The Bank assumes a conservative approach to risk-taking. The constituent documents require that loans be granted in accordance with sound banking principles, that adequate security be obtained for the loans, unless sufficient security is considered to exist under the circumstances, and that the Bank protect itself against the risk of exchange rate losses to the extent practicable.
As an international financial institution, the Bank is not subject to national or international prudential regulation of the banking sector.
The Bank recognises that effective risk management is based on a sound risk culture, which is characterised, among other things, by a high level of awareness concerning risk and risk management in the organisation. The Board approves credits and grants authorisation to the Bank to raise funds in the capital markets based on its estimated funding requirements.
The Board of Directors has delegated some credit approval authority to the President for execution in the Credit Committee. The Executive Committee consists of the President and senior officers, whose appointment to the committee has been confirmed by the Board of Directors. The committee is the forum for addressing policy and management issues, including following up the financial results, business plan and strategy of the Bank.
The committee meets approximately twice a month.
Note 2: Risk management
The Credit Committee consists of the President and senior officers appointed by the Board of Directors. The committee is responsible for preparing and making decisions on credit matters related to lending operations and for decisions on treasury counterparties.
Among other things, the committee reviews all credit proposals before they are submitted to the Board of Directors for approval.
The committee usually meets weekly. The committee is responsible for preparing and making decisions on matters related to treasury operations. The committee makes recommendations and, where appropriate, decisions in the area of market, counterparty and liquidity risk exposure. The committee usually meets monthly. The committee meets approximately six times a year.
The chairman of the Committee shall be a member of the Executive Committee. In the day-to-day operations, the Bank has established a segregation of duties between units that enter into business transactions with customers or otherwise expose the Bank to risk, and units in charge of risk assessment, risk measurement, monitoring and control.
Treasury provides support by executing the funding strategy and managing the liquidity as well as balance sheet risks Asset and Liability Management.
Key risk responsibilities
The business units carry out the day-to-day management of all risks assumed in their operations and ensure that an adequate return is achieved for the risks taken. The Head of Risk and Finance reports to the President. The Credit unit oversees that credit proposals are in compliance with established limits and policies.
The Special Credits unit manages transactions requiring particular attention due to restructuring work-out and recovery processing. The Head of Credit and Analysis reports to the President.
The General Counsel reports to the President. The Compliance function assists the Bank in identifying, assessing, monitoring and reporting on compliance risks in matters relating to the institution, its operations and the personal conduct of staff members. Internal Audit provides an independent evaluation of the controls, risk management and governance processes.
Risk powers performance
It ensures that the operations of the Bank are conducted in accordance with the Statutes. The committee also monitors the anti-corruption and compliance practices of the Bank.
The Bank is also exposed to credit risk in its treasury activities, where credit risk derives from the financial assets that the Bank uses for investing its liquidity, such as fixed-income securities and interbank deposits, and from derivative instruments used for managing currency and interest rate risks and other market risks related to structured funding transactions. The maximum credit exposure that the Bank is willing to take is expressed in terms of exposure limits set by the Board of Directors.
Credit exposure is the aggregate of lending and treasury exposure. Counterparty limits are determined based on the probability of default and expected loss. For exposure limit purposes, the Bank considers the entity where the risk resides, i. To prevent excessive concentrations, the Bank applies portfolio-level limits for large counterparty exposure, as well as for industry sector and country exposures.
The Bank has not set limits for the aggregate lending exposure in its member countries. Lending in non-member countries is subject to country limits.
Based on the assessment, a risk rating indicating the probability of default PD is assigned to the counterparty. The credit risk assessment includes the use of quantitative risk methodologies and models as well as qualitative assessments based on expert judgement.
A separate expected loss EL rating is assigned at the transaction level. The LGD assignment process relies on models that produce an LGD estimate based on the type of counterparty and the characteristics of the transaction, such as guarantees, collateral, the seniority of the claim and other credit enhancing factors in the transaction.
The risk ratings are approved by the Credit Committee. In addition, a separate D class applies for non-performing transactions. The Bank lends and invests on a senior unsecured or secured basis. When lending on an unsecured basis, the Bank requires that various undertakings, such as negative pledges and financial and non-financial covenants, are incorporated in the loan agreements.
The collateral should preferably be independent from the obligor e. The ISDA master agreement allows for a single net settlement of all swap transactions covered by the agreement in the event of a counterparty default or early termination of the transactions.
The CSA further mitigates credit risk related to swaps, as the swap positions are marked to market daily and the resulting exposures exceeding agreed thresholds, if any, are collateralised by cash or high-quality government securities. The Bank puts strong emphasis on continuous monitoring of the credit risk development in its lending and treasury operations.
Credit risk is monitored both at counterparty level and at portfolio level.
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The primary responsibility for credit risk monitoring resides with the unit responsible for the client relationship, i. Risk Management carries out the portfolio level monitoring. In addition, an annual follow-up is conducted on the entire loan portfolio. The annual follow-up is presented to the Credit Committee and reported to the Board of Directors. Treasury exposures are subject to continuous monitoring of events and market signals that could potentially lead to or indicate a material change in risk.
At a minimum, the counterparties are analysed and the risk class validated every two years.
The follow-up is presented to the Credit Committee. Watch-listed counterparties are reviewed by the Credit Committee at agreed intervals and reported to the Board of Directors. If a credit exposure requires the expertise of specialists in workout and restructuring, it will be transferred to the Special Credits unit.
Credit risk monitoring at portfolio level includes, among others, an analysis of the aggregate credit risk exposure, credit risk concentrations and changes in the risk profile.
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Compliance with existing limits is monitored regularly; for treasury counterparties, limit compliance is monitored on a daily basis. Exposure in excess of maximum limits may occur e.
Limit breaches are reported to senior management, relevant committees and the Board of Directors. The Statutes stipulate that the Bank shall operate according to sound banking principles and aim for a profit allowing the formation of reserves and a reasonable return on capital.
For loan pricing purposes, the Bank uses a pricing tool that enables calculation of the minimum earnings required on a loan in order to cover all lending related costs and an appropriate return for the level of risk assumed.
Internal credit risk ratings and associated risk parameters, as well as the structure of the transaction, are key input factors in the pricing tool.
The Bank maintains two credit risk funds within its equity, in addition to the Statutory Reserve. At year-end , the fund amounted to EUR 1, million before allocation of the profit for the year.
At year-end , the fund amounted to EUR million before allocation of the profit for the year. At least every four months, the Bank reviews the need for impairment provisions on weak exposures. The assessment is carried out both at the level of the individual counterparty and collectively for groups of counterparties.
Collective impairment provisions are determined on a portfolio basis for exposures with similar credit risk characteristics as reflected in their risk ratings. In the assessment of sovereign exposures, the Bank takes into account its preferred creditor status. Aggregate credit exposure comprises lending and treasury exposure.
Lending exposure includes loans outstanding and loans agreed but not yet disbursed, without taking into account any collateral or other credit enhancement. Regarding the treasury exposure, capital market investments are included at nominal value, while derivatives are included at market value net of collateral held.
The exposure to collateralised placements in the form of reverse repo transactions is calculated as a fixed percentage of the market value of the collateral held.
Around one third of the disbursements were to counterparties in the best risk classes EL , which was largely explained by new lending to the public sector. The lending exposure in the weakest risk classes EL was reduced mainly due to repayment. The decrease in exposure in risk class D non-performing was the result of payments received, write off of claims as well as the upgrade of one customer.
The geographical distribution of the aggregate credit risk exposure is shown in the table below. The largest lending exposures outside the member countries were in Poland, China, Brazil and India. The major part of the treasury exposure outside Europe was in Canada.
The distribution of the credit risk exposure by sector is based on the industry sector of the risk-owner. These sectors are different from the four business areas into which the Bank has organised its lending operations.
In nominal terms the most significant increase was in the exposure to the public sector and the financial sector. The exposure to these sectors increased as a consequence of new lending and included EUR 1. At year-end , the Bank was in compliance with these limits. A counterparty exposure is defined as the consolidated group exposure, i. Any deviations from the set limits must be approved by the Board of Directors.
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At year-end , the Bank was within the aggregate limits set for large exposures. The Bank defines market risk as the risk of valuation loss or reduction in the expected earnings stemming from adverse fluctuations in exchange rates, interest rates, credit spreads and cross-currency basis spreads. Cross-currency basis risk stems from the hedging techniques used by the Bank to mitigate spot foreign exchange risk deriving from funding and lending in different currencies.
This risk relates to transactions exchanging foreign currencies at a future point in time. The Bank manages market risks by hedging against foreign exchange risk and interest rate risk with the objective of protecting its earnings and the economic value of its assets and liabilities.
Operational Risk and Compliance Management
Foreign exchange risk is practically fully hedged. Interest rate risk deriving from mismatches between funding and lending is kept at a modest level. As part of its structured funding transactions, the Bank may use financial instruments linked to other market risk factors than the above.