateral management policy plays a significant role in establishing minimum transaction terms. The Bank’s and the Group’s collateral management policy is meant to properly protect it against credit risk to which the Group is exposed, including first and foremost by establishing collateral as liquid as possible. Collateral may be considered liquid if it can be sold without a significant decrease in its price and at a time which does not expose the Bank to a change in the collateral value due to price fluctuations typical for a given asset.

The Group strives to diversify collateral in terms of its forms and assets used as collateral.

The Group evaluates collateral from the perspective of the actual possibility of using it to satisfy its claims.

In addition, when assessing collateral, the Group takes into account the following factors:

• the economic, financial and economic, or social and financial position of entities which provide personal guarantees;
• the condition and market value of the assets accepted as collateral and their vulnerability to depreciation in the period of maintaining the collateral (the impact of the technological wear and tear of a collateralized asset on its value);
• potential economic benefits to the Group resulting from a specific method of securing receivables, including, in particular, the possibility of reducing allowances for expected credit losses;
• the method of establishing collateral, including the typical duration and complexity of formalities, as well as the necessary costs (the costs of maintaining collateral and the enforcement on collateral), using the Group’s internal regulations concerning the assessment of collateral;
• the complexity, time-consuming nature and economic and legal conditions of the effective realization of collateral, in the context of enforcement restrictions and the applicable principles for the distribution of the sums obtained from individual enforcement or in the course of bankruptcy proceedings, the ranking of claims;
• the type of collateral depends on the level of risk of a given customer or transaction.

When granting loans intended to finance housing and commercial properties, a mortgage on the financed property is an obligatory type of collateral.

Until an effective protection is established (depending on the type and amount of a loan), the Group may accept temporary collateral in different form.

With regard to consumer loans, usually personal guarantees (a civil law surety/guarantee, a bill of exchange) are used or collateral is established on the customer’s bank account, car or securities.

The collateral for loans intended for the financing of small- and medium-sized enterprises as well as corporate customers is established, among other things: on receivables from business operations, bank accounts, movables, real estate or securities. The collateral management policy is set out in the internal regulations of the Group’s subsidiaries.

When concluding lease agreements, the PKO Leasing SA Group, as the owner of the assets leased, treats the leased assets as collateral.