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Interest rate risk

Interest rate risk

Interest rate risk results from the exposure of the Group’s financial performance and equity to adverse changes in interest rates.

The Group’s interest rate risk is managed at the level of the Bank as the risk assumed by the subsidiaries is immaterial considering the nature of their business.

The interest rate risk arises from:

• mismatch of revaluation dates: the risk is expressed as a threat to the Bank's revenue, mostly interest income, in case of unfavorable changes of market interest rates or significant changes of the balance sheet revaluation structure resulting in changes in the interest gain/loss,
• basis risk arising from imperfect correlation between interest rates on products that generate interest income and expense and have the same revaluation dates,
• yield curve risk where the ratio between the interest rates concerning different periods but the same index or market changes,
• client option risk arising when clients change the amount and timeline of cash flows on assets, liabilities and off-balance sheet items according to their rights arising from loan or deposit agreements, without incurring any additional costs.

The Bank adapts its interest rate risk management to the type and scale of its business. Interest rate risk in the Bank may be related to the banking book and to the trading book.

The objective of interest rate risk management is to build a structure of assets and liabilities ensuring protection of the present value and net interest income of the Bank for the banking book and to obtain financial benefits through transactions on interest rate instruments concluded on own account in the trading book, with the accepted interest rate risk level.

Interest rate risk management in the Bank is based on written policies and procedures, which define the methods of:

• risk identification,
• risk measure calculation (risk measurement),
• risk exposure limiting – determining the acceptable risk level,
• monitoring items and changes in each book, portfolio and the limit use levels,
• risk exposure reporting,
• hedging exposures against interest rate risk

Interest rate risk related to the banking book is measured and monitored with the use of such risk measures as:

• BPV (Basis Point Value) denoting interest rate risk expressed as a cash value, related to maintaining of a given position when interest rates change by one basis point
• NII (net interest income) – a change in net interest income representing the difference between interest income and expense with an interest rate change at a specified level,
• BPV gap value in each revaluation range,
• duration: a measure of interest rate risk interpreted as the average duration of an instrument or portfolio,
• early repayment of loans and withdrawal of deposits ratios for each type of products and entities..

Interest rate risk related to the Trading Book is measured and monitored with the use of such risk measures as:

• BPV and BPV gap value in each revaluation range,
• Value at Risk (VaR).

Additionally, the Bank performs stress tests involving sensitivity analysis and examining the effects of interest rate changes on the present value of risk-exposed items based on specified changes in the yield curve, and the effects of changes in interest rates on net interest income of the Group. Under stress tests, the Bank measures its exposure using a variety of interest rate risk scenarios, among others assuming:

• sudden parallel upward and downward shifts on the yield curve,
• sudden changes in the shape of the yield curve (e.g. increasing/decreasing/flat short-term interest rates when medium- and long-term ones change at a different pace or in opposite direction),
• basis risk (including that arising from changes in relations among key market rates),
• potential behavior changes of various types of assets or liabilities under the assumed scenarios.

For the purpose of calculating the Banking Book risk measures, the current value of loans and deposits is determined based on reference rates arising from revaluation dates and liquidity adjustment excluding the commercial margin realized on each product. Additionally, stress tests for downward curve shift purposes are based on the assumption that interest on items sensitive to interest rate risk shall not drop below 0%.

The following tables present the interest rate risk level for the banking book (BPV and stress tests).

The following table presents a change in annual net interest income with the rate change by +/-100 b.p. and balance sheet assumed to be stable. The analysis is based on the following assumptions:

• for interest rate decrease: interest rates on loans shall not exceed the interest rate cap determined in applicable laws and interest rates on deposits (both term and current accounts) shall not drop below 0%;
• for interest rate increase: interest on interest-free current accounts shall not increase.

In 2016, Bank’s trading activities regarding interest rates were limited to transactions on Polish treasury securities denominated in PLN. The Bank did not conclude speculative derivative transactions on its own behalf or derivative transactions with its clients. In 2016 the Bank held no open speculative interest rate positions at day closing.

The following table presents BPV for the trading book.