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BANKIA GIVES PRIORITY TO CREDIT RISK, WHICH IS THE PREDOMINANT RISK IN ITS BUSINESS ACTIVITIES, BUT ALSO MANAGES NON-FINANCIAL RISKS.

BANKIA’S RISK PROFILE SHOWS A CLEAR PREDOMINANCE OF CREDIT RISK (89%), FOLLOWED BY OPERATIONAL RISK (9%) AND MARKET RISK (2%).

CREDIT RISK

During 2017, the mortgage portfolio accounted for 59% of the total loan book, followed by the corporates portfolio, which accounted for 22% of the total. Micro-enterprises and the self-employed and the public sector together accounted for 5%, while consumer finance and cards and specialised lending accounted for 4%.

The distribution of loans to customers between wholesale and retail segments remained similar to 2016, with 33% wholesale and 67% retail. The portfolio of real estate development-related assets represented only 0.7% of total loans and receivables.

Bankia reduced non-performing loans by 1,736 million euros, to a total of 9,740 million at year-end, and brought the NPL ratio down to 8.5%, 1.3 percentage points below the level recorded one year earlier. Including BMN, the Group’s non-performing loans were up 6%, at 12,117 million euros, and the NPL ratio was 8.9%.

Also significant in 2017 was the distribution of doubtful (non-performing) loans: 55% were classified as doubtful in arrears, while the remaining 45% were either classified as doubtful for reasons other than in arrears or else were in a cure period. This means there is no past-due debt in this portfolio that is doubtful in arrears.

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Credit risk at year-end, measured using Exposure at Default (EAD), expected loss and regulatory capital, is distributed by portfolio as follows:

Name segment Regulatory capital Expected loss
Public bodies 59.9 120.4
Banks and financial intermediaries 177.3 13.1
Companies 1,601.7 2,324.6
Developers 72.5 512
Retail: 2,150.2 2,381.2
Mortgage 1,707 1,184.9
Consumer finance 169 102.8
Cards 78.1 38.6
Micro-enterprises and self-employed 196 425
Equity 14.1 0.5
TOTAL 4,075.6 5,351.9

The expected loss, which represents 3.4 % of the total exposure (including the non-performing portfolio), would be fully covered by the provisions recorded on the balance sheet at the end of 2017. Regulatory capital, meanwhile, amounted to 4,076 million euros, of which 42% relates to the mortgage portfolio and 39% to the corporates portfolio.

From an analysis of these data, it can be concluded that Bankia has more than sufficient provisions and capital to face both expected and unexpected losses with a very high level of confidence.

CREDIT RISK POLICIES

The policies for the granting of credit are based on a series of general rules, the most important being:

Responsible lending

The first step when granting credit is to understand the customer’s financing needs and ability to pay. Care must be taken to offer the most appropriate financing facilities and in retail banking the customer must be given the necessary information to understand the inherent risks.


Activity criteria

From 1 January 2018 the restrictions under the Recapitalisation Plan approved by the European Commission have been lifted. Consequently, from that date the bank’s activities include the retail, wholesale and developer segments.


Customer risk

A comprehensive customer assessment must include information about the customer’s ability to pay, the identity of the owners and their guarantors, and the customer’s credit record through the Banco de España’s credit reporting agency CIRBE.


Transaction risk

The credit agreement must include a realistic repayment schedule with periodic due dates linked to the borrower’s sources of income, suitability of the product for the intended purpose and valuation of collateral.


Environmental and social risk

The environmental impact of the customer’s business activity must be taken into account and transactions with customers that do not respect human rights or fail to offer decent working conditions will be avoided.


Another relevant consideration that should influence credit approval is the need to diversify lending, setting limits per customer and per sector.The credit risk policies also introduce specific credit approval criteria for particular portfolio segments. Specifically, they set minimum rating grades and collateral coverage ratios.

For risk monitoring purposes, the bank has established a policy of monitoring customers’ business activity. The main aim is to involve all the group’s units in early management of exposures, so that problematic situations of impairment are detected before any default occurs.

CREDIT RISK MANAGEMENT TOOLS

The credit risk policy relies on a set of tools that can be grouped in the following categories, based on their functionality:

  • Rating. Rating and scoring tools are used to classify borrowers or transactions according to their level of risk.  Rating also includes the system of monitoring levels (with four categories: high risk, medium-high, medium and normal).
  • Measurement. Based on two metrics: the expected loss of the portfolios, which reflects the average amount of losses and is associated with setting provisioning requirements; and the unexpected loss, which is the likelihood that the actual loss in a given period will substantially exceed the expected loss, thus affecting the level of capital needed to meet objectives.
  • Projection. Stress tests are another key element of credit risk management, as they can be used to assess portfolio risk profiles and capital adequacy in adverse scenarios.
  • Risk-adjusted return (RaR). RaR is a fundamental risk management tool. The return of a transaction must be adjusted for the cost of the various risks it entails (not just credit risk).
  • Business development. One of the functions of risk management is to keep value creation and business development aligned with the bank’s risk appetite. The Risk Directorate provides tools that help identify potential customers, simplify decision processes and help assign credit lines.
  • Recovery management. Recovery management starts before any default occurs and covers all phases of the recovery cycle until a resolution is reached, whether friendly or otherwise. In retail lending, early warning models are used. In business lending, the system of monitoring levels serves as the basis for early management of arrears.
  • Concentration risk management. In order to analyse and monitor risk concentration, the specific economic capital component is identified as the difference between systemic economic capital and total economic capital, which includes the concentration effect.

MARKET RISK

Market risk is the loss that would be incurred in the event of adverse changes in the prices of the financial instruments in which an entity trades.

During 2017, the group’s activity in the financial markets was limited, due to the restrictions imposed by the Restructuring Plan, and Bankia did not deal on its own account, which reduces market risk and the need for capital to cover such dealing.

Market risk is measured using two metrics:

  • VaR, which is the maximum loss that can be incurred in a given period with a given confidence level. SVaR (stressed VaR) is the VaR calculated in an extreme market situation.
  • Sensitivity, which quantifies the changes in the economic value of a portfolio due to predetermined fixed movements in the variables that affect that value, such as interest rates, equity prices and the exchange rate.

Stress tests are performed at regular intervals  to quantify the economic impact that extreme movements in the market factors would have on the portfolio. Bankia carried out various initiatives in this respect during the year.

It also adopted the prudent valuation methodology and responded to the requests of the European Banking Authority (EBA) and the European Central Bank (ECB) to take part in their various exercises.

The Group took part in the following market risk exercises:

  • ECB Target Review of Internal Models (TRIM)
  • EBA 2017 EU-wide Transparency Exercise
  • EBA 2017 Benchmarking Exercise
  • SSM 2017 Short Term Exercise for SREP (STE quarterly report)
  • SSM 2017 Reporting of time series concerning back-testing (quarterly report)
  • BCBS 2017 QIS Basel III

COUNTERPARTY RISK IN FINANCIAL MARKETS

Counterparty credit risk is the risk that a counterparty will fail to meet its contractual obligations, giving rise to a loss for the bank in its financial market activity.

The policy for controlling and managing counterparty risk is reflected in the Policy Manual for Credit Risk in Market Activities.

In 2017, Bankia carried out various activities in this sphere, the most noteworthy being the migration of part of the current limit monitoring system to the integrated system it is already using and the novation of the collateral master agreements to adapt them to the new variation margin requirements. The bank also took part in various counterparty risk exercises at the request of the EBA and the ECB.

AN INFORMED BOARD

The group’s exposure to interest rate risk is monitored and managed in accordance with the criteria approved by its governing bodies. The measures corresponding to regulatory scenarios are incorporated in the bank’s Risk Appetite Framework and the limits are adapted to the tolerance and appetite levels set by the Board of Directors.

To allow these measures to be monitored, the Assets and Liabilities Committee receives monthly reports on the situation of asset and liability management (ALM) risk, both in terms of economic value and in terms of net interest income.

The Board of Directors is informed at least quarterly through the Risk Advisory Committee on the situation and monitoring of the limits and is notified immediately if the high-level limits have been exceeded.

INTEREST RATE RISK IN THE BANKING BOOK

Interest rate risk in the banking book (IRRBB) is the risk of loss resulting from adverse changes in market interest rates. These changes affect both net interest income and the value of assets and liabilities.

The intensity of the impact depends largely on the different schedules of maturities and repricing of assets, liabilities and off-balance sheet transactions. The management of IRRBB, like the management of other risks, is based on a clear separation of roles and responsibilities.

During 2017, the bank focused on implementing the metrics associated with the new EBA guidelines on interest rate risk. It addressed issues such as the inclusion of the scenarios, curves and options envisaged in the EBA guidelines, prepared a system of limits adapted to new scenarios and horizons, added eight interest rate movement scenarios in euros, as established by the EBA/BCBS, and performed calculations applying the different floors to the current yield curve.

The challenges to be met in 2018 include continuing to improve information and data quality and developing and implementing methodological improvements to the IRRBB model, particularly as regards the treatment of automatic option risk.

LIQUIDITY AND FUNDING RISK

One of Bankia’s principal objectives is to maintain a long-term funding structure in accordance with the liquidity of its assets, seeking maturity profiles that are compatible with the generation of stable, recurring cash flows, so that the balance sheet can be managed without liquidity strains in the short term. To that end, it ensures that its liquidity position is identified, controlled and monitored daily.

Customer deposits are the bank’s main source of funding, given that its banking activity is based on a retail business model. To cover any additional liquidity requirements Bankia raises funds in the domestic and international capital markets and has sizeable funding activity in the repo markets.

For reasons of prudence, the bank also holds various assets as collateral at the ECB, which allow it to obtain immediate liquidity.

As regards the structure of roles and responsibilities in relation to liquidity risk, the ALCO is charged with monitoring and managing the risk. The Market and Operational Risks Directorate acts as an independent unit, one of its tasks being to monitor and analyse liquidity risk.

To supplement the monitoring of liquidity risk under normal business conditions, an action framework has been designed that will help prevent and manage liquidity stress events.

Its cornerstone is the Contingency Funding Plan (CFP), which specifies both the committees responsible for monitoring liquidity risk and activating the plan and a protocol that sets out responsibilities, communication flows and potential action plans for bringing the risk profile back within the bank’s tolerance limits.

During 2017, Bankia continued to strengthen the liquidity and funding risk management framework. To do that, it assessed a range of qualitative aspects in order to determine the extent to which the management framework built around liquidity and funding risk complies with the principles and guidelines required at regulatory and supervisory level.

The bank has also improved its regulatory reporting by developing and automating metrics and by defining methodologies and processes that will result in a higher quality of information.

To supplement the regulatory approach, the risk measurement metrics have been reinforced: the perimeter of existing metrics has been expanded and the monitoring of liquidity risk in various frameworks has been made more consistent and coherent.

For 2018, the bank aims to increase the automation of regulatory reports and will take steps to adapt to the implementation standards published by the EBA. It also aims to further integrate the regulatory liquidity measures in management and develop measures of intra-day liquidity under conditions of stress.

OPERATIONAL RISK

Operational risk is the risk of loss resulting from inadequate or failed processes or systems or external events. This definition includes legal risk but excludes reputational risk.

To manage operational risk, Bankia seeks to reliably identify and measure the risk and applies systems for continuous improvement of processes and controls, while also developing new risk transfer mechanisms that limit exposure.

From March 2017, the responsibility for operational risk has been extended to include technology risk and cyber security risk, as a second line of defence, bringing in a team of two people with training and experience in systems development. Additionally, a policies and procedures manual was drafted. In January 2018, the bank purchased insurance from AIG to cover cyber security risks.

ENVIRONMENTAL RISK

By the nature of its activity, Bankia has a very limited direct environmental impact, yet it has a very significant indirect influence through its investment and financing decisions. 

The goal of environmental risk management is therefore to protect the quality of the bank’s assets by supervising the portfolios of loans to customers and monitoring decisions to invest in financial or physical assets.

Environmental risk may be transferred to the bank by two paths:

  • Credit risk. From the impact that environmental issues may have on the viability of a customer’s business (regulation or environmental authorisations), increased investments in technology, regulatory risk, loss of cash flows, impairment of assets posted as collateral, or civil or criminal liabilities with internal or external bail.
  • Reputational risk. With increased awareness of environmental issues, society and customers subject the bank’s activities to closer scrutiny, so the risk to the bank’s reputation is increased. The threat of climate change further intensifies this risk.

To manage environmental risk, Bankia has a tool that assigns corporate customers an environmental rating, supplementary to the financial rating. The environmental rating can be used to assess the environmental impact of a company’s activities, how that impact may affect the viability of the company’s businesses and thus the influence it may have on the bank’s credit risk.

The tool uses a questionnaire based on the Equator Principles, which, in combination with the industry rating and the financial rating, assigns the company or project in question a rating on a five-point scale from very low to very high risk.

The tool can be used to obtain an overall rating of the portfolios of loans to large and medium-sized companies. The result of the assessment shows that 80.3% of the obligors or customers and 72.8% of the exposure is in portfolios rated as having low or very low environmental risk.

Bankia has undertaken to preserve the environment by taking steps to reduce the environmental impact of its activities. It also contributes to the establishment of best practices and promotes the necessary training among its professionals.

In the last quarter of 2017, a working group was appointed to analyse certain sectors liable to generate controversies, such as energy, agriculture, mining and defence. The findings will be used to prepare guides on the risky sectors.

Future lines of work will include analysing the recommendations issued in June 2017 by the Task Force on Climate-related Financial Disclosures, a working group set up in 2015 within the UN’s Financial Stability Board. 

COMMITMENT TO COMBAT CLIMATE CHANGE

Bankia’s Responsible Management Policy sets out Bankia’s general commitment to the fight against climate change. Specifically, Bankia undertakes to:

  • Minimise its impact on the environment and reduce the associated costs through more efficient use of resources.
  • Implement proper environmental management in all its processes.
  • Raise its employees’ environmental awareness and train them.
  • Develop products and services that help combat climate change.
  • Include clauses on environmental commitment in its contracts with suppliers.

REPUTATIONAL RISK

During 2017 Bankia continued to put considerable effort into managing reputational risk, complying with the regulator’s and supervisor’s requirements and remaining an exemplary institution in this respect.

One of the key aspects of Bankia’s reputational risk model is that it is integrated in the bank’s overall risk model. In 2017 the bank worked with the heads of reputational risk management and coordination to reinforce the risk culture.

Also, the number of organisational units involved was increased, so as to gain a more comprehensive and accurate view of the situation.

The main change in 2017 was the design of a synthetic indicator for regularly monitoring changes in reputation.

This indicator helps the Board of Directors judge whether Bankia’s reputation is at the desired level or whether action is needed.

SOCIAL RISK

In 2017 Bankia extended its policy to improve and strengthen the framework of protection for obligors whose wealth or financial circumstances have been adversely affected by unforeseen events.

Since 2012, when various measures to protect mortgage debtors were passed into law, the bank has been sensitive to the vulnerability of numerous Spanish households and has applied measures and solutions in line with the spirit of the law.

In addition, Bankia applies voluntary measures aimed at resolving, as far as possible, situations where families face the loss of their primary residence. These measures are taken both at the customer’s request and when the problem is channelled through the social agents (social services departments, NGOs, associations of various kinds, etc.) with which the bank has agreements.

As a result of this policy, a total of 1,236 mortgage modifications (more flexible terms to adapt the loans to the household’s ability to pay) were implemented in 2017, compared to 5,628 in 2016. At the same time, the bank accepted 665 home surrenders (agreements to cancel the mortgage debt in return for surrender of the home), compared to 550 the previous year.

In all cases, these were negotiated solutions, aimed at avoiding evictions among especially vulnerable groups in society, while at the same time seeking to minimise the loss to the bank. Since 2012, Bankia has accepted 8,592 home surrenders and has executed 75,511 mortgage modifications.

Foreclosed homes (i.e., homes repossessed by the bank under a court order) totalled 1,823 (1,971 the previous year).

Bankia’s help for customers in need also extends to other loans. In 2017 it renegotiated the terms of 1,549 consumer loans (1,809 in 2016) and 793 loans to self-employed workers and companies (1,005 in 2016). The cumulative totals since 2012 are 61,824 and 17,932, respectively.

EMERGING RISKS

Although in previous years the impact of regulatory risk was already analysed and mitigated through specific actions that entailed major investments for financial institutions, the steady increase in regulatory pressure on the sector since the financial crisis of the first decade of the 21st century can be considered a new risk in its own right.

The European regulation on Banking Union (which currently includes bank regulation, supervision and resolution) provides a demanding framework for banking activity. Of particular importance is the Supervisory Review and Evaluation Process (SREP), which determines the capital requirements of each credit institution.

In this context, the new risk management structures and tools must be based on the assumption that the regulatory pressure will continue and possibly intensify.

Specifically, during 2017 the Bankia Group carried out plans to adapt its systems, processes and resources to IFRS 9 and MiFID II (both affecting management and the business), which came into force at the beginning of 2018. Specific training plans were also carried out.

The bank has a Regulatory Compliance Committee, whose tasks include deliberating upon and evaluating new regulatory requirements, assessing non-compliance risks in systems, policies and procedures, and proposing and adopting measures as necessary.

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