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 – 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 – the possibility of incurring loss as a result of changes in the valuation of unquoted shares;
- property risk – 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 – 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 – 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 – the risk of being unable to realize investments and other assets without affecting their market prices in order to settle financial liabilities when they fall due;
- interest rate risk – 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 – 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 – 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 – 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;
- credit spread risk – 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 – the possibility of incurring loss stemming either from lack of diversification 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 risk management process 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 and Alior Bank – generating material exposure to interest rate risk.
A number of documents approved by supervisory boards, management boards and dedicated committees govern investment activity in PZU Group companies.
Risk units take part in the risk identification process, measure, monitor and report on the risks. Market risk is measured using the model of calculating market risk economic capital based on the value at risk method (VaR) or the standard formula in accordance with the principles defined by the Solvency II Directive. 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 individual market risk factors.
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 limiting potential adverse changes in economic value of equity and optimizing the financial result.
Exposure to market risk
|
Carrying amount
|
Note
|
31 December 2020 | 31 December 2019 | ||||||
| Assets at Group’s risk |
Assets at the client’s risk
|
Total
|
Assets at Group’s risk |
Assets at the client’s risk
|
Total
|
||||
| including banks’ assets | including banks’ assets | ||||||||
| Financial assets and cash exposed to interest rate risk | 343,532 | 298,283 | 1,221 | 344,753 | 309,124 | 267,846 | 1,167 | 310,291 | |
| Fixed-income debt securities | 36 | 99,459 | 64,231 | 1,142 | 100,601 | 62,965 | 32,858 | 1,101 | 64,066 |
| Variable-income debt securities | 36 | 24,436 | 22,633 | 43 | 24,479 | 31,144 | 29,494 | 15 | 31,159 |
| Loan receivables from clients | 34 | 197,288 | 197,288 | - | 197,288 | 194,868 | 194,868 | - | 194,868 |
| Term deposits in credit institutions | 36 | 919 | 516 | 33 | 952 | 1,405 | 599 | 49 | 1,454 |
| Loans | 36 | 3,384 | - | - | 3,384 | 4,490 | - | - | 4,490 |
| Cash | 39 | 7,936 | 7,040 | 3 | 7,939 | 7,786 | 6,759 | 2 | 7,788 |
| Buy-sell-back transactions | 36 | 4,657 | 1,127 | - | 4,657 | 4,064 | 897 | - | 4,064 |
| Derivatives | 35 | 5,453 | 5,448 | - | 5,453 | 2,402 | 2,371 | - | 2,402 |
| Financial assets exposed to other price risk | 2,676 | 1,486 | 5,059 | 7,735 | 2,163 | 1,079 | 4,725 | 6,888 | |
| Equity instruments | 36 | 1,818 | 636 | 5,031 | 6,849 | 1,501 | 486 | 4,682 | 6,183 |
| Derivatives | 35 | 858 | 850 | 28 | 886 | 662 | 593 | 43 | 705 |
| Total | 346,208 | 299,769 | 6,280 | 352,488 | 311,287 | 268,925 | 5,892 | 317,179 | |
The following table presents financial assets of banks and at client’s risk, by the item in which they are classified in the consolidated financial statements:
| Financial assets of banks and financial assets at client’s risk | Note | 31 December 2020 | 31 December 2019 | ||
| Pekao and Alior Bank |
Financial assets at client’s risk | Pekao and Alior Bank |
Financial assets at client’s risk | ||
| Loan receivables from clients | 34 | 197,288 | - | 194,868 | - |
| Financial derivatives | 6,298 | 28 | 2,964 | 43 | |
| Investment financial assets | 89,143 | 6,249 | 64,334 | 5,847 | |
| Measured at amortized cost | 37,321 | 33 | 21,130 | 49 | |
| Debt securities | 35,678 | - | 19,634 | - | |
| Sovereign Debt | 29,806 | - | 13,944 | - | |
| Domestic | 29,806 | - | 13,944 | - | |
| Fixed rate | 26,965 | - | 11,094 | - | |
| Floating rate | 2,841 | - | 2,850 | - | |
| Other | 5,872 | - | 5,690 | - | |
| Fixed rate | 2,128 | - | 797 | - | |
| Floating rate | 3,744 | - | 4,893 | - | |
| Buy-sell-back transactions | 1,127 | - | 897 | - | |
| Term deposits in credit institutions | 516 | 33 | 599 | 49 | |
| Measured at fair value through other comprehensive income | 50,131 | - | 41,605 | - | |
| Equity instruments | 396 | - | 276 | - | |
| Debt securities | 49,735 | - | 41,329 | - | |
| Government securities | 37,248 | - | 26,960 | - | |
| Domestic | 37,248 | - | 26,960 | - | |
| Fixed rate | 29,254 | - | 14,525 | - | |
| Floating rate | 7,994 | - | 12,435 | - | |
| Other | 12,487 | - | 14,369 | - | |
| Fixed rate | 4,764 | - | 6,186 | - | |
| Floating rate | 7,723 | - | 8,183 | - | |
| Measured at fair value through profit or loss | 1,691 | 6,216 | 1,599 | 5,798 | |
| Equity instruments | 232 | 376 | 181 | 378 | |
| Participation units and investment certificates | 8 | 4,655 | 29 | 4,304 | |
| Debt securities | 1,451 | 1,185 | 1,389 | 1,116 | |
| Government securities | 1,415 | 1,145 | 1,226 | 1,101 | |
| Domestic | 1,415 | 1,139 | 1,226 | 1,096 | |
| Fixed rate | 1,117 | 1,136 | 247 | 1,096 | |
| Floating rate | 298 | 3 | 979 | - | |
| Foreign | - | 6 | - | 5 | |
| Fixed rate | - | 6 | - | 5 | |
| Other | 36 | 40 | 163 | 15 | |
| Fixed rate | 3 | - | 9 | - | |
| Floating rate | 33 | 40 | 154 | 15 | |
| Cash | 7,040 | 3 | 6,759 | 2 | |
| Total financial assets of banks and financial assets at client’s risk | 299,769 | 6,280 | 268,925 | 5,892 | |
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 PZU Group’s exposure to derivatives is presented in section 35.
Exposure to debt securities issued by governments other than the Polish government
| Carrying amount of debt securities issued by governments other than the Polish government | 31 December 2020 | 31 December 2019 |
| Lithuania | 910 | 756 |
| Romania | 221 | 134 |
| Croatia | 173 | 132 |
| Latvia | 169 | 149 |
| Hungary | 144 | 57 |
| Ukraine | 132 | 130 |
| Indonesia | 129 | 86 |
| Columbia | 104 | 83 |
| Russia | 100 | 70 |
| Bulgaria | 90 | 74 |
| Brazil | 83 | 80 |
| Panama | 78 | 74 |
| Mexico | 68 | 18 |
| Kazakhstan | 62 | 41 |
| Peru | 58 | 46 |
| Saudi Arabia | 57 | 27 |
| South Africa | 55 | 52 |
| Uruguay | 55 | 50 |
| Dominican Republic | 53 | 56 |
| Other | 3281 | 3282 |
| Total | 3,069 | 2,443 |
1 The line item “Other” includes bonds issued by 41 countries with respect to which the balance sheet exposure does not exceed the equivalent of PLN 50 million.
2 The line item “Other” includes bonds issued by 40 countries.
Exposure to debt securities issued by corporations and local government units
| Carrying amount of debt securities issued by corporations, local government units and National Bank of Poland | 31 December 2020 | 31 December 2019 |
| Foreign banks | 7,069 | 4,717 |
| Domestic local governments | 5,859 | 6,199 |
| National Bank of Poland | 2,275 | 4,815 |
| Companies from the WIG-Energy Index | 1,732 | 2,375 |
| Energy and fuel sector companies (including: Companies from the WIG-Fuels Index) | 1,324 | 651 |
| Financial and insurance services | 793 | 761 |
| Transportation and storage | 603 | 615 |
| Companies included in the WIG-Banks Index | 555 | 558 |
| Manufacturing | 482 | 1,163 |
| Construction and real estate market service | 481 | 479 |
| Public utility services | 382 | 410 |
| Arts, entertainment and recreation (including: WIG | hotels and restaurants) | 365 | 315 |
| Information and communication (including: WIG | Telecommunications) | 307 | 201 |
| Mining and quarrying (including companies included in the WIG-Mining index) | 252 | 353 |
| Other professional, scientific and technical activity | 184 | 410 |
| Other | 92 | 147 |
| Total | 22,755 | 24,169 |
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 instrument | 31 December 2020 | 31 December 2019 | ||
| decrease | increase | decrease | increase | |
| Polish zloty | 3,307 | (3,163) | 2,090 | (1,982) |
| Euro | 34 | (30) | 16 | (16) |
| US dollar | 183 | (163) | 127 | (111) |
| other | (9) | 8 | (9) | 8 |
| Total | 3,515 | (3,348) | 2,224 | (2,101) |
The above sensitivity tests do not include the effects of changes in interest rates for technical provisions and liabilities under investment contracts. An analysis of effect of a change in technical rate on measurement of insurance contracts is presented in sections 7.5.2.1 and 7.5.2.2.
The exposures to interest rate risk and the level of the recorded net interest income in 2020 was significantly impacted by the series of significant interest rate cuts by NBP and increase in the liquidity of the banking sector in response to the developing COVID-19 pandemic. To secure the current accounts and protect the net interest income, the PZU Group continued to pursue its hedging strategy through concluding IRS transactions and purchase of fixed-coupon bonds.
In connection with taking into account the current interest rate levels in the business processes, in the short term the risk associated with low interest rates in the PZU Group’s insurance segment is not perceived as significant. The risk is monitored and analyzed on an ongoing basis to ensure proper adaptation of the investment portfolio structure.
The table below presents the contractual level of sensitivity of net interest income (NII) to a 100 bp change in interest rates and sensitivity of the economic value of equity (EVE) of PZU Group’s banks to a 200 bps change in interest rates. The measure (NII) is used for managing interest rate risk in order to reduce variations in net interest income. 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 sensitivity, for deposits from retail customers, the declines in interest rates are limited to the zero interest rate level, but not down to negative figures, while for EVE sensitivity the zero-based limitation of interest rate decreases applies to all liabilities. Also, in the case of EVE sensitivity for PLN-denominated current deposits, a model that ensures realistic revaluation is used.
| Entity | Measure | 31 December 2020 | 31 December 2019 | ||
| decrease | increase | decrease | increase | ||
| Pekao Group | NII | (6.31%) | 1.99% | (6.98%) | 4.08% |
| EVE | 2.76% | (7.1%) | 1.61% | (3.04%) | |
| Alior Bank Group | NII | (13.09%) | 1.84% | (9.30%)1 | 3.14% |
| EVE | (0.14%) | (1.03%) | (1.7%) | 1.35% | |
1 due to the reconstruction of the interest rate risk appetite in September 2020, the data were brought to comparability
7.5.3.2. Foreign exchange risk
Exposure to FX risk
| Assets by currency | 31 December 2020 | 31 December 2019 | ||||||||
| PLN | EUR | USD | Other | Total | PLN | EUR | USD | Other | Total | |
| Loan receivables from clients | 163,264 | 28,498 | 1,617 | 3,9091 | 197,288 | 163,827 | 25,914 | 1,423 | 3,7042 | 194,868 |
| Financial derivatives | 5,796 | 374 | 165 | 4 | 6,339 | 2,626 | 368 | 110 | 3 | 3,107 |
| Investment financial assets | 123,250 | 7,243 | 9,374 | 1,055 | 140,922 | 97,050 | 7,427 | 5,748 | 1,191 | 111,416 |
| Measured at amortized cost | 65,120 | 1,271 | 205 | 268 | 66,864 | 43,587 | 1,643 | 278 | 430 | 45,938 |
| Debt securities | 57,056 | 695 | 5 | 115 | 57,871 | 34,837 | 969 | 1 | 123 | 35,930 |
| Government securities | 50,374 | 138 | 5 | 115 | 50,632 | 28,975 | 88 | 1 | 123 | 29,187 |
| Other | 6,682 | 557 | - | - | 7,239 | 5,862 | 881 | - | - | 6,743 |
| Buy-sell-back transactions | 4,657 | - | - | - | 4,657 | 4,064 | - | - | - | 4,064 |
| Term deposits in credit institutions | 576 | 183 | 40 | 153 | 952 | 885 | 175 | 87 | 307 | 1,454 |
| Loans | 2,831 | 393 | 160 | - | 3,384 | 3,801 | 499 | 190 | - | 4,490 |
| Measured at fair value through other comprehensive income | 49,915 | 5,189 | 8,417 | 727 | 64,248 | 44,523 | 5,006 | 4,965 | 717 | 55,211 |
| Equity instruments | 569 | 36 | - | - | 605 | 504 | 14 | - | - | 518 |
| Debt securities | 49,346 | 5,153 | 8,417 | 727 | 63,643 | 44,019 | 4,992 | 4,965 | 717 | 54,693 |
| Government securities | 38,884 | 3,749 | 5,617 | - | 48,250 | 30,774 | 3,600 | 3,099 | 3 | 37,476 |
| Other | 10,462 | 1,404 | 2,800 | 727 | 15,393 | 13,245 | 1,392 | 1,866 | 714 | 17,217 |
| Measured at fair value through profit or loss | 8,215 | 783 | 752 | 60 | 9,810 | 8,940 | 778 | 505 | 44 | 10,267 |
| Equity instruments | 701 | 15 | 207 | 23 | 946 | 567 | 140 | 114 | 24 | 845 |
| Participation units and investment certificates | 4,200 | 730 | 341 | 27 | 5,298 | 3,954 | 604 | 243 | 19 | 4,820 |
| Debt securities | 3,314 | 38 | 204 | 10 | 3,566 | 4,419 | 34 | 148 | 1 | 4,602 |
| Government securities | 3,240 | 25 | 168 | 10 | 3,443 | 4,250 | 19 | 123 | 1 | 4,393 |
| Other | 74 | 13 | 36 | - | 123 | 169 | 15 | 25 | - | 209 |
| Receivables | 5,044 | 1,006 | 102 | 94 | 6,246 | 4,125 | 1,404 | 110 | 98 | 5,737 |
| Cash and cash equivalents | 3,654 | 1,810 | 1,290 | 1,1853 | 7,939 | 4,973 | 1,542 | 482 | 7914 | 7,788 |
| Total assets | 301,008 | 38,931 | 12,548 | 6,247 | 358,734 | 272,601 | 36,655 | 7,873 | 5,787 | 322,916 |
1 of which PLN 2,617 million in Swiss francs and PLN 611 million in British pounds.
2 of which PLN 2,695 million in Swiss francs and PLN 533 million in British pounds.
3 of which PLN 317 million in British pounds, PLN 284 million in Norwegian kroner, PLN 186 million in Swiss francs, PLN 82 million in Swedish kronor, PLN 68 million in Romanian leu and PLN 60 million in Danish kroner.
4 of which PLN 310 million in British pounds, PLN 144 million in Swiss francs, PLN 70 million in Norwegian kroner, PLN 56 million in Swedish kronor and PLN 39 million in Danish kroner.
| Liabilities by currency | 31 December 2020 | 31 December 2019 | ||||||||
| PLN | EUR | USD | Other | Total | PLN | EUR | USD | Other | Total | |
| Subordinated liabilities | 6,632 | 47 | - | - | 6,679 | 6,656 | 44 | - | - | 6,700 |
| Liabilities on the issue of own debt securities | 7,084 | 429 | 19 | - | 7,532 | 9,006 | 229 | 38 | - | 9,273 |
| Liabilities to banks | 5,392 | 4,171 | 18 | 1701 | 9,751 | 3,120 | 3,242 | 19 | 2232 | 6,604 |
| Liabilities to clients | 203,273 | 22,631 | 12,802 | 3,2693 | 241,975 | 182,288 | 22,150 | 11,123 | 3,0274 | 218,588 |
| under deposits | ||||||||||
| Financial derivatives | 5,528 | 501 | 244 | 8 | 6,281 | 2,529 | 378 | 106 | 5 | 3,018 |
| Other liabilities | 10,661 | 1,266 | 418 | 89 | 12,434 | 8,902 | 1,251 | 347 | 99 | 10,599 |
| Total liabilities by currency | 238,570 | 29,045 | 13,501 | 3,536 | 284,652 | 212,501 | 27,294 | 11,633 | 3,354 | 254 782 |
1 of which PLN 153 million in Swiss francs.
2 of which PLN 187 million in Swiss francs.
3 of which PLN 1,740 million in British pounds, PLN 760 million in Swiss francs, PLN 236 million in Norwegian kroner, PLN 134 million in Swedish kronor, PLN 108 million in Canadian dollars, PLN 64 million in Australian dollars, PLN 47 million in Russian ruble, PLN 32 million in Romanian leu, PLN 30 in Czech korunas and PLN 26 million in Japanese yen.
4 of which PLN 1,532 million in British pounds, PLN 648 million in Swiss francs, PLN 234 million in Norwegian kroner, PLN 147 million in Swedish kronor, PLN 86 million in Canadian dollars, PLN 48 million in Czech korunas and PLN 121 million in Japanese yen.
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 investment (deposit) financial assets of the PZU Group and derivative financial assets denominated in foreign currencies.
| Change in portfolio value caused by a +/-20% change of the exchange rate | 31 December 2020 | 31 December 2019 | ||
| decrease | increase | decrease | increase | |
| EUR | (700) | 724 | (598) | 643 |
| USD | (74) | 68 | (51) | 59 |
| GBP | 4 | (4) | 7 | (7) |
| Other | (49) | 50 | (52) | 52 |
| Total | (819) | 838 | (694) | 747 |
7.5.3.3. Equities prices risk
Level of risk exposure
The value of the portfolio of equity financial instruments is presented in section 36.2.
Sensitivity analysis
The following table presents the sensitivity test of PZU Group’s 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 equity | 31 December 2020 | 31 December 2019 |
| increase in measurement of quoted equity instruments by 20% | 122 | 112 |
| decrease in measurement of quoted equity instruments by 20% | (122) | (112) |