3 Risk developments

For a detailed overview of FMO’s risk governance and risk management approach please refer to the "Risk Management" section in FMO’s 2022 annual report. The risk developments in the first half year of 2023 are described below.

3.1 Capital adequacy 

FMO complies with the CRR/CRD requirements and reports its capital ratios to the Dutch Central Bank every quarter. FMO calculates the capital requirement for its entire portfolio based on the standardized approach. At the end of June 2023, the capital ratio is 24.21%. 

The increased production during the first half year, results in higher risk weighted assets (RWA) and higher deductions from own funds. The higher RWA combined with lower own funds decreases the total capital ratio by 0.6%.

FMO’s capital ratio remains above the combined ratio of the supervisory review and evaluation process (SREP) minimum and FMO’s internal requirements. 

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.

3.2 Credit risk 

In the first half of 2023, Russia’s invasion of Ukraine continued to cause a deep regional slowdown as well as lower growth and rising inflation worldwide. As a result of low economic performance and rising inflation, FMO downgraded exposures in Argentina and Pakistan. On a positive note, in March 2023, Sri Lanka agreed to a financing package from the IMF, which buffered the impact of its political and economic crisis.

FMO’s NPL portfolio saw a decrease during the first half of 2023 from 11.9% to 9.9% primarily driven by the Sri Lanka portfolio, which remained classified as NPL at the end of 2022 and returned to a performing status following the government’s agreement with the IMF. In addition, FMO received repayments on the NPL portfolio of €52 million and wrote off €59 million, approximately half of which due to settlement agreements with debtors. New NPLs were primarily recorded in the Energy sector, particularly in Honduras and Rwanda where FMO’s customers faced slow payments from off-takers. In addition, there was a small new NPL within the forestry portfolio. As a result, FMO’s NPLs are concentrated in the Energy and Agribusiness, Food and Water sectors, while NPLs in Financial Institutions remain low.

In terms of countries, NPLs are concentrated in Ukraine, Uganda, and Honduras. Each country represented 15%, 14% and 12% of the total NPL portfolio, respectively. Other countries with high NPLs are India, Argentina, Ghana, and Peru.

Past due information related to FMO’s portfolio loans and receivables are presented in the table below. This categorization does not apply to financial assets other than loans, including interest-bearing securities and short-term deposits.

All interest-bearing securities (credit quality of AA or higher) and Banks (credit quality of BBB- or higher) are classified as Stage 1. An amount of € 90 is calculated for the ECL of both asset classes as per June 30, 2023 (as per December 31, 2022 € 86).

The following table shows the credit quality and the exposure to credit risk of the loans to the private sector at amortized cost and fair value at June 30, 2023.

The following table shows the credit quality and the exposure to credit risk of the financial guarantees on June 30, 2023.

The following table shows the credit quality and the exposure to credit risk of the loan commitments to the private sector on June 30, 2023. These represent contracts signed but not yet disbursed.

The following tables show the changes in loans, financial guarantees and loan commitments. 

The full contractual amount of assets that were written off during the current and prior reporting period are still subject to enforcement activity.

The modelling methodologies applied in determining ECL in the current period are consistent with those applied in the financial year ending December 31, 2022.

The macroeconomic scenarios’ model was updated following the publication of new macroeconomic outlook data by the International Monetary Fund (IMF) in April 2023 (2022 October). The updates of the model based on GDP forecast, caused new point-in-time adjustments to probability of defaults in the impairment model, leading to an increase of €1.41 million in combined stage-1 and stage-2 impairment charges. 

FMO continues to support customers by undertaking several forborn measures.

3.3 Equity investment risk 

The first half of 2023 was marked by high inflation in major economies, leading to further tightening of interest rates in the US and euro zone. Although energy prices decreased, inflation remained high, and additional tightening measures are expected. The higher rates in the US exerted pressure on local currencies, impacting the USD performance of funds in Africa, Turkey, and India. Due to the USD weakening against the EUR, the value of our USD-denominated fund portfolio suffered.

Fortunately, the market for investments in renewable energy experienced a revival due to improved availability of materials after the Covid-19 pandemic. Financial institutions have also been recovering, and fund managers have actively sought to raise funds. Consequently, we expect to be able to make a good level of new investments in 2023. Moreover, our exits/distributions and dividends are in line with budget. 

Re-measurement of fair values for the equity portfolio (excluding results from sales) resulted in a total loss of €15 million (H1 2022: €113 million gain). This loss was primarily attributed to the weakening of the USD against the EUR, which is part of the total unrealized loss from FX conversions of €36 million (H1 2022: €123 million gain). The remaining results from fair value re-measurements is driven by capital results, which is a gain of €21 million (HY 2022: €10 million loss). As of June 30, 2023, the equity investment portfolio amounts to €2.3 billion (H1 2022: €2.2 billion). Additionally, dividend income amounted to €11 million (H1 2022: €32 million).

3.4 Concentration risk 

Concentration risk is the risk that FMO’s exposures are too concentrated within or across different risk categories. Concentration risk may trigger losses large enough to threaten our financial stability. Strong diversification within FMO’s emerging market portfolio is ensured through stringent limits on individual counterparties, sectors, countries and regions.

Country risk

Country risk arises from country-specific events that adversely impact FMO’s exposure to a specific country. They include all factors that impact FMO’s portfolio in a country, such as economic, banking and currency crises, sovereign defaults and political risk events. To ensure FMO’s emerging market portfolio, is diverse enough we use a country and sector limit framework. Country limits range from 8% to 22% of FMO’s shareholders’ equity, depending on the country rating, with higher limits in less risky countries. Sectoral exposures are limited to 50% of the country limit for each sector in any given country.

During the first half of 2023, country risk in FMO’s markets stabilized compared to 2022, which was turbulent due to the war between Ukraine and Russia. Although many economies continue to recover from the shocks generated by the pandemic and the war in Ukraine, the outlook remains uncertain. Particularly the impact of the ongoing war and related sanctions, increasing global interest rates, higher exchange rate volatility, and political instability in Sub-Saharan Africa weigh on FMO’s markets. In this period, credit ratings of Argentina, Bolivia and Pakistan were downgraded one notch on FMO's internal country rating scale, while Costa Rica and El Salvador were upgraded one notch.

3.5 Market risk

Currency risk 

Our appetite for currency risk remained limited. Exposures are hedged through matching currency characteristics of assets with liabilities, or through derivative transactions such as cross-currency swaps and FX forwards conducted with either commercial parties or with The Currency Exchange Fund (TCX Fund N.V.). Most currency exposures are hedged to US dollars on a micro-hedge basis, whereby the US dollar position is managed on a portfolio basis. FMO does not take any active positions in any currency for purpose of making a profit. Each individual currency is managed within a strict position limit and an overall appetite level is set at 1% of shareholder’s equity for the total open position across all currencies. Individual exposures and total open currency positions were within risk appetite in 2023. FMO maintains a deliberately unhedged foreign currency position which stems from the private equity investments and which serves as a structural hedge for our capital ratio.

Interest Rate Risk in the banking book 

Interest rate risk is the risk of potential loss due to adverse changes to interest rates. Changing interest rates mainly influence the fair value of fixed interest balance sheet items and affect our earnings by altering interest rate sensitive income and expenses, affecting our net interest income (NII). FMO's appetite for interest rate risk is low.  FMO does not take any active interest rate positions for the purpose of making a profit.

The interest rate gap and basis point value exposure are monitored each week against limits set by the Asset and Liability Committee. The delta of the economic value of equity limit is defined in the risk appetite framework and is set at 5% of Tier I. The NII at Risk limit is defined in the risk appetite framework and is set at 1% of Tier 1. In spite of rising rates in the United States, Europe and beyond our positions remained within our risk appetite in 2023.

3.6 Regulatory risk

On 27 October 2021, The European Commission published proposals for reforms to the Capital Requirements Regulations (CRR-3) and Capital Requirements Directive (CRD-6). These draft regulations focus on three main parts: 1) the implementation of the finalized Basel III reforms into European legislation, 2) new rules requiring banks to systematically identify, disclose and manage sustainability risks (ESG risks) as part of their risk management, and 3) stronger enforcement tools for supervisors overseeing EU banks. The first two parts are of relevance to FMO and we closely monitor these as regulations are being drafted and discussed in Europe.

With regards to the European translation of the Basel III standard, updates included the use of internal models, recalibrations to the standardized approach for credit risk, operational risk, credit valuation adjustment and market risk. Important elements were the implementation date (1 January 2025) and changes to treatment of private equity exposures under the standardized approach for credit risk. Under the current draft, foreseen risk weight will increase from the current 150% to 250% if the intended holding period is greater than three years, rather than 400% when falling under the speculative equity classification.

The CRR-3 and CRD-6 proposals also include several amendments to ESG risk. Most notably, FMO will have to disclose ESG risks each year as part of its Pillar 3 disclosures starting in 2025, ESG risks are also added to the scope of the Supervisory Review and Evaluation Process, the annual assessment of banks conducted by banking supervisors. A more elaborate description of the relevant changes expected from CRR-3 and CRD-6 can be found in FMO’s 2022 annual report.

3.7 Compliance risk 

In our continued efforts to implement learnings, FMO reviews its FEC framework with the KYC Department on an ongoing basis. Further, Compliance moved from monitoring all KYC files on a project basis to a business-as-usual approach. Each month, a random sample of KYC files is monitored. In addition, risk-based thematic KYC monitoring is conducted. This approach further embeds the KYC responsibility in the investment teams. We also rolled out an annual integrity refresher e-learning, continued face-to-face awareness on FEC/unusual transactions and anti-bribery and corruption. This further strengthens the risk culture.

As part of our Financial Economic Crime Enhancement program, we conducted a full KYC file remediation that was finalized at the end of 2021. We followed up on the recommendations in DNB’s conclusions and observations, which also included acknowledgement of the improvements we made. As a result of the file remediation, we reported a limited number of incidents to DNB at the end of 2021 and the beginning of 2022, that involved late notifications of unusual transactions to the Financial Intelligence Unit (FIU). DNB reviewed these late notifications and the related KYC files. As a result, DNB decided on enforcement measures. FMO has requested DNB, by means of objection, to reconsider these measures.

In 2022 FMO conducted a dedicated Systematic Integrity Risk Analysis (SIRA) and formulated specific risk appetite statement on private equity fund investments and fund portfolio companies. As a result of this SIRA, the investment teams are implementing enhancements of certain controls. FMO is reviewing its SIRA framework based on the learnings from past SIRAs and has planned a companywide SIRA, to start in the second half of 2023. 

In 2023 FMO continued with the roll out of operational effectiveness of GDPR framework and implement it in business-as-usual processes. In addition, a follow-up GDPR project was begun to identify additional measures and controls to further strengthen the personal data security. To keep our staff aware enough of data security, several data privacy roadshows were held across FMO. For the three FMO representative offices outside of the Netherlands, requirements are being implemented based on new local (privacy) legislation and developments.

We continue to closely follow the developments of the EU sanction packages and measures in relation to the war in Ukraine and assess their potential impact on FMO’s activities.