57. Credit risk management

Definition

Credit risk is defined as a risk of occurrence of losses due to counterparty’s default of payments to the Group or as a risk of decrease in economic value of amounts due to the Group as a result of deterioration of counterparty’s ability to repay amounts due to the Group.

Management objective

The objective of credit risk management is to minimize losses on the loan portfolio as well as to minimize the risk of occurrence of loans exposed to impairment, while keeping expected level of profitability and value of loan portfolio at the same time.

The Bank and subsidiaries of the Group primarily follow the following principles of credit risk management:

  • each loan transaction is subject to comprehensive credit risk assessment, which is reflected in an internal rating or credit scoring,
  • credit risk relating to loan transactions is measured on the stage of examining loan application and on a regular basis, as part of the monitoring process taking into consideration changes in external conditions and in the financial standing of the borrowers,
  • credit risk assessment of exposures which are significant due to their risk levels or its value is subject to additional verification by credit risk assessment teams, which are independent of the business teams
  • terms of loan transactions that are offered to a client depend on the assessment of credit risk level or its value generated by the transaction,
  • loan granting decisions are made only by authorized persons,
  • credit risk is diversified particularly by geographical location, by industry, by product and by clients,
  • expected credit risk level is mitigated by collateral received by the Bank, margins from clients and impairment allowances (provisions) on loan exposures.

The above-mentioned principles are executed by the Group through the use of advanced credit risk management methods, both on the level of individual credit exposures and on the level of the whole loan portfolio of the Group. These methods are verified and developed to ensure compliance with the internal rating – based method requirements (IRB), i.e. advanced credit risk measurement method, which can be used while calculating requirements as regards own funds for credit risk after being approved by the Polish Financial Supervision Authority.

The Group entities, which have significant credit risk levels (the KREDOBANK SA Group, the PKO Leasing SA Group, PKO Bank Hipoteczny SA and a subsidiary: Finansowa Kompania ‘Prywatne Inwestycje’ Sp. z o.o.) manage their credit risk individually, but the methods used by them for credit risk assessment and measurement are adjusted to the methods used by PKO Bank Polski SA, taking into account the specific nature of the activities of these companies.

Any changes to the solutions used by the Group’s subsidiaries are agreed every time with the Bank's units responsible for risk management.

The PKO Leasing SA Group, the KREDOBANK SA and subsidiaries: Finansowa Kompania ‘Prywatne Inwestycje’ Sp. z o.o. and PKO Bank Hipoteczny SA measure credit risk regularly and the results of such measurements are submitted to the Bank.

The KREDOBANK SA Group and the PKO Leasing SA Group have organizational units responsible for risk in their organizational structures, which are in particular responsible for:

  • developing methods of credit risk assessment, recognizing provisions and allowances,
  • controlling and monitoring credit risk during the lending process,
  • the quality and efficiency of restructuring and enforcement of the amounts due from clients.

In these companies, the credit decision limits depend primarily on: the amount of the exposure to a given client, the amount of an individual credit transaction and the period of credit transaction.

The process of credit decision-making in the KREDOBANK SA Group, the PKO Leasing SA Group is supported by credit committees, which are involved in the case of credit transactions which generate increased credit risk level.

Appropriate organizational units of the Risk Management Area participate in managing the credit risk in the Group entities by giving their opinions on projects and periodically reviewing internal regulations of these companies relating to the assessment of credit risk and preparation of recommendations relating to amendments in the drafts of regulations. The Bank supports implementation of the recommended changes in principles for assessing credit risk in the Group entities.

Measurement and assessment of credit risk

  • Credit risk measurement and assessment methods

In order to assess the level of credit risk and profitability of loan portfolios, the Group uses different credit risk measurement and valuation methods, including:

  • Probability of Default (PD),
  • Expected Loss (EL),
  • Unexpected Loss (UL),
  • Loss Given Default (LGD),
  • Credit Value at Risk (CVaR),
  • share and structure of impaired loans,
  • coverage ratio of impaired loans with impairment allowances,
  • cost of credit risk.

The Group extends regularly the scope of credit risk measures used, taking into account the internal rating-based method (IRB) requirements, and extends the use of risk measures to fully cover the whole Group’s loan portfolio with these methods.

The portfolio credit risk measurement methods allow i.a. to reflect the credit risk in the price of products, determine the optimum conditions of financing availability and determine rates of impairment allowances.

The Group performs analysis and stress-tests regarding the influence of potential changes in macroeconomic environment on the quality of Group’s loan portfolio. The test results are reported to the Group’s authorities. The above-mentioned information enables to identify and take measures to limit the negative influence of unfavourable market changes on the Group’s performance.

  • Rating and scoring methods

The Group assesses the risk of individual credit transactions with the use of scoring and rating methods, which are created, developed and supervised by the Banking Risk Division. These methods are supported by specialist IT application software. The scoring method is defined by Group’s internal regulations whose main aim is to ensure uniform and objective assessment of credit risk during the lending process.

The Group assess the credit risk of retail clients in two dimensions: creditworthiness assessed quantitatively and qualitatively. The quantitative assessment of creditworthiness consists of evaluation of the financial situation, whereas the qualitative assessment involves scoring and evaluating the client’s credit history obtained from internal records of the Group and external databases.

In the case of corporate clients from the small and medium enterprises segment that meet certain criteria, the Group assesses credit risk using the scoring method. Such assessment refers to low-value, non-complex loan transactions and it is performed in two dimensions: clients’ borrowing capacity and his creditworthiness. The assessment of borrowing capacity involves examination of the client’s economic and financial situation, whereas the creditworthiness assessment involves scoring and evaluation of the client’s credit history obtained from internal records of the Group and external databases.

In other cases, the rating method is used for institutional customers.

The evaluation of credit risk related to financing institutional clients is performed in two dimensions: in respect of the client and of the transaction. The assessment measures comprise the assessment of the credibility of the client, i.e. rating: and the assessment of the transaction, i.e. liability repayment capacity in the specified amount and timing.

Rating models for corporate clients were prepared using internal data of the Group which ensures that they are tailored to the risk profile of the Group's clients. Models are based on a statistical dependence analysis between the default and a customer's risk rating. Rating includes an assessment of the financial indicators, qualitative factors and evaluation of behavioural factors. The client's risk assessment depends on the size of the enterprise for which analysis is made. In addition, the Group uses a model for assessment of credited entrepreneurs in the formula of specialised lending, which allows adequate credit risk assessment of large projects involving real estate financing (e.g. office space, retail areas, industrial areas) and infrastructure projects (e.g. telecommunications, industrial, public utility infrastructure).

The rating models are implemented in the IT tool supporting the Group’s credit risk assessment related to financing institutional customers.

In order to examine the correctness of functioning of method applied in the Group, the methodologies of credit risk assessment related to individual loan exposures are subject to periodical reviews.

The credit risk assessment process in Group takes into account the requirements of the Polish Financial Supervision Authority as defined in the Recommendation S, relating to best practices for the management of mortgage-secured loan exposures and Recommendation T relating to best practices for the management of retail credit exposures.

The information about ratings and scoring is widely used in the Group for the purposes of credit risk management, the system of credit decision making powers, determining the conditions in which credit assessment services are activated and in the credit risk assessment and reporting system.

Monitoring of credit risk

Monitoring of credit risk is performed at individual loan transaction level and at portfolio level.

Monitoring of credit risk at the individual loan transaction level is governed, in particular, by the Group’s internal regulations concerning:

  • the principles for the recognition of impairment allowances for loan exposures and impairment allowances on receivables due to unsettled forward transactions;
  • the rules of functioning of the Early Warning System at the Bank;
  • early monitoring of delays in the collection of receivables;
  • the principles for the classification of loan exposures and determining the level of specific provisions.

In order to shorten the time of reaction to the warning signals observed, signaling an increase in the credit risk level, the Group uses and develops an IT application, an Early Warning System (EWS).

Monitoring of credit risk at the portfolio level consists of:

  • supervising the level of the portfolio credit risk on the basis of the adopted tools used for measuring credit risk, taking into consideration the identified sources of credit risk and analyzing the effects and actions taken as part of system management,
  • recommending preventive measures in the event of identifying an increased level of credit risk.

Credit risk reporting

The Group prepares monthly and quarterly credit risk reports. The reporting of credit risk covers specifically cyclic information on the risk exposure of the credit portfolio. In addition to the information concerning the Bank, the reports also contain information about the credit risk level for the Group subsidiaries (i.a. KREDOBANK SA Group and the PKO Leasing SA Group), which have significant credit risk levels.

Management actions concerning credit risk

Basic credit risk management tools used by the Group include:

  • minimum transaction requirements (risk parameters) determined for a given type of transaction (e.g. minimum LTV value, maximum loan amount, required collateral),
  • the principles of defining credit availability, including cut-offs – the minimum number of points awarded in the process of creditworthiness assessment with the use of a scoring system (for retail clients and SMEs) or the client’s rating class (for corporate clients), which a client must obtain to receive a loan,
  • concentration limits – limits defined in the Regulation of the European Parliament and Council (EU) No. 575/2013 dated 26 June 2013 on prudential requirements for credit institutions and investment firms (Regulation CRR) and the Banking Law.
  • industry-related limits – limits which reduce the risk level related to financing institutional clients that conduct business activities in industries characterized by high level of credit risk,
  • limits on credit exposures related to the Group's clients – the limits defining the appetite for credit risk as result of among others the recommendations S and T,
  • credit limits defining the Group’s maximum exposure to a given client or country in respect of wholesale operations and settlement limits and limits for the period of exposure,
  • competence limits – they define the maximum level of credit decision-making powers with regard to the Group’s clients, the limits depend primarily on the amount of the Bank’s exposure to a given client (or a group of related clients) and the loan transaction period, the competence limit depends on the credit decision-making level (in the Bank’s organizational structure),
  • minimum credit margins – credit risk margins relating to a given credit transaction concluded by the Group with a given corporate client, but the interest rate offered to a client cannot be lower than the reference rate plus credit risk margin.

Use of credit risk mitigation techniques - Collateral

Collateral management policy as regards credit risk plays a significant role in establishing minimum transaction terms. The Group’s collateral management is meant to secure properly the credit risk, to which the Bank is exposed, including first of all the fact of establishing collateral that will ensure the highest possible level of recovery in the event of realization of debt collateral activity.

In assessing collateral, the following factors are taken into account in particular:

  • the economic and financial or social and financial situation of the entities providing personal guarantees,
  • the condition and market value of the assets accepted as collateral and their vulnerability to depreciation in the period of maintaining the collateral (the impact of the technological wear and tear of a collateralized asset on its value),
  • potential economic benefits of the Group resulting from a specific method of securing receivables, including, in particular, the possibility of reducing impairment allowances,
  • the method of establishing collateral, including the typical duration and complexity of formalities, as well as the necessary costs (the costs of maintaining collateral and the enforcement against the collateral), using the Group’s internal regulations concerning the assessment of collateral,
  • the complexity, time-consuming nature and economic and legal conditions of the effective realization of collateral, in the context of enforcement restrictions and the applicable principles for the distribution of the sums obtained from individual enforcement or in the course of bankruptcy proceedings, the ranking of claims.

The type of collateral depends on the product and the client segment.

With regard to mortgage loans the obligatory collateral are mortgages on the property.

Until an effective protection is established (depending on the type and amount of a loan) the Group may accept temporary collateral in different form.

With regard to consumer loans, usually personal guarantees are used (a civil law surety/guarantee, a bill of exchange) or collateral is established on the client’s bank account, his car or securities.

The collateral for loans intended for financing small and medium-sized enterprises as well as corporate customers is established, i.a.: on institutional debt, bank accounts, movables, real estate or securities or in the form of BGK guarantees (universally used in respect of small and medium enterprises). The policy regarding collateral is defined by the internal regulations of subsidiaries of the Group.

When signing a leasing agreement, the PKO Leasing SA Group, as a proprietor of leased objects, treats them as collateral.