Capital management

Risk appetite

FMO aims to optimize development impact. This can only be achieved with a sound financial framework in place, combining healthy long-term profitability and sound capital adequacy. Therefore, FMO seeks to maintain a strong capital position, by means of an integrated capital adequacy planning and control framework, regularly reviewed by the ALCO. FMO has risk appetite levels defined for the following metrics:

  • Regulatory capital

  • Economic capital

Regulatory capital (CRR/CRD-IV)

Under the CRR/CRD-IV banks are required to hold sufficient capital to cover for the risks it faces. FMO reports its capital ratio to De Nederlandsche Bank N.V. (DNB) on a quarterly basis according to the standardized approach for all risk types. Of the total capital requirement, 80.3% is related to credit risk (equity investments included), 14.6% to market risk, 4.6% to operational risk and 0.4% to credit valuation adjustment risk. Per December 2017, FMO's available qualifying capital equals EUR 2,693,622 (2016: EUR 2,681,519) which makes FMO well prepared to compensate for potential losses.

  

At December 31, 2017

At December 31, 2016

IFRS shareholders’ equity (parent)

2,822,882

2,770,544

Tier 2 capital

175,000

175,000

Regulatory adjustments:

  

-

Interim profit not included in CET 1 capital

-101,977

-62,683

-

Other adjustments (deducted from CET 1)

-153,619

-157,913

-

Other adjustments (deducted from Tier 2)

-48,664

-43,429

Total capital

2,693,622

2,681,519

of which common equity Tier 1 capital

2,567,286

2,549,948

    

Risk weighted assets

10,434,768

11,214,531

Total capital ratio

25.8%

23.9%

Common equity Tier 1 ratio

24.6%

22.7%

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 corresponds to approximately 10% of regulatory capital. Exposures below the 10% thresholds are risk weighted accordingly.

FMO performs an annual Internal Capital Adequacy Assessment Process (ICAAP) in which we assess our capital adequacy in light of all material risk types, stress testing and future regulation. As part of the Supervisory Review and Evaluation Process (SREP), DNB sets the minimum capital requirements. The total capital requirement for 2018 consists of the total SREP capital ratio (14.3%), the combined buffer requirement (1.875%) and the Pillar 2 Guidance (1%).

  • The combined buffer requirement applicable to FMO comprises of the capital conservation buffer and the institution specific countercyclical buffer (currently 0%). Both are formally applicable as of 1 January 2016. The buffers are phased in during a period of four years, whereby the capital conservation buffer will be 1.875% in 2018 and 2.5% in 2019. The countercyclical buffer is calculated as the weighted average of the buffers in effect in the jurisdictions to which FMO has a credit exposure. Both buffers should consist entirely of Common Equity Tier 1 capital and, if the minimum buffer requirements are breached, capital distribution and remuneration (variable pay) constraints will be imposed on the bank. The constraints imposed do not relate to the operation of the bank. Per December 2017, FMO does not have exposures that activated FMO's institution specific countercyclical buffer.

  • The so-called Pillar 2 guidance (P2G) indicates to banks the adequate level of capital to be maintained over and above the existing capital requirements, in order to have sufficient capital as a buffer to withstand stressed situations, in particular in context of the adverse scenario in the supervisory stress tests. The P2G is a non-binding requirement and no automatic restrictions are imposed on distributions such as dividends and bonuses. Nevertheless, credit institutions are expected to comply with P2G.

FMO's internal 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 already covered by the structural hedge. This structural hedge - or open foreign exchange position in FMO's private equity portfolio - 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 market risk section.

Economic capital

In addition to regulatory capital, for Pillar 2, FMO applies an economic capital (EC) model. Economic capital is calculated using a conservative confidence interval of 99.99%. This level is chosen to support an AAA rating and the bank’s actual growth is steered to ensure that this will remain the case. 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 and interest rate risk in the banking (IRRBB). Second, the EC model applies an internal model approach for credit risk resulting from FMO’s emerging market loan portfolio. FMO’s portfolio is invested 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 tailored towards these higher credit risks leading to a higher capital requirement than the standardized approach.

The most important input parameters for the EC model for credit risk are the Probability of Default (PD) and the Loss Given Default (LGD). The PD is based on the outcome of FMO’s ratings methodology, which was developed in cooperation with one of the leading rating agencies. The client is assigned a rating class on a scale of F1 to F21, with the majority of the ratings of FMO clients in the range of F11 to F16, or BB- to B+ in S&P-comparable rating terms. The LGD is determined on the basis of internal expert assessments. In 2017, the internal models for corporate and financial institutions were revised and improved. Furthermore, the probability of default average for the portfolio related to these models and the loss given default average for the full portfolio was calibrated to the expected long-term average. The improvements led to an upward revision of the EC ratio 16.2% the end of 2017 (2016: 14.2%).

 

At December 31, 2017

At December 31, 2016

   

Pillar 1

  

Credit risk emerging market portfolio (99.99% interval)

1,197,960

1,348,033

Credit risk treasury portfolio

24,987

28,980

Market risk

127,574

136,786

Operational risk

38,343

35,147

Credit valuation adjustment

6,037

4,115

Total pillar 1

1,394,901

1,553,061

   

Pillar 2

  

Interest rate risk in the banking book

67,647

99,420

Reputation risk

68,020

65,000

Economic capital (pillar 1 & 2)

1,530,568

1,717,481

   

Available capital

  

Total Capital

2,994,355

2,938,387

Surplus provisioning (capped at 0.6% RWA)[1]

104,618

116,479

Total available capital

3,098,973

3,054,866

EC - Risk weighted assets (internal model)

19,132,105

21,468,498

EC - Total capital ratio

16.2%

14.2%

  • 1 Surplus provisioning for the loan portfolio refers to the difference between the total provisioning minus total expected loss.
  • 1 Surplus provisioning for the loan portfolio refers to the difference between the total provisioning minus total expected loss.

Leverage ratio

The leverage ratio represents a non-risk-adjusted capital requirement. Since January 2014, the CRR/CRD IV rules have required that credit institutions calculate, monitor and report on their leverage ratios, defined as tier 1 capital as a percentage of total exposure. On the basis of the European Commission’s legislative proposal for a revised CRR, a leverage ratio of 3% is expected to become a minimum requirement with the implementation of the revised CRR. FMO’s leverage ratio equals 26.6% (2016: 25.4%).

Future regulation

On 7 December 2017, the Basel Committee on Banking Supervision (BCBS) published the long-awaited completion of the Basel III reforms. FMO is closely monitoring the process of translating the Basel III reforms into European legislation, and incorporates the latest available information in terms of capital planning. The following two components of the reforms are of particular relevance to FMO.

As previously mentioned, FMO reports its regulatory capital ratio following the standardized approach for credit risk. In the current regulatory framework FMO’s equity exposures are treated as investments with a particular high risk and receive a 150% risk weight accordingly. In the second consultative document by Basel, an increase to 250% for was proposed. The final standard includes three separate categories: speculative equity (400% risk weight), equity holdings under national legislated programmes (100% risk weight), and all other equity exposures (250% risk weight). The exact impact of the new standard will depend on the translation into European legislation in the coming years. As currently foreseen, the standard will become mandatory per January 2022.

In January 2016, the BCBS concluded its work on the fundamental review of the trading book (FRTB) and published a new standard on the treatment of market risk, the so-called capital requirements for market risk (bcbs 352). Although FMO does not have a trading book portfolio, the revised standards affect the capital requirements for FMO’s foreign exchange position in the banking book. As previously mentioned, a depreciation of home reporting currency (Euro) can significantly affect the capital ratio since FMO’s assets are mainly US dollar denominated or in local currencies. FMO has created an open foreign exchange position in its private equity portfolio in order to hedge against this adverse effect of the exchange rate on the capital ratios. The capital requirements for foreign exchange position will increase and depend on the type of currency and the correlation between the currencies. Together with the finalization of the Basel III reforms, the BCBS announced that the capital requirements for market risk will come into effect only in January 2022; three years later than initially planned giving banks more time to adapt.