Risk management

FINANCIAL STATEMENTS RISK MANAGEMENT

Risk management

Financial risks

Risk governance

The Bank’s overall framework for identifying and managing risks is underpinned by independent second line of defence control functions, including the Risk Management department, Office of the Chief Compliance Officer, Environmental and Social Department, Finance Department, Evaluations Department and other relevant units. An Internal Audit Department acts as third line of defence and independently assesses the effectiveness of the processes within the first and second lines of defence. The Vice President, Risk and Compliance, Chief Risk Officer (CRO) is responsible for ensuring the independent risk management of the Banking and Treasury exposures, including adequate processes and governance structure for independent identification, measurement, monitoring and mitigation of risks incurred by the Bank. The challenge of the control functions, review of their status and assessment of their ability to perform duties independently falls within the remit of the Audit Committee of the Board.

 

Matters related to Bank-wide risk and associated policies and procedures are considered by the Risk Committee. The Risk Committee is accountable to the President. It oversees all aspects of the Banking and Treasury portfolios across all sectors and countries, and provides advice on Risk Management policies, measures and controls. It also approves proposals for new products submitted by Banking or Treasury. The membership comprises senior managers across the Bank including representatives from Risk Management, Finance, Banking and the Office of the General Counsel.

The Risk Committee is chaired by the VP Risk and Compliance, CRO.

 

The Managing Director, Risk Management reports to the VP Risk and Compliance, CRO and leads the overall management of the department. Risk Management provides an independent assessment of risks associated with individual investments undertaken by the Bank, and performs an ongoing review of the portfolio to monitor credit, market and liquidity risks and to identify appropriate risk management actions. It also assesses and proposes ways to manage risks arising from correlations and concentrations within the portfolio, and ensures that adequate systems and controls are put in place for identifying and managing operational risks across the Bank. It develops and maintains the Risk Management policies to facilitate Banking and Treasury operations and promotes risk awareness across the Bank.

 

In exercising its responsibilities, Risk Management is guided by its mission to:

 

  • Provide assurance to stakeholders that risk decision-making in the Bank is balanced and within agreed appetite, and that control processes are rigorously designed and applied; and
  • Support the Bank’s business strategy including the maximisation of transition impact through provision of efficient and effective delivery of risk management advice, challenge and decision-making.

 

Risks in 2016

Below is a summary of current top and emerging risks identified by the Bank. These are risks that, if they were to crystallise, have the potential to negatively affect the Bank’s ability to carry out its mandate and/or which would cause a material deterioration in its portfolio. These risks therefore provide a background to understanding the changes in the Bank’s risk profile and exposures and are closely monitored by management.

 

  • Political and economic environment in Turkey (the Bank’s largest country of operations). Weakening of the business environment, reduced investor confidence and vulnerability to US interest rates are likely to negatively impact the volatility of capital flows, foreign exchange rates, and debt availability.
  • Elevated uncertainties about political and economic outlook for the eurozone following the UK referendum to exit the EU.
  • Global dynamics following the US presidential election, with the likely shifts in the US approach towards international trade and the global environmental agreements, and its impact on the rest of the world trade and on multilateral cooperation.
  • Radicalisation and threat of terrorist activity in Middle East and beyond, undermining investment climate and intensifying the refugee crisis across borders.
  • The continued weakness in the oil price and in other export commodity prices often leading to currency devaluations, exacerbating budget problems and affecting creditworthiness of companies exposed to foreign currency risk in commodity producing countries.

 

In carrying out its mission, the Bank is exposed to financial risks through both its Banking and Treasury activities. These are principally credit, market, operational and liquidity risks.

 

A. Credit risk

Credit risk is the potential loss to a portfolio that could result from either the default of a counterparty or the deterioration of its creditworthiness. The Bank also monitors concentration risk, which arises when too high a proportion of the Bank’s exposure is to a single obligor and/or has the potential to simultaneously deteriorate due to correlation to an event. Exposures to obligors in the same country or sector are examples but such concentrations could also include clusters or subsets of country or sector portfolios.

 

The Bank is exposed to credit risk in both its Banking and Treasury activities, as Banking and Treasury counterparties could default on their contractual obligations, or the value of the Bank’s investments could become impaired. The Bank’s maximum exposure to credit risk from financial instruments is represented on the balance sheet, inclusive of the undrawn commitments related to loans and guarantees (see note 26 on page 71).

Details of collateral and other forms of risk reduction are provided within the respective sections on Banking and Treasury below.

 

Credit risk in the Banking portfolio: Management

 

Underlying principles and procedures

The Board of Directors approves a document that defines the principles underlying the credit process for the approval, management and review of Banking exposures. The Audit Committee periodically reviews these principles and its review is submitted to the Board for approval.

 

The Operations Committee reviews all Banking projects prior to their submission for Board approval. The Committee is chaired by the First Vice President and Head of Client Services Group and its membership comprises senior managers of the Bank, including the VP Risk & Compliance, CRO and the Managing Director, Risk Management. A number of frameworks for smaller projects are considered by the Small Business Investment Committee or by senior management under a delegated authority framework supervised by the Operations Committee. The project approval process is designed to ensure compliance with the Bank’s criteria for sound banking, transition impact and additionality. It operates within the authority delegated by the Board, via the President, to approve projects within Board-approved framework operations. The Operations Committee is also responsible for approving significant changes to existing operations.

 

The Equity Committee acts as the governance committee for the equity portfolio and reports to the Operations Committee. Risk Management is represented at both the Equity Committee and the Small Business Investment Committee.

 

Risk Management conducts reviews of all exposures within the Banking portfolio. At each review, Risk Management assesses whether there has been any change in the risk profile of the exposure, recommends actions to mitigate risk and reconfirms or adjusts the risk rating. It also reviews the fair value of equity investments.

 

Portfolio level review

Risk Management reports on the development of the portfolio as a whole on a quarterly basis to senior management and the Audit Committee of the Board. The report includes a summary of key factors affecting the portfolio and provides analysis and commentary on trends within the portfolio and various sub-portfolios. It also includes reporting on compliance with all portfolio risk limits including an explanation of any limit breaches.

 

To identify emerging risk and enable appropriate risk mitigating actions Risk Management also conducts regular Bank-wide (top-down) and regional (bottom-up) stress testing exercises and comprehensive reviews of its investment portfolios. The Bank recognises that any resulting risk mitigation is constrained by the limited geographical space within which the Bank operates.

 

EBRD internal ratings

Probability of default (PD)

The Bank assigns its internal risk ratings to all counterparties, including borrowers, investee companies, guarantors, put counterparties and sovereigns in the Banking and Treasury portfolios. Risk ratings reflect the financial strength of the counterparty as well as consideration of any implicit support, for example from a major shareholder. The sovereign rating takes into consideration the ratings assigned by external rating agencies. For sovereign risk projects, the overall rating is the same as the sovereign rating. For non-sovereign operations, probability of default ratings are normally capped by the sovereign rating, except where the Bank has recourse to a guarantor from outside the country which may have a better rating than the local sovereign rating.

The table below shows the Bank’s internal probability of default rating scale from 1.0 (lowest risk) to 8.0 (highest risk) and how this maps to the external ratings of Standard & Poor’s (S&P). References to risk rating through this text relate to probability of default ratings unless otherwise specified.

 

EBRD risk rating category

EBRD risk rating

External rating equivalent

Category name

Broader category

1

1.0

 

AAA

Excellent

 

2

1.7

2.0

2.3/2.5

AA+

AA

AA-

Very strong

 

Investment grade

 

3

2.7

3.0

3.3

A+

A

A-

 

Strong

 

4

3.7

4.0

4.3

BBB+

BBB

BBB-

 

Good

 

5

4.7

5.0

5.3

BB+

BB

BB-

 

Fair

Risk class 5

6

5.7

6.0

6.3

 

B+

B

B-

Weak

Risk class 6

7

6.7

7.0

7.3

CCC+

CCC

CCC-/CC/C

Special attention

 

 

Classified

8

8.0

D

Non-performing

 

Loss given default (LGD)

The Bank also assigns loss given default ratings on a scale of 0 to 100 determined by the seniority of the instrument in which the Bank invested and the jurisdiction and sector of the transaction.

 

Non-performing loans (NPL)

NPL definition

An asset is designated as non-performing when either the borrower is more than 90 days past due on payment to any material creditor, or when Risk Management considers that the counterparty is unlikely to pay its credit obligations in full without recourse by the Bank to actions such as realising security, if held.

 

Provisioning methodology

A specific provision is raised on all NPLs accounted for at amortised cost. The provision represents the amount of anticipated loss, being the difference between the outstanding amount from the client and the expected recovery amount. The expected recovery amount is equal to the present value of the estimated future cash flows discounted at the loan’s original effective interest rate.

General portfolio provisions

In the performing portfolio, provisions are held against losses incurred but not identified at the balance sheet date. These amounts are based on the PD rates associated with the rating assigned to each counterparty, the LGD parameters reflecting product seniority and the Exposure at Default (EAD). EAD is calculated based on outstanding operating assets and the expected disbursement of committed but not yet drawn amounts.

 

Credit risk in the Banking portfolio: 2016

Total Banking loan exposure (operating assets including fair value adjustments but before provisions) increased during the year from €22.2 billion at 31 December 2015 to €23.2 billion at 31 December 2016. The total signed Banking loan portfolio and guarantees increased from €33.4 billion at 31 December 2015 to €33.8 billion at 31 December 2016.

The average credit profile of the portfolio remained unchanged in 2016 as the weighted average probability of default (WAPD) rating improved slightly to 5.80 (2015: 5.81). Classified assets (those risk-rated 6.7 to 8.0) increased from 26.1 to 26.9 per cent and the absolute level now stands at €9.2 billion (2015: €8.8 billion). This performance largely reflected a deterioration in the economic and political environment since the end of 2014 in the countries where the Bank invests, most notably in Turkey, Ukraine and Russia.

 

Credit risk in the Banking portfolio 2016

 

 

 

NPLs26 still remain low relative to the average portfolio risk rating, amounting to €1.3 billion or 5.5 per cent of operating assets at year-end 2016 (2015: €1.3 billion or 5.9 per cent). Distressed restructured loans27 were also relatively low, at €626 million or 2.7 per cent of operating assets at year-end 2016 (2015: €516 million or 2.3 per cent). Net write-offs amounted to €79 million in 2016 (2015: €60 million). Write-offs are typically relatively low as the Bank benefits from its strong liquidity and capitalisation to work out distressed loans.

 

Specific provisions remained broadly at the same level in 2016. This reflects the macro-financial environment in the countries in which the Bank invests, particularly in Turkey, Ukraine and Russia, which in turn affected the quality of the Bank’s portfolio.

 

Movement in NPLs28

2016

€ million

2015

€ million

Opening balance

1,316

1,183

Repayments

(228)

(216)

Write-offs

(79)

(60)

New impaired assets

269

330

Other movements

14

79

Closing balance

1,292

1,316

Movement in specific provisions29

2016

€ million

2015

€ million

Opening balance

799

631

Provision cover

64%

54%

New/increased specific provisions

189

266

Provisions release – repayments

(117)

(54)

Provisions release – restructuring

(11))

-

Provisions release – write-offs

(79)

(39)

Provisions release – loans sold

-

(20)

Release against amounts recovered from guarantees

-

(3)

Foreign exchange movement

13

45

Unwinding discount30

(29)

(27)

Closing balance

765

799

Provision cover31

63%

64%

 

Loan investments at amortised cost

Set out below is an analysis of the Banking loan investments and the associated impairment provisions for each of the Bank’s internal risk rating categories.

 

 

Risk rating category

Neither past

due nor

impaired

€ million

Past due

but not

impaired

€ million

Impaired

€ million

Total

€ million

Total %

Portfolio

provisions for

unidentified

impairment

€ million

Specific

provisions for

identified

impairment

€ million

Total net of

impairment

€ million

Impairment

provisions %

2: Very strong

4

-

-

4

-

-

-

4

-

3: Strong

292

-

-

292

1.2

-

-

292

-

4: Good

2,365

-

-

2,365

11.5

(2)

-

2,364

-

5: Fair

6,998

-

-

6,998

30.6

(10)

-

6,998

0.1

6: Weak

7,562

-

-

7,562

33.1

(69)

-

7,493

0.9

7: Special

attention

4,449

3

-

4,448

19.5

(199)

-

4,249

4.5

8: Non-

performing32

-

-

1,216

1,216

5.3

-

(765)

451

62.9

At 31 December 2016

21,666

3

1,216

22,885

100.0

(297)

(765)

21,841

 

Risk rating category

Neither past

due nor

impaired

€ million

Past due

but not

impaired

€ million

Impaired

€ million

Total

€ million

Total %

Portfolio

provisions for

unidentified

impairment

€ million

Specific

provisions for

identified

impairment

€ million

Total net of

impairment

€ million

Impairment

provisions %

2: Very strong

11

-

-

11

0.1

-

-

11

-

3: Strong

416

-

-

416

1.9

-

-

416

-

4: Good

2,503

-

-

2,503

11.5

(2)

-

2,501

0.1

5: Fair

6,630

-

-

6,630

30.4

(11)

-

6,619

0.2

6: Weak

7,206

15

-

7,221

33.0

(66)

-

7,115

0.9

7: Special

attention

3,774

14

-

3,778

17.44

(205)

-

3,583

5.4

8: Non-

performing

-

-

1,248

1,248

5.7

-

(799)

449

64.1

At 31 December 2015

20,540

29

1,248

21,817

100.0

(284)

(799)

20,734

 

 

At the end of 2016, €3 million of loans were past due but not impaired. Loans amounting to €3 million were outstanding for more than 30 days but less than 90 days (2015: €29 million past due, of which €20 million were outstanding for less than 30 days, and €9 million were outstanding for more than 30 days but less than 90 days).

 

At 31 December 2016 the Bank had security arrangements in place for €7.5 billion of its loan operating assets (2015: €6.9 billion). It also benefited from guarantees and risk-sharing facilities provided by Special Funds and Cooperation Funds (see note 29 on page 74: Related Parties) which provided credit enhancement of approximately €63 million at the year-end (2015: €66 million).

 

Loans at fair value through profit or loss

Set out below is an analysis of the Bank’s loans held at fair value through profit or loss for each of the Bank’s relevant internal risk rating categories.

 

Risk rating category

Fair value

2016

€ million

Fair value

2015

€ million

5: Fair

14

135

6: Weak

222

124

7: Special attention

71

64

8: Non-performing

6

16

At 31 December

313

339

 

Undrawn loan commitments and guarantees

Set out below is an analysis of the Bank’s undrawn loan commitments and guarantees for each of the Bank’s relevant internal risk rating categories.

 

Risk rating category

Undrawn loan

commitments

2016

€ million

Guarantees

2016

€ million

Undrawn loan

commitments

2015

€ million

Guarantees

2015

€ million

3. Strong

28

-

37

-

4: Good

1275

-

1,044

-

5. Fair

2,123

20

2,001

21

6: Weak

3,642

195

4,312

237

7: Special attention

2,850

322

3,088

298

8: Non-performing

111

28

147

20

At 31 December

10,029

565

10,629

576

The Bank would typically have conditions precedent that would need to be satisfied before further disbursements on its debt transactions. In addition, for projects risk rated 8, it is unlikely that commitments would be drawn down without additional assurances that credit quality would improve.

 

Credit risk in the Banking portfolio: Concentration

Concentration by country

The following table breaks down the main Banking credit risk exposures in their carrying amounts by country. In 2015 Turkey became the largest country exposure. Yet the Bank is generally well diversified by country apart from its concentration in Turkey, Russia and Ukraine which account for 18.8, 12.4 and 11.3 per cent of loans drawn down respectively (as shown below) and 14.7, 9.4 and 14.4 per cent of the Bank’s total loans including undrawn respectively. However, by the nature of the regional focus of the Bank’s business model, some groups of countries in which the Bank operates are highly correlated.

 

 

Loans

2016

€ million

Undrawn loan

commitments

and guarantees

2016

€ million

Total

2016

€ million

Loans

2015

€ million

Undrawn loan

commitments

and guarantees

2015

€ million

Total

2015

€ million

Albania

153

340

493

225

209

434

Armenia

154

74

228

189

72

261

Azerbaijan

548

378

962

567

470

1,037

Belarus

358

105

463

434

55

489

Bosnia and Herzegovina

584

403

987

583

301

884

Bulgaria

818

152

970

584

102

686

Croatia

882

145

1,027

751

217

968

Cyprus

10

64

74

-

13

13

Czech Republic

4

-

4

5

-

5

Egypt

714

1,069

1,783

627

839

1,466

Estonia

70

-

70

59

40

99

Former Yugoslav Republic of Macedonia

242

474

716

240

596

836

Georgia

553

127

680

397

184

581

Greece

356

148

504

49

-

49

Hungary

256

47

303

272

55

372

Jordan

307

389

696

228

207

435

Kazakhstan

1,651

823

2,474

1,370

657

2,027

Kosovo

38

114

152

16

90

106

Kyrgyz Republic

174

72

246

138

95

233

Latvia

107

2

109

90

23

113

Lithuania

31

-

31

22

-

22

Moldova

140

340

480

142

304

446

Mongolia

896

42

938

488

416

904

Montenegro

208

138

346

171

228

39

Morocco

289

425

714

228

418

646

Poland

1,541

752

2,293

1,584

561

2,145

Romania

1,009

201

1,210

1,326

243

1,569

Russia

1,731

174

1,905

2,753

381

4,004

Serbia

1,267

737

2,004

1,064

1,071

2,135

Slovak Republic

150

160

310

387

18

405

Slovenia

185

19

204

173

6

179

Tajikistan

108

265

373

98

237

335

Tunisia

151

94

245

178

38

216

Turkey

5,094

755

5,849

4,163

758

4,921

Turkmenistan

25

12

37

34

8

42

Ukraine

2,386

1,554

3,940

2,505

2,293

4,798

Uzbekistan

8

-

8

16

-

16

At 31 December

23,198

10,594

33,792

22,156

11,205

33,361

 

Concentration by industry sector

 

The following table breaks down the main Banking credit exposures in their carrying amounts by the industry sector of the project. The portfolio is generally well diversified with only depository credit (banks) constituting a material sector concentration.

 

 

Loans

2016

€ million

Undrawn loan

commitments

and guarantees

2016

€ million

Total

2016

€ million

Loans

2015

€ million

Undrawn loan

commitments

and guarantees

2015

€ million

Total

2015

€ million

Agribusiness

2,014

518

2,532

2,268

504

2,772

Depository credit (banks)

5,020

881

5,901

5,023

933

5,956

Information and communication

technologies

602

91

693

295

21

316

Insurance, pension, mutual funds

57

-

57

55

2

57

Leasing finance

470

39

509

374

126

500

Manufacturing and services

2,486

319

2,805

2,486

319

2,805

Municipal and environmental

infrastructure

1,323

998

2,321

1,323

998

2,321

Natural resources

1,814

883

2,697

1,814

883

2,697

Non-depository credit (non-bank)

498

52

550

498

52

550

Power and energy

2,668

990

3,678

2,804

797

3,601

Property and tourism

314

112

426

292

230

522

Transport

1,630

626

2,256

1,899

734

2,623

Non-sovereign

19,200

5,479

24,679

19,121

5,599

24,720

Sovereign

3,998

5,115

9,113

3,035

5,606

8,641

At 31 December

23,198

10,594

33,792

22,156

11,205

33,361

 

Concentration by counterparty

Maximum exposure (after risk transfers) to a non-sovereign economic group was €687 million at year-end 2015 (2014:  €647 million). The Bank has a maximum nominal as well as risk-based non-sovereign Banking counterparty exposure limits.

 

Credit risk in Treasury: Management

Key risk parameters for funding, cash management, asset and liability management and liquidity risk appetite are approved by the Board of Directors and articulated in the Treasury Authority and Liquidity Policy (TALP). The TALP is the document by which the Board of Directors delegates authority to the Senior Vice President, Chief Financial Officer and Chief Operating Officer to manage and the Vice President Risk & Compliance, CRO to identify, measure, monitor and mitigate the Bank’s Treasury exposures. The TALP covers all aspects of Treasury activities where financial risks arise and also Risk Management’s identification, measurement, management and mitigation of those risks. In addition, Treasury and Risk Management Guidelines (TRMG) are approved by the Senior Vice President, Chief Financial Officer and Chief Operating Officer and the VP Risk & Compliance, CRO to regulate operational aspects of Treasury risk-taking and the related risk management processes and procedures.

 

Eligible Treasury counterparties and investments are normally rated between 1.0 and 3.3 (approximately equivalent to S&P AAA to A– ratings), with the exception of counterparties approved for local currency activities in the countries where the Bank invests. These activities support the Bank’s initiatives to provide local currency financing to Banking clients and to develop local capital markets. In cases where the creditworthiness of an issuer or counterparty deteriorates to levels below the standard of eligibility for new exposures, Risk Management and Treasury jointly recommend actions for the approval of the VP Risk & Compliance, CRO and the Senior Vice President, Chief Financial Officer and Chief Operating Officer. Any decision to retain ineligible exposures is reported to the Audit Committee.

 

The TRMG state the minimum rating and maximum tenor by type of eligible counterparty and set the maximum credit limits per rating. The internal credit rating scale is the same as that used for Banking exposure. The actual credit limit and/or tenor approved for individual counterparties by Risk Management may be smaller or shorter than the ceilings defined in the TRMG, based on the likely direction of creditworthiness over the medium term, or on sector considerations. The limits apply across the range of eligible Treasury products for the relevant counterparty with exposures measured on a risk-adjusted basis. All individual counterparty and investment credit lines are monitored and reviewed by Risk Management at least annually.

 

The Bank’s exposure measurement methodology for Treasury credit risk uses a “Monte Carlo” simulation technique that produces, to a high degree of confidence, maximum exposure amounts at future points in time for each counterparty (in practice, 95 per cent eVaR).33 This includes all transaction types and is measured out to the maturity of the longest dated transaction with that counterparty. These potential future exposures (PFE) are calculated and controlled against approved credit limits on a daily basis with exceptions escalated to the relevant authority level for approval.

 

Risk mitigation techniques (such as netting and collateral) and risk transfer instruments reduce calculated credit exposure. For example, Credit Support Annexes (CSA) for OTC derivatives activity reduce PFE in line with collateral posting expectations.

 

Credit risk in Treasury: Treasury liquid assets

The carrying value of Treasury’s liquid assets stood at €24.0 billion at 31 December 2016 (2015: €23.8 billion).34

 

The internal ratings of Treasury’s counterparties and sovereign exposures are reviewed at least annually and adjusted as appropriate. Overall the WAPD rating, weighted by the carrying value of Treasury’s liquid assets, deteriorated to 2.34 at 31 December 2016 (2015: 2.23)

 

Credit quality of Treasury’s liquid assets Credit quality of Treasury’s liquid assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Placements with and advances to credit institutions

Set out below is an analysis of the Bank’s placements with and advances to credit institutions for each of the Bank’s relevant internal risk rating categories.

Risk rating category

2016

€ million

2015

€ million

1: Excellent

568

143

2: Very strong

2,238

2,619

3: Strong

10,384

8,498

4: Good

422

422

5: Fair

436

19

6: Weak

42

23

At 31 December

14,110

11,724

At 31 December 2015 there were no placements with and advances to credit institutions that were past due or impaired (2015: €nil).

 

Debt securities at fair value through profit or loss

Set out below is an analysis of the Bank’s debt securities at fair value through profit or loss for each of the Bank’s relevant internal risk rating categories.

 

Risk rating category

2016

€ million

2015

€ million

1: Excellent

223

267

2: Very strong

502

401

3: Strong

-

-

4: Good

127

26

5: Fair

3

52

6: Weak

71

1

At 31 December

92

747

There were no debt securities at fair value past due in 2016 (2015: €nil).

 

Debt securities at amortised cost

Set out below is an analysis of the Bank’s debt securities at amortised cost for each of the Bank’s relevant internal risk rating categories.

.

 

Risk rating category

2016

€ million

2015

€ million

1: Excellent

4,918

5,751

2: Very Strong

2,790

3,709

3: Strong

1,273

1,869

At 31 December

8,981

11,329

There were no debt securities at amortised cost past due in 2016 (2015: €nil).

 

Treasury potential future exposure

In addition to Treasury’s liquid assets there are other products such as OTC swaps and forward contracts that are included within Treasury’s overall PFE. PFE calculations show the future exposure throughout the life of a transaction or, in the case of collateralised portfolios, over the appropriate unwind periods. This is particularly important for Treasury’s repo/reverse repo activity and hedging products such as OTC swaps and forwards. Calculation of PFE reduces counterparty exposures through standard risk mitigations such as netting and collateral, which enables Risk Management to see a comprehensive exposure profile of all Treasury products (including liquid assets) against a specific counterparty limit on a daily basis.

 

Treasury PFE stood at €20.7 billion at 31 December 2016 (2015: €20.6 billion).

 

Treasury maintained a high quality average credit risk profile during 2016 by investing liquidity in AAA sovereign and other highly rated assets. However the WAPD rating, weighted by PFE exposures, deteriorated slightly to 2.19 at 31 December 2016 (2015: 2.08).

A very low proportion of Treasury exposures was below investment grade quality,35 amounting to 2.8 per cent at 31 December 2016 (2015: 0.7 per cent). This comprised a small pool of local currency liquidity assets held with counterparties from the countries in which the Bank invests together with several financial sector bonds.

 

Credit quality of Treasury PFE Credit quality of Treasury PFE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

There were no impaired assets in the Treasury portfolio at 31 December 2016 (2015: €nil).

 

Derivatives

The Bank makes use of derivatives for different purposes within both its Banking portfolio and its Treasury activities. Within the Banking portfolio option contracts are privately negotiated with third parties to provide potential exit routes for the Bank on many of its unlisted share investments. Banking also has a limited portfolio of swaps with clients to hedge their market risks or to facilitate hard currency funding. Furthermore, Banking has a small number of currency swaps that are fully hedged and have been entered into with clients to assist them in the management of their market risks. Within Treasury, use of exchange-traded and OTC derivatives is primarily focused on hedging interest rate and foreign exchange risks arising from Bank-wide activities. Market views expressed through derivatives are also undertaken as part of Treasury's activities (within the tight market risk limits described on page 44), while the transactions through which the Bank funds itself in capital markets are typically swapped into floating-rate debt with derivatives.

 

The risks arising from derivative instruments are combined with those deriving from all other instruments dependent on the same underlying risk factors, and are subject to overall market and credit risk limits, as well as to stress tests. Additionally, special care is devoted to those risks that are specific to the use of derivatives through, for example, the monitoring of volatility risk for options.

 

The table below shows the fair value of the Bank’s derivative financial assets and liabilities at 31 December 2016 and 31 December 2015.

 

Assets

2016

€ million

Liabilities

2016

€ million

Total

2016

€ million

Assets

2015

€ million

Liabilities

2015

€ million

Total

2015

€ million

Portfolio derivatives not designated as

hedges

 

 

 

 

 

 

OTC foreign currency products

 

 

 

 

 

 

Currency swaps

400

(82)

318

856

(52)

804

Spot and forward currency transactions

333

(151)

182

114

(139)

(25)

 

733

(233)

500

970

(191)

779

OTC interest rate products

 

 

 

 

 

 

Interest rate swaps

87

(170)

(83)

65

(166)

(101)

Caps/floors

1

-

1

-

-

-

Banking derivatives

 

 

 

 

 

 

Fair value of equity derivatives held in

relation to the Banking portfolio

567

(50)

517

489

(77)

412

Total portfolio derivatives not designated as

hedges and Banking derivatives

1,388

(453)

935

1,524

(434)

1,090

Derivatives held for hedging

 

 

 

 

 

 

Derivatives designated as fair value hedges

 

 

 

 

 

 

Interest rate swaps

1,195

(237)

958

1,510

(222)

1,288

Cross currency interest rate swaps

1,672

(1,357)

(315)

1,562

(2,203)

(641)

Embedded derivatives36

64

(121)

(57)

-

(134)

(134)

 

2,931

(1,715)

1,216

3,072

(2,559)

513

Derivatives designated as cash flow hedges

 

 

 

 

 

 

Forward currency transactions

-

(2)

(2)

 

-

-

Total derivatives held for hedging

2,931

(1,717)

1,214

3,072

(2,559)

5

Total derivatives at 31 December

4,319

(2,170)

2,149

4,596

(2,993)

1,603

 

Set out below is an analysis of the Bank’s derivative financial assets for each of the Bank’s internal risk rating categories.

 

Risk rating category

2016

€ million

2015

€ million

1: Excellent

64

-

2: Very Strong

760

767

3: Strong

2,800

3,298

4: Good

317

223

5: Fair

198

187

6: Weak

48

63

7: Special attention

132

58

At 31 December

4,319

4,596

 

There were no derivative financial assets past due in 2016 (2015: €nil).

 

Included in the valuation of derivatives is an overall positive value to the Bank of €44 million attributable to the counterparty portfolio-level adjustments for CVA/DVA/FVA. The Bank implemented valuation adjustments for CVA/DVA/FVA in 2016 in line with the latest market practice for fair valuing derivatives. There was therefore no comparable valuation adjustment made in 2015. The valuation adjustment may be analysed thus:

 

  • CVA: the credit valuation adjustment which reflects the impact on the price of a derivative trade from changes in the credit risk associated with the counterparty; €14 million
  • DVA: the debit valuation adjustment which reflects the impact on the price of a derivative trade from changes in the credit risk associated with the EBRD; €(11) million
  • FVA: the funding valuation adjustment which reflects the costs and benefits arising when uncollateralised derivative exposures are hedged with collateralised trades; €41 million

 

In order to manage credit risk in OTC derivative transactions,37 the Bank’s policy is to approve, ex ante, each counterparty individually and to review its creditworthiness and eligibility regularly. Derivatives limits are included in overall counterparty credit limits. OTC derivative transactions are normally carried out only with the most creditworthy counterparties, rated at the internal equivalent of A and above. Furthermore, the Bank pays great attention to mitigating the credit risk of OTC derivatives through the negotiation of appropriate legal documentation with counterparties. OTC derivative transactions are documented under a Master Agreement (MA) and a CSA. These provide for close-out netting and the posting of collateral by the counterparty once the Bank’s exposure exceeds a given threshold, which is usually a function of the counterparty’s risk rating.

 

The Bank has also expanded the scope for applying risk mitigation techniques by documenting the widest possible range of instruments transacted with a given counterparty under a single MA and CSA, notably foreign exchange transactions. The Bank also uses credit-downgrade clauses and, for long-dated transactions, unilateral break clauses to manage its credit exposures. Similarly, the Bank emphasises risk mitigation for repurchase and reverse repurchase agreements and related transaction types through MA documentation.

 

Collateral

The Bank mitigates counterparty credit risk by holding collateral against exposures to derivative counterparties.

 

Counterparty exposure, for the purposes of collateralising credit risk, is only concerned with counterparties with whom the Bank has an overall net positive exposure. At 31 December 2016 this exposure stood at €2.0 billion (2015: €2.4 billion). Against this, the Bank held collateral of €2.0 billion (2015: €2.4 billion), reducing its net credit exposure to €nil (2015: €nil).

 

Where the Bank borrows or purchases securities subject to a commitment to resell them (a reverse repurchase agreement) but does not acquire the risk and rewards of ownership, the transactions are treated as collateralised loans. The securities are not included in the balance sheet and are held as collateral.

 

The table below illustrates the fair value of collateral held that is permitted to be sold or repledged in the absence of default. Sold or repledged collateral includes collateral on-lent through bond lending activities. In all cases the Bank has an obligation to return equivalent securities.

 

 

Collateral held as security

Held

collateral

2016

€ million

Sold or

repledged

2016

€ million

Held

collateral

2015

€ million

Sold or

repledged

2015

€ million

Derivative financial instruments

 

 

 

 

High grade government securities

640

-

990

-

Cash

1,336

1,336

1,384

1,384

 

1,976

1,336

2,374

1.384

Reverse sale and repurchase transactions

4,912

-

4,887

-

At 31 December

6,888

1,336

7,261

1,384

 

The table below shows the reported values of derivatives that are subject to MA netting arrangements.

.

 

 

 

Recognised

derivative

assets

2015

€ million

Recognised

derivative

liabilities

2015

€ million

Net

position

2015

€ million

Collateral

held 2015

€ million

Subject to a master netting agreement

 

 

 

 

Net derivative assets by counterparty

3,140

(728)

2,412

2,348

Net derivative liabilities by counterparty

844

(2,053)

(1,209)

26

 

3,984

(2,781)

1,203

2,374

No master netting agreement

 

 

 

 

Other derivatives

123

-

123

-

Embedded derivatives

-

(135)

(135)

-

Equity derivatives

489

(77)

412

-

 

612

(212)

400

-

At 31 December

4,596

(2,993)

1,603

2,374

 

Recognised

derivative

assets

2016

€ million

Recognised

derivative

liabilities

201

€ million

Net

position

2016

€ million

Collateral

held

2016

€ million

Subject to a master netting agreement

 

 

 

 

Net derivative assets by counterparty

2,764

(809)

1,955

1,952

Net derivative liabilities by counterparty

904

(1,187)

(283)

24

 

3,668

(1,996)

1,672

1,976

No master netting agreement

 

 

 

 

Other derivatives

20

(3)

17

-

Embedded derivatives

64

(121)

(57)

-

Equity derivatives

567

(50)

517

-

 

651

(174)

477

-

At 31 December

4,319

(2,170)

2,149

1,976

Credit risk in Treasury: Concentration

Concentration by country

At the end of 2016, Treasury credit risk exposure was spread across the following countries.

 

 

Concentration of Treasury peak exposure by country/region Concentration of Treasury peak exposure by country/region

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Concentration by counterparty type

The Bank continues to be largely exposed to banks in the Treasury portfolio which accounted for 59 per cent of the portfolio peak exposure (2015: 54 per cent). Direct sovereign exposure decreased to 15 per cent (2015: 22 per cent), while exposure to counterparties in the countries in which the Bank invests increased to 5 per cent (2015: 3 per cent) on a PFE basis.

 

 

Concentration of peak exposure by counterparty type Concentration of peak exposure by counterparty type

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CoO: Countries of operations ABS: Asset-backed securities

 

B. Market risk

Market risk is the potential loss that could result from adverse market movements. The drivers of market risk are: (i) interest rate risk; (ii) foreign exchange risk; (iii) equity risk; and (iv) commodity price risk.

 

Market risk in the Banking portfolio

The Banking loan portfolio is match-funded by Treasury in terms of currency, so for loan facilities extended in currencies other than euro the foreign exchange risk is hedged by Treasury. Likewise, interest rate risk to which the Banking loan portfolio would normally be exposed is managed through the Treasury portfolio. As such there is minimal residual foreign exchange or interest rate risk present in the Banking loan portfolio.

 

The main exposure to market risk in the Banking portfolio arises from the exposure of share investments to foreign exchange and equity price risk, neither of which is captured in the VaR figures discussed under “Market risk in the Treasury portfolio”. Additional sensitivity information for the Bank’s share investments has been included under “fair value hierarchy” later in this section of the report.

 

The EBRD takes a long-term view of its equity investments, and therefore accepts the short-term volatilities in value arising from exchange rate risk and price risk.

 

Foreign exchange risk

The Bank is subject to foreign exchange risks as it invests in equities that are denominated in currencies other than euro. Accordingly, the value of the equity investments may be affected favourably or unfavourably by fluctuations in currency rates. The table below indicates the currencies to which the Bank had significant exposure on its equity investments at 31 December 2016.39 The sensitivity analysis summarises the total effect of a reasonably possible movement of the currency rate40 against the euro on equity fair value and on profit or loss with all other variables held constant.

 

Share investments at fair value through profit or loss

 

 

5-year rolling average movement

in exchange rate

%

Fair value

€ million

Impact on

net profit

€ million

Euro

-

1,646

-

Polish zloty

5.1

437

22

Romanian leu

1.2

312

4

Russian rouble

17.3

843

146

Turkish lira

12.5

332

41

Ukrainian hryvnia

23.6

89

21

United States dollar

6.4

899

58

Other non-euro

10.1

475

48

At 31 December 2015

 

5,033

340

 

5-year rolling average movement

in exchange rate

%

Fair value

€ million

Impact on

net profit

€ million

Euro

-

1,760

-

Hungarian forint

3.2

141

5

Polish zloty

3.3

375

12

Romanian leu

1.0

293

3

Russian rouble

20.5

871

178

Turkish lira

12.3

296

37

Ukrainian hryvnia

25.0

111

28

United States dollar

6.3

459

60

Other non-euro

10.6

459

49

At 31 December 2016

 

5,265

372

The average movement in exchange rate for the “other non-euro” consists of the weighted average movement in the exchange rates listed in the same table.

 

Equity price risk

Equity price risk is the risk of unfavourable changes in the fair values of equities as the result of changes in the levels of equity indices and the value of individual shares. In terms of equity price risk, the Bank expects the effect on net profit will bear a linear relationship to the movement in equity indices, for both listed and unlisted equity investments. The table below summarises the potential impact on the Bank’s net profit from a reasonably possible change in equity indices.41

 

Share investments at fair value through profit or loss

 

 

 

5-year rolling average movement

in exchange rate

%

Fair value

€ million

Impact on

net profit

€ million

Georgia

BGAX Index

13.5

112

15

Greece

GREK Index

27.4

170

47

Poland

WIG Index

11.1

543

60

Romania

BET Index

11.2

294

33

Russia

MICEX Index

13.4

1,570

211

Serbia

BELEX15 Index

9.2

191

18

Turkey

XU100 Index

23.5

404

95

Ukraine

PFTS Index

24.8

132

33

Regional and other

Weighted average

15.0

1,849

277

At 31 December 2016

 

 

5,265

789

 

 

5-year rolling average movement

in exchange rate

%

Fair value

€ million

Impact on

net profit

€ million

Cyprus

CYCMMAPA Index

36.2

79

29

Greece

GREK Index

26.9

265

71

Hungary

CHTX Index

19.6

80

16

Kazakhstan

KASE Index

12.9

76

10

Poland

WIG Index

13.0

479

62

Romania

BET Index

14.5

323

47

Russia

MICEX Index

11.5

1,050

120

Serbia

BELEX15 Index

11.6

100

12

Turkey

XU100 Index

26.2

386

101

Ukraine

PFTS Index

31.8

124

39

Regional and other

Weighted average

17.1

2,071

354

At 31 December 2015

 

-

5,033

861

 

 

 

The average movement in benchmark index for “regional and other” is made up of the weighted average movement in benchmark indices of the countries listed in the same table.

 

Commodity risk in the Banking portfolio

The Bank is exposed to commodity risk through some of its investments and due to the significant importance of commodities in a number of the countries in which it invests. The aggregate direct exposure to oil and gas extraction, metal ore mining and coal mining (and related support activities) amounts to 4.5 per cent (2015: 5.9 per cent) of the overall banking portfolio. Although the share of this portfolio is still a small percentage of the total, the potential overall risk can be more substantial, as several countries in which the Bank invests, most notably Russia, Kazakhstan, Azerbaijan and Mongolia, are heavily reliant on commodity exports to support their economic growth, domestic demand and budgetary revenues. A prolonged and material decline in oil prices would have an adverse effect on hydrocarbon producers and processors, as well as on the relevant sovereigns and corporate clients reliant on domestic demand. The Bank monitors this risk carefully and incorporates oil price movements into its stress testing exercises.

 

Market risk in the Treasury portfolio

Interest rate and foreign exchange risk

The Bank’s market risk exposure arises from the fact that the movement of interest rates and foreign exchange rates may have an impact on positions taken by the Bank. These risks are centralised and hedged by the Asset and Liability Management desk in Treasury.

 

Interest rate risk is the risk that the value of a financial instrument will fluctuate due to changes in market interest rates. The length of time for which the interest is fixed on a financial instrument indicates the extent to which it is exposed to interest rate risk. Interest rate risks are managed by synthetically hedging the interest rate profiles of assets and liabilities through the use of exchange-traded and OTC derivatives.

 

The Bank measures its exposure to market risk and monitors limit compliance daily. The main market risk limits in the Bank are based on eVaR computed at a 95 per cent confidence level over a one-day trading horizon; eVaR is defined as the average potential loss above a certain threshold (for example 95 per cent) that could be incurred due to adverse fluctuations in interest rates and/or foreign exchange rates. The Bank’s overall eVaR limit, laid down in the Board-approved TALP, at a 95 per cent confidence level over a one-day trading horizon is €60.0 million (less than 0.5 per cent of capital).

 

For enhanced comparability across institutions, numbers disclosed in this financial report show eVaR-based measures scaled up to a 10-trading-day horizon. The market risk methodology considers the three-month swap curve as the main interest rate risk factor and the other factors as basis spread risk factors.42 The total eVaR (95 per cent confidence level over a 10-day trading horizon) of the Bank's Treasury portfolio, including basis spread risks, stood at €11.1 million at 31 December 2016 (2015: €30.6 million)43 with an average eVaR over the year of €17.2 million (2015: €33.4 million). Year on year, the total eVaR was lower (mainly due to lower basis risk) and driven primarily by the Government bond spread risk, to which Treasury is exposed through its sovereign bond holdings. Interest rate option exposure remained modest throughout the year with option eVaR at €0.6 million at year-end (2015: €0.8 million), having peaked at €3.7 million during the year (2015: €1.9 million). The specific contribution from foreign exchange risk to the overall eVaR stood at €1.5 million at year-end (2015: €1.5 million). As in previous years, this contribution was small throughout 2016 and never exceeded €3.2million (2015: € 3.2 million).

 

Equity price risk

The Bank has direct exposure to equity risk of €75 million at 31 December 2016 through three Treasury share investments44 (2015: €63 million). Indirect exposure to equity risk occurs in the form of linked structures that are traded on a back-to-back basis and therefore result in no outright exposure.

 

C. Operational risk

The Bank defines operational risk as all aspects of risk-related exposure other than those falling within the scope of credit, market and liquidity risk. This includes the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events and reputational risk. Examples include:

 

  • errors or failures in transaction support systems
  • inadequate disaster recovery planning
  • errors in the mathematical formulae of pricing or hedging models
  • errors in the computation of the fair value of transactions
  • damage to the Bank’s name and reputation, either directly by adverse comments or indirectly
  • errors or omissions in the processing and settlement of transactions, whether in the areas of execution, booking or settlement or due to inadequate legal documentation
  • errors in the reporting of financial results or failures in controls, such as unidentified limit excesses or unauthorised trading/trading outside policies
  • dependency on a limited number of key personnel, inadequate or insufficient staff training or skill levels
  • external events.

 

The Bank has a low tolerance for material losses arising from operational risk exposures. Where material operational risks are identified (that is, those that may lead to material loss if not mitigated), appropriate mitigation and control measures are put in place after a careful weighing of the risk/return trade-off. Maintaining the Bank’s reputation is of paramount importance and reputational risk has therefore been included in the Bank’s definition of operational risk. The Bank will always take all reasonable and practical steps to safeguard its reputation.

 

Within the Bank, there are policies and procedures in place covering all significant aspects of operational risk. These include consideration of the Bank’s high standards of business ethics, its established system of internal controls, checks and balances and segregation of duties. These are supplemented with:

 

  • the Bank’s Codes of Conduct
  • disaster recovery/contingency planning
  • the Public Information Policy
  • the Environment and Social Policy
  • client and project integrity due diligence procedures, including anti-money-laundering measures
  • procedures for reporting and investigating suspected staff misconduct
  • the Bank’s Enforcement Policies and Procedures
  • the information security framework
  • the Procurement Policies and Rules.

 

Responsibility for developing the operational risk framework and for monitoring its implementation resides within the Risk Management department. Risk Management is responsible for the overall framework and structure to support line managers who control and manage operational risk as part of their day-to-day activities.

 

The Bank’s current operational risk framework includes an agreed definition; the categorisation of different loss type events to assess the Bank’s exposure to operational risk; a group of key risk indicators to measure such risks; the identification of specific operational risks through an annual self-assessment exercise; internal loss data collection; and the contribution to, and use of, external loss data.

 

Departments within the Bank identify their operational risk exposures and evaluate the mitigating controls that help to reduce the inherent or pre-control risk. Each risk (both inherent and post-control) is assessed for its impact, according to a defined value scale and the likelihood of occurrence, based on a frequency-by-time range. Operational risk incident losses or near misses above €5,000 are required to be reported. The collection of such data is primarily to improve the control environment by taking into account the cost of control strengthening and perceived potential future losses. The Bank is a member of the Global Operational Risk Loss Database, the external loss database where members “pool” operational risk incident information over a monetary threshold. This provides the Bank with access to a depth of information wider than its own experience and supplements its own analysis on reported internal incidents.

 

D. Liquidity risk

Liquidity risk management process

The Bank’s liquidity policies are reviewed annually and any changes approved by the Board of Directors. The policies are designed to ensure that the Bank maintains a prudent level of liquidity, given the risk environment in which it operates, and to support its AAA credit rating.

 

The Bank’s medium term liquidity requirements are based on satisfying each of the following three minimum constraints:

 

  • net Treasury liquid assets must be at least 75 per cent of the next two years’ projected net cash requirements, without recourse to accessing funding markets;
  • the Bank’s liquidity must be considered a strong positive factor when rating agency methodologies are applied. These methodologies include applying haircuts to the Bank’s liquid assets, assessing the level of debt due within one year and considering undrawn commitments. This provides an external view of liquidity coverage under stressed circumstances;
  • the Bank must be able to meet its obligations for at least 12 months under an extreme stress scenario. This internally generated scenario considers a combination of events that could detrimentally impact the Bank’s liquidity position.

 

For the purposes of the net cash requirements coverage ratio above, all assets managed within the Treasury portfolio are considered to be liquid assets while ‘net’ treasury liquid assets represent gross treasury assets net of short-term debt. 45

 

The Bank typically holds liquidity above its minimum policy levels to allow flexibility in the execution of its borrowing programme. The Bank exceeded the minimum requirements under the new liquidity policy at 31 December 2016 and consistently exceeded the prevailing liquidity policy requirements throughout the year. The average weighted maturity of assets managed by Treasury at 31 December 2016 was 1.3 years (2015: 1.3 years).

 

The Bank’s short-term liquidity policy is based on the principles of the Liquidity Coverage Ratio within the Basel III reform package. The policy requires that the ratio of maturing liquid assets and scheduled cash inflows to cash outflows over both a 30-day and 90-day horizon must be a minimum of 100 per cent. The minimum ratios under the Bank’s policy have been exceeded at 31 December 2016 and consistently throughout the year.

 

In addition to the above, Treasury actively manages the Bank’s liquidity position on a daily basis.

The Bank has a proven record of access to funding in the capital markets via its global medium-term note programme and commercial paper facilities. In 2016 the Bank raised €5.6 billion of medium- to long-term debt with an average tenor of 3.8 years (2015: €4.2 billion and 4.8 years). The Bank’s AAA credit rating with a stable outlook was affirmed by the three major rating agencies in 2016.

 

The Bank’s liquidity policies are subject to independent review by Risk Management and by the Risk Committee prior to the submission for Board approval.

.

 

Financial liabilities at

31 December 2016

Up to and

including

1 month

€ million

Over 1 month

and up to and

including

3 months

€ million

Over 3 months

and up to and

including

1 year

€ million

Over 1 year and

up to and

including

3 years

€ million

Over

3 years

€ million

Total

€ million

Non-derivative cash flows

 

 

 

 

 

 

Amounts owed to credit institutions

(2,207)

(309)

-

-

-

(2,516)

Debts evidenced by certificates

(1,927)

(4,444)

(5,736)

(13,638)

(12,089)

(37,834)

Other financial liabilities

(12)

(5)

(333)

(18)

(2)

(370)

At 31 December 201

(4,416)

(4,758)

(6,069)

(13,656)

(12,091)

(40,720)

Trading derivative cash flows

 

 

 

 

 

 

Net settling interest rate derivatives

(2)

(3)

(34)

(53)

(94)

(186)

Gross settling interest rate

derivatives – outflow

(13)

(360)

(381)

(871)

(284)

(1,909)

Gross settling interest rate

derivatives – inflow

1

332

355

769

245

1,729

Foreign exchange derivatives – outflow

(1,147)

(1,845)

(888)

-

-

(3,880)

Foreign exchange derivatives – inflow

1,108

1,739

840

-

-

3,687

Credit derivatives

-

-

-

-

-

-

At 31 December 2016

(53)

(137)

(108)

(128)

(133)

(559)

Hedging derivative cash flows

 

 

 

 

 

 

Net settling interest rate derivatives

(200)

11

(602)

(482)

(53)

(1,326)

Gross settling interest rate derivatives – outflow

(28)

(308)

(1,258)

(2,695)

(2,432)

(6,721)

Gross settling interest rate derivatives – inflow

37

268

1,055

2,264

2,044

5,668

At 31 December 2016

(191)

(29)

(805)

(913)

(441)

(2,379)

Total financial liabilities at 31 December 2016

(4,390)

(4,924)

(6,982)

(14,697)

(12,665)

(43,658)

Other financial instruments

 

 

 

 

 

 

Undrawn commitments

 

 

 

 

 

 

Financial institutions

(2,361)

-

-

-

-

(2,361)

Non-financial institutions

(9,714)

-

-

-

-

(9,714)

At 31 December 2016

(12,075)

-

-

-

-

(12,075)

Financial liabilities at

31 December 2015

Up to and

including

1 month

€ million

Over 1 month

and up to and

including

3 months

€ million

Over 3 months

and up to and

including

1 year

€ million

Over 1 year and up to and

including

3 years

€ million

Over

3 years

€ million

Total

€ million

Non-derivative cash flows

 

 

 

 

 

 

Amounts owed to credit institutions

(2,441)

(152)

-

-

-

(2,593)

Debts evidenced by certificates

(1,326)

(4,659)

(10,331)

(14,011)

(14,132)

(44,459)

Other financial liabilities

(11)

(6)

(212)

(44)

(11)

(284)

At 31 December 2015

(3,778)

(4,817)

(10,543)

(14,055)

(14,143)

(47,336)

Trading derivative cash flows

 

 

 

 

 

 

Net settling interest rate derivatives

(3)

(4)

(31)

(54)

(77)

(169)

Gross settling interest rate

derivatives – outflow

(59)

(29)

(751)

(644)

(657)

(2,140)

Gross settling interest rate

derivatives – inflow

52

14

745

630

655

2,096

Foreign exchange derivatives – outflow

(2,344)

(3,978)

(850)

-

-

(7,172)

Foreign exchange derivatives – inflow

2,311

3,911

814

-

-

7,036

At 31 December 2015

(43)

(86)

(73)

(68)

(79)

(349)

Hedging derivative cash flows

 

 

 

 

 

 

Net settling interest rate derivatives

(4)

5

(93)

(63)

(36)

(191)

Gross settling interest rate derivatives – outflow

(392)

(797)

(1,528)

(3,729)

(2,730)

(9,176)

Gross settling interest rate derivatives – inflow

265

708

1,029

3,120

2,303

7,425

At 31 December 2015

(131)

(84)

(592)

(672)

(463)

(1,942)

Total financial liabilities at

31 December 2015

(3,952)

(4,987)

(11,208)

(14,795)

(14,685)

(49,627)

Other financial instruments

 

 

 

 

 

 

Undrawn commitments

 

 

 

 

 

 

Financial institutions

(2,641)

-

-

-

-

(2,641)

Non-financial institutions

(10,318)

-

-

-

-

(10,318)

At 31 December 2015

(12,959)

-

-

-

-

(12,959)

 

E. Capital management

The Bank’s original authorised share capital was €10.0 billion. Under Resolution No. 59, adopted on 15 April 1996, the Board of Governors approved a doubling of the Bank’s authorised capital stock to €20.0 billion.

 

In accordance with the requirements of Article 5.3 of the Agreement, the Board of Governors reviews the capital stock of the Bank at intervals of not more than five years. At the Annual Meeting in May 2010 the Bank’s Board of Governors approved the Fourth Capital Resources Review (CRR4) which established the Bank’s strategy for the period 2011 to 2015. This included an analysis of the transition impact and operational activity of the Bank; an assessment of the economic outlook and transition challenges in the region; the formulation of medium-term portfolio development strategy and objectives; and a detailed analysis of the Bank’s projected future financial performance and capital adequacy. The review underlined the fact that the Bank relies on a strong capital base and stressed the need for prudent financial policies supporting conservative provisioning, strong liquidity and long-term profitability.

 

As a result of the assessment of capital requirements in CRR4, in May 2010 the Board of Governors approved a two-step increase in the authorised capital stock of the Bank: an immediate €1.0 billion increase in authorised paid-in shares (Resolution No. 126), and a €9.0 billion increase in authorised callable capital shares (Resolution No. 128). This amounts to an aggregate increase in the authorised capital stock of the Bank of €10.0 billion (collectively referred to as the second capital increase). The increase in callable capital became effective on 20 April 2011 when subscriptions were received for at least 50 per cent of the newly authorised callable capital. The callable shares were issued subject to redemption in accordance with the terms of Resolution No. 128. At 31 December 2016, €8.9 billion of the callable capital increase had been subscribed (2015: €8.9 billion).

 

At the May 2015 Annual Meeting the Board of Governors reviewed the capital stock of the Bank pursuant to Article 5.3 of the Agreement and resolved that the projected capital stock is appropriate for the 2016-2020 period, in the context of the approval of the Bank’s Strategic and Capital Framework 2016-2020. The Board of Governors further resolved that no callable capital shares would be redeemed and that the redemption and cancellation provisions in Resolution No. 128 be removed. Finally, the Board of Governors resolved that the adequacy of the Bank’s capital would next be reviewed at the 2020 Annual Meeting (Resolutions No. 181, 182 and 183).

 

The Bank does not have any other classes of capital.

 

The Bank’s capital usage is guided by statutory and financial policy parameters. Article 12 of the Agreement establishes a 1:1 gearing ratio which limits the total amount of outstanding loans, share investments and guarantees made by the Bank in the countries in which it invests to the total amount of the Bank’s unimpaired subscribed capital, reserves and surpluses. This capital base incorporates unimpaired subscribed capital (including callable capital), the unrestricted general reserves, loan loss reserve, special reserve and adjustments for general loan impairment provisions on Banking exposures and unrealised equity losses. Reflecting a change in interpretation in 2015, specific provisions are not included in the statutory capital base. The capital base for these purposes amounted to €39.7 billion at 31 December 2016 after 2016 net income allocation decisions (2015: €39.2 billion).

 

The Bank interprets the gearing ratio on a ‘disbursed Banking assets’ or ‘operating assets’ basis. To ensure consistency with the statutory capital base, specific provisions are deducted from total operating assets for the purposes of the ratio. At 31 December 2016, the Bank’s gearing ratio on an aggregated basis was 73 per cent (2015: 71 per cent). Article 12 also limits the total amount of disbursed share investments to the total amount of the Bank's unimpaired paid-in subscribed capital, surpluses and general reserve. No capital utilisation limits were breached during the year (2015: none).

 

The Bank’s statutory measure of capital adequacy under the gearing ratio is supplemented by a risk-based prudential capital adequacy limit under its Capital Adequacy Policy (previously named the Economic Capital Policy).

 

The Bank defines required capital as the potential capital losses it may incur based on probabilities consistent with the Bank’s AAA credit rating. The main risk categories assessed under the capital adequacy framework are credit risk, market risk and operational risk, and the total risk is managed within an available capital base that excludes callable capital, while maintaining a prudent capital buffer.

 

One of the main objectives of the Capital Adequacy Policy is to manage the Bank’s capital within a medium-term planning framework, providing a consistent measurement of capital headroom over time. The Bank’s objective is to prevent the need to call on subscribed callable capital and to use only available risk capital including paid-in capital and reserves.

 

At 31 December 2016 the ratio of required capital to available capital was 77 per cent (2015: 80 per cent) compared with a policy threshold for this ratio of 90 per cent. The Bank’s risk-based capital requirement under this policy is managed alongside the Bank’s statutory capital constraint.

 

The Bank’s prudent approach to capital management is reflected in the key financial ratios presented on page 7. At 31 December 2016, the ratio of members’ equity to total assets was 27 per cent (2015: 27 per cent) and the ratio of members’ equity to Banking assets was 56 per cent (2015: 56 per cent).

 

F. Fair value of financial assets and liabilities

Classification and fair value of financial assets and liabilities

 

Financial assets at 31 December 2016

Carrying

amount

€ million

Fair value

€ million

Financial assets measured at fair value through profit or loss or fair value through other comprehensive income:

 

 

– Debt securities

926

926

– Derivative financial instruments

4,319

4,319

– Banking loans at fair value through profit or loss

313

313

– Banking portfolio: Share investments at fair value through profit or loss

5,265

5,265

– Treasury portfolio: Share investments at fair value through other comprehensive income

75

75

 

 

10,898

10,898

Financial assets measured at amortised cost:

 

 

– Placements with and advances to credit institutions

14,110

14,110

 

– Debt securities

8,981

8,981

– Other financial assets

214

214

– Banking loan investments at amortised cost

21,841

22,610

 

45,146

45,934

Total

56,044

56,832

Financial assets at 31 December 2015

Carrying

amount

€ million

Fair value

€ million

Financial assets measured at fair value through profit or loss or fair value through other comprehensive income:

 

 

– Debt securities

747

747

– Derivative financial instruments

4,596

4,596

– Banking loans at fair value through profit or loss

339

339

– Banking portfolio: Share investments at fair value through profit or loss

5,033

5,033

– Treasury portfolio: Share investments at fair value through other comprehensive income

63

63

 

10,778

10,778

Financial assets measured at amortised cost:

 

 

– Placements with and advances to credit institutions

11,724

11,724

– Debt securities

11,329

11,301

– Collateralised placements

13

13

– Other financial assets

335

335

– Banking loan investments at amortised cost

20,734

21,363

 

44,135

44,736

Total

54,913

55,514

Financial liabilities at 31 December 2016

Held for

trading

€ million

At fair value

through

profit or loss

€ million

Derivatives

held for

hedging

purposes

€ million

Financial

liabilities at

amortised

cost

€ million

Carrying

amount

€ million

Fair value

€ million

Amounts owed to credit institutions

-

-

-

(2,478)

(2,478)

(2,478)

Debts evidenced by certificates

-

-

-

(35,531)

(35,561)

(35,429)

Derivative financial instruments

(403)

(50)

(1,717)

-

(2,170)

(2,170)

Other financial liabilities

-

-

-

(540)

(540)

(540)

Total financial liabilities

(403)

(50)

(1,717)

(38,549)

(40,719)

(40,617)

Financial liabilities at 31 December 2015

Held for

trading

€ million

At fair value

through

profit or loss

€ million

Derivatives

held for

hedging

purposes

€ million

Financial

liabilities at

amortised

cost

€ million

Carrying

amount

€ million

Fair value

€ million

Amounts owed to credit institutions

-

-

-

(2,590)

(2,590)

(2,590)

Debts evidenced by certificates

-

-

-

(34,280)

(34,280)

(34,280)

Derivative financial instruments

(357)

(77)

(2,559)

-

(2,993)

(2,993)

Other financial liabilities

-

-

-

(577)

(577)

(577)

Total financial liabilities

(357)

(77)

(2,559)

(34,447)

(40,440)

(40,351)

Fair value hierarchy

 

IFRS 13 specifies classification of fair values on the basis of a three-level hierarchy of valuation methodologies. The classifications are determined based on whether the inputs used in the measurement of fair values are observable or unobservable. These inputs have created the following fair value hierarchy:

 

  • Level 1 – Quoted prices in active markets for identical assets or liabilities. This level includes listed share investments on stock exchanges.
  • Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (that is, as prices) or indirectly (that is, derived from prices). This level includes debt securities and most derivative products. The sources of inputs include prices available from screen-based services such as SuperDerivatives and Bloomberg, broker quotes and observable market data such as interest rates and foreign exchange rates which are used in deriving the valuations of derivative products.
  • Level 3 – Inputs for the asset or liability that are not based on observable market data (unobservable inputs). This level includes share investments and debt securities or derivative products for which not all market data is observable.

 

At 31 December 2016, the Bank’s balance sheet approximates to fair value in all financial asset and liability categories, with the exception of loan investments at amortised cost.

 

The amortised cost instruments held within placements with and advances to credit institutions, other financial assets, amounts owed to credit institutions, and other financial liabilities are all deemed to have amortised cost values approximating their fair value, being primarily simple, short-term instruments. They are classified as having Level 2 inputs as the Bank’s assessment of their fair value is based on the observable market valuation of similar assets and liabilities.

Amortised cost debt securities are valued using Level 2 inputs. The basis of their fair value is determined using valuation techniques appropriate to the market and industry of each investment. The primary valuation techniques used are quotes from brokerage services and discounted cash flows. Techniques used to support these valuations include industry valuation benchmarks and recent transaction prices.

 

The Bank’s collateralised placements are valued using discounted cash flows and are therefore based on Level 3 inputs.

 

Banking loan investments whereby the objective of the Bank’s business model is to hold these investments to collect the contractual cash flow, and the contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest, are recognised at amortised cost. The fair value of these loans was calculated using Level 3 inputs by discounting the cash flows at a year-end interest rate applicable to each loan and further discounting the value by an internal measure of credit risk.

 

Debts evidenced by certificates represents the Bank’s borrowings raised through the issuance of commercial paper and bonds. The fair value of the Bank’s issued bonds is determined using discounted cash flow models and therefore relies on Level 3 inputs. Due to the short-tenor nature of commercial paper, amortised cost approximates fair value. The fair value of the Bank’s issued commercial paper is determined based on the observable market valuation of similar assets and liabilities and therefore relies on Level 2 inputs.

 

The table below provides information at 31 December 2016 about the Bank’s financial assets and financial liabilities measured at fair value. Financial assets and financial liabilities are classified in their entirety based on the lowest level input that is significant to the fair value measurement.

 

 

 

 

 

 

 

 

Level 1

€ million

Level 2

€ million

Level 3

€ million

Total

€ million

Debt securities

-

926

 

926

Derivative financial instruments

-

3,742

577

4,319

Banking loans

-

-

313

313

Share investments (Banking portfolio)

1,810

-

3,445

5,265

Share investments (Treasury portfolio)

-

75

-

75

Total financial assets at fair value

1,810

4,743

4,345

10,898

 

 

 

 

 

Derivative financial instruments

-

(2,119)

(51)

(2,170)

Total financial liabilities at fair value

-

(2,119)

(51)

(2,170)

At 31 December 2016

 

 

 

 

 

 

Level 1

€ million

Level 2

€ million

Level 3

€ million

Total

€ million

Debt securities

-

747

-

7477

Derivative financial instruments

-

4,098

798

4,596

Banking loans

-

-

339

339

Share investments (Banking portfolio)

1,819

-

3,214

5,033

Share investments (Treasury portfolio)

-

63

-

63

Total financial assets at fair value

1,819

4,908

4,051

10,77

 

 

 

 

 

Derivative financial instruments

-

(2,915)

(78)

(2,993)

Total financial liabilities at fair value

-

(2,915)

(78)

(2,993)

 

 

 

 

 

At 31 December 2015

There have been no transfers between Level 1 and Level 2 during the year.

 

The table below provides a reconciliation of the fair values of the Bank’s Level 3 financial assets and financial liabilities for the year

ended 31 December 2016.

 

 

 

 

 

 

 

 

 

Derivative

financial

instruments

€ million

Banking loans

€ million

Banking share

investment

€ million

Total assets

€ million

Derivative

financial

instruments

€ million

Total

liabilities

€ million

Balance at 31 December 2015

498

339

3,214

4,051

(78)

(78)

Total gains/(losses) for the

year ended 31 December

2016 in:

 

 

 

 

 

 

Net profit/(loss)

180

48

(250)

(22)

27

27

Deferred profit

25

-

-

25

-

-

Purchases/issues

-

108

746

854