Risk management

FINANCIAL STATEMENTS RISK MANAGEMENT

Risk management

Financial risks

Risk governance

The Bank’s overall framework for identification and management of risks is underpinned by independent “second line of defence”18 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 Chief Risk Officer (VP & 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 & CRO.

 

The Managing Director Risk Management reports to the VP & 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 identification and management of 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 in its mission to carry out its mandate and 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.

 

  • Material deterioration in global economic outlook driven by slowdown in China and leading to persistent weakening of commodity prices and substantial decline in international trade.
  • Prolonged recession in Russia and spill-over effects on Commonwealth of Independent States (CIS). Partly driven by a sustained period of low commodity prices, this would result in further deterioration of economic and fiscal performance in several CIS countries, particularly those heavily reliant on oil exports (for example, Kazakhstan and Azerbaijan).
  • Fragile macro-financial situation in Ukraine, including the ongoing conflict in the country, its direct impact on the economic performance of the country, cross-border economic linkages, as well as the access to capital for future investments.
  • Potential capital outflow from Turkey, driven by domestic political vulnerabilities, escalation of regional conflicts, as well as monetary policy changes in developed markets and shifts in overall sentiment towards emerging markets.
  • Radicalisation and threat of terrorist activity in Middle East and beyond, with direct impact on tourism revenues and growth outlooks, as well as indirect effects related to refugee flow, deteriorating investors’ sentiment and increasing fiscal pressures.

 

In carrying out its mission, the Bank is exposed to financial risks through both its Banking and Treasury activities. This is 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 from too high a proportion of the portfolio being allocated to a specific country, industry sector or obligor, a particular type of instrument or an individual transaction.

 

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 27).

 

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.

 

Individual projects

The Operations Committee reviews all Banking projects prior to their submission for Board approval. The Committee is chaired by the First Vice President Banking and its membership comprises senior managers of the Bank, including the VP & 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 Executive Committee, 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 the Bond Portfolio Review Committee oversees the Banking bond investments. Both these committees report to the Operations 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 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 country level (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: 2015

Total Banking loan exposure (operating assets including fair value adjustments but before provisions) increased during the year from €20.7 billion at 31 December 2014 to €22.2 billion at 31 December 2015. The total signed Banking loan portfolio and guarantees increased from €30.6 billion at 31 December 2014 to €33.4 billion at 31 December 2015.

The average credit profile of the portfolio deteriorated in 2015 as the weighted average probability of default (WAPD) rating worsened slightly to 5.81 (2014: 5.78). Classified assets (those risk rated 6.7 to 8.0) increased from 24.9 to 26.1 per cent and the absolute level now stands at €8.8 billion (2014: €7.7 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 Ukraine and Russia.

 

Credit risk in the Banking portfolio 2015

 

 

 

NPLs20 still remain low relative to the average portfolio risk rating, amounting to €1.3 billion or 5.9 per cent of operating assets at year-end 2015 (2014: €1.2 billion or 5.6 per cent). Distressed restructured loans21 were also relatively low, comprising an additional €516 million or 2.3 per cent of operating assets at year-end 2015 (2014: €568 million or 2.7 per cent). Net write-offs amounted to €60 million in 2015 (2014: €76 million). Write-offs are typically relatively low as the Bank benefits from its strong liquidity and capitalisation to work out distressed loans.

 

Specific provisions continued to increase in 2015, reflecting the deteriorating macro-financial environment in the countries in which the Bank invests, particularly in Ukraine, Russia and Mongolia which in turn affected the quality of the Bank’s portfolio.

 

Movement in NPLs22

2015

€ million

2014

€ million

Opening balance

1,183

663

Repayments

(216)

(141)

Write-offs

(60)

(76)

New impaired assets

330

679

Other movements

79

58

Closing balance

1,316

1,183

Movement in specific provisions23

2015

€ million

2014

€ million

Opening balance

631

382

Provision cover

54%

58%

New/increased specific provisions

266

368

Provisions release – repayments

(54)

(19)

Provisions release – restructuring

-

(25)

Provisions release – write-offs

(39)

(73)

Provisions release – loans sold

(20)

(16)

Release against amounts recovered from guarantees

(3)

-

Foreign exchange movement

45

27

Unwinding discount24

(27)

(13)

Closing balance

799

631

Provision cover

64%

54%

 

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

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)

-

7,155

0.9

7: Special

attention

3,774

14

-

3,788

17.4

(205)

-

3,583

5.4

8: Non-

performing25

-

-

1,248

1,248

5.7

-

(799)

449

64.1

At 31 December 2015

20,540

29

1,248

21,817

100

(284)

(799)

20,734

 

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

88

-

-

88

0.4

-

-

88

-

3: Strong

333

-

-

333

1.6

-

-

333

-

4: Good

2,764

-

-

2,764

13.6

(10)

-

2,754

0.4

5: Fair

6,536

-

-

6,536

32.1

(24)

-

6,512

0.4

6: Weak

6,473

42

-

6,515

32.0

(139)

-

6,376

2.1

7: Special

attention

2,940

13

-

2,953

14.5

(405)

-

2,548

13.7

8: Non-

performing

-

-

1,169

1,169

5.8

-

(631)

538

54.0

At 31 December 2014

19,134

55

1,169

20,358

100.0

(578)

(631)

19,149

-

 

At the end of 2015, €29 million of loans were past due but not impaired. Loans amounting to €20 million were outstanding for less than 30 days while loans amounting to €9 million were outstanding for more than 30 days but less than 90 days (2014: €55 million, all of which were outstanding for less than 30 days).

 

At 31 December 2015 the Bank had security arrangements in place for €6.9 billion of its loan operating assets (2014: €6.4 billion). It also benefited from guarantees and risk-sharing facilities provided by Special Funds (see note 31: Related Parties) which provided credit enhancement of approximately €66 million at the year-end (2014: €88 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

2015

€ million

Fair value

2014

€ million

5: Fair

135

138

6: Weak

124

66

7: Special attention

64

131

8: Non-performing

16

3

At 31 December

339

338

 

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

2015

€ million

Guarantees

2015

€ million

Undrawn loan

commitments

2014

€ million

Guarantees

2014

€ million

2: Very strong

-

-

53

-

3. Strong

37

-

21

-

4: Good

1,044

-

843

-

5. Fair

2,001

21

1,472

44

6: Weak

4,312

237

3,790

270

7: Special attention

3,088

298

2,923

309

8: Non-performing

147

20

128

5

At 31 December

10,629

576

9,230

628

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

2015

€ million

Undrawn loan

commitments

and guarantees

2015

€ million

Total

2015

€ million

Loans

2014

€ million

Undrawn loan

commitments

and guarantees

2014

€ million

Total

2014

€ million

Albania

225

209

434

267

211

478

Armenia

189

72

261

203

70

273

Azerbaijan

567

470

1,037

489

332

821

Belarus

434

55

489

479

100

579

Bosnia and Herzegovina

583

301

884

588

264

852

Bulgaria

584

102

686

756

114

870

Croatia

751

217

968

766

192

958

Cyprus

-

13

13

-

-

-

Czech Republic

5

-

5

26

-

26

Egypt

627

839

1,466

166

535

701

Estonia

59

40

99

40

24

64

Former Yugoslav Republic of Macedonia

240

596

836

254

500

754

Georgia

397

184

581

324

226

550

Greece

49

-

49

-

-

-

Hungary

272

55

327

288

60

348

Jordan

228

207

435

101

179

280

Kazakhstan

1,370

657

2,027

1,164

532

1,696

Kosovo

16

90

106

19

42

61

Kyrgyz Republic

138

95

233

156

98

254

Latvia

90

23

113

74

43

117

Lithuania

22

-

22

59

-

59

Moldova

142

304

446

147

260

407

Mongolia

488

416

904

370

183

553

Montenegro

171

228

399

164

169

333

Morocco

228

418

646

233

113

346

Poland

1,584

561

2,145

1,405

468

1,873

Romania

1,326

243

1,569

1,345

523

1,868

Russia

2,753

381

3,134

3,497

507

4,004

Serbia

1,064

1,071

2,135

1,012

1,065

2,077

Slovak Republic

387

18

405

417

53

470

Slovenia

173

6

179

168

-

168

Tajikistan

98

237

335

50

116

166

Tunisia

178

38

216

96

71

167

Turkey

4,163

758

4,921

2,911

802

3,713

Turkmenistan

34

8

42

38

4

42

Ukraine

2,505

2,293

4,798

2,594

2,002

4,596

Uzbekistan

16

-

16

30

-

30

At 31 December

22,156

11,205

33,361

20,696

9,858

30,554

 

 

 

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

2015

€ million

Undrawn loan

commitments

and guarantees

2015

€ million

Total

2015

€ million

Loans

2014

€ million

Undrawn loan

commitments

and guarantees

2014

€ million

Total

2014

€ million

Agribusiness

2,268

504

2,772

2,181

435

2,616

Depository credit (banks)

5,023

933

5,956

4,942

1,120

6,062

Information and communication

technologies

295

21

316

230

31

261

Insurance, pension, mutual funds

55

2

57

58

1

59

Leasing finance

374

126

500

332

134

466

Manufacturing and services

2,486

319

2,805

2,375

341

2,716

Municipal and environmental

infrastructure

1,323

998

2,321

1,093

1,036

2,129

Natural resources

1,814

883

2,697

1,498

486

1,984

Non-depository credit (non-bank)

498

52

550

462

8

470

Power and energy

2,804

797

3,601

2,439

1,040

3,479

Property and tourism

292

230

522

370

199

569

Transport

1,889

734

2,623

1,796

532

2,328

Non-sovereign

19,121

5,599

24,720

17,776

5,363

23,139

Sovereign

3,035

5,606

8,641

2,920

4,495

7,415

At 31 December

22,156

11,205

33,361

20,696

9,858

30,554

 

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 VP & CFO to manage and the VP & 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 Treasury Risk Management Guidelines (T&TRMG) are approved by the VP & CFO and the VP & 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 & CRO and the VP & CFO. Any decision to retain ineligible exposures is reported to the Audit Committee.

 

The T&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 T&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).26

 

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 over-the-counter (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 €23.8 billion at 31 December 2015 (2014: €22.5 billion).27

 

The internal ratings of Treasury’s counterparties and sovereign exposures are reviewed at least annually and adjusted as appropriate. In addition in 2015 the rating methodology relating to a specific portfolio, namely covered bonds, was updated. Overall the WAPD rating, weighted by the carrying value of Treasury’s liquid assets, deteriorated slightly to 2.36 at 31 December 2015 (2014: 2.28) on a like-for-like basis and moved to 2.23 after the methodology updates.28

 

 

Credit quality of Treasury’s liquid assets29 Credit quality of Treasury’s liquid assets30

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

2015

€ million

2014

€ million

1-3: Excellent to strong

11,260

10,580

4: Good

422

-

5-6: Fair to weak

42

32

7-8: Special attention to non-performing

-

-

At 31 December

11,724

10,612

At 31 December 2015 there were no placements with and advances to credit institutions that were past due or impaired (2014: €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

2015

€ million

2014

€ million

1-3: Excellent to strong

668

11

4: Good

26

18

5-6: Fair to weak

53

77

7-8: Special attention to non-performing

-

-

At 31 December

747

106

There were no debt securities at fair value past due in 2015 (2014: €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

2015

€ million

2014

€ million

1-3: Excellent to strong

11,329

11,653

4: Good

-

12

5-6: Fair to weak

-

23

7-8: Special attention to non-performing

-

-

At 31 December

11,329

11,688

There were no debt securities at amortised cost past due in 2015 (2014: €nil).

 

Collateralised placements

Collateralised placements of €13 million (2014: €57 million) were all internally risk rated 1-3: excellent to strong, with none that were past due or impaired (2014: €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 €20.6 billion at 31 December 2015 (2014: €18.8 billion).

 

Treasury maintained a high quality average credit risk profile during 2015 by investing liquidity in AAA sovereign and other highly rated assets. However the WAPD rating, weighted by PFE exposures, deteriorated slightly to 2.22 at 31 December 2015 (2014: 2.17) on a like-for-like basis, or moved to 2.08 taking into account the rating methodology update.31

 

A very low proportion of Treasury exposures was below investment grade quality,32 amounting to 0.7 per cent at 31 December 2015 (2014: 1.0 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 PFE33 Credit quality of Treasury PFE34

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

There were no impaired assets in the Treasury portfolio at 31 December 2015 (2014: €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 party sponsors 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 later in this section), 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 2015 and 31 December 2014.

 

Assets

2015

€ million

Liabilities

2015

€ million

Total

2015

€ million

Assets

2014

€ million

Liabilities

2014

€ million

Total

2014

€ million

Portfolio derivatives not designated as

hedges

 

 

 

 

 

 

OTC foreign currency products

 

 

 

 

 

 

Currency swaps

856

(52)

804

904

(70)

834

Spot and forward currency transactions

114

(139)

(25)

379

(80)

299

 

970

(191)

779

1,283

(150)

1,133

OTC interest rate products

 

 

 

 

 

 

Interest rate swaps

65

(166)

(101)

76

(209)

(133)

Banking derivatives

 

 

 

 

 

 

Fair value of equity derivatives held in

relation to the Banking portfolio

489

(77)

412

506

(81)

425

Total portfolio derivatives not designated as

hedges and Banking derivatives

1,524

(434)

1,090

1,865

(440)

1,425

Derivatives held for hedging

 

 

 

 

 

 

Derivatives designated as fair value hedges

 

 

 

 

 

 

Interest rate swaps

1,510

(222)

1,288

1,548

(330)

1,218

Cross currency interest rate swaps

1,562

(2,203)

(641)

1,565

(1,471)

94

Embedded derivatives

-

(134)

(134)

-

(189)

(189)

Total derivatives held for hedging

3,072

(2,559)

513

3,113

(1,990)

1,123

Total derivatives at 31 December

4,596

(2,993)

1,603

4,978

(2,430)

2,548

 

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

2015

€ million

2014

€ million

1-3: Excellent to strong

4,065

4,153

4: Good

233

116

5-6: Fair to weak

250

297

7-8: Special attention to non-performing

58

52

At 31 December

4,596

4,978

There were no derivative financial assets past due in 2015 (2014: €nil).

 

In order to manage credit risk in OTC derivative transactions,36 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 2015 this exposure stood at €2.4 billion (2014: €3.1 billion). Against this, the Bank held collateral of €2.4 billion (2014: €2.8 billion), reducing its net credit exposure to €nil (2014: €0.3 billion).

 

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

2015

€ million

Sold or

repledged

2015

€ million

Held

collateral

2014

€ million

Sold or

repledged

2014

€ million

Derivative financial instruments

 

 

 

 

High grade government securities

990

-

1,393

-

Cash

1,384

1,384

1,434

1,434

 

 

 

 

 

Reverse sale and repurchase transactions

4,887

-

4,293

-

At 31 December

7,261

1,384

7,120

1,434

The term “collateralised placements” in the Bank’s balance sheet is used to describe the economic substance of the transactions comprising that category. Such transactions involve the purchase of a financial asset together with entering into a total return swap whereby the risks and rewards of ownership of the asset are transferred back to the entity selling the asset. For accounting purposes, therefore, the economic substance of such transactions is a form of collateralised lending. However as the assets are legally owned by the Bank, they do not represent collateral for the purposes of the above disclosure. At 31 December 2015, the Bank held €13 million (2014: €57 million) of collateralised placements.

 

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

.

 

 

 

Recognised

derivative

assets

2014

€ million

Recognised

derivative

liabilities

2014

€ million

Net

position

2014

€ million

Collateral

held

2014

€ million

Subject to a master netting agreement

 

 

 

 

Net derivative assets by counterparty

3,604

(720)

2,884

2,819

Net derivative liabilities by counterparty

838

(1,440)

(602)

8

 

4,442

(2,160)

2,282

2,827

No master netting agreement

 

 

 

 

Other derivatives

30

-

30

-

Embedded derivatives

-

(189)

(189)

-

Equity derivatives

506

(81)

425

-

 

536

(270)

266

-

At 31 December

4,978

(2,430)

2,548

2,827

 

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

Total return swaps are excluded from the fair values of the above tables as they are accounted for as collateralised placements and not stand-alone derivatives. The full amount of collateral held from the counterparty to those swaps is, however, reported above as it relates to the net exposure on the entire derivatives portfolio with that counterparty. At 31 December 2015, the amount of collateral held in relation to total return swaps was €nil (2014: €nil).

 

Credit risk in Treasury: Concentration

Concentration by country

At the end of 2015, 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 54 per cent of the portfolio peak exposure (2014: 53 per cent). Direct sovereign exposure37 slightly decreased to 22 per cent (2014: 24 per cent), while exposure to counterparties in the countries in which the Bank invests increased to 2.6 per cent (2014: 1.2 per cent) on a PFE basis.

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 loan facilities extended in currencies other than the 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 the 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 2015.38 The sensitivity analysis summarises the total effect of a reasonably possible movement of the currency rate39 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

Croatian kuna

1.0

377

4

Euro

-

1,401

-

Polish zloty

5.8

494

29

Romanian leu

1.2

357

4

Russian rouble

16.4

663

109

Turkish lira

11.0

197

22

United States dollar

5.7

1,048

60

Other non-euro

7.2

532

38

At 31 December 2014

-

5,069

266

 

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

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.40

 

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

Cyprus

CYSMMAPA 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

 

 

5-year rolling average movement

in exchange rate

%

Fair value

€ million

Impact on

net profit

€ million

Croatian

CROBEX Index

5.7

377

22

Kazakhstan

KASE Index

11.7

134

16

Poland

WIG Index

14.8

528

78

Romania

BET Index

15.6

367

57

Russia

MICEX Index

10.9

1,128

123

Serbia

BELEX15 Index

11.3

100

11

Turkey

XU100 Index

27.9

242

68

Ukraine

PFTS Index

38.2

74

28

Regional and other

Weighted average

13.7

2,119

290

At 31 December 2014

 

-

5,069

693

 

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 5.9 per cent (2014: 3.7 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, are heavily reliant on hydrocarbon 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 mainly 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 foreign exchange rates. The Bank’s overall eVaR limit, laid down in the Board-approved TALP, was increased during the year due to increased rouble-US dollar basis spread volatility. The limit remains low compared with the Bank’s capital (less than 0.5 per cent of capital).

 

The Bank’s interest rate risk measurement is complemented by accepted market techniques including VaR, (non-credit) spread risk and volatility risk, on which frequent management reporting takes place. For enhanced comparability across institutions however, numbers disclosed in this financial report show VaR-based measures scaled up to a 99 per cent confidence level over a 10-trading-day horizon. The VaR methodology considers the three-month swap curve as the main interest rate risk factor and the other factors as basis spread risk factors (for example six-month Libor vs. three-month Libor tenor basis spreads and Government asset swap spreads).

 

The total VaR of the Bank's Treasury portfolio, including basis spread risks, stood at €34.5 million at 31 December 2015 (2014: €25.0 million) with an average VaR over the year of €37.7 million (2014: €13.3 million). Year on year, the total VaR was higher due to the euro Government bond spread risk and the increased spread volatility. The increase in the average VaR in 2015 was driven primarily by the increase in the rouble-US dollar basis spread volatility, to which Treasury is exposed as it utilises cross-currency basis swaps for rouble funding. Secondly, from the end of the first quarter, the sovereign debt which is actively managed and the VaR increased due to the euro Government bond spread risk and the increased spread volatility. The second half of the year saw a decrease in the VaR level mainly due to the lower rouble-US dollar basis spread volatility. The average VaR remained in the range of €26.0 million to €50.3 million (2014: €10.0 million to €25.0 million) during the year.

 

Interest rate option exposure remained modest throughout the year with option VaR at €1.0 million at year-end (2014: €1.2 million), having peaked at €5.4 million during the year (2014: €4.5 million during the year). The specific contribution from foreign exchange risk to the overall VaR stood at €1.4 million at year-end (2014: €0.4 million). As in previous years, this contribution was small throughout 2015 and never exceeded €5.0 million (2014: €2.0 million).

 

VaR and eVaR measures remain limited by their historical framework insofar as past market events are not necessarily a perfect predictor of future unfolding scenarios. For these reasons a number of other risk measures are employed to complement VaR and eVaR data, with numbers produced using a different set of assumptions and based on a set of risk factor sensitivities. This is also to ensure that material risks are not ignored by focusing on one particular set of risk measures. Foreign exchange risk and the various types of interest rate risks, whether for outright exposures or for options, are monitored with sensitivity-based measures independently for each currency and type of option. A series of stress tests is also produced on a daily basis. These primarily encompass:

 

  • stress-testing the options portfolio for joint large changes in the level of the price of the underlying security and that of volatility;
  • analysing, for each currency separately, the profit and loss impact of large changes in the level and shape of the yield curve; and
  • stress tests covering the entire Treasury portfolio based on historical scenarios.

 

 

Equity price risk

The Bank has direct exposure to equity risk of €63 million at 31 December 2015 through two Treasury share investments41 (2014: €62 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 Vice Presidency. 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 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 Board of Directors approved a revised liquidity policy during the year and 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 consistent with being considered as a strong positive factor under rating agency methodologies. 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; and
  • 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.

 

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 2015 and consistently exceeded the prevailing liquidity policy requirements throughout the year. The average weighted maturity of assets managed by Treasury at 31 December 2015 was 1.3 years (2014: 1.5 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 2015 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 2015 the Bank raised €4.2 billion of medium- to long-term debt with an average tenor of 4.8 years (2014: €5.2 billion and 4.2 years). The Bank’s AAA credit rating with a stable outlook was affirmed by the three major rating agencies in the second half of 2015.

 

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.

 

As the figures represent undiscounted cash flows, they do not agree to the balance sheet.

 

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

Credit derivatives

-

-

-

-

-

-

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 2014

(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)

Financial liabilities at

31 December 2014

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

(2,403)

(133)

-

-

-

(2,536)

Debts evidenced by certificates

(2,031)

(779)

(5,902)

(13,564)

(16,596)

(38,872)

Other financial liabilities

(6)

(15)

(96)

(39)

-

(156)

At 31 December 2014

(4,440)

(927)

(5,998)

(13,603)

(16,596)

(41,564)

Trading derivative cash flows

 

 

 

 

 

 

Net settling interest rate derivatives

(6)

(8)

(50)

(56)

(99)

(219)

Gross settling interest rate

derivatives – outflow

(335)

(100)

(554)

(1,185)

(289)

(2,463)

Gross settling interest rate

derivatives – inflow

309

75

544

1,188

260

2,376

Foreign exchange derivatives – outflow

(57)

(510)

(502)

-

-

(1,069)

Foreign exchange derivatives – inflow

56

478

457

-

-

991

Credit derivatives

-

-

-

(1)

-

(1)

At 31 December 2014

(33)

(65)

(105)

(54)

(128)

(385)

Hedging derivative cash flows

 

 

 

 

 

 

Net settling interest rate derivatives

(8)

1

(35)

(185)

(131)

(358)

Gross settling interest rate derivatives – outflow

(57)

(131)

(1,747)

(3,523)

(3,047)

(8,505)

Gross settling interest rate derivatives – inflow

68

160

1,532

2,903

2,755

7,148

At 31 December 2014

3

30

(250)

(805)

(423)

(1,445)

Total financial liabilities at 31 December 2014

(4,470)

(962)

(6,353)

(14,462)

(17,147)

(43,394)

Other financial instruments

 

 

 

 

 

 

Undrawn commitments

 

 

 

 

 

 

Financial institutions

(2,654)

-

-

-

-

(2,654)

Non-financial institutions

(8,877)

-

-

-

-

(8,877)

At 31 December 2014

(11,531)

-

-

-

-

(11,531)

 

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 2015, €8.9 billion of the callable capital increase had been subscribed (2014: €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 €39.2 billion at 31 December 2015 after 2015 net income allocation decisions (2014: €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 2015, the Bank’s gearing ratio on an aggregated basis was 71 per cent (2014: 69 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 (2014: 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 2015 the ratio of required capital to available capital was 80 per cent (2014: 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 2015, the ratio of members’ equity to total assets was 27 per cent (2014: 27 per cent) and the ratio of members’ equity to Banking assets was 56 per cent (2014: 58 per cent).

 

F. Fair value of financial assets and liabilities

Classification and fair value of financial assets and liabilities

 

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 assets at 31 December 2014

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

106

106

– Derivative financial instruments

4,978

4,978

– Banking loans at fair value through profit or loss

338

338

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

5,069

5,069

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

62

62

 

10,553

10,553

Financial assets measured at amortised cost:

 

 

– Placements with and advances to credit institutions

10,612

10,612

– Debt securities

11,688

11,713

– Collateralised placements

57

58

– Other financial assets

345

345

– Banking loan investments at amortised cost

19,149

20,153

 

41,851

42,881

Total

52,404

53,434

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)

(34,191)

Derivative financial instruments

(357)

(77)

(2,559)

-

(2,993)

(2,993)

Other financial liabilities

-

-

-

(577)

(577)

(577)

Total financial liabilities

(357)

(77)

(2,559)

(37,447)

(40,440)

(40,351)

Financial liabilities at 31 December 2014

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

-

-

-

(2,534)

(2,534)

(2,534)

Debts evidenced by certificates

-

-

-

(32,922)

(32,922)

(32,818)

Derivative financial instruments

(359)

(81)

(1,990)

-

(2,430)

(2,430)

Other financial liabilities

-

-

-

(452)

(452)

(452)

Total financial liabilities

(359)

(81)

(1,990)

(35,908)

(38,338)

(38,234)

 

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 2015, 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 yearend 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 2015 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

-

747

 

747

Derivative financial instruments

-

4,098

498

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

10,778

 

 

 

 

 

Derivative financial instruments

-

(2,915)

(78)

(2,993)

Total financial liabilities at fair value

-

(2,915)

(78)

(2,993)

At 31 December 2015

 

 

 

 

 

 

Level 1

€ million

Level 2

€ million

Level 3

€ million

Total

€ million

Debt securities

-

106

-

106

Derivative financial instruments

-

4,463

515

4,978

Banking loans

-

-

338

338

Share investments (Banking portfolio)

1,682

-

3,387

5,069

Share investments (Treasury portfolio)

-

62

-

62

Total financial assets at fair value

1,682

4,631

4,240

10,553

 

 

 

 

 

Derivative financial instruments

-

(2,348)

(82)

(2,430)

Total financial liabilities at fair value

-

(2,348)

(82)

(2,430)

 

 

 

 

 

At 31 December 2014

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 2015.

 

 

 

 

 

 

 

 

 

 

Debt

securities

€ million

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 2014

-

515

338

3,387

4,240

(82)

(82)

Total gains/(losses) for the

year ended 31 December

2015 in:

 

 

 

 

 

 

 

Net profit/(loss)

-

14

(44)

(174)

(204)

4

4

Purchases/issues

-

62

61

693

816

-

-

Sales/settlements

-

(93)

(44)

(626)

(763)

-

-

Reclassification

-

-

28

(28)

-

-

-

Transfers out of Level 3

-

-

-

(38)

(38)

-

-