Capital is central to a bank’s ability to absorb unexpected losses and to be able to continue its operations. FMO aims to maintain a strong capital position that meets regulatory requirements and supports its AAA rating.
Risk appetite and governance
FMO maintains a strong capital position by means of an integrated capital adequacy planning and control framework. Capital adequacy metrics are calculated by Risk and regularly reviewed by the ALCO and senior management.
FMO uses both regulatory capital ratios and an internal economic capital ratio to determine its capital position. The regulatory ratios, the Total Capital Ratio and Common Equity Tier 1 (CET1) Ratio, are calculated based on the standardized approach of the Capital Requirements Regulation (CRR) and take credit, market, operational and credit valuation adjustment risks into account. The internal ratio (Economic Capital Ratio) is based on an economic capital model having credit risk as the most important element. Other risks in FMO’s economic capital framework are operational, market, credit value adjustment, interest rate risk and reputation risk.
FMO has implemented a Capital Management Framework that aggregates all elements to manage FMO’s current and future capital position in line with the RAF. The Capital Management Framework provides insights to FMO’s management about the degree to which the strategy and capital position may be vulnerable to (unexpected) changes. These insights may require a management intervention to steer FMO's capital position against these unexpected events. Risk is responsible for flagging potential capital issues and proposing and quantifying possible interventions to ALCO.
FMO’s Total Capital Ratio increased from 22.5% at year-end 2019 to 24.9% at year-end 2020, which is well above the SREP minimum and the other regulatory requirements. Given that FMO has no additional tier 1 and limited tier 2 capital, the Total Capital ratio is more restrictive than the CET-1 ratio. The outbreak of the COVID-19 crisis had a significant impact on FMO’s economic result, mostly due to the depreciation of the fair valued equity portfolio. However, the resulting impact on capital ratios was offset by the USD depreciation that took place over 2020 and by the lower than expected portfolio growth. Furthermore, a positive impact on total eligible capital was provided by the replacement of the Tier 2 capital instrument of €175 million, that was called in December and replaced with an issuance of higher amount (€250 million).
Please refer to more details on the methodology used for calculating the capital ratios in the sections below. The Economic Capital Ratio, calculated based on total capital, increased from 14.7% to 14.9%. The increase is mainly the result of a decrease in capital requirements originating from foreign exchange risk and from a decline of the total balance sheet amount.
Under the CRR/CRD banks are required to hold sufficient capital to cover for the risks they face. FMO reports its capital ratio to the Dutch Central Bank (DNB) on a quarterly basis according to the standardized approach for all risk types. Per December 31, 2020, FMO's total available qualifying capital equals €2,908 million (2019: €2,929 million).
December 31, 2019
IFRS shareholders' equity
Tier 2 capital
-Interim profit not included in CET 1 capital
-Other adjustments (deducted from CET 1)
-Other adjustments (deducted from Tier 2)
Of which Common Equity Tier 1 capital
Risk weighted assets
-Credit and counterparty risk
-Credit valuation adjustment
Total capital ratio
Common Equity Tier 1 ratio
Following specific provisions in the CRR, FMO is required to deduct from its regulatory capital significant and insignificant stakes for subordinated loans and (in)direct holdings of financial sector entities above certain thresholds. These thresholds correspond to approximately 10% of regulatory capital. Exposures below the 10% thresholds are risk weighted accordingly.
As part of the Supervisory Review and Evaluation Process (SREP), DNB sets the minimum capital requirements for credit institutions. For 2020, The Dutch Central Bank has set a prudential requirement for FMO in terms of total capital at 16.8% and CET1 of 13.3%. The total prudential requirement consists of the total SREP capital ratio (13.3%), the combined buffer requirement (2.5%) and a Pillar 2 Guidance (1%).
The combined buffer requirement applicable to FMO consists of the capital conservation buffer and the institution specific countercyclical buffer (currently insignificant). As of 2020, the capital conservation buffer was still recognized at 2.5%.
The Pillar 2 guidance (P2G) determines the adequate level of capital to be maintained above the existing capital requirements in order to have sufficient capital buffer to withstand stressed situations. The P2G is a non-binding requirement and no automatic restrictions on distributions of dividends or bonuses are imposed.
FMO's regulatory target capital ratio incorporates the fully phased-in capital requirement by DNB supplemented with
(i) a management buffer, and
(ii) a dynamic FX buffer. The dynamic FX buffer is in place to cover variations in the regulatory capital ratio following changes in the EUR/USD exchange rate that are not covered by the structural hedge. This structural hedge functions as a partial hedge against an adverse effect of the exchange rate on the regulatory capital ratios. Further information regarding the structural hedge is provided in the currency risk section.
In reaction to the COVID-19 pandemic, the Dutch Central Bank adopted several relief measures to provide temporary capital relief for banks if needed. FMO and other banks were temporarily allowed to operate below the level of capital defined by the Pillar 2 Guidance (P2G) and the capital conservation buffer. In addition, relief was provided in the composition of capital for Pillar 2 Requirements (P2R), since the P2R was no longer required to be composed entirely out of CET1 capital. This change in composition derived from CRD V was scheduled to take effect in January 2021, but was brought forward by supervisors.
Economic capital is calculated using a conservative confidence interval of 99.99%. This level is chosen to support a AAA rating. The economic capital model differs in two elements from the regulatory capital ratios. First, the EC model captures risks that are not covered under Pillar 1: reputational risk, interest rate risk in the banking book (IRRBB). Second, the EC model applies an internal model approach for credit risk resulting from FMO’s emerging market loan portfolio. FMO invests in emerging markets, which results in a profile with higher credit risk exposure than generally applies to credit institutions in developed economies. The internal model is more risk sensitive, leading to a higher capital requirement than the standardized approach. The most important parameters for calculating credit risk capital requirements are the probability of default and loss given default calculated using FMO’s internal credit risk rating. Please refer to the 'credit risk' section for more information regarding the internal credit risk rating system.
Dec 31, 2020
Dec 31, 2019
Credit risk emerging market portfolio (99.99% interval)
Credit risk treasury portfolio
Credit valuation adjustment
Total pillar 1
Interest rate risk in the banking book
Economic capital (pillar 1 & 2)
Surplus provisioning (capped at 0.6% RWA)
Total available capital
EC - Risk weighted assets (internal model)
EC - Total capital ratio
- 1 Surplus provisioning for the loan portfolio refers to the difference between the total provisioning minus total expected loss.
The leverage ratio represents a non-risk-adjusted capital requirement. Since 2014, the CRR/CRD IV rules required that credit institutions calculate, monitor and report on their leverage ratios, defined as tier 1 capital as a percentage of FMO's total unweighted exposures. FMO’s leverage ratio equals 27% (2019: 29%) which is far above the minimum requirement of 3% proposed by European authorities.