Capital
adequacy

Capital adequacy is the maintenance of a level of capital by the PKO Bank Polski SA Group exceeds sum of regulatory capital requirements (the so-called Pillar 1) and sum of internal capital requirements (the so-called Pillar 2).

The objective of capital adequacy management is to maintain capital on a level that is adequate to the risk scale and profile of the Group's activities.

The process of managing the Group’s capital adequacy comprises:

  • identifying and monitoring of all of significant risks,
  • assessing internal capital to cover the individual risk types and total internal capital,
  • monitoring, reporting, forecasting and limiting of capital adequacy,
  • performing internal capital allocations to business segments, client segments and entities in the Group in connection with profitability analyses,
  • using tools affecting the capital adequacy level (including: tools affecting the level of equity, the scale of equity item reductions and the level of the loan portfolio).

The main measures of capital adequacy are:

  • the capital adequacy ratio whose minimum level in accordance with the Banking Act is 8%,
  • the ratio of equity to internal capital whose acceptable minimum level in accordance with the Banking Act is 1.0.

As at 31 December 2011 compared with 31 December 2010 (comparable data calculated in accordance with the amended regulations concerning rules of calculating capital requirements as well as own funds), the Group’s capital adequacy ratio dropped by 0.10 pp. to 12.37%, mainly due to an increase in the Group’s credit risk capital requirement, resulted mainly from the fast loan portfolio growth of the Group.

Despite the drop in the capital adequacy ratio, the Group’s capital adequacy 2011 remained at a safe level, significantly above the statutory limits.

Own funds calculated for the capital adequacy purposes

Own funds for the purposes of capital adequacy are calculated based on the provisions of the Banking Law and the Resolution No. 325/2011*of the Polish Financial Supervision Authority of 20 December 2011 on decreasing core funds (Official journal of the PFSA nr 13 item 49 as of 30 December 2011).

Own funds comprise basic funds, supplementary funds and short-term capital.

Basic funds are comprised of the following items:

  1. principal funds comprising: share capital, reserve capital, other reserve capital,
  2. general banking risk fund,
  3. unappropriated profits from previous years,
  4. net profit prior to approval and net profit for the current reporting period, calculated based on appropriate accounting standards, decreased by any expected charges and dividends, in amounts not exceeding amounts audited by certified public accountants, in accordance with the Banking Law, Article 127.2, Point 2)c).

Basic funds are reduced by deducting the following items:

  1. intangible assets stated at carrying amount,
  2. the Bank’s equity exposures to financial institutions, lending institutions, domestic banks, foreign banks and insurance companies – in the amount of 50% of the value of such exposures,
  3. unrealised losses on debt, equity instruments and other receivables classified as available for sale,
  4. negative currency translation differences from foreign operations,
  5. negative amounts in respect of adjustments on revaluation of assets in the trading portfolio.

Supplementary funds are comprised of the following items:

  1. subordinated liabilities,
  2. unrealised gains on debt and equity instruments classified as available for sale – in the amount of 80% of their pre-tax value,
  3. positive currency translation differences from foreign operations.

Moreover, the supplementary funds are reduced by 50% of the value of the Bank’s equity exposures to financial institutions, lending institutions, domestic banks, foreign banks and insurance companies. If the amount of reduction would result in supplementary funds falling below nil, the excess above the value of the supplementary funds is subtracted from the basic funds.

The own funds of the Group include also short-term capital.

In addition, the following items are included in the calculation of consolidated own funds of the Group:

  1. goodwill of subsidiaries (which decreases the value of own funds),
  2. non- controlling interests in equity (which increase the value of own funds).

As at 31 December 2011, the Group’s own funds increased by PLN 724 370 thousand, mainly as a result of including in the funds the Bank's net profit for 2010, net of dividend paid (of PLN 836 209 thousand) and an increase in the reserve capital and other reserves of the Group’s entities of PLN 41 132 thousand. Compared with the balance as at the end of 2010, the accumulated profit dropped by PLN 135 459 thousand, and the amount of unrealised losses on debt and equity securities in the AFS portfolio increased by PLN 62 112 thousand, with a simultaneous drop in the value of other reductions of PLN 36 861 thousand.

The structure of the Group’s own funds is presented in the table below:

GROUP'S OWN FUNDS 31.12.2011 31.12.2010
Basic funds (Tier 1) 16 664 233 15 960 072
Share capital 1 250 000 1 250 000
Reserve capital 13 041 390 12 212 177
Other reserves 3 460 368 3 412 239
General banking risk fund for unidentified banking activities risk 1 070 000 1 070 000
Profits from previous years (23 162) 112 297
Unrealised losses on debt and equity instruments and other receivables classified as available for sale (129 518) (67 406)
Assets valuation adjustments in trade portfolio (143) (183)
Intangible assets, of which: (1 800 008) (1 802 037)
goodwill of subsidiaries (227 349) (229 740)
Equity exposures (109 054) (118 285)
Negative currency translation differences from foreign operations (94 350) (110 720)
Non-controlling interest (1 290) 1 990
Supplementary funds (Tier 2) 1 545 549 1 512 546
Subordinated liabilities classified as supplementary funds 1 600 700 1 600 700
Unrealised profits on debt and equity instruments classified as available for sale (up to 80% of their values before tax) 51 576 29 158
Positive currency translation differences from foreign operations 2 327 973
Equity exposures (109 054) (118 285)
Short-term equity (Tier 3) 133 134 145 928
TOTAL EQUITY 18 342 916 17 618 546

Capital requirements (Pillar 1)

The Group calculates capital requirements in accordance with the Resolution No. 76/2010 of the Polish Financial Supervision Authority dated 10 March 2010 on scope and detailed principles of setting capital requirements in connection with the individual risk types (Polish Financial Supervision Authority’s Journal of Laws No 2, item 11 dated 9 April 2011 with subsequent amendments): in respect of the Bank’s operational risk – using the standard method, in respect of operating risk - starting from 30 June 2011 using the advanced method (AMA) (for the year 2010 using the standard method (TSA)) and in respect of market risk - using the basic methods.

The scale of the Bank’s and the Group’s trading activities is significant, therefore the total capital requirements constitute sum of the capital requirements for:

  1. credit risk – including credit risk of the banking book and counterparty credit risk,
  2. market risk – including foreign exchange risk, commodities risk, equity securities risk, specific risk of debt instruments, general risk of interest rates,
  3. operational risk,
  4. other types of capital requirements in respect of:
    1. settlement/delivery risk,
    2. the risk of exceeding the exposure concentration limit and the large exposure limit,
    3. the risk of exceeding the capital concentration threshold.

The table below shows the Group’s exposure to particular types of risk.

Capital requirements 31.12.2011 31.12.2010
Credit risk 10 657 309 9 821 710
credit risk (banking book) 10 534 714 9 756 757
counterparty risk (trading book) 122 595 64 953
Market risk 355 284 422 154
equity securities risk 1 604 767
specific risk of debt instruments 262 412 341 058
general risk of interest rates 91 268 80 329
Operational risk 852 099 1 057 922
Total capital requirements 11 864 692 11 301 786
Capital adequacy ratio 12,37% 12,47%

An increase in the capital requirement in 2011 in respect of credit risk resulted from a significant increase in the volume of loan portfolio (statement of financial position and off-balance-sheet exposure) by approx. 6.6%.

A decrease in the capital requirement in respect of market risk by 15.8% to the level of PLN 355 million resulted mainly from a decrease in the value of issue underwriting, whereas an increase in the value of corporate bonds (total decrease in the requirements on bonds approx. by 29%).

The Bank’s capital requirements in respect of operating risk as at 31 December 2011 has been calculated under the advanced measurement approach (AMA). On 21 June 2011, the Bank obtained approval from the PFSA for implementing this approach with a temporary limitation (until the conditions set by the PFSA have been met) on the drop in the capital requirement by no more than up to a level of 75% of the requirement calculated under the standardised approach (TSA). As a consequence, as at December 2011 the requirement in respect of operating risk for the Group compared with the value at the end of December 2010 dropped by PLN 206 million to PLN 852 million.

The requirement in respect of operational risk of Group entities was calculated using the basic index approach (BIA) both in 2011 and 2010.

The Group calculates capital requirements on account of credit risk according to the following formula:

  • in case of statement of financial position items – a product of a carrying amount, a risk weight of the exposure calculated according to the standardised method of credit risk requirement and 8% (considering collateral),
  • in case of granted contingent liabilities and commitments – a product of nominal value of liability (considering value of allowances on the liability), a risk weight of the product, a risk weight of exposure calculated according to the standardised method of credit risk requirement and 8% (considering recognised collateral),
  • in case of off-balance sheet transactions (derivative instruments) – a product of risk weight of the exposure calculated according to the standardised method of credit risk requirement, equivalent in the statement of financial position of off-balance sheet transaction and 8% (the value of the equivalent in the statement of financial position is calculated in accordance with the mark-to-market method).

Risk-weighted amount divided into portfolios (on account of credit risk of instruments included into banking book, counterparty credit risk and specific risk of instruments from the trading portfolio) as at 31 December 2011 is as follows:

Type of instrument Carrying amount Risk - weighted value
Bank portfolio 183 766 482 118 090 798
Trading portfolio 6 981 555 2 643 592
Total instruments in the statement of financial position 190 748 037 120 734 390


Type of instrument Nominal value Statement of financial position equivalent Risk - weighted value
Bank portfolio 35 815 703 13 639 658 12 642 199
Trading portfolio 1 074 685 1 074 685 656 608
Total off-balance sheet instruments 36 890 388 14 714 343 13 298 807


Type of instrument Nominal value Statement of financial position equivalent Risk - weighted value
Bank portfolio 83 382 850 2 448 267 950 931
Trading portfolio 318 503 683 2 918 421 1 532 443
Total derivative instruments 401 886 533 5 366 688 2 483 374

Risk-weighted amount divided into portfolios (on account of credit risk of instruments included into banking book, counterparty credit risk and specific risk of instruments from the trading portfolio) as at 31 December 2010 is as follows:

Type of instrument Carrying amount Risk - weighted value
Bank portfolio 163 897 606 110 839 073
Trading portfolio 5 762 895 1 976 896
Total instruments in the statement of financial position 169 660 501 112 815 969


Type of instrument Nominal value Statement of financial position equivalent Risk - weighted value
Bank portfolio 34 289 347 11 654 884 10 662 583
Trading portfolio 2 496 031 2 496 031 2 295 917
Total off-balance sheet instruments 36 785 378 14 150 915 12 958 500


Type of instrument Nominal value Statement of financial position equivalent Risk - weighted value
Bank portfolio 65 615 762 1 401 166 457 802
Trading portfolio 212 165 405 1 994 358 811 914
Total derivative instruments 277 781 167 3 395 524 1 269 716

Internal capital (Pillar 2)

The Group calculates internal capital in accordance with the Resolution No 258/2011 of the Financial Supervision Authority of 4 October 2011 on detailed principles for functioning of risk management system and internal control system and detailed terms of estimating internal capital by banks and reviewing the process of estimating and maintaining internal capital (Financial Supervision Authority’s Journal of Laws 2011, No. 11, item 42 as at 23 November 2011).

Internal capital is the amount of capital estimated by the Group that is necessary to cover all of the significant risks characteristic of the Group’s activities and the effect of changes in the business environment, taking account of the anticipated risk level.

The internal capital in the PKO Bank Polski SA Group is intended to cover each of the significant risk types:

  • credit risk (including default and concentration risk),
  • currency risk,
  • interest rate risk,
  • liquidity risk,
  • operational risk,
  • business risk (including strategy risk).

The Bank regularly monitors the significance of the individual risk types relating to the activities of the Bank and other Group’s subsidiaries.

The internal capital for covering the individual risk types is determined using the methods specified in the internal regulations. In the event of performing internal capital estimates based on statistical models, the annual forecast horizon is adopted and a 99.9% confidence level.

The total internal capital of each entity of the Group is the sum of internal capital amount necessary to cover all of the significant risks for the entity.

The total internal capital of the Group is the sum of internal capital amount of the Bank and all Group’s entities.

The correlation coefficient for different types of risk and different Group’s entities used in the internal capital calculation is equal to 1.

In 2011, the relation of the Group’s own funds to its internal capital remained on a level exceeding both the threshold set by the law and the Group’s internal limits.

Disclosures (Pillar 3)

In accordance with § 6 of the Resolution No. 385/2008 of the Polish Financial Supervision Authority dated 17 December 2008, on the detailed principles and methods for banks to disclose qualitative and quantitative information concerning capital adequacy and the scope of the information to be announced (Polish Financial Supervision Authority’s Journal of Laws 2008, No. 8, item 39 with subsequent amendments), the PKO Bank Polski SA, which is the parent company within the meaning of §3 of the resolution, publishes information about capital adequacy in a separate document on an annual basis, not later than within 30 days of the date of authorisation of the annual financial statements by the Ordinary General Shareholders’ Meeting.

Details of the scope of capital adequacy information disclosed, the method of its verification and publication are presented in the PKO Bank Polski SA Capital Adequacy Information Policies, which are available on the Bank’s website(http://www.pkobp.pl/).