7.5 Risk profile (continued)

Reference Areas:
Health
Investments
Banking
Best Pratices in PZU

7.5.3. Market risk

Market risk means the risk of loss or of adverse change in the financial situation resulting, directly or indirectly, from fluctuations in the level and in the volatility of market prices of assets, credit spread, value of liabilities and financial instruments.

Market risk types in the PZU Group include:

  • equity risk is the possibility of incurring loss as a result of changes in the values of assets, liabilities and financial instruments caused by changes in the level or in the volatility of market prices of equities;
  • unquoted equity risk is the possibility of incurring loss as a result of changes in the valuation of unquoted shares;
  • property risk is the possibility of incurring loss as a result of changes in the values of assets, liabilities and financial instruments caused by changes in the level or in the volatility of market prices of real estate;
  • commodity risk is the possibility of incurring loss as a result of changes in the values of assets, liabilities and financial instruments caused by changes in the level or in the volatility of market prices of commodities;
  • inflation risk is the possibility of incurring loss associated with the level of information, especially inflation of prices  of goods and services as well as expectations as to the future inflation level, which affect the valuation of assets and liabilities;
  • liquidity risk means the risk of being unable to realize investments and other assets without affecting their market prices in order to settle financial obligations when they fall due;
  • interest rate risk is the possibility of incurring a loss as a result of changes in the value of financial instruments or other assets and a change in the present value of projected cash flows from liabilities, caused by changes in the term structure of market rates or in the volatility of risk-free market interest rates;
  • basis risk is the possibility of incurring a loss as a result of changes in the value of financial instruments or assets and a change in the present value of projected cash flows from liabilities, caused by changes in the term structure of spreads between market interest rates and risk-free rates or in the volatility of such spreads, excluding credit spreads;
  • foreign exchange risk is the possibility of incurring loss as a result of changes in the value of assets, liabilities and financial instruments, caused by changes in the level or in the volatility of currency exchange rates;
  • credit spread risk is the possibility of incurring loss as a result of changes in the value of assets, liabilities and financial instruments, caused by changes in the level or in the volatility of credit spreads over the term structure of the interest rates on debt securities issued by the State Treasury;
  • concentration risk is the possibility of incurring loss stemming either from lack of persification in the asset portfolio or from large exposure to default risk by a single issuer of securities or a group of related issuers.

Concentration risk and credit spread risk are regarded as an integral part of market risk when measuring risk for the purposes of risk profile, risk tolerance, and market risk ratio reporting. The process of managing the risks has however a different set of traits from the process of managing the other sub-categories of market risk and has been described in section 7.5.1.1 along with the process for managing counterparty insolvency risk.

The market risk in the PZU Group originates from three major sources:

  • operations associated with asset and liability matching (ALM portfolio);
  • operations  associated  with  active  allocation,  i.e.  designating  the  optimum  medium-term  asset   structure   (AA portfolios);
  • banking operations in Pekao Alior Bank – in conjunction with them the PZU Group has materially increased its exposure to interest rate risk.

A number of documents approved by supervisory boards, management boards and dedicated committees govern investment activity in the PZU Group’s companies.

Risk units take part in the risk identification process, measure, monitor and report on the risks. Market risk is measured using the value at risk method (VaR). The total market risk value is calculated by aggregating the amounts of inpidual risks based on a pre-defined correlation matrix. In order to effectively manage market risk, risk limits are adopted  in     a form of a capital amount allocated to each market risk and limits for inpidual market risks.

In Pekao, the market risk management system forms the structural, organizational and methodological framework, which aims to maintain the balance sheet and off-balance sheet structure in line with the accepted strategic objectives. The market risk management process and the governing procedures include the separation into the banking and trading books.

In managing its trading book’s market risk, Pekao strives to optimize the financial performance and ensure the highest possible quality of service of the bank’s clients in respect to market-making, while remaining within the limits approved by the management board and the supervisory board.

When managing interest rate risk in its banking book, Pekao endeavors to secure the economic value of equity and to achieve its intended net interest income target within the accepted limits.

In Alior Bank, the exposure to market and liquidity risk is restricted by the system of periodically updated limits introduced by the resolution of the supervisory board or the management board that include all risk measures. In Alior Bank, there are three types of limits that differ in respect to their functioning - basic, supplementary and stress-test limits. Market risk management focuses on potential changes in economic result.

Exposure to market risk

Carrying amount as at 31 December 2017NoteAssets at Group’s riskAssets at client’s risk Total
 including banks’ assets
Financial assets and cash exposed to interest rate risk 280,829243,7361,384282,213
Fixed-income debt securities33.2, 33.3,33.4, 33.666,97339,2781,27068,243
Variable-income debt securities33.2, 33.3,33.4, 33.628,12825,4492328,151
Loan receivables from clients33.6169,457169,457-169,457
Term deposits with credit institutions33.61,751851901,841
Loans33.63,698--3,698
Cash358,2386,62018,239
Buy-sell-back transactions33.6885553-885
Derivatives33.4, 33.51,6991,528-1,699
Financial assets exposed to other price risk 3,3778984,5037,880
Equity instruments33.3, 33.42,7253634,5037,228
Derivatives33.4, 33.5652535-652
Total 284,206244,6345,887290,093

Carrying amount as at 31 December 2016NoteAssets at Group’s riskAssets at client’s riskTotal
 including banks’ assets
Financial assets and cash exposed to interest rate risk 99,09457,8771,463100,557
Fixed-income debt securities33.2, 33.3,33.4, 33.635,6886,9771,14036,828
Variable-income debt securities33.2, 33.3,33.4, 33.68,0782,6451058,183
Loan receivables from clients33.644,99844,998-44,998
Term deposits with credit institutions33.62,0685832172,285
Loans33.61,708--1,708
Cash352,9721,12612,973
Buy-sell-back transactions33.62,8801,264-2,880
Derivatives33.4, 33.5702284-702
Financial assets exposed to other price risk 3,9292433,7737,702
Equity instruments33.3, 33.43,678433,7737,451
Derivatives33.4, 33.5251200-251
Total 103,02358,1205,236108,259

The following table presents financial assets of banks and at client’s risk, by classification into their respective portfolios:

 Financial assets of banks and financial assets at client’s risk31 December 201731 December 2016
Pekao and Alior BankFinancial assets at client’s risk Alior BankFinancial assets at client’s risk
Financial instruments held to maturity4,839-220-
Debt securities4,839-220-
Government securities4,808-220-
Domestic4,808-220-
Fixed rate3,839-220-
Floating rate969---
Other31---
Not quoted on a regulated market31---
Fixed rate31---
Financial instruments available for sale45,772-9,438-
Equity instruments358-36-
Quoted on a regulated market117---
Not quoted on a regulated market241-36-
Debt instruments45,414-9,402-
Government securities31,484-6,438-
Domestic30,762-6,438-
Fixed rate19,060-4,146-
Floating rate11,702-2,292-
Foreign722---
Fixed rate722---
Other13,930-2,964-
Quoted on a regulated market652---
Fixed rate652---
Not quoted on a regulated market13,278-2,964-
Fixed rate13,077-2,611-
Floating rate201-353-

 Financial assets of banks and financial assets at client’s risk31 December 201731 December 2016
Pekao and Alior BankFinancial assets at client’s riskAlior BankFinancial assets at client’s risk
Financial instruments measured at fair value through profit or loss – classified as such upon first recognition-68-61
Equity instruments-65-56
Quoted on a regulated market-61-53
Not quoted on a regulated market-4-3
Debt instruments-3-5
Government securities-3-5
Foreign-3-5
Fixed rate-3-5
Financial instruments measured at fair value through profit or loss – held for trading3,5335,7284194,957
Equity instruments54,43873,717
Quoted on a regulated market53836398
Not quoted on a regulated market-4,05513,319
Debt instruments1,8121,290-1,240
Government securities1,7321,267-1,167
Domestic1,7321,267-1,167
Fixed rate4351,267-1,135
Floating rate1,297--32
Other8023-73
Not quoted on a regulated market8023-73
Floating rate8023-73
Derivatives1,716-412-
Loans183,5239046,845217
Debt securities12,662---
Other12,662---
Quoted on a regulated market977---
Fixed rate281---
Floating rate696---
Not quoted on a regulated market11,685---
Fixed rate1,181---
Floating rate10,504---
Loan receivables from clients169,457-44,998-
Buy-sell-back transactions553-1,264-
Term deposits with credit institutions85190583217
Hedge derivatives347-72-
Cash6,62011,1261
Total financial assets of banks and financial assets at client’s risk244,6345,88758,1205,236

In its investing activities, the PZU Group uses derivatives as a tool to mitigate risk (with or without hedge accounting) and to facilitate efficient management of the investment portfolio.

The following tables present the PZU Group’s exposure to derivatives.

 Interest rate derivativesBase amount by maturities as at 31 December 2017Assets as at 31 December 2017Liabilities as at 31 December 2017
Up to 3 months3 monthsto 1 year1 yearto 5 yearsOver 5 yearsTotal
Instruments designated as fair value hedges – unquoted instruments, including: 115 - 1,744 1,696 3,555 16 186
- SWAP transactions115-1,7441,6963,55516186
Instruments designated as cash flow hedges – unquoted instruments, including: 2,950 1,653 12,849 2,181 19,633 289 682
- SWAP transactions2,9501,65312,8492,18119,633289682
Instruments carried as held for trading, including:17,39631,415101,62522,573173,0091,3941,929
Unquoted instruments, including:17,39631,415101,62522,573173,0091,3941,929
- FRA transactions1,285450--1,7351-
- SWAP transactions14,93227,81396,64822,468161,8611,3811,921
- call options (purchase)4111,3633,854115,639102
- put options (sale)7681,7891,123943,77426
Total interest rate derivatives20,46133,068116,21826,450196,1971,6992,797

Interest rate derivativesBase amount by maturities as at 31 December 2016Assets as at 31 December 2016Liabilities as at 31 December 2016
Up to 3 months3 monthsto 1 year1 yearto 5 yearsOver 5 yearsTotal
Instruments designated as cash flow hedges – unquoted instruments, including: 1,100 2,225 3,394 250 6,969 72 6
- SWAP transactions1,1002,2253,3942506,969726
Instruments carried as held for trading, including:5,56122,33832,7399,13769,775630633
Instruments quoted on a regulated market, including:1,355-361-1,716719
- forward contracts1,355-361-1,716719
Unquoted instruments, including:4,20622,33832,3789,13768,059623614
- SWAP transactions3,47521,27730,7969,02864,576597586
- call options (purchase)-43539-5824-
- put options (sale)1329331,0071092,181-6
- other5998536-7202222
Total interest rate derivatives6,66124,56336,1339,38776,744702639

Foreign exchange derivativesBase amount by maturities as at 31 December 2017Assets as at 31 December 2017Liabilities as at 31 December 2017
Up to 3 months3 monthsto 1 year1 yearto 5 yearsOver 5 years Total
Instruments designated as cash flow hedges – unquoted instruments, including: 480 501 - - 981 42 -
- SWAP transactions480501--98142-
Instruments carried as held for trading, including:36,95510,9542,0604250,011402517
Instruments quoted on a regulated market, including:456---456191
- forward contracts456---456191
Unquoted instruments, including:36,49910,9542,0604249,555383516
- forward contracts11,6844,300945-16,929175221
- SWAP transactions22,6502,8514624226,005164256
- call options (purchase)1,0051,32371-2,399278
- put options (sale)1,1602,480582-4,2221731
 Total foreign exchange derivatives 37,435 11,455 2,060 42 50,992 444 517

Foreign exchange derivativesBase amount by maturities as at 31 December 2016Assets as at 31 December 2016Liabilities as at 31 December 2016
Up to 3 months3 monthsto 1 year1 yearto 5 yearsOver 5 years Total
Instruments quoted on a regulated market, including:--361-3613-
- forward contracts--361-3613-
Unquoted instruments, including:11,4283,0911,3007615,895199125
- forward contracts1,863980311-3,1546225
- SWAP transactions8,6081,0068677610,55711577
- call options (purchase)49054761-1,09822-
- put options (sale)46755861-1,086-23
Total foreign exchange derivatives 11,428 3,091 1,661 76 16,256 202 125

Equity derivativesBase amount by maturities as at 31 December 2017Assets as at 31 December 2017Liabilities as at 31 December 2017
Up to 3 months3 monthsto 1 year1 yearto 5 yearsOver 5 yearsTotal
Unquoted instruments, including:4852,4302,924-5,83910457
- call options (purchase)2791,2451,666-3,19010210
- put options (sale)2061,1851,258-2,649247
Total equity derivatives4852,4302,924-5,83910457

Equity derivativesBase amount by maturities as at 31 December 2016Assets as at 31 December 2016Liabilities as at 31 December 2016
Up to 3 months3 monthsto 1 year1 yearto 5 yearsOver 5 yearsTotal
Instruments quoted on a regulated market, including:26---26--
- put options (sale)26---26--
Unquoted instruments, including:6956093,712-5,0164923
- call options (purchase)3513702,083-2,804481
- put options (sale)3442391,629-2,212122
Total equity derivatives7216093,712-5,0424923

Commodity derivativesBase amount by maturities as at 31 December 2017Assets as at 31 December 2017Liabilities as at 31 December 2017
Up to 3 months3 monthsto 1 year1 yearto 5 yearsOver 5 yearsTotal
Instruments quoted on a regulated market, including:285407-3321021
- forward contracts285407-3321021
Unquoted instruments, including:542678976-2,1969482
- forward contracts22726--253197
- SWAP transactions252233190-6755959
- call options (purchase)45240398-683158
- put options (sale)18179388-58518
Total equity derivatives827718983-2,528104103

As at 31 December 2016, the PZU Group held no commodity derivatives.

Risk concentration

 31 December 201731 December 2017 (% of financial assets)31 December 201631 December 2016 (% of financial assets)
Exposure to treasury securities issued and guaranteed by the State Treasury of the Republic of Poland and in buy-sell-back transactions on those securities 65,126 22.5% 38,315 35.4%
PZU Group’s exposure to shares quoted on the Warsaw Stock Exchange2,3270.8%3,3403.1%
Overall exposure to banking assets: bank deposits cash, debt securities issued by banks, shares of banks and derivative transactions concluded with banks 21,897 7.5% 10,814 10.0%
Exposure in financial assets denominated in Polish zloty249,67486.1%92,81585.7%

Exposure to debt securities issued by governments other than the Polish government

As at 31 December 2017

CountryCurrencyPurchase priceCarrying amountMeasurement at fair valueImpairment loss
ArgentinaARS/USD102101101-
AzerbaijanUSD101010-
BrazilUSD106105105-
BulgariaEUR545558-
ChileUSD212020-
CroatiaEUR/USD1019899-
Dominican RepublicUSD303030-
PhilippinesUSD424141-
SpainEUR101010-
IndonesiaEUR/USD198199199-
JamaicaUSD141414-
KazakhstanUSD262626-
ColumbiaUSD114110110-
Costa RicaUSD111111-
LithuaniaEUR/USD424431435-
LatviaEUR626465-
MexicoEUR/MXN/USD948888-
GermanyEUR461449449-
OmanUSD323131-
PakistanUSD101010-
PanamaUSD313131-
PeruPEN/USD838484-
RussiaUSD484646-
South AfricaUSD/ZAR134133133-
RomaniaEUR/RON/USD109106108-
SerbiaUSD101010-
SlovakiaEUR222020-
SloveniaEUR454848-
Sri LankaUSD434242-
United StatesUSD854833833-
TurkeyEUR/USD151150150-
UkraineEUR/USD/UAH771)621)621)-
UruguayUSD272727-
HungaryEUR/HUF/USD205195196-
ItalyEUR191818-
Côte d’IvoireUSD101010-
OtherEUR/USD/GBP636061-
Total 3,8533,7783,791-

1) For some of the bonds, every 6 months the par value of the bonds in a fixed amount of UAH 100 is repaid (i.e. 10% of the par value of the bonds). The purchase price reflects the actual price paid by the company and does not take into account the repayments of the par value.

As at 31 December 2016

CountryCurrencyPurchase priceCarrying amountMeasurement at fair valueImpairment loss
ArgentinaUSD708080-
BrazilUSD697979-
BulgariaEUR235259261-
CroatiaEUR/USD535758-
CyprusEUR242525-
Czech RepublicCZK337345345-
SpainEUR403939-
IndonesiaEUR/USD404444-
LithuaniaEUR/USD459485491-
LatviaEUR/USD91110110-
MexicoEUR/USD333333-
PortugalEUR586060-
South AfricaEUR/ZAR687373-
RomaniaEUR/USD/RON397422423-
SlovakiaEUR164162162-
SloveniaEUR132138138-
Sri LankaUSD424545-
United StatesUSD148149149-
TurkeyEUR/USD/TRY324345345-
UkraineEUR/USD/UAH69 1)68 1)68 1)-
HungaryEUR/USD/HUF399423424-
otherEUR/USD/GBP434444-
Total 3,2953,4853,496-

1) For some of the bonds, every 6 months the par value of the bonds in a fixed amount of UAH 100 is repaid (i.e. 10% of the par value of the bonds). The purchase price reflects the actual price paid by the company and does not take into account the repayments of the par value.

Exposure to debt securities issued by corporations and local government units

As at 31 December 2017

IssuerPurchase priceCarrying amountMeasurement at fair valueImpairment loss
Companies from the WIG-Banks Index558563564-
Companies from the WIG- Chemicals Index999-
Companies from the WIG-Energy Index1,8771,8861,9026
Companies from the WIG-Fuels Index6636666682
Mining and quarrying (including companies included in the WIG- Mining index) 627 644 619 2
Manufacturing1,1111,1591,1974
Transportation and storage1,8981,9041,9117
Public utility services6156116112
Privately held domestic banks202021-
Foreign banks6261621
Domestic local governments6,0536,0926,0868
National Bank of Poland13,09713,09713,097-
Other1,6371,6631,66770
Total28,22728,37528,414102

As at 31 December 2016

IssuerPurchase priceCarrying amountMeasurement at fair valueImpairment loss
Companies from the WIG-Banks Index 1,299 1,320 1,327-
Companies from the WIG-Fuels Index 995 1,007 1,009-
Companies from the WIG- Chemicals Index 9 9 9-
Companies from the WIG-Energy Index 315 316 316-
Privately held domestic banks202021-
Foreign banks7478811
Domestic local governments96102105-
Companies from the WIG-Mining Index 293 254 250 61
National Bank of Poland2,6002,6002,600-
Other42538538517
Total6,1266,0916,10379

7.5.3.1. Interest rate risk

The following table presents the sensitivity test of the portfolio of financial instruments for which the PZU Group bears the risk (except for loan receivables from clients and deposit liabilities).

Change in portfolio value caused by a +/- 100 bp shift in the yield curve, by currency of the instrument31 December 201731 December 2016
decreaseincreasedecreaseincrease
Polish zloty1,059(1,004)379(363)
Euro7(4)80(73)
US dollar144(127)30(25)
other34(34)53(61)
Total1,244(1,169)542(522)

The above sensitivity tests do not include the effects of changes in interest rates for technical provisions and liabilities under investment contracts. The analysis of effect of a change in technical rate on measurement of insurance contracts is presented in section 7.5.2.

Interest rate risk in Pekao

The VaR model is the main tool for measuring interest rate risk of the trading book. This value reflects the level of ten- day loss that may be exceeded with a probability of no more than 1%. VaR is determined through historical simulation, based on a 2-year history of observation of the evolution of risks. The set of factors taken into account in the calculation of VaR includes all the relevant market factors that are taken into account in the valuation of financial instruments, except for the issuer’s and counterparty’s specific credit risk. The impact of changes in market factors on the current portfolio value is estimated using full revaluation (as a difference between the value of the portfolio after the change in market parameters, by the historically observed changes in those factors, and the present value of the portfolio). For such a set of probable changes in the portfolio's value (distribution function), VaR is determined as the 1% quantile.

The following table presents VaR for the interest rate risk in Pekao’s trading book.

 31 December 2017for January-December 2017
MinimumMediumMaximum
Trading book – VaR interest rate risk (in thous. PLN)2,5011,5683,2036,087

When managing interest rate risk in its banking book, Pekao endeavors to secure the economic value of equity and to achieve its intended net interest income target within the accepted limits. The financial position in view of the changing interest rates is monitored by using interest rate gap (revaluation gap), duration analysis, sensitivity analysis, stress testing and VaR.

The table below presents the contractual level of sensitivity of net interest income (NII) to a 100 bp decline in interest rates and sensitivity of Pekao’s economic value of equity (EVE) to a 200 bps decline in interest rates as at the end of December 2017. EVE is defined as the present value of future cash flows that will be generated by the entity’s assets, less the present value of the future cash flows necessary to pay the entity’s liabilities. Both analyses assume an immediate change in market rates. The interest rate on bank products changes according to the contractual provisions, whereas in the case of contractual NII, for deposits from retail customers, the declines in interest rates are limited to the zero interest rate level (that is, the interest on customer deposits will not drop beneath zero). In the case of EVE sensitivity for PLN-denominated current deposits, a model that ensures realistic revaluation is used.

Sensitivity in %31 December 2017
NII-8.14%
EVE0.79%

Interest rate risk in Alior Bank

The interest rate risk related to Alior Bank’s open positions is linked, first of all, to:

  • revaluation date mismatch risk;
  • basis risk, or the impact of non-parallel change in reference indexes with a similar revaluation date on the financial result;
  • yield curve risk;
  • client option risk.

One of the method of estimating exposure to interest rate risk is to calculate BPV, which provides information on the estimated change in the valuation of a transaction/item after a parallel shift in the yield curve by 1 basis point. The following tables present the BPV estimation for Alior Bank.

As at 31 December 2017 (thous. PLN)

CurrencyUp to 6 months6 months to 1 year1-3 years3-5 years5 to 10 yearsTotal
PLN319319695(90)397
EUR-(8)6190(5)138
USD18(2)-(1)6
CHF(1)-(1)--(2)
GBP(4)2---(2)
Other(1)2(1)---
Total(2)197253185(96)537

As at 31 December 2016 (thous. PLN)

CurrencyUp to 6 months6 months to 1 year1-3 years3-5 years5 to 10 yearsTotal
PLN(19)305605111(433)569
EUR(16)-(28)(44)(35)(123)
USD1311(13)-(1)10
CHF(1)-(2)--(3)
GBP-3---3
Other(2)(5)3--(4)
Total(25)31456567(469)452

For the interest rate risk management purposes, Alior Bank distinguishes trading activity involving securities and derivatives concluded for trading purposes and banking activity involving other securities, own issues, loans, deposits, credits and derivative transactions used to hedge the risk of the banking book. Alior Bank uses the Value at Risk (VaR) model to estimate the level of interest rate risk. The following table presents the economic capital to cover interest rate risk measured using this method at the end of 2017 and 2016 (99% VaR with a 10-day horizon).

Bookfor January-December 2017for January-December 2016
MinimumMediumMaximumMinimumMediumMaximum
Banking book6183131133
Trading book124115
Total7203541238

Alior Bank conducts scenario analysis that includes, among others, the impact of changes in interest rates on the future net interest income and economic value of equity. Within these scenarios internal limits are maintained, whose utilization is measured daily. Utilization of the limit of change in economic value of capital after a parallel shift of the percentage curve by +/-200 bps and non-parallel shifts in the +/- 100/400 bps scenarios (for 1M/10Y tenors, the shift between  them follows a linear interpolation) is presented in the following table:

(1M/10Y) scenarioChange in the economic value of equity
31 December 201731 December 2016
+400 / +1002.80%3.80%
+100 / -4001.01%0.50%
+200 / +2001.52%1.72%
- 200 / - 200-1.26%-1.77%
- 100 / - 400-0.64%-0.73%
- 400 / - 100-1.40%-1.75%

7.5.3.2. Foreign exchange risk

Exposure to FX risk

Assets by currency31 December 2017
PLNEURUSDCZKGBPHUFRONOtherTotal
Assets held to maturity20,72446413----3621,237
Government securities20,58936813----3621,006
Other13596------231
Assets available for sale43,7313,0581,725-3--248,519
Equity instruments43920321----1664
Debt securities43,2922,8551,704-3--147,855
Government securities29,1132,8281,704-3--133,649
Other14,17927------14,206
Assets measured at fair value – classified as such upon first recognition5,967324252-22177616,650
Equity instruments1,61623947-2227141,947
Debt securities4,35185205--15-474,703
Government securities4,32675201--15-474,664
Other25104-----39
Assets held for trading12,2641,3321,775-10601014615,597
Equity instruments4,288185133--11--4,617
Debt securities6,6167971,475--1710618,976
Government securities6,5147941,303--1710618,699
Other1023172-----277
Derivatives1,360350167-1032-852,004
Hedge derivatives330413-----347

Assets by currency31 December 2017
PLNEURUSDCZKGBPHUFRONOtherTotal
Loans161,78120,8542,91749464573,427189,504
Debt securities12,4521,059111----113,623
Government securities-------11
Other12,4521,059111-----13,622
Other, including:149,32919,7952,80649464573,426175,881
- loan receivables from clients143,41719,6022,603-464--3,371 1)169,457
- buy-sell-back transactions885-------885
- term deposits with credit institutions1,606586149-57551,841
- loans3,421135142-----3,698
Receivables7,0121,741289-2--529,096
Cash and cash equivalents4,8771,959492289193188403 2)8,239
Total assets256,68629,7367,476338694100324,127299,189

1) of which PLN 3,152 million denominated in Swiss francs and PLN 121 million in Norwegian kroner.
2) of which PLN 108 million denominated in Swiss francs, PLN 83 million in Norwegian kroner and PLN 55 million in Swedish kronor.

Assets by currency (restated)31 December 2016
PLNEURUSDCZKGBPHUFRONOtherTotal
Assets held to maturity16,79050717----3217,346
Government securities16,68738117----3217,117
Other103126------229
Assets available for sale10,832635176-6--311,652
Equity instruments275159------434
Debt securities10,557476176-6--311,218
Government securities7,344452176-6--37,981
Other3,21324------3,237
Assets measured at fair value – classified as such upon first recognition12,282807780175-17815310414,479
Equity instruments2,6392293517-10-212,951
Debt securities9,643578745158-1681538311,528
Government securities9,618532742158-1681536611,437
Other25463----1791
Assets held for trading5,301987540212994841767,403
Equity instruments3,72421194--1324-4,066
Debt securities1,241582349188-1458242,456
Government securities1,168582349188-1458242,383
Other73-------73
Derivatives33619497249672152881
Hedge derivatives72-------72
Loans47,6055,166578491202--29254,334
Debt securities2,421-40----22,463
Government securities-------22
Other2,421-40-----2,461
Other, including:45,1845,166538491202--29051,871
- loan receivables from clients39,5264,797232-202--241 1)44,998
- buy-sell-back transactions2,880-------2,880
- term deposits with credit institutions1,238231276491---492,285
- loans1,54013830-----1,708
Receivables4,415828377----445,664
Cash and cash equivalents7251,61623013197121161 2)2,973
Total assets98,02210,5462,6981,009314284238812113,923

1) of which PLN 228 million denominated in Swiss francs.

2) of which, among others, PLN 30 million denominated in Swiss francs, PLN 29 million denominated in Swedish kronor, PLN 23 million denominated in Canadian dollars and PLN 22 million denominated in Norwegian kroner.

Liabilities by currency as at 31 December 2017PLNEURUSDGBPHUFRONOtherTotal
Financial liabilities measured at fair value4,1993852231024-1154,956
Derivatives held for trading2,0382851341024-1152,606
Cash flow hedge derivatives682------682
Fair value hedge derivatives7510011----186
Liabilities on borrowed securities (short sale)672-78----750
Investment contracts for the client’s account and risk (unit-linked)312------312
Liabilities to members of consolidated mutual funds420------420
Financial liabilities measured at amortized cost177,54827,34610,7901,607382,249219,551
Liabilities to banks2,0672,559956--596 1)5,323
Liabilities to clients163,35020,85310,6951,601381,653 2)198,163
Liabilities on the issue of own debt securities5,7183,849-----9,567
Subordinated liabilities5,23485-----5,319
Liabilities on account of repurchase transactions1,167------1,167
Investment contracts with guaranteed and fixed terms and conditions1------1
Finance lease liabilities11------11
Other liabilities7,6279542571224261459,045
Total liabilities by currency189,37428,68511,2701,62951342,509233,552

1) of which PLN 591 million denominated in Swiss francs.
2) of which PLN 597 million denominated in Czech korunas, PLN 534 million denominated in Swiss francs, PLN 153 million denominated in Norwegian kroner and PLN 129 million denominated in Swedish kronor.

Liabilities by currency as at 31 December 2016 (restated)PLNEURUSDGBPHUFCZKOtherTotal
Financial liabilities measured at fair value2,760146192846251373,314
Derivatives held for trading31412013184625137781
Cash flow hedge derivatives-6-----6
Liabilities on borrowed securities (short sale)5732061----654
Investment contracts for the client’s account and risk (unit-linked)329------329
Liabilities to members of consolidated mutual funds1,544------1,544
Financial liabilities measured at amortized cost45,2208,1542,376547--41956,716
Liabilities to banks4354840----523
Liabilities to clients43,6034,3362,336547--41951,241
Liabilities on the issue of own debt securities (PZU)-3,680-----3,680
Subordinated liabilities (Alior Bank)93790-----1,027
Liabilities on account of repurchase transactions178------178
Investment contracts with guaranteed and fixed terms and conditions67------67
Other liabilities4,4483401498--464,991
Total liabilities by currency52,4288,6402,717563462560265,021

To manage its FX risk, the PZU Group uses also derivatives which allows it to take a selected market exposure in a more efficient manner than by using cash instruments.

The following table presents the sensitivity test of the portfolio of PZU Group’s financial instruments (except for loan receivables from clients and deposit liabilities) in respect to financial instruments for which the PZU Group bears the risk.

Financial assets exposed to exchange risk include deposit transactions and debt securities used to hedge payments from technical provisions denominated in foreign currencies, exposures to equity instruments quoted on stock exchanges other than WSE, mutual fund units and certificates, exposures to derivatives denominated in foreign currencies and financial assets of consolidated international insurance companies.

Change in portfolio value caused by a +/-20% change of the exchange rate31 December 201731 December 2016
decreaseincreasedecreaseincrease
EUR371(305)395(395)
USD(29)391(1)
GBP(3)3(3)3
Other(80)80(12)12
Total259(183)381(381)

Both Pekao and Alior Bank use the VaR model to measure currency risk. It allows them to calculate potential loss on currency positions kept by the Bank caused by changes in exchange rates, while maintaining the assumed confidence level (99%) and the period in which the position is kept. The following table presents VaR determined for the trading book FX risk in both banks:

10-day VaR – fx risk – trading book (thous. PLN)31 December 201731 December 2016
Pekao2,337n/a
Alior Bank157280

7.5.3.3. Equity risk

Level of risk exposure

The value of the portfolio of financial instruments available for sale and measured at fair value through profit or loss is presented respectively in sections 33.3 and 33.4.

Sensitivity analysis

The following table presents the sensitivity test of PZU Group’s equity to the portfolio of quoted equity instruments for which the PZU Group bears the risk.

Impact of a change in the measurement of quoted equity instruments on equity31 December 201731 December 2016
increase in measurement of quoted equity instruments by 20%350527
decrease in measurement of quoted equity instruments by 20%(350)(527)

7.5.3.4. Liquidity risk

Insurance activity

Financial liquidity risk of the PZU Group may result from three types of events:

  • shortage of liquid cash compared to current needs;
  • illiquidity of financial instruments held;
  • structural maturity mismatch between assets and liabilities.

In the liquidity risk management process, liquidity is controlled in the short, medium and long term, i.e.:

  • short-term liquidity – the balance of funds in the liquidity portfolio is maintained at no more than the limit specified for them. Conditional sell-buy-back transactions are also used to manage liquidity;
  • medium-term liquidity – investment portfolios with appropriate liquidity are maintained;
  • long-term liquidity and risk of structural mismatch between the maturity of assets and liabilities – Asset Liability Management (ALM) involves matching the structure of financial investments, which provide coverage for technical provisions, to the character of such provisions.

Another objective of the ALM process is to ensure the capability to pay claims and benefits, also in unfavorable economic conditions. The level of liquidity risk is measured by estimating the shortages of cash required to pay liabilities. The estimate is made using a set of analyzes, including among others a liquidity gap analysis (a mismatch of net cash flows) and an analysis of the distribution of expenditures relating to operating activity.

Pekao

The objective of liquidity risk management is to:

  • ensure and maintain the ability to meet both current and future liabilities, taking into account the costs of raising liquidity and return on equity;
  • prevent a crisis situation, and
  • identify the arrangements for overcoming a crisis when and if it occurs.

Pekao has a centralized liquidity risk management system in place, which includes regular liquidity management and first level control exercised by responsible units, second level control exercised by a dedicated unit responsible for risk management and independent audit.

Liquidity management in the Pekao Group is planned within the following time horizons:

  • intraday – applicable to intra-day flows;
  • short-term – including a liquidity measurement system within a one-year horizon;
  • long-term – covering a period of more than one year.

Due to the specific nature of the liquidity risk management tools and techniques used, the Pekao Group manages its current and medium-term liquidity together with short-term liquidity.

Alior Bank

The liquidity risk management policy at Alior Bank consists in maintaining liquidity positions so that it is possible to satisfy payment obligations at all times using the available cash in hand, proceeds from transactions with specified maturity dates or through the sale of transferable assets, while minimizing the costs of maintaining liquidity.

Alior Bank manages its liquidity by using ratios and related limits of the following types of liquidity:

  • payment liquidity – capacity to finance assets and pay liabilities on a timely basis in the ordinary course of business or in other foreseeable circumstances, without a need to incur loss. In payment liquidity management, special emphasis is placed on the analysis of immediate and current liquidity (up to 7 days);
  • short-term liquidity – capacity to pay  all cash liabilities as they become due and payable, in the period of next 30 days;
  • medium-term liquidity – capacity to pay all liabilities with maturity dates from 1 to 12 months;
  • long-term liquidity – monitoring the capacity to pay all cash liabilities as they become due, in the period of more than 12 months.

Risk exposure

Carrying amount of debt instruments by maturity, as at 31 December 2017up to 1 year1 – 2 years2 – 3 years3 – 4 years4 – 5 yearsover 5 yearsTotal
Debt instruments held to maturity2291,3501,0871,2434,60412,72421,237
Government securities1391,2711,0811,2004,60012,71521,006
Other907964349231
Debt instruments available for sale19,4575,2602,6323,7564,80311,94747,855
Government securities6,2695,0102,5193,4244,57111,85633,649
Other13,1882501133322329114,206
Debt instruments measured at fair value – classified as such upon first recognition222727711,5544441,6404,703
Government securities202727701,5494171,6364,664
Other2-1527439
Debt securities held for trading2637801,5871,9171,1103,3198,976
Government securities2407641,4821,9031,0943,2168,699
Other23161051416103277
Loans52,02520,03615,89312,14914,19075,211189,504
Debt securities1,8821,6011,3899821,5636,20613,623
Government securities-1----1
Other1,8821,6001,3899821,5636,20613,622
Other, including:50,14318,43514,50411,16712,62769,005175,881
- loan receivables from clients47,53118,36213,64011,03612,32166,567169,457
- buy-sell-back transactions885-----885
- term deposits with credit institutions1,6252376110-71,841
- loans10250788213062,4313,698
Total71,99627,69821,97020,61925,151104,841272,275

Carrying amount of debt instruments by maturity, as at 31 December 2016 (restated)up to 1 year1 – 2 years2 – 3 years3 – 4 years4 – 5 yearsover 5 yearsTotal
Debt instruments held to maturity2,7961861,15039846412,35217,346
Government securities2,7711271,06939141812,34117,117
Other25598174611229
Debt instruments available for sale4,0511,7081,2331,4851,6441,09711,218
Government securities1,4341,6968971,3201,6399957,981
Other2,6171233616551023,237
Instruments measured at fair value – classified as such upon first recognition1,3051,5748551,4372,1574,20011,528
Government securities1,3041,5548551,4362,1154,17311,437
Other120-1422791
Instruments held for trading553303263012951,1492,456
Government securities53073263012951,1492,383
Other5023----73
Loans21,0065,0393,6334,4983,30716,85154,334
Debt securities71417734627271,1722,463
Government securities1-1---2
Other71317734527271,1722,461
Other, including:20,2924,8623,2874,4713,28015,67951,871
- loan receivables from clients15,3004,7323,2153,2213,22615,30444,998
- buy-sell-back transactions2,880-----2,880
- term deposits with credit institutions2,082-2212932202,285
- loans30130501,121223551,708
Total29,2138,8377,1978,1197,86735,64996,882

The following table presents future undiscounted cash flow from assets and liabilities as at 31 December 2017.

Liquidity riskUp to 1 year1 – 2 years2 – 3 years3 – 4 years4 – 5 years5 to 10 yearsOver 10 yearsTotal
Assets104,01031,63526,07021,72825,12258,77251,646318,983
Cash and cash equivalents4,935193139112963452,4198,239
Receivables7,6091,2881482441639,110
Loan receivables from clients50,13524,48318,78413,82916,84141,62433,070198,766
Debt securities38,4965,0715,9397,4097,58914,49315,84994,846
Loans3075761,0533125722,3061455,271
Buy-sell-back transactions885------885
Term deposits with credit institutions1,6432414158---1,866
Liabilities(116,564)(16,916)(7,347)(6,125)(4,694)(19,181)(96,044)(266,871)
Technical provisions(6,873)(1,714)(1,146)(929)(798)(2,940)(20,469)(34,869)
Financial liabilities(104,300)(15,047)(6,190)(5,189)(3,894)(16,231)(73,741)(224,592)
Other liabilities(5,391)(155)(11)(7)(2)(10)(1,834)(7,410)
Gap(12,554)14,71918,72315,60320,42839,591(44,398)52,112

The following table presents future undiscounted cash flows from banks’ off-balance sheet liabilities (by contractual terms)

Off-balance sheet liabilities grantedup to 1 month1 -3 months3 months to 1 year1 – 5 yearsover 5 yearsTotal
Financing37,1463411,6214,1671,81845,093
Guarantees11,5348144140528212,743
Total48,6804222,0624,5722,10057,836

7.5.4. Operational risk

Operational risk is the risk of suffering loss resulting from improper or erroneous internal processes, human activities, system failures or external events.

Operational risk management has the purpose of optimizing the level of operational risk and operating efficiency in the PZU Group’s operations, leading to a reduction of losses and costs arising from such risks and ensuring adequate and effective controls. Operational risk is managed in accordance with defined guidelines which take into account external conditions and information on operational risk levels is regularly reported to relevant internal authorities.

7.5.5. Compliance risk

Compliance risk is the risk of legal sanctions, financial losses or loss of reputation or credibility arising from a failure of PZU Group companies, their employees or entities acting on their behalf to comply with the law, internal regulations or standards of conduct, including ethical standards.

The demarcation of responsibilities with respect to systemic and ongoing compliance risk management is based on internal regulations.

Systemic management entails in particular: developing solutions for implementing compliance risk management principles, monitoring the compliance risk management process and promoting and monitoring compliance with internal regulations and standards of conduct in respect to compliance.

Ongoing compliance risk management entails: identifying, assessing and measuring and adaptation to regulatory requirements.

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