Financial risk

Credit risk

Definition

Credit risk is defined as the risk that the bank will suffer an economic loss because a customer fails to meet its obligations in accordance with agreed terms.

Risk appetite and governance

Adverse changes in credit quality can develop within FMO’s emerging market loan portfolio due to specific customer and product risk, or risks relating to the country in which the customer conducts its business. The main source of credit risk arises from investments in emerging markets and off-balance instruments such as loan commitments and guarantees.

Credit risk management is important when selecting and monitoring projects. In this process, a set of investment criteria per sector and product is used that reflects minimum standards for the required financial strength of FMO’s customers. This is further supported by credit risk models that are used for risk quantification, calculations of expected credit loss allowance, and the determination of economic capital use per transaction. Funding decisions depend on the risk profile of the customer and financing instrument. As part of regular credit monitoring, FMO customers are subject to annual reviews at a minimum. Customers that are identified as having financial difficulties fall under an intensified monitoring regime to proactively manage loans before they become non-performing, including quarterly portfolio monitoring meetings.  For distressed assets, the Special Operations department actively manages workout and restructuring.

FMO has set internal appetite levels for non-performing exposures and specific impairments on loans. If any of the metrics exceed the appetite levels, Credit will assess the underlying movements and analyze trends per sector, geography, and any other parameter. Credit will also consider market developments and peer group benchmarks. Based on the analysis, Credit will propose mitigating measures to the FRC. If any of the indicators deteriorate further, the Risk department will be involved to assess to what extent the trend is threatening FMO’s capital and liquidity ratios.

Developments

FMO has embarked on an overhaul of its credit risk policy and processes. The objective is to implement a more aligned and effective portfolio management framework across the organization. Implementation started in 2021 and is ongoing.

As part of this process, FMO has fundamentally redesigned the Credit Risk Policy and has adjusted internal processes and systems accordingly. The new Credit Risk Policy has been formally implemented in 2023. The main changes include strengthening the governance framework, alignment amongst key prudential policies, and enhancing the loan monitoring framework.

Exposures and credit scoring

The following table shows FMO's total gross exposure to credit risk at year-end. The exposures, including derivatives, are shown gross, before impairments and the effect of mitigation using third-party guarantees, master netting, or collateral agreements. Regarding derivative financial instruments, only the ones with positive market values are presented. The maximum exposure to credit risk increased during the year to €9.0 billion at year-end 2023 (2022: €8.6 billion).

When measuring the credit risk of the emerging market portfolio at customer level, the main parameters used are the credit quality of the counterparties and the expected recovery ratio in case of defaults. Credit quality is measured by scoring customers on various financial and key performance indicators. FMO uses a Customer Risk Rating (CRR) methodology. The model follows the EBA guidelines regarding the appropriate treatment of a low default portfolio and uses an alternative for statistical validation to perform the risk assessment of the models when there is limited or no default data.

The CRR models are based on quantitative and qualitative factors and are different for respective customer types. The models for banks and non-banking financial institutions use factors including the financial strength of the customer, franchise value, and the market and regulatory environment. The model for corporates uses factors including financial ratios, governance, and strategy. The project finance model uses factors such as transaction characteristics, market conditions, political and legal environment, and financial strength of the borrower.

Based on these scores, FMO assigns ratings to each customer on an internal scale from F1 (lowest risk) to F20 (default) representing the probability of default. This rating system is equivalent to the credit quality rating scale applied by Moody's and S&P. Likewise, the loss given default is assigned by scoring various dimensions of the product specific risk and incorporating customer characteristics. The probability of default and loss given default scores are also used as parameters in the IFRS9 expected credit loss model. Please refer to the 'Material accounting policies' section, for details of the expected credit loss calculation methodology.

The majority of our gross loan portfolio (66 percent) remains in the F11 to F16 ratings categories.

Credit quality analysis

Apart from on-balance finance activities, FMO is also exposed to off-balance credit-related commitments. Guarantees, which represent contingent liabilities to make payments if a customer cannot meet its obligations to third parties, carry similar credit risks as loans. Most of the guarantees are quoted in US dollars. Guarantees on export facilities are collateralized by the underlying letters of credit, and therefore carry less credit risk than direct uncollateralized borrowing. The following table shows the credit quality and the exposure to credit risk of the financial guarantees for the period.

Financial guarantees represent €154,675 thousand (2022: €138,359 thousand) classified as contingent liabilities and €195,733 thousand (2022: €180,836 thousand) classified as irrevocable facilities.

Additionally, irrevocable facilities represent commitments to extend finance to customers and consist of contracts signed but not disbursed, yet which are usually not immediately and fully drawn.

The following table shows the credit quality and the exposure to credit risk of the loan commitments are part of the irrevocable facilities for the period.

The "Other" category relates to loan commitments for which no ECL is calculated (fair value loans or expired availability date).

Non-performing exposures

A customer is considered non-performing when it is not probable that the customer will be able to pay his payment obligations in full without realization of collateral or calling on a guarantee, regardless of the existence of any past-due amount or of the number of days past due.
This situation is considered to have occurred when one or more of the following conditions apply:

• The customer is past due more than 90 days on any outstanding facility;

• An unlikeliness to pay (UTP) trigger is in place that automatically leads to non-performing exposure (NPE);

• An impairment analysis, done upon a UTP trigger that possibly leads to NPE, results in an impairment higher than 12.5% on any outstanding facility;

• There are additional criteria for a customer to enter NPE status in case of Forbearance. If a customer with (No) Financial Difficulty - Forbearance status under probation is extended additional forbearance measures/ concessions or becomes more than 30 days past-due, it shall be classified as non-performing. This only applies if the customer has been non-performing while it was forborne.

NPE is applied at customer level.

During 2023, NPEs in FMO decreased from 11.9 percent as of 31 December 2022 to 9.8 percent as of 31 December 2023. In euro terms, the NPEs decreased from €653 million to €511 million. The largest contributors to the reduction were the positive developments in Sri Lanka and repayments. Write-offs also contributed to the reduction.

NPEs remain concentrated in a few large facilities. Top three NPEs are 20 percent of the total (2022: 16 percent), top ten are 52 percent (2022: 48 percent). As a result, a limited number of large new NPEs result in large movements in the NPE percentage. In terms of sector, NPEs are highest in Energy, in absolute terms at €234 million (2022: €227 million), followed by AFW at €174 million (2022: €184 million), Diverse Sectors at €54 million (2022: €143 million), and FI at €44 million (2022: €106 million). In relative terms (as percentage of the exposure in that sector) NPLs remain highest for Diverse Sectors at 35 percent, followed by AFW at 24 percent, Energy at 16 percent and FI at 2 percent. FMO stopped providing loans to Diverse Sector customers in 2017. NPEs excluding other sectors are 9.1 percent.

NPEs have traditionally been high in India.  However, in 2023, FMO’s NPE exposure reduced from €93 million to €4.1 million, as a result of write-offs of €63 million and repayments of €30 million. The amounts written off were to a large extent already impaired on 31 December 2022.  During 2023, FMO’s NPE exposure in Sri Lanka also decreased, from €62 million to zero, as all NPEs in Sri Lanka improved their performance and as a result the NPE status was lifted.  At the end of 2023, the 3 countries with the highest level of NPEs were Ukraine, Uganda and Honduras, which together make up 41 percent of all NPEs.

NPE levels in FMO’s portfolio partially reflect long recovery periods, which are inherent in markets in which FMO operates.

Past due information related to FMO’s loans portfolio is presented in the tables below.

The table below presents the distribution of Stage 3 loans according to regions and sectors. 

Modified financial assets

Changes in terms and conditions usually include extending the maturity, changing the interest margin and changing the timing of interest payments. When the terms and conditions are modified due to financial difficulties, these loans are qualified as forborne. Refer to paragraph related to 'Modification of financial assets' in the 'Accounting policies' section.

The Credit department reviews modified loans periodically in accordance with the watch-list process. When a loan is deemed no longer collectible, it is written off against the related loss allowance. In 2023, FMO’s write-offs including disposals equaled to €83.6 million (2022: €89.8 million).

The following table provides a summary of FMO’s forborne assets, both classified as performing and non-performing, as of December 31, 2023.

The following table shows the gross carrying amount of previously modified financial assets for which the loss allowance has changed to stage 1 measurement during the period:

The table below includes Stage 2 and Stage 3 assets for which terms and conditions were modified including the related net modification result.

Credit risk mitigation

As per December 31, 2023, the total carrying value of the FMO’s loan portfolio is €4.9 billion; of which €400.0 million is guaranteed by either the Dutch Government or highly rated guarantors. The following table shows a breakdown of guaranteed amounts received and carrying values of guaranteed loans per credit ranking of the guarantors. 

The total carrying value of defaulted (Stage 3) loans in FMO’s loan portfolio is €242.9 million; of which €47.3 million is guaranteed by either the Dutch Government or highly rated guarantors. The following table shows a breakdown of guaranteed amounts received and carrying values of guaranteed loans. 

Equity risk

Definition

Equity risk is the risk that the fair value of an equity investment decreases. It also includes exit risk, which is the risk that FMO’s stake cannot be sold for a reasonable price and in a sufficiently liquid market.

Risk appetite and governance

FMO has a long-term view on its equity portfolio, usually selling its equity stake within a period of five to 10 years. FMO can accommodate an increase in the average holding period of its equity investments and wait for markets to improve before pursuing an exit. The equity investment portfolio consists of direct investments, largely in the financial institutions and energy sectors, co-investments with aligned partners (mainly in cooperation with funds) and indirect investments in private equity funds. Equity investments are approved by the Investment Committee. In close cooperation with the Credit and Finance departments, the Private Equity department assesses the valuation of equity investments on a periodic basis which are approved by the FRC. Diversification across geographical area, sector and equity type across the total portfolio is evaluated before new investments are made. Based on this performance and the market circumstances, direct exits are pursued by involving intermediaries. In the case of co-investments, our fund managers initiate the exit process as they are in the lead. Exits are challenging due to limited availability of liquidity in some markets and the absence of well-developed stock markets.

The risk of building an equity portfolio is driven by two factors:

• Negative value adjustments due to currency effects (EUR/USD and USD/local currencies), negative economic developments in emerging markets (EM) and specific investee related issues. This would negatively affect the profitability of FMO.

• Liquidity of the portfolio – in case FMO is not able to liquidate (part) of its maturing equity portfolio by creating sufficient exits for its direct and co-investment portfolio. This is also reflected in the fund portfolio where some fund managers have to hold longer to their portfolio due to the lack of good exit opportunities.

Developments

In 2023 like in the year before, de-globalization continued to put a strain on GDP growth and the realization of the SDGs. Also, the war in Ukraine continued, the war in Gaza erupted, and the US – China economic war continued. This resulted in higher prices for food and basic goods especially in Africa. Meanwhile climate risk became more evident by record high temperatures and extreme weather patterns across the globe. Central banks in US and Europe continued with aggressive monetary policies, pushing interest rates higher. USD 10-year treasury peaked at 5 percent, a level not seen since the start of this century. Many African countries have high budget deficits (50 percent has more than 5 percent deficit). This had a strong negative impact on capital flows to emerging markets and strong pressure on local currencies which further depreciated. Overall, the risk appetite of investors further declined. 

Despite these difficult circumstances in 2023 we saw a good deal-flow: distributions from fund managers and exits resulted in cash distributions of € 244 million and again a strong level of dividends at € 34 million. At the same time, we also made a high level of new commitments  of €510 million and invested (paid-in) capital of €334 million. Overall, our committed equity portfolio (including associates) increased to €3.1 billion (2022: €3.0 billion) which was the result of the sum of new commitments, distributions, the weakening of the USD  resulting in a €62 million loss and Fair Value gain for the portfolio of € 13 million gain. Although it is difficult to quantify, one of the main reasons for the disappointing value development is the devaluation of local currencies in some larger markets. Aside from that, our Venture Capital portfolio was also negatively impacted by a worsening sentiment around Venture Capital investments where the value reduced with €37 million.

Exposures

The total outstanding equity portfolio on December 31, 2023, amounted to €2.7 billion (2022: €2.6 billion) of which €1.3 billion (2022 €1.3 billion) was invested in investment funds.

The equity portfolio is left unhedged for currency risk. For more information please refer to the 'Currency risk' and 'Structural hedge' sections.

Concentration risk

Definition

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 FMO’s health or ability to maintain its core operations or trigger material change in our risk profile.

Risk appetite and governance

Strong diversification within FMO’s emerging market portfolio is ensured through stringent limits on individual counterparties (single and group risk limits), sectors, countries and regions. These limits are monitored by Risk, reviewed regularly and approved by the FRC, the Managing Board and the Supervisory Board. Diversification across countries, sector and individual counterparties is a key strategy to safeguard the credit quality of the portfolio.

Developments

Global growth is set to decelerate from 3.5 percent in 2022 to 3.1 percent in 2023 and projected to remain at 3.1 percent in 2024 (IMF WEO January 2024). Developing economies continue to suffer from the repercussions of the pandemic and the war in Ukraine. Furthermore, global swift monetary policy tightening exacerbates the fiscal burdens. IMF highlights a growing debt concern, with 56 percent of low-income nations and a quarter of emerging markets either facing or on the brink of significant debt distress. Ghana, Sri Lanka, Belarus, Zambia, and Lebanon experienced debt defaults or ongoing default situations, while Argentina, Tunisia and Ethiopia encountered heightened risks. FMO monitored its portfolio throughout 2023 and will continue to do so. Given FMO's diverse exposure across more than 70 markets, it is well positioned to mitigate the negative effects of country specific crises.

Southern Turkey and northern Syria were struck by two potent earthquakes, causing significant devastation. FMO has a longstanding presence in Turkey and holds a substantial portfolio within the nation. While certain assets/activities of our clients were impacted by the earthquake, the overall credit risk of FMO's portfolio in Turkey remains stable. FMO has no financial engagements in Syria.

The war in Ukraine continued. The UK, US and EU have imposed sanctions on Russia and Belarus. FMO has been active in Ukraine for decades. At year-end 2023, FMO had a €65 million direct exposure in Ukraine across 12 customers in the Energy and Agribusiness Food and Water sectors. FMO received €14 million in repayments from its loans in Ukraine. Unlike the €137 million loss of last year, this year FMO has recognized a €19 million profit from its Ukraine exposure. FMO has no direct exposure and a limited indirect exposure to Russia. The exposure towards Belarus is around €17 million, in indirect equity. 

With the war erupting in Gaza and the region's intricate geopolitics, there's a tangible risk that this war could impact neighboring countries, notably Lebanon, Syria, Egypt, and Jordan. FMO’s exposure in the Palestinian Territories is limited to €12 million in commitments to two microfinance customers through Nasira guarantee program, with €5 million outstanding. While FMO has no exposure to Israel, Syria, and Lebanon, it maintains commitments of €163 million in Jordan and €329 million in Egypt. FMO closely monitors developments but has so far not identified any significant financial impact on its portfolio. 

Country, regional and sector exposures 

Country risk arises from country-specific events that adversely impact FMO’s exposure in a specific country. Within FMO, country risk is broadly defined. It includes all relevant factors that have a common impact on FMO’s portfolio such as economic, banking and currency crises, sovereign defaults and political risk events.

To ensure diversification within FMO’s emerging market portfolio across regions, a country limit is in place to minimize concentration risk in the portfolio as a whole. Country limits range from 8 percent to 22 percent of FMO’s shareholders equity, depending on the country rating, with higher limits in less risky countries. The assessment of the country rating (F-rating scoring in line with internal credit risk rating) is based on a benchmark of external rating agencies and other external information.

In determining the limit within a country for investments, the committed portfolio amount as well as underlying transaction specific elements - which may lead to effective reduction of country risk - are considered. The figure below provides an overview of the diversification over the countries of FMO’s gross outstanding in the loan portfolio.

In general, the loan portfolio remains well diversified across different countries. The single largest country exposure is under 10 percent of the total loan book. The three largest country exposures in the loan book at the end of 2023 were India, Turkey, and Georgia, together 16 percent of the total loan exposure. In 2023, the rating of these countries remained stable. Noteworthy changes in country ratings include upgrades of the Europe & Central Asia region to F14 (2022: F15), Latin America & The Caribbean region to F13 (2022: F14), Global region to F14 (2022: F15), Armenia to F13 (2022: F14), Brazil to F12 (2022: F13), Costa Rica to F14 (2022: F15), El Salvador to F18 (2022: F19) and Vietnam to F11 (2022: F12). Furthermore, the country ratings have been downgraded for Argentina to F20 (2022: F19), Bangladesh to F14 (2022: F13), Bolivia to F16 (2022: F15), Cameroon to F16 (2022: F15), Ethiopia to F20(2022: F18), Palestine to F19 (2022: F17) and Pakistan to F18 (2022: F17).

In addition to country risk limits, FMO has limits to ensure adequate diversification across sectors and regions. Below an overview of the gross exposure of loans distributed by region and sector is given.

Single and group risk exposures 

Regarding single and group risk exposures, FMO has set stringent internal limits where the maximum loss possible for one single customer or group is set as a percentage of FMO’s shareholders’ equity. At year-end, all exposures were well within these limits. These internal single and group risk limits are more stringent than the regulatory limits such as the ones foreseen under the CRR norm of 25 percent of eligible regulatory capital.

Counterparty credit risk

Definition

Counterparty credit risk in the treasury portfolio is the risk that FMO will suffer economic losses because a counterparty fails to fulfill its financial or other contractual obligations from open positions in the portfolio.

Risk appetite and governance

The main responsibility of FMO’s Treasury department is to fund the core business of FMO and to efficiently and effectively mitigate risks in line with Treasury’s mandate. Treasury's portfolio aims to maintain a liquidity buffer such that FMO can meet its liquidity needs in regular and in stressed circumstances. The Treasury department does not have its own trading book and does not actively take open positions in the pursuit of profits. FMO aims to balance between keeping losses within its limited risk tolerance and supporting FMO's business strategy, thereby minimizing credit risk and concentration risk in the treasury portfolio, derivative portfolio, and several bank accounts.

The Treasury department is responsible for day-to-day counterparty risk management. The Risk department is the second line and responsible for assessing, quantifying, and monitoring counterparty risk daily. Limit excesses and material findings are reported to the FRC on a monthly basis, together with recommended mitigations and actions. The Risk department is also responsible for updating policies and processes and for setting up limits, including minimum credit rating requirements, exposure limits, and transaction limits. The policies, processes, relevant parameters, and limits are reviewed and approved by the FRC periodically.

Developments 

There have been developments in the transition of LIBOR as well as rates for other currencies to new benchmark rates affecting the valuations of transactions with the counterparties. For more details, please refer to the ‘Interest rate risk' in the 'Banking book’ section.

Exposures

Counterparty risk exposures in FMO’s treasury portfolios originate from short-term investments (deposits, investment in money market funds, commercial papers, and collaterals related to transacted derivatives), interest-bearing securities (e.g., bonds), and transacted derivatives for hedging purpose. The tables below show outstanding positions as of 31 December.

Supra-nationals are international organizations or unions to which member states delegate part of their national powers.

FMO mitigates its counterparty credit risk through various means. Minimum requirements of credit quality are set for counterparties of treasury activities. Netting and collateral agreements are also utilized to reduce counterparty credit risk originating from derivative transactions. FMO has Credit Support Annexes (CSAs) with all derivative counterparties. Additionally, part of the derivative portfolio, particularly EUR and USD interest rate swaps, is cleared through central counterparties, as required by the European Market Infrastructure Regulations.

The exposure of derivative financial instruments is presented for only derivatives with positive market value, netted with derivatives with a negative market value if it concerns the same counterparty. For this reason, the total amount shown in the table above does not equal the exposure presented in other tables.

The tables below include financial assets and financial liabilities that:

• are offset in the consolidated balance sheet of FMO; or

• are subject to an enforceable master netting arrangement or similar agreement that covers similar financial instruments, irrespective of whether they are offset in the consolidated balance sheet.

FMO receives and pledges only cash collateral with respect to derivatives.

Liquidity risk

Definition

Liquidity risk is defined as the risk for FMO not being able to fulfill its financial obligations due to insufficient availability of liquid means.

Risk appetite and governance

FMO’s risk appetite is to maintain adequate liquidity buffers to fulfill FMO’s current and future financial obligations at all times. The appetite follows a similar rationale as for capital and it is aimed at maintaining enough liquidity to ensure FMO would never need to fall back on the guarantee provided by the Dutch State to our investors. To realize this ambition, minimum liquidity requirements apply as prescribed by the regulator.

FMO’s liquidity risk policy framework is built on four pillars:

1. Survival period and minimum liquidity buffer under stress

2. Maturity matched funding

3. Diversified funding

4. Regulatory ratio requirements

FMO’s risk appetite levels are defined to ensure a minimum buffer above the seven-months minimum survival period under stress, a liquidity coverage ratio (LCR) above 135 percent, a Net Stable Funding Ratio (NSFR) above 107 percent, and restrictions on failed funding periods and cost of wholesale funding above peers. Additional thresholds such as matching funding, funding diversification and liquidity in specific currencies are also in place for managing and monitoring the risk profile of the bank. These monitoring metrics are delegated to the Director Risk and the Director Treasury and are subject to a formal sign- off procedure and reported to the FRC. The FRC is also responsible for approving the liquidity risk policy.

FMO has a conservative liquidity policy and funding strategy that is well suited to its business. Stress tests are conducted on FMO’s liquidity position on a weekly basis to ensure this conservative position is maintained. During the Internal Liquidity Adequacy Assessment Process (ILAAP), FMO performs additional stress tests, including scenarios provided by DNB and reverse stress testing. A continuous review is performed on the liquidity position, FMO’s assumptions, internal expectations and external market conditions to ensure that FMO’s liquidity planning is accurate.

The liquidity contingency plan sets out FMO’s strategy for addressing liquidity needs in the case of a crisis, ensuring that various sources of emergency liquidity are available to meet all current and future financial obligations, while avoiding excessive funding costs, incurring unacceptable losses and significantly changing the business profile. The liquidity sources include a long-term bond portfolio and a portfolio of short-term instruments such as cash, money market funds, commercial paper and treasury bills. The long-term bonds and commercial paper can be used as collateral in repurchase agreements to obtain short-term cash from the ECB.

Developments 

In the first half of 2023, significant bank failures occurred both in the United States and Switzerland, primarily stemming from deposit runs, the devaluation of liquid assets due to rapidly rising interest rates and associated reputational issues. Following these distressing events, global central banks swiftly intervened by injecting extraordinary liquidity into the financial system to preempt any potential contagion. Although apprehensions about the stability of the international banking sector heightened, the crisis has not escalated further so far. 

FMO, not engaged in accepting deposits, remained unaffected by the deposit run of 2023 and had no exposure to the collapsed banks. The market values of bonds held throughout the year increased compared to the end of 2022. Collateral inflows due to derivative portfolio was €247 million (2022: €478 million outflow). Throughout the year, FMO ensured capital markets access. Overall, FMO experienced minimal impact from the developments in terms of liquidity risk, apart from the rising funding costs.

FMO is an established issuer in local currency frontier markets due to its regular presence and is keen to continue issuances in 2023, developing capital markets in line with its mandate. In total, FMO issued approximately €373 million of equivalent funding in local currency transactions during 2023, including 2-year TRY 300 million (around €15 million) of retail notes under the FMO Debt Issuance Programme.

Liquidity position

FMO's liquidity position remained comfortably above regulatory requirements and internal managerial limits in 2023, with an LCR never falling below 197 percent.

The following table shows the categorization of the balance sheet per maturity bucket. This table shows the timing of the undiscounted principal cash flows, and not the market values, per instrument. The totals per instrument may therefore differ from the totals on the balance sheet. Expected cash flows resulting from irrevocable facilities being drawn are not included in the liquidity gap. For internal liquidity planning and management, cash flows from irrevocable facilities are included in the cash flow forecasts.

The tables below are based on the final availability date of the contingent liabilities and irrevocable facilities.

FMO expects that not all of these off-balance items will be drawn before expiration date.

FMO complies with DNB’s Pillar 2 liquidity requirements methodology for Less Significant Institutions (LSIs) which have been applied from the Supervisory Review and Evaluation Process (SREP). The liquidity requirements are a survival period of at least six months based on internal stress testing methodology, a Net Stable Funding Ratio (NSFR) of 100 percent and a specific Liquidity Coverage Ratio (LCR) requirement of 100 percent. FMO's internal liquidity appetite levels include a safety cushion over and above the minimum requirements as described in the section above.

FMO's liquidity position has been well above regulatory requirements and internal risk appetite levels throughout 2023. Per the reporting date, FMO has a survival period exceeding 12 months, an LCR of 686 percent (2022: 439 percent) and a NSFR of 114 percent (2022: 114 percent).

FMO’s major liquidity exposures are in EUR and USD currencies. However, some transactions are denominated – and may be settled – in local currencies. These exposures are specifically hedged using financial instruments to minimize liquidity and settlement risks.

Funding and sustainability bonds 

Treasury aims to ensure good market access by diversifying FMO’s funding sources. The result of this is a balanced funding mix in terms of currency, instrument and maturity.

Eurodollar (e.g. USD investors outside the United States) constitutes a key market for FMO. Treasury has identified USD and EUR as strategic funding markets. Other markets to attract funding include Australia, Sweden, UK, Japan and local frontier currencies. Typical investors in FMO debentures and notes, either through public or private issuances, hold these instruments till maturity. Except for our Tier II issuance, FMO funding is plain vanilla and generally senior unsecured funding. 

ESG bonds are an important part of FMO’s funding strategy, which accounted for about 43 percent of the funding portfolio in 2023. In October 2022 FMO priced a successful €500 million five-year fixed rate sustainability bond. FMO has accelerated this EUR sustainability bond issue, originally planned for Q1 2023, due to additional funding need stemming from a strong pipeline towards year-end and an outflow of cash collateral. The new sustainability bond has been issued under FMO’s Sustainability Bonds Framework (SBF), and proceeds will be used to finance or refinance eligible green and social projects, or to repay a note issued under the FMO’s Sustainability Bond Framework.

Market risk

Market Risk is the risk that the value and/or the earnings of the bank decline because of unfavorable market movements. At FMO, this includes interest rate risk and currency risk.

Interest rate risk in the banking book

Definition

Interest rate risk is the risk of potential loss due to adverse movements in interest rates. Changing interest rates mainly influence the fair value of fixed interest balance sheet items and affect the bank’s earnings by altering interest rate-sensitive income and expenses, affecting its net interest income (NII).

Risk appetite and governance

FMO has no trading book and all assets (loans and investments) are part of the banking book. FMO’s policy is to match assets and liabilities within defined limits. As the loan portfolio is more granular, loans are pre-funded and new funding is obtained periodically and matched to the asset portfolio in terms of expected maturity and interest rate sensitivity. Interest rate risk arises from the residual tenor mismatch, mismatch in fixed rate assets funded by floating rate liabilities, and differences in reference rates or currencies resulting in basis risk. FMO has little optionality in its portfolio and has no material exposure to rates-driven prepayment risk. The volatility of the market value of assets and liabilities over the holding period due to interest rate movements is of less concern as these are held until maturity.

Interest rate risk management falls under the responsibility of the FRC. The Treasury department acts as the first line and is responsible for the day-to-day management of interest rate risk and daily transactions. The quantification, monitoring and control of market risk is the responsibility of Risk as second line. Interest rate risk is monitored using earnings-based metrics and value-based metrics.

Earnings-based methods capture short-term effects of interest rate refixing or repricing that may impact net interest incomes. The following two metrics are used for this purpose.

• The interest rate gap provides a static overview of the full balance sheet’s repricing and refinancing characteristics. The gap is monitored over different time buckets with limits in place per bucket and on a cumulative level, for all currencies (aggregate and currency-by-currency).

• Net Interest Income (NII) at Risk provides a dynamic projection of net interest income sensitivity to yield curve shocks. FMO monitors NII at Risk on a two-year forward-looking basis and applies different scenarios simultaneously that allow for identification of basis risk as well.

Economic value methods capture changes in net present values of assets, liabilities and off-balance sheet items to changes in yield curves. Value-based metrics measure long-term effects of interest rate changes over the full tenor of the balance sheet. The following economic value metrics are calculated:

• Basis Point Value (BPV) provides the change in market value of assets, liabilities and interest-rate risk sensitive off-balance items for a one basis point change in yield curves. Limits are in place for the whole balance sheet, and for main currencies (EUR and USD) separately.

• Delta Economic Value of Equity (delta EVE) provides changes in the economic value of the shareholder’s equity given certain shifts in yield curves. The impact of a 200 basis-points parallel shifts and SA-IRRRB scenarios are reported. 

The interest rate gap and BPV exposure are monitored on weekly basis against limits set by the FRC. BPV limits are defined dynamically to accommodate a 200 basis-points shock within five percent of Tier I. The delta EVE limit is defined in the Risk Appetite Framework and set at five percent of Tier I. The NII at Risk limit is defined based on one percent of Tier 1.

The interest rate positions were within risk appetite in 2023. In spite of rates volatility in the United States, Europe and globally our positions remain within limits.

Developments  

The IBOR project was initiated in 2018 to prepare the transitioning of FMO’s loans and derivatives (swaps) referencing USD LIBOR to SOFR.

Loan transition: About 250 loan contracts were in scope for transitioning from IBOR to SOFR. By the end of 2023, all loans were remediated, apart from a couple of contracts which - in agreement with the FMO front office and their clients - were moved to synthetic LIBOR. These synthetic LIBOR contracts will be remediated before the end of September 2024.

Derivatives transition: FMO adhered to the ISDA 2020 Fallback Protocol for transitioning its derivatives portfolio. In 2023, FMO’s derivatives exposure to USD LIBOR has been transitioned from forward-looking USD LIBOR to backward-looking daily compounded SOFR according to the conditions set by the ISDA 2020 Fallback Protocol.

Exposures

The interest rate risk limits were not breached in 2023. The following table summarizes the interest re-pricing characteristics for FMO’s assets and liabilities.

Fair value of individual components (e.g. individual swap legs) of derivative financial instruments is allocated to the relevant interest re-pricing category.

Currency risk

Definition

Currency risk is defined as the risk that changes in foreign currency exchange rates have an adverse effect on the value of FMO’s financial position and future cash flows. FMO also reviews currency risk in terms of impact on the capital ratios.

Risk appetite and governance

FMO offers loans and attracts funding in a wide range of currencies. This is done to provide financing in the currency best fitting FMO’s customers and to reduce currency risks on their side.

FMO has limited appetite for currency risk. 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 accordingly. 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 one percent of shareholder’s equity for the total open position across all currencies. Both the individual and overall open positions are monitored by Risk on a daily basis. Additionally, FMO maintains a deliberately unhedged foreign currency position for the purpose of structural hedge which is reported to the FRC monthly. Please refer to the 'Structural hedge' sub-section for further details.

Developments

No material developments occurred in 2023. The overall trend in the EUR/USD exchange rate for 2023 showed a weakening of the US Dollar versus the Euro. Our positions remained well within the limits.

Exposures

Individual and total open currency positions were within risk appetite in 2023. The table below illustrates that the currency risk sensitivity gap per December 2023 is almost completely part of FMO's equity investments and investments in associates.

Fair value of individual components (e.g. individual swap legs) of derivative financial instruments is allocated to the relevant currency category.

As described above, FMO’s loan assets in local currencies, such as Indian Rupee (INR), are fully swapped to the US Dollar on a cash flow basis. The positions in these currencies are therefore fully hedged. For IFRS reporting, however, the loans are recorded at (amortized) cost, while the related swaps are recorded at fair value, leading to an accounting mismatch in these currencies.

The sensitivities employ simplified scenarios. The sensitivity of profit and loss account and shareholders’ equity to possible changes in the main foreign currencies is based on the immediate impact on the financial assets and liabilities held at year-end. This includes the effect of hedging instruments.

Shareholders’ equity is sensitive to equity investments valued at fair value through other comprehensive income.

Structural hedge

FMO maintains a deliberately unhedged foreign currency position in private equity investments to manage the volatility of the capital ratio. These foreign currency positions act as an economic hedge against an adverse effect of the exchange rate on the regulatory capital ratios. A depreciation of FMO's reporting currency (euro) can significantly affect the capital ratio since FMO’s assets - and hence also the risk weighted assets - are mainly denominated in foreign currencies. The long open position in the equity portfolio thereby functions as a partial hedge for FMO’s regulatory capital ratios. In addition, the uncertainty in the size and the timing of the cash flows for equity investments makes micro-hedging less effective, hence these positions are better fit for use as a capital ratio hedge.