56.5. Interest rate risk in the banking portfolio (ALM Treasury)

The banking book of BNP Paribas Bank Polska S.A. is composed of two parts: the first one is the ALM portfolio as part of which structural interest rate, currency and liquidity risks resulting from the structure of the statement of financial position determined by the core lending, deposit and investing operations of the Bank, are managed. On the other hand, the Treasury portfolio is subject to daily and short-term liquidity management. It is also used by the Bank for purposes of performing its investing activities as well as concluding hedging transactions on the financial market.

The ALM portfolio comprises accounts, deposits and loans, strategic items (long-term investments, own debt issues and long-term loans), financial market transactions hedging the portfolio (derivative instruments) and zero-interest items (to include equity, tangible assets, intangible assets, taxes and provisions and profit for the period), transferred under management of ALM Treasury through the Fund Transfer Pricing (FTP) system.

The Treasury portfolio includes liquid securities (liquidity buffer), interbank deposits and placements, nostro and loro accounts as well as financial market transactions hedging the market risk of the portfolio (derivative instruments).

The Bank’s policy in respect of the banking book – ALM and Treasury portfolios managed collectively – is to earn additional, stable revenue in excess of the product margin, without any threat to the stability of funds deposited by customers, equity and profit. The above mentioned objective is accomplished by the Bank by maintaining or matching its natural exposure generated by the core lending and deposit operations, in line with the adopted risk limits which guarantee limited sensitivity of the Bank’s profit to changes in market factors, in addition to bringing the exposure into line with financial market trends forecast in the medium and long term.

Competitive conditions of the local financial market and customer expectations are the main factors shaping the Bank’s product policy, in particular the application of variable interest rates for medium- and long-term credit products, and financing of these assets with short deposits and interest-free accounts.

The real interest rate gap, net interest income sensitivity and economic capital sensitivity are the key measures of the market risk in the banking book, which comprises the ALM portfolio and the Treasury portfolio.

The major assumptions adopted for measurement of interest rate risk in banking book are as follows:

a) individual assets, liabilities and off-balance sheet transactions are analysed at their nominal value which is used as the basis for calculation of interest;

b) items and transactions based on floating reference rates, such as WIBOR, LIBOR, EURIBOR, NBP rediscount rate etc. are taken into account for purposes of determining the gap at the nearest repricing date for a given contract;

c) items based on floating reference rates scaled with a multiplier are taken into account for purposes of determining the gap at the nearest repricing date for a given contract at nominal value scaled with a multiplier and the nominal amount scaled with a value (1 – multiplier) is considered at the maturity date or proportionally at the principal payment dates;

d) fixed rate items and transactions are taken into account for purposes of determining the gap at the principal payment dates, at the amounts of the principal paid at a given date or at the full amount at the maturity date for items in case of which the principal is not repaid (e.g. term deposits). Items and transactions with unspecified maturity, repricing date or non-interest bearing are taken into account in line with the profile determined as a result of modelling, which is aimed to ensure the best possible reflection of the changes in interest and principal cash flows resulting from customer behaviours and in response to external factors, in particular the market interest rates.

e) for the portfolio of impaired loans – for net values (decreased by the created reserves) – the average contractual maturity for unimpaired exposures (IFRS stage 1 and 2) increased by two years is applied,

f) economic capital is calculated based on positions at internal prices.

As part of interest rate risk management in the banking portfolio, the Bank distinguishes structural elements consisting of interest-free current accounts and the Bank’s capital as well as other commercial items. In terms of structural elements, the Bank secures a significant portion of them by long-term positions (bonds, interest rate exchange transactions). Regarding other commercial items, the Bank plans to reduce interest rate risk.

For interest rate risk models, the Bank uses the provisions of the 'W’ recommendation regarding verification of the model’s operation, qualitative criteria, minimum model acceptance criteria and ongoing control of the model’s accuracy.

Replication portfolio models for accounts with no specific maturity dates are behavioural models built on the basis of the historical variability of deposit account balances and the analysis of the closing ratios for the modelled position. As part of modelling, the portfolio is divided into the stable parts and a variable part, which is assigned the symbol ON in interest rate analyses. The stable part is divided into a part that is insensitive to interest rate changes (the structural part) and a part sensitive to interest rate changes (the unstructured part). A long-term interest rate repricing profile is determined for the structural part, while for the non-structural part it depends on the current macroeconomic situation and forecasts of the behaviour of interest rates for individual currencies.

As regards loans with a fixed interest rate, prepayment ratios determined in accordance with the applicable models at the Bank are used. Prepayments are analysed separately for individual types of loans (cash, car), due to the different characteristics of these products. Factors included in the prepayment analysis: loan age, seasonality, financial incentive for the customer to prepay the loan.

The following tables present the Bank’s real interest rate gap as at 31 December 2021 and 31 December 2020 (PLN ‘000)* on a consolidated basis:

Estimated decreases or increases in the net interest income for the banking portfolio between 1 and 3 years, resulting from changes in market interest rates, are the measure of its sensitivity. For management and risk control purposes, the Bank calculates sensitivity to a number of different market parameter change scenarios: immediate shifts and shifts in time, parallel and non-parallel shifts, in normal and stress conditions, varying depending on the currency, market and instrument.

Annual net interest income sensitivity to an immediate shift of market rates by 100 bps (in PLN ’000) assuming the most probable change in the product structure, especially in the corporate segment, is presented in the below tables:

Sensitivity of interest result by currency:

In case of the significant decrease in net interest rates, the decrease in interest income has been hedged with fee income from current accounts of corporate clients resulting from negative interest rates in both foreign currencies and PLN.

The most probable cumulative impact of the interest rate rises (from October 2021 to February 2022, a total increase by 215 bs) on the Bank’s financial results has been estimated at the level of PLN 520-580 million.

The economic sensitivity of capital to a sudden parallel shift of market rates by +/- 200 basis points in PLN ‘000 and as percentage of own funds:

In terms of base risk, the Bank analyses positions based on different types of rates with the same interest rate repricing date. The largest potential change in the Bank’s net interest income may result from a change in the spread between Wibor 1M rates and the NBP reference rate.

If the market rate changes by 50 bps compared to the reference rate, the change in the result will be PLN 4,930 thousand.

The COVID-19 pandemic did not fundamentally affect the method of managing the interest rate risk in the banking portfolio.

BNP Paribas Bank Polska S.A. (the „Bank”) conducted a project related to the Regulation (EU) 2016/1011 of the European Parliament and of the Council of 8 June 2016 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds and amending Directives 2008/48/EC and 2014/17/EU and Regulation (EU) No 596/2014  (the „BMR Regulation”). The project not only aimed to bring financial contracts within the meaning of the BMR Regulation into line with the requirements under Article 28(2) of the BMR Regulation, but also included the application of an identical approach to the Bank’s customer relations with respect to products and contracts other than such financial contracts.

On 5 March 2021, Financial Conduct Authority – FCA – (British financial regulator) announced the liquidation of LIBOR rates for EUR, GBP, CHF, JPY and USD (ON, SW, 2M, 1Y) at the end of 2021 and LIBOR USD (1M, 3M, 6M) on 30.06.2023. At the beginning of April 2021, the Bank informed its customers about this fact through the Bank’s website as well as through electronic banking channels. The Bank identified balance sheet and off-balance sheet items based on CHF LIBOR, GBP LIBOR, USD LIBOR indices. Until the liquidation of the aforementioned indices, the resulting cash flows continue to be exchanged between counterparties under existing rules.

As at 31.12.2021. The Bank holds:

• USD LIBOR-based financial assets of USD 84.7 million, of which USD 5.8 million maturing beyond 30.06.2023,
• USD LIBOR based financial liabilities of USD 0.01 million maturing in full before 30.06.2023,
• CHF LIBOR-based financial assets of CHF 999.3 million
• CHF LIBOR-based financial liabilities of CHF 150.0 million
• GBP LIBOR-based financial assets of GBP 1.4 million

As at 31 December 2021 the Bank also had interest rate swaps (IRS) under fair value hedge accounting based on USD LIBOR for USD 70.0 million, of which USD 55.0 million matures beyond 30.06.2023.

The Bank has no hedging relationships based on CHF LIBOR and GBP LIBOR.

As at 31 December 2021 the Bank does not have any currency interest rate swaps (CIRS) that require LIBOR to be swapped for alternative rates.

At present, it is not possible to identify any rationale for discontinuation of the publication of the WIBOR and EURIBOR indices. Thus, the flows resulting from these indices will continue to be exchanged between counterparties under existing rules.

For the EONIA rate, which also expires at the end of 2021, the Bank has no established relationship as at 31 December 2021.

Due to contractual provisions (extended periods of stabilisation of billing rates, i.e. application of a single rate for subsequent billing periods), LIBOR CHF, LIBOR GBP and LIBOR USD rates may be applied to the settlements occurring after the date of the announced cessation for these indices. These indices to be replaced: LIBOR CHF by SARON (Swiss Averaged Rate Overnight) administered by SIX Swiss Exchange, LIBOR GBP by SONIA (Sterling Overnight Index Average) administered by the Bank of England and LIBOR USD by SOFR (Secured Overnight Financing Rate) administered by the Federal Reserve Bank of New York. Application of new indices in financial contracts may involve the use of a composite rate or other method depending on the market standard adopted or the standard adopted by the administrator for the calculation of a given index.

As part of the project concerning the IBOR reform implementation, the Bank focused, inter alia, on establishing or updating the content of the so-called fallback clauses regulating how to establish substitute (alternative) indices to those which are currently in use; confirming the method of implementation of these clauses; developing changes to the Bank’s IT systems that will allow for the practical application of substitute indices in the event the development of a given reference index is discontinued. It should be pointed out that, starting from mid-2018, the Bank has introduced fallback clauses in mortgage loan agreements.

It should be emphasised that the IT systems at 31 December 2021 allow for a multivariate use of overnight rates in banking products depending on the usage standards for these indicators that may take shape in the future. The Bank is prepared to use hedging instruments for these indicators.

In the case of hedging instruments, the Bank, as recommended by the PFSA, has joined the ISDA IBOR Fallbacks Supplement and Protocol and is actively working with its counterparties to introduce the rules in line with this methodology.

It should also be noted that under Article 23 b of the BMR Regulation, the European Commission has been given the power to set a substitute index. On this basis, Commission Implementing Regulation (EU) 2021/1847 of 14 October 2021 on the designation of a statutory replacement for certain settings of CHF LIBOR was published on 22 October 2021. The Regulation applies to contracts (including credit agreements) and financial instruments that use CHF LIBOR rates and which did not have appropriate fallback clauses as at the date when the Regulation entered into force. According to the Regulation, as of 1 January 2022, a substitute – SARON Compound (SARON Compound Rate) will be used by law in place of LIBOR CHF with an appropriate adjustment. As a consequence, the continuity of agreements, including loan agreements in which LIBOR CHF was an element of the calculation of the loan interest rate, will be preserved, without the need to amend them individually. The Bank will convert LIBOR rates to SARON Compound rates in accordance with the individual interest payment schedule for each loan. The Bank has informed customers of this change using various communication channels. There is a risk that the legality of the Implementing Regulation may be challenged, due to an action for annulment filed under Article 263 of the Treaty on the Functioning of the European Union (T-725/21). At the date of publication of the Financial Statements, the reasons for the action have not been published and, consequently, it is not possible to assess the materiality of this risk.

The Bank assesses that the introduction of fallback clauses in customer documentation in the form of annexes and amendments to regulations, the use of Term Rates for selected indices, the entry into force of the Commission’s Implementing Regulation and the accession to the ISDA IBOR Fallbacks Supplement and Protocol significantly reduce uncertainty about the timing and amounts of cash flows for the SOFR, SONIA and SARON indices.

As at 31 December 2021, the Bank has confirmed its operational and systemic readiness for the swap of the liquidated LIBOR rates and has thus completed the tasks that were planned under the dedicated project.