65. 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;
• MREL ratio in relation to total equity and liabilities.

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 emergency measures to be implemented or a capital protection plan to be prepared.

Major regulations applicable in the capital adequacy assessment process include:

• the Polish Banking Law;
• the CRR;
• the Act of 5 August 2015 on macro-prudential supervision over the financial system and crisis management in the financial system (as amended), hereinafter referred to as “the Act on macro-prudential supervision”;
• the Regulation of the Minister of Finance of 6 March 2018 on the risk management and internal control systems, remuneration policy and the detailed procedure for estimating the internal capital in banks;
• the Act of 10 June 2016 on the Bank Guarantee Fund, Deposit Guarantee Scheme and Resolution.

In accordance with Article 92 of the CRR, 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 Act on macro-prudential supervision, the Group is obliged to maintain a combined buffer above the minimum set in Article 92 of the CRR Regulation, representing the sum of the applicable buffers, namely:

• the conservation buffer which applies to all banks. As at 31 December 2019, the conservation buffer amounted to 2.5%.

• 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. The countercyclical buffer for loan exposures on the territory of Poland is equal to zero. Due to the fact that the Group also conducts foreign activities, the level of the countercyclical buffer specific to the Group is 0.01%.
• the 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 2019, the systemic risk buffer was equal to 3% for exposures on the territory of Poland. Due to the fact that the Group also conducts foreign activities, the systemic risk buffer specific to the Bank’s Group is 2.88%
• O-SII buffer related to the Bank being identified as a systemically important institution, which did not change in 2019 and amounts to 1% of the total exposure to risk calculated in accordance with the IRR 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 (“discretionary capital requirement”). As at 31 December 2019, the discretionary capital requirement for consolidated capital ratios was: 0.36 p.p. for the total capital ratio; 0.27 p.p. for Tier 1 capital ratio; and 0.20 p.p. for Tier 1 core capital ratio.

Irrespective of the above buffers, to meet the requirements for distributing 100% of the profit, the Polish Financial Supervision Authority determined an add-on in respect of the Bank’s sensitivity to an adverse macroeconomic scenario, of 0.10 p.p.

On 4 November 2019, the Group received a letter from the Bank Guarantee Fund concerning the plan for achieving the required minimum level of own funds and liabilities which can be written off or converted (MREL). The MREL set for the Bank on the consolidated level amounted to 14.376% of the total liabilities and own funds (“TLOF”), which corresponds to 22.807% of the total risk exposure (“TRE”). This requirement should be achieved as at 1 January 2023. The BGF has set a path for reaching the target level of MREL according to which as at the end of 2019 the ratio of MREL to TLOF is 9.316% on the consolidated level, which corresponds to 14.779% of TRE. As at 31 December 2019 the Bank’s consolidated MREL ratio amounted to 11.665% in relation to TLOF and 18.419% in relation to TRE, significantly exceeding the transitional levels indicated by the Bank Guarantee Fund.

In 2019 and 2018, the Group’s capital adequacy level remained at a safe level, well above the supervisory limits.

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

According to CRR Regulations for capital adequacy purposes, prudential consolidation is used, unlike consolidation in accordance with IFRS, includes only subsidiaries that meet the definition of an institution, financial institution or any ancillary services enterprise.

In addition, pursuant to Article 19 Paragraph 1 of the CRR, prudential consolidation may exclude entities whose total value of assets and off-balance sheet items are less than EUR 10 million.

Other subsidiaries, not consolidated with the full method for the purposes of prudential consolidation are measured using the equity method.

The Group for the purposes of prudential consolidation consists of following entities:

• PKO Bank Polski SA;
• Grupa Kapitałowa PKO Leasing SA;
• PKO BP BANKOWY PTE SA;
• PKO Towarzystwo Funduszy Inwestycyjnych SA;
• Grupa Kapitałowa KREDOBANK SA;
• PKO Finance AB;
• PKO BP Finat sp. z o.o.;
• PKO Bank Hipoteczny SA;
• Grupa Kapitałowa Bankowe Towarzystwo Kapitałowe SA

Non-financial and insurance entities are excluded from the prudential consolidation.

The table below shows a reconciliation of items of the statement of financial position used to calculate own funds with the regulatory own funds.

In 2019, the Group calculated internal capital in accordance with the commonly binding legal regulations:

• the CRR;
• the Polish Banking Law;
• the Regulation of the Minister of Development and Finance 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 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 significant risk types is determined using the methods specified in the internal regulations.

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 publishes annual information in particular concerning risk management and capital adequacy in accordance with: the CRR Regulation and the executive acts to the CRR, guidelines of the European Banking Authority, including guidelines concerning disclosure requirements pursuant to section eight of the CRR Regulation (“EBA guidelines”), the Act on Macro-prudential supervision, the Polish Banking Law Act, Recommendations H, M and P issued by the Polish Financial Supervision Authority as part of the Report, “Capital adequacy and other information to be published by the Powszechna Kasa Oszczędności Banku Polskiego Spółka Akcyjna Group”.

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).