61. Credit risk management

Credit risk is defined as the risk of losses being incurred as a result of a customer’s default on its liabilities towards the Group or the risk of a decrease in the economic value of amounts due to the Group as a result of a deterioration in the customer’s ability to repay its liabilities.

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 at risk of impairment, while maintaining the expected level of profitability and value of the loan portfolio.

The Bank and the Group subsidiaries are guided mainly by the following credit risk management principles:

• a 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 at the stage of examining a loan application and on a regular basis, as part of the monitoring process, taking into consideration changes in the external conditions and in the financial standing of the borrowers;
• credit risk assessment of exposures is separated from the sales function by ensuring an appropriate organizational structure, independence in developing and validating tools supporting an assessment of credit risk and independence of decisions approving deviations from the suggestions resulting from the use of these tools;
• the terms and conditions of a loan transactions offered to a customer depend on the assessment of credit risk level generated by the transaction;
• credit decisions may be taken solely by the persons authorized to do so;
• credit risk is diversified, in particular, in terms of geographical areas, industries, products and customers;
• an expected credit risk level is mitigated by collateral received by the Bank, margins from customers and impairment allowances (provisions) for expected credit losses.

The above-mentioned principles are implemented by the Group through the use of advanced credit risk management methods, both at the level of individual credit exposures and of the entire loan portfolio of the Group. These methods are verified and developed to ensure compliance with the requirements of the internal rating-based method (IRB), i.e. an advanced credit risk measurement method which may be used to calculate the capital requirements for credit risk, subject to approval by the Polish Financial Supervision Authority.

The Group entities which have significant credit risk levels (the KREDOBANK S.A. Group, the PKO Leasing S.A. Group, PKO Bank Hipoteczny S.A. and Finansowa Kompania “Prywatne Inwestycje” sp. z o.o.) manage their credit risk individually, but the methods used for credit risk assessment and measurement are adjusted to the methods used by PKO Bank Polski S.A., taking into account the specific nature of the activities of these companies.

Any changes to the solutions used by the Group’s subsidiaries must be agreed each time with the Bank’s units responsible for risk management.

The PKO Leasing S.A. Group, the KREDOBANK S.A. Group, and Finansowa Kompania “Prywatne Inwestycje” sp. z o.o. as well as PKO Bank Hipoteczny S.A. measure their credit risk regularly and the results of such measurements are submitted to the Bank.

Within the structures of PKO Bank Hipoteczny S.A., the KREDOBANK S.A. Group and the PKO Leasing S.A. Group, there are organizational units in the risk management areas which are responsible, in particular, for:

• developing methodologies for credit risk assessment and recognition of provisions and allowances;
• control over and monitoring of credit risk in the lending process;
• quality and efficiency of the restructuring and debt collection processes;

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

The process of credit decision-making in PKO Bank Hipoteczny S.A., the KREDOBANK S.A. Group and the PKO Leasing S.A. Group is supported by credit committees which are involved in the process for credit transactions which generate an increased level of credit risk.

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

• probability of default (PD);
•  loss given default (LGD);
• credit conversion factor (CCF);
• expected credit loss (ECL);
• credit value at risk (CVaR);
• the share and structure of impaired credit exposures;
• coverage ratio of impaired loans;
• cost of credit risk;
• stress tests.

The Group systematically expands the scope of credit risk measures used, taking into account the requirements of the IRB method, and extends the use of risk measures to cover the entire loan portfolio of the Group.

The portfolio credit risk measurement methods allow, among other things, to reflect the credit risk in the price of products, determine the best conditions of financing availability and determine the level of impairment allowances.

The Group performs analyses and stress tests relating to the impact of potential changes in the macroeconomic environment on the quality of the Group’s loan portfolio, and the results of such analyses and stress tests are presented in reports to the Bank’s governing bodies. Such information enables the identification and implementation of the measures mitigating the negative effects of the impact of unfavourable market conditions on the Group’s profit or loss.

The credit risk assessment process at the Bank’s Group takes into account the requirements of the Polish Financial Supervision Authority as laid down in the PFSA Recommendations.

The description of the anticipated credit losses is disclosed in the Note “Net expected credit losses”.

An assessment of the risk of individual loan transactions is performed by the Group using the scoring and rating methods which are supported by dedicated IT applications. The risk assessment method is defined in the Group’s internal regulations whose main aim is to ensure a uniform and objective evaluation of credit risk during the lending process.

The Group evaluates the credit risk of retail customers in two dimensions: qualitative and quantitative assessment of their borrowing capacity. A quantitative borrowing capacity assessment consists of examining a customer’s financial position, and the qualitative assessment involves scoring and assessing a customer’s credit history obtained from the Group’s internal records and external databases.

In the case of corporate customers in the small- and medium-sized enterprises segment who 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: a customer’s borrowing capacity and his creditworthiness. An assessment of the borrowing capacity consists of examining a customer’s economic and financial position, and the assessment of creditworthiness involves scoring and evaluating the customer’s credit history obtained from the Group’s internal records and external databases.

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

An assessment of the credit risk associated with financing institutional customers is performed by the Bank in two dimensions: the customer and the transaction. The measures involved include an evaluation of the customer’s creditworthiness, i.e. the rating, and an assessment of the transaction risk, i.e. the customer’s ability to repay the amounts due in the amounts and on the dates specified.

Rating models for institutional customers are developed using the Group’s internal data, thus ensuring that they are tailored to the risk profiles of the Group’s customers. Models are based on a statistical dependence analysis between the default and a customer’s risk scoring. The scoring includes an evaluation of financial ratios, qualitative factors and behavioral factors. A customer’s risk assessment depends on the size of the assessed enterprise. In addition, the Group applies a model for the assessment of credited entrepreneurs in the formula of specialized lending, which allows an adequate credit risk assessment of large projects involving real estate financing (e.g. office space, retail space, industrial space) and infrastructure projects (e.g. telecommunication, industrial or public utility infrastructure).

Rating models are implemented within the IT tool which supports the assessment of the Group’s credit risk associated with the financing of institutional customers.

In order to examine the correct operation of the methods applied by the Group, credit risk assessment methodologies relating to individual loan exposures are subject to periodical reviews.

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

Information on rating and scoring assessments is widely used in the Group to manage credit risk, in the system of credit decision authorizations, to determine the amounts triggering the credit risk assessment services and in the credit risk measurement and reporting system.

Credit risk forecasting and monitoring involves preparing risk level forecasts and monitoring deviations from the forecasts or the adopted benchmarks (e.g. limits, thresholds, plans, prior period measurements, recommendations and instructions issued by external supervisory and regulatory authorities), and performing (specific and comprehensive) stress tests. Risk level forecasts are subject to backtesting.

Credit risk is monitored at the level of individual credit transactions and at portfolio level.

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

• assessment of the credit risk related to customer financing;
• methods of assessing customers;
• identification of groups of related entities;
• evaluation of collateral and inspection of investments;
• recognition of allowances for expected credit losses;
• Early Warning System;
• operating procedures.

In order to accelerate the response to the warning signals noted reflecting an increased credit risk level, the Group uses and develops an IT application, the Early Warning System (EWS).

Credit risk monitoring 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 analysing 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 includes periodical reporting of the loan portfolio risk exposure.

The Group prepares monthly and quarterly credit risk reports. Credit risk reporting includes periodical reporting of the loan portfolio risk exposure. In addition to information for the Bank, the reports also include information on the level of credit risk in the Group entities where a material level of credit risk was identified (e.g. the KREDOBANK S.A. Group, the PKO Leasing S.A. Group, PKO Bank Hipoteczny S.A.).

The purpose of management actions is to shape and optimize the credit risk management system and credit risk level at the Group.

The credit risk management actions include particularly:

• issuing internal regulations governing the credit risk management system at the Group;
• issuing recommendations, guidelines for conduct, explanations and interpretation of the Group’s internal regulations;
• taking decisions regarding the acceptable level of credit risk, including in particular lending decisions;
• developing and improving credit risk control tools and mechanisms which make it possible to maintain the credit risk level within the limits acceptable to the Group;
• developing and monitoring the operation of credit risk management controls;
• developing and improving credit risk assessment methods and models;
• developing and improving IT tools used in credit risk management;
• planning actions and issuing recommendations.

The main 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 customers and SMEs) or the customer’s rating class (for corporate clients), which a customer must obtain to receive a loan;
• Concentration limits – limits under the CRR and Banking Law or external limits that define the appetite for concentration risk;
• industry-related limits – limits which reduce the risk level related to financing institutional customers conducting business activities in industries characterized by high levels of credit risk;
• the limits defining the appetite for credit risk resulting from, among other things, Recommendations S and T;
• credit limits defining the Group’s maximum exposure to a customer or a country in respect of wholesale market transactions, settlement limits and limits for exposure duration;
• authorization limits – limits defining the maximum level of credit decision-making powers with regard to the Group’s customers; the limits depend primarily on the amount of the Bank’s exposure to a given customer (or a group of related customers) and the lending period; authorization limits depend on the level (in the Bank’s organizational structure) at which credit decisions are made;
• minimum credit margins – credit risk margins relating to a given credit transaction concluded by the Group with a given corporate customer, where the interest rate offered to the customer should not be lower than the reference rate plus an appropriate credit risk margin.

The collateral management policy plays a significant role in establishing minimum transaction terms. The Bank’s and the Group companies’ collateral management policy is intended to properly protect them against credit risk to which the Group is exposed, including above all by establishing that is collateral as liquid as possible. Collateral may be considered liquid if it can be sold without a significant decrease in its price and at a time which does not expose the Bank to a change in the collateral value due to price fluctuations typical of a given asset.

The Group strives to diversify collateral in terms of its forms and assets used as collateral.

The Group evaluates collateral from the perspective of the actual possibility of using it to satisfy its claims.

In addition, when assessing collateral, the Bank takes into account the following factors:

• the economic, financial and economic, or social and financial position of entities which provide 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 to the Group resulting from a specific method of securing receivables, including, in particular, the possibility of reducing allowances for expected credit losses;
• 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 for 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 level of risk of a given customer or transaction.

When granting loans intended to finance housing and commercial funding properties, a mortgage is an obligatory type of collateral.

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

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

The collateral for loans intended for the financing of small- and medium-sized enterprises as well as corporate customers is established, among other things: on receivables from business operations, bank accounts, movables, real estate or securities. The collateral management policy is set out in the internal regulations of the Group’s subsidiaries.

When concluding lease agreements, the PKO Leasing S.A. Group, as the owner of the leased assets, treats the leased assets as collateral.