12.2.3. Market risk

mBank organises market risk management processes in line with the principles and requirements set out in the resolutions and recommendations of PFSA which address issues related to market risk management, in particular Recommendations A and I.

Tools and measures

In its business, mBank is exposed to market risk, i.e., the risk of unfavourable changes in the present value of financial instruments in the Bank’s portfolios due to changes in market risk factors: interest rates, FX rates, prices of securities, the implied volatility of options, and credit spreads. The Bank identifies market risk related with positions of the trading book measured at fair value (using the direct measurement method or the model measurement method) which may materialise in the form of losses reflected in mBank’s financial performance. Moreover, the Bank attributes market risk to the banking book positions, regardless of the methods for calculating earnings generated from those positions used for the purpose of accounting reporting. In particular, in order to measure the interest rate risk of Retail and Corporate Banking products without a fixed interest revaluation date or with rates administered by the Bank, the Bank uses replicating portfolio models. In 2013, the Bank introduced the capital modelling concept, which is reflected in market risk measurement at the level of the Bank’s internal organisational structures. In 2014, the Bank modified the capital modelling concept by changing the investment time horizon from 3 years to 5 years and converting quarterly tranches to monthly tranches. Market risk measures of the interest positions of the banking book are calculated with the use of net present value (NPV) models. Market risk exposure is quantified by measurement of Value at Risk (VaR) and by use of stress tests.

Stress testing reflects the hypothetical change in the present valuation of mBank’s portfolios that would occur as a result of stress-test scenarios, i.e., specific stressed values of risk factors in a one-day time horizon.

Stress testing includes standard stress test was defined for standard risks: FX rates, interest rates, stock prices and their volatility, as well as a stress test including change of credit spreads. This addressed among others the requirement for stress tests to cover independent impact of underlying risk (spread between T-bond yields and IRS rates) to which the Bank is exposed by holding a portfolio of T-bonds.

Value at Risk measures the potential loss of market value (of a financial instrument, a portfolio, an institution) such that the probability of generating or exceeding it within a set time horizon is equal to the set tolerance (confidence) interval assuming an unchanged portfolio structure within a defined period of time. mBank calculates and limits one-day Value at Risk at a 97.5% confidence interval. In March 2014, a new risk factor was added to the VaR calculation: credit spread (credit spread for corporate and government bonds; for government bonds, the spread is measured as the difference between the rates of the zero-coupon bond curve and the swap curve), and the valuation methodology of floating-rate government bonds for risk measurement was modified in order to include the base risk effect between bond and swap curves in the valuation. As a result of the foregoing, some of the risk (previously presented as interest rate risk) related to the volatility of the spread between the curves is presented as of March under VaR CS (credit risk spread). The expected resulting increase of VaR is included in the market risk limits approved for 2014 for mBank and entities subject to market risk limits.

Market risk, in particular interest rate risk of the banking book, is also quantified by measurement of Earning at Risk (EaR) of the banking book.

Organisational set up of the market risk management process

The main principle of organisation of the market risk management process stipulates separation between the market risk monitoring and control function and the functions related with opening and maintaining open market risk positions. The market risk monitoring and control functions are performed by the Financial Markets Risk Department (DRR) in the Risk Area of the Bank supervised by the Deputy President of the Management Board and Chief Risk Officer, whereas operational management of market risk positions takes place in the Financial Markets Department (DFM), the Brokerage House (BM) and the Treasury Department (DS) supervised by the Member of the Management Board of mBank responsible for the Financial Markets Area. BM is an organisational unit of mBank which was separated from the DFM structure and carries out its operations focusing on financial instruments traded on the Warsaw Stock Exchange (WSE). The Debt Origination Department (DCM) was separated from the organisation of DFM in 2014 and is responsible for debt origination and management of positions in non-Treasury securities on the banking book. In addition, investment positions sensitive to market risk factors (to prices of shares listed on the Warsaw Stock Exchange) are managed by the Structured and Mezzanine Finance Department (DFS). DCM and DFS are part of the Corporate and Investment Banking area.

In order to limit the level of exposure to market risk, the Bank’s Management Board (for the Bank portfolio) and the Financial Markets Risk Committee operating as part of the Risk and Business Forum  (for portfolios of business units) set binding VaR limits, stress test limits which are warning thresholds, as well as maturity gap limits which are warning thresholds.

Measuring mBank’s risk

Value at Risk

In 2014, the Bank’s market risk exposure, measured by Value at Risk (VaR, for one day holding period, at 97.5% confidence level), was moderate in relation to the VaR limits. The average utilisation of VaR limits for the portfolio of the Financial Markets Department (DFM), whose positions consist primarily of trading book portfolios, amounted to 33% (PLN 2.0 million), for the Brokerage Bureau (BM) 15% (PLN 0.34 million), and for the Treasury Department (DS), whose positions are classified solely in the banking book, 59% (PLN 26.1 million) for the positions without capital modelling, and 55% (PLN 23.9 million) for the positions with capital modelling. Value at Risk of the positions of the Debt Origination Department (DCM) was limited as of March 2014. The average utilisation of the limit was 9% (PLN 0.3 million). The average utilisation of the VaR limit for the positions of the Structured and Mezzanine Finance Department (DFS) in shares listed on the Warsaw Stock Exchange was 72% (PLN 6.4 million). In 2014, the VaR figures for the Bank’s portfolio were driven mainly by portfolios of instruments sensitive to interest rates – the banking book T-bonds portfolios managed by DS and the trading book portfolios and interest rate swap positions managed by DFM. The second major factor impacting the Bank’s risk profile was the DFS equities portfolio, where the PZU share price is a significant risk due to the maintained large position in the company by the Bank. The DFM portfolios of instruments sensitive to changes in exchange rates, such as FX futures and options, and the exposure of the BM portfolios to equity price risk and the risk of implied variability of options traded on the WSE had a relatively low impact on the Bank’s risk profile.

The tables below present VaR statistics in 2014 for the Bank’s portfolio.

 

 

PLN thousand

2014

2013

31.12.14

average

max

min

31.12.13

average

max

min

VaR IR

16,457

14,693

19,081

8,122

15,155

16,034

22,806

6,774

VaR FX

937

348

1,162

95

212

348

1,196

73

VaR EQ

6,243

6,507

7,647

5,836

7,268

5,659

7,451

4,551

VaR CS

25,142

27,245

31,279

25,049

VaR

33,393

29,448

36,453

15,968

16,910

17,622

23,556

10,840

VaR IR – interest rate risk

VaR FX - FX risk

VaR EQ – stock price risk

VaR CS – credit spread risk

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Stress testing

The average utilisation of the stress test limits in 2014 is presented in the below table:

 

PLN million

2014

2013

31.12.2014

average

max

min

31.12.2013

average

max

min

Base stress test

93

85

130

44

52

70

109

46

CS stress test

705

699

760

634

643

851

1,104

621

Total stress test

798

784

888

684

694

921

1,198

689

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In 2014, the average utilisation of the stress test limits in mBank was 50% (PLN 783.9 million). The average utilisation of the stress test limits in 2014 was 65% (PLN 618.9 million) for the portfolio held by DS without capital modelling and 59% (PLN 616.7 million) with capital modelling. The average utilisation of the limit was 30% (PLN 121.7 million) for the DFM portfolio, 7% (PLN 0.8 million) for the BM portfolio, 25% (PLN 15.5 million) for the DCM portfolio, and 65% (PLN 32.7 million) for the DFS portfolio. The main part of the presented stress test results is the value of stress tests for change of the credit spread of T-bond portfolios because the stress test scenarios assume on average a 100 bps increase of interest rates. 

Interest rate risk of the banking book

In 2014, the interest rate risk of the banking book as measured by EaR, i.e., potential decrease of interest income within 12 months assuming an unfavourable 100 bps change of market interest rates and based on a stable value of the portfolio over the period, was at the level of values presented in the below table:

 

 

 

PLN million

2014

2013

31.12.14

average

max

min

31.12.13

average

max

min

PLN

32.8

28.4

69.8

4.2

70.9

50.6

116.9

6.7

USD

1.0

1.4

4.0

0.2

1.0

1.2

2.3

0.1

EUR

4.5

6.6

12.6

1.4

7.2

6.5

10.0

1.8

CHF

13.3

0.8

15.7

0.0

0.5

0.4

0.6

0.2

CZK

2.3

4.2

8.5

2.2

4.6

5.6

7.4

3.0

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Measuring the Group’s market risk

The main source of the Group’s market risk are the positions of the Bank. The table below presents the statistics of Value at Risk measures (for one day holding period, at 97.5% confidence level) of the mBank Group in 2014 for those subsidiaries of the Group where market risk positions were identified (i.e., the portfolios of mBank, mBank Hipoteczny, mLeasing, Dom Maklerski mBanku) and broken down by Value at Risk for the main risks: the interest rate risk (VaR IR), the foreign exchange risk (VaR FX), the equity price/index risk (VaR EQ), the credit risk spread risk (VaR CS). The table below presents VaR as at the end of 2014.

 

 

 

PLN thousand

mBank Group

mBank

mBH

mLeasing

DM mBanku

VaR IR

15,119

14,693

75

436

8

VaR FX

357

348

26

108

20

VaR EQ

6,540

6,507

0

0

137

VaR CS

27,245

27,245

0

0

0

VaR średni

29,678

29,448

86

418

134

VaR max

36,718

36,453

251

627

171

VaR min

16,183

15,968

45

308

71

VaR

33,513

33,393

53

424

112

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For comparison, Value at Risk at mBank Group level was PLN 17,152 thousand at the end of 2013 including PLN 16,910 thousand for mBank, PLN 64 thousand for mBank Hipoteczny, PLN 615 thousand for mLeasing, and PLN 108 thousand for DM mBank.