53. Credit risk management

Credit risk is defined as the risk losses being incurred as a result of a customer’s default on its liabilities towards the Group or the risk of a decrease in the economic value of amounts due to the Group as a result of deterioration of a customer’s ability to settle liabilities.

The objective of credit risk management is to minimize losses on the loan portfolio as well as to minimize the risk of occurrence of loans at risk of impairment, while maintaining the expected level of profitability and value of the loan portfolio.

The Bank and the Group subsidiaries are guided mainly by the following credit risk management principles:

• every loan transaction is subject to comprehensive credit risk assessment, which is reflected in an internal rating or credit scoring;
• credit risk relating to loan transactions is measured at the stage of examining a loan application and on a regular basis, as part of the monitoring process, taking into consideration changes in external conditions and in the financial standing of the borrowers and links between the Group’s customers;
• credit risk assessment of exposures is separated from the sales function by ensuring an appropriate organizational structure, independence in developing and validating tools supporting an assessment of credit risk and independence of decisions approving deviations from the suggestions resulting from using these tools;
• terms and conditions of a loan transactions offered to a customer depend on the assessment of credit risk level generated by the transaction;
• lending decisions are taken only by persons or bodies authorised to do so or are generated automatically on the basis of risk models approved by the Bank’s Credit Committee;
• the cyclical measurement of portfolio credit risk is carried out on the total credit exposures of customers as well as on different cross-sections of the portfolio, such as customer groups, credit product groups,
• credit risk is diversified, in particular, in terms of geographical areas, industries, products and customers;
• an expected credit risk level is secured by collateral received by the Group, risk margins from customers and impairment allowances (provisions) for expected credit losses;
• an incentive system contributes to compliance with the credit risk management policies and principles adopted by the Group.

The aforementioned principles are implemented by the Group through the use of advanced credit risk management methods, both at the level of individual credit exposures and of the entire loan portfolio of the Group. These methods are verified and developed to ensure compliance with the requirements of the internal rating-based method (IRB), i.e. an advanced credit risk measurement method which may be used to calculate the capital requirements for credit risk, subject to approval by the Polish Financial Supervision Authority.

The Group entities which have significant credit risk levels (the KREDOBANK SA Group, the PKO Leasing SA Group, PKO Bank Hipoteczny SA and Finansowa Kompania “Prywatne Inwestycje” sp. z o.o.) manage their credit risk individually, but the methods used for credit risk assessment and measurement are adjusted to the methods used by PKO Bank Polski S.A., taking into account the specific nature of activities of these companies.

Any changes to the solutions used by the Group’s subsidiaries must be agreed every time with the Bank’s units responsible for risk management.

The aforementioned companies measure their credit risk regularly and the results of such measurements are submitted to the Bank.

Within the structures of PKO Bank Hipoteczny SA, the KREDOBANK SA Group and the PKO Leasing SA Group, there are organizational units in the risk management areas which are responsible, in particular, for:

• developing methodologies for credit risk assessment and recognition of provisions and allowances;
• control over and monitoring of credit risk in the lending process;
• quality and efficiency of the restructuring and debt collection processes;

In these companies, the credit decision limits depend primarily on: the amount of the exposure to a given customer, the amount of an individual credit transaction and the duration of the lending period.

The process of credit decision-making in PKO Bank Hipoteczny SA, the KREDOBANK SA Group and the PKO Leasing SA Group is supported by credit committees which are involved in the process for credit transactions which generate an increased credit risk level.

The description of performing the estimates of expected credit losses is disclosed in the Note “Allowances for expected credit losses”.

In order to assess the level of credit risk and profitability of its loan portfolios, the Group uses different credit risk measurement and valuation methods, including:

• probability of default (PD);
• loss given default (LGD);
• credit conversion factor (CCF);
• expected credit loss (ECL);
• credit value at risk (CVaR);
• the share and structure of impaired credit exposures;
• coverage ratio of impaired loans;
• cost of credit risk;
• stress testing.

The Group  systematically expands the scope of credit risk measures adopted, taking into account the requirements of the IRB method, and extends the use of risk measures to cover the entire loan portfolio of the Group.

The portfolio credit risk measurement methods allow, among other things, to reflect the credit risk in the price of products, determine the best conditions of financing availability and determine the level of impairment allowances.

The Group performs analyses and stress-tests relating to the impact of the potential changes in the macroeconomic environment on the quality of the Group’s loan portfolio, and the results of such analyses and stress tests are presented in reports to the Bank’s governing bodies. Such information enables identification and implementation of the measures mitigating the negative effects of the impact of unfavourable market conditions on the Group’s profit or loss.

The credit risk assessment process at the Bank’s Group takes into account the requirements of the Polish Financial Supervision Authority as laid down in the PFSA Recommendations.

The Group assesses the risk of individual credit transactions with the use of scoring and rating methods. which are supported by dedicated IT applications. The risk assessment method is defined in the Group’s internal regulations whose main aim is to ensure a uniform and objective evaluation of credit risk during the lending process.

The Group evaluates the credit risk of retail customers in two dimensions: qualitative and quantitative borrowing capacity assessment. A quantitative creditworthiness assessment consists of examining a customer’s financial position, and the qualitative risk assessment involves scoring and assessing a customer’s credit history obtained from the Group’s internal records and external databases.

In the case of some corporate customers in the small- and medium-sized enterprises segment who meet certain criteria, the Group assesses credit risk using the scoring method. Such assessment refers to low-value, non-complex loan transactions and it is performed in two dimensions: a customer’s borrowing capacity and his creditworthiness. An assessment of the borrowing capacity consists of examining a customer’s economic and financial position, and the assessment of creditworthiness involves scoring and evaluating the customer’s credit history obtained from the Group’s internal records and external databases.

In other cases, the rating method is used for institutional customers.

An assessment of the credit risk associated with financing institutional customers is performed by the Group in two dimensions: the customer and the transaction. The measures involved include an evaluation of a customer’s creditworthiness, i.e. the rating, and an assessment of the transaction risk, i.e. the customer’s ability to repay the amounts due at the amounts and dates specified.

Rating models for institutional customers are developed using the Group’s internal data, thus ensuring that they are tailored to the risk profiles of the Group’s customers. Models are based on a statistical dependence analysis between the default and a customer’s risk scoring. The scoring includes an evaluation of financial ratios, qualitative factors and behavioural factors. A customer’s risk assessment depends on the size of the assessed enterprise. In addition, the Group applies a model for the assessment of credited entrepreneurs in the formula of specialized lending, which allows an adequate credit risk assessment of large projects involving real estate financing (e.g. office space, retail space, industrial space) and infrastructure projects (e.g. telecommunication, industrial or public utility infrastructure).

Rating models are implemented within the IT tool which supports the assessment of the Group’s credit risk associated with the financing of institutional customers.

In order to examine the correct operation of the methods applied by the Group, credit risk assessment methodologies relating to individual loan exposures are subject to periodical reviews.

The credit risk assessment process in the Group takes into account the requirements of the Polish Financial Supervision Authority as defined in Recommendation S concerning good practices for the management of mortgage-secured loan exposures and Recommendation T concerning good practices for the management of retail credit exposures.

In the lending process for corporate Customers and SME Customers evaluated with the use of the rating method, the Group each time assesses the impact of environmental, social and governance factors (ESG factors) on the Customer’s creditworthiness, and identifies credit transactions with an increased financial leverage (levered transactions). The Group also examines the impact of credit transactions on ESG and classifies them to four categories, from transactions with a positive impact on ESG to those with a material negative impact. When assessing the ESG factors, the Group takes into account such factors as the risk of climate change and its impact on the customer’s operations, potential influence of the customer on climate, factors related to human capital or health and safety, and governance factors (including the corporate culture and internal audit).

Information on rating and scoring assessments is widely used in the Group to manage credit risk, in the system of credit decision authorizations, to determine the amounts triggering the credit risk assessment services and in the credit risk measurement and reporting system.

Credit risk forecasting and monitoring involves preparing risk level forecasts and monitoring deviations from the forecasts or the adopted benchmarks (e.g. limits, thresholds, plans, prior period measurements, recommendations and instructions issued by external supervisory and regulatory authority), and performing (specific and comprehensive) stress tests. Risk level forecasts are subject to backtesting.

Credit risk is monitored at the level of individual customers, groups of related customers, credit transactions and their collateral, and at portfolio level.

Credit risk monitoring at the individual loan transaction level is governed, in particular, by the Group’s internal regulations concerning:

• assessment of the credit risk related to customer financing;
• methods of assessing customers;
• identification of groups of related entities;
• evaluation of collateral and inspection of investments;
• recognition of allowances for expected credit losses;
• Early Warning System;
• operating procedures.

In order to accelerate the response to the warning signals noted reflecting an increased credit risk level, the Group uses and develops an IT application, the Early Warning System (EWS).

Credit risk monitoring at the portfolio level consists of:

• supervising the level of the portfolio credit risk on the basis of the adopted tools used for measuring credit risk, taking into consideration the identified sources of credit risk and analysing the effects and actions taken as part of system management;
• recommending preventive measures in the event of identifying an increased level of credit risk.

Credit risk reporting includes periodical reporting of the loan portfolio risk exposure.

The Group prepares monthly and quarterly credit risk reports. Credit risk reporting should ensure the fullest possible information on credit risk, in particular regarding the effectiveness of the credit risk management policy, identification of sources and factors of credit risk, measurement of the cost of credit risk, monitoring of compliance with limits and taking corrective and preventive action.

In addition to information for the Bank, the reports also include information on the level of credit risk in the Group entities where a material level of credit risk was identified (e.g. the KREDOBANK SA Group, the PKO Leasing SA Group, PKO Bank Hipoteczny SA).

The purpose of management actions is to shape and optimize the credit risk management system and credit risk level at the Group.

The credit risk management actions include particularly:

• issuing internal regulations governing the credit risk management system at the Group;
• issuing recommendations, guidelines for conduct, explanations and interpretation of the Group’s internal regulations;
• taking decisions regarding the acceptable level of credit risk, including in particular lending decisions;
• developing and improving credit risk control ls and mechanisms which make it possible to maintain the credit risk level within the limits acceptable to the Group;
• developing and monitoring the operation of credit risk management controls;
• developing and improving credit risk assessment methods and models;
• developing and improving IT tools used in credit risk management;
• planning actions and issuing recommendations.

The main credit risk management tools used by the Group include:

• strategic limits of tolerance to credit risk and concentration risk which set the maximum level of these risks the Bank, the Group entities and the Bank’s Group are ready to accept. These limits take into account, among other things, the requirements of the CRR Regulation, the Polish Banking Law or Recommendations S and T.
• internal limits of tolerance to credit risk or concentration risk including:
  • limits determining the level of tolerance to portfolio credit risk and concentration risk;
  • industry-related limits, which reduce the risk level related to financing institutional customers conducting business activities in industries characterized by a high level of credit risk;
  • competence limits, which set the maximum level of competences to make lending decision with respect to customers, including customers shared by the entities belonging to the Bank’s Group;
• verifying the quality of lending processes in order to identify the causes of late repayments and inadequacies in the lending process,
• branch rating representing a synthetic assessment of the quality of the branch’s work in lending processes.
• threshold amounts which trigger involvement of risk analysts in the credit risk assessment, including with respect to transactions with customers shared by the entities belonging to the Bank’s Group.

Credit risk management tools from the customer and transaction level include:

• minimum transaction requirements determined for a given type of transaction (e.g. maximum loan amount, required collateral);
• the principles of defining credit availability, including cut-offs – the minimum number of points awarded in the process of qualitative assessment with the use of a scoring system, or the customer’s rating class above which a lending transaction can be concluded with a customer;
• minimum credit margins – credit risk margins relating to a given credit transaction concluded by the Group with a given customer, where the interest rate offered to the customer should not be lower than the reference rate plus an appropriate credit risk margin.

Collateral management policy plays a significant role in establishing minimum transaction terms. The Bank’s and the Group entities’ collateral management policy is meant to properly protect them against credit risk to which the Group is exposed, including first of all by establishing collateral that is as liquid as possible. Collateral may be considered liquid if it is possible to be sold without a significant decrease in its price and at a time which does not expose the Bank to a change in the collateral value due to price fluctuations typical of a given asset.

The Group strives to diversify collateral in terms of its forms and assets used as collateral.

The Group evaluates collateral from the perspective of the actual possibility of using it to satisfy its claims.

In addition, when assessing collateral, the Group takes into account the following factors:

• the economic, financial and economic or social and financial position of entities which provide personal guarantees;
• the condition and market value of the assets accepted as collateral and their vulnerability to depreciation in the period of maintaining the collateral (the impact of the technological wear and tear of a collateralized asset on its value),
• potential economic benefits to the Group resulting from a specific method of securing receivables, including, in particular, the possibility of reducing allowances for expected credit losses;
• the method of establishing collateral, including the typical duration and complexity of formalities, as well as the necessary costs (the costs of maintaining collateral and the enforcement against the collateral), using the Group’s internal regulations concerning the assessment of collateral;
• the complexity, time-consuming nature and economic and legal conditions of the effective realization of collateral, in the context of enforcement restrictions and the applicable principles for the distribution of the sums obtained from individual enforcement or in the course of bankruptcy proceedings, the ranking of claims;
• the type of collateral depends on the level of risk of a given customer or transaction.

When granting loans intended to finance housing and commercial funding properties, a mortgage is an obligatory type of collateral.

Until effective protection is established (depending on the type and amount of a loan), the Group may accept temporary collateral in a different form.

With regard to consumer loans, usually personal guarantees (a civil law surety/guarantee, a bill of exchange) are used or collateral is established on the customer’s bank account, car or securities.

The collateral for loans intended for the financing of small- and medium-sized enterprises as well as corporate customers is established, among other things: on receivables from business operations, bank accounts, movables, real estate or securities. The collateral management policy is set out in the internal regulations of the Group’s subsidiaries.

When concluding lease agreements, the PKO Leasing SA Group, as the owner of the assets leased, treats the assets leased as collateral.

See also the information in the note “Collateral”.