7.5.3. Market risk
Market risk means the risk of loss or of adverse change in the financial situation resulting, directly or indirectly, from fluctuations in the level and in the volatility of market prices of assets, credit spread, value of liabilities and financial instruments.
Market risk types in the PZU Group include:
- equity risk – the possibility of incurring loss as a result of changes in the values of assets, liabilities and financial instruments caused by changes in the level or in the volatility of market prices of equities;
- unquoted equity risk – the possibility of incurring loss as a result of changes in the valuation of unquoted shares;
- property risk – the possibility of incurring loss as a result of changes in the values of assets, liabilities and financial instruments caused by changes in the level or in the volatility of market prices of real estate;
- commodity risk – the possibility of incurring loss as a result of changes in the values of assets, liabilities and financial instruments caused by changes in the level or in the volatility of market prices of commodities;
- inflation risk – the possibility of incurring loss associated with the level of information, especially inflation of prices of goods and services as well as expectations as to the future inflation level, which affect the valuation of assets and liabilities;
- liquidity risk – the risk of being unable to realize investments and other assets without affecting their market prices in order to settle financial liabilities when they fall due;
- interest rate risk – the possibility of incurring a loss as a result of changes in the value of financial instruments or other assets and a change in the present value of projected cash flows from liabilities, caused by changes in the term structure of market rates or in the volatility of risk-free market interest rates;
- basis risk – the possibility of incurring a loss as a result of changes in the value of financial instruments or assets and a change in the present value of projected cash flows from liabilities, caused by changes in the term structure of spreads between market interest rates and risk-free rates or in the volatility of such spreads, excluding credit spreads;
- foreign exchange risk – the possibility of incurring loss as a result of changes in the value of assets, liabilities and financial instruments, caused by changes in the level or in the volatility of currency exchange rates;
- credit spread risk – the possibility of incurring loss as a result of changes in the value of assets, liabilities and financial instruments, caused by changes in the level or in the volatility of credit spreads over the term structure of the interest rates on debt securities issued by the State Treasury;
- credit spread risk – the possibility of incurring loss as a result of changes in the value of assets, liabilities and financial instruments, caused by changes in the level or in the volatility of credit spreads over the term structure of the interest rates on debt securities issued by the State Treasury;
- concentration risk – the possibility of incurring loss stemming either from lack of diversification in the asset portfolio or from large exposure to default risk by a single issuer of securities or a group of related issuers.
Concentration risk and credit spread risk are regarded as an integral part of market risk when measuring risk for the purposes of risk profile, risk tolerance, and market risk ratio reporting. The risk management process has, however, a different set of traits from the process of managing the other sub-categories of market risk and has been described in section 7.5.1.1 along with the process for managing counterparty insolvency risk.
The market risk in the PZU Group originates from three major sources:
- operations associated with asset and liability matching (ALM portfolio);
- operations associated with active allocation, i.e. designating the optimum medium-term asset structure (AA portfolios);
- banking operations in Pekao Alior Bank – generating material exposure to interest rate risk.
A number of documents approved by supervisory boards, management boards and dedicated committees govern investment activity in PZU Group companies.
Risk units take part in the risk identification process, measure, monitor and report on the risks. Market risk is measured using the model of calculating market risk economic capital based on the value at risk method (VaR) or the standard formula in accordance with the principles defined by the Solvency II Directive. In order to effectively manage market risk, risk limits are adopted in a form of a capital amount allocated to each market risk and limits for individual market risks.
In Pekao, the market risk management system forms the structural, organizational and methodological framework, which aims to maintain the balance sheet and off-balance sheet structure in line with the accepted strategic objectives. The market risk management process and the governing procedures include the separation into the banking and trading books.
In managing its trading book’s market risk, Pekao strives to optimize the financial performance and ensure the highest possible quality of service of the bank’s clients in respect to market-making, while remaining within the limits approved by the management board and the supervisory board.
When managing interest rate risk in its banking book, Pekao endeavors to secure the economic value of equity and to achieve its intended net interest income target within the accepted limits.
In Alior Bank, the exposure to market risk is restricted by the system of periodically updated limits introduced by the resolution of the supervisory board or the Capital, Asset and Liability Management Committee, covering all risk measures the level of which is monitored and reported by Alior Bank’s organizational units that are independent of the business division. In Alior Bank, there are three types of limits that differ in respect to their functioning – basic, supplementary and stress-test limits. Market risk management focuses on limiting potential adverse changes in economic value of equity.
Exposure to market risk
| Carrying amount | Note | 31 December 2021 | 31 December 2020 | ||||||
| Assets at Group’s risk | Assets at client’s risk | Total | Assets at Group’s risk | Assets at client’s risk | Total | ||||
| including banks’ assets | including banks’ assets | ||||||||
| Financial assets and cash exposed to interest rate risk | 360,904 | 316,355 | 1,032 | 361,936 | 343,532 | 298,283 | 1,221 | 344,753 | |
| Fixed-income debt securities | 36 | 95,855 | 60,477 | 965 | 96,820 | 99,459 | 64,231 | 1,142 | 100,601 |
| Variable-income debt securities | 36 | 24,825 | 22,798 | 43 | 24,868 | 24,436 | 22,633 | 43 | 24,479 |
| Loan receivables from clients | 34 | 215,008 | 215,008 | - | 215,008 | 197,288 | 197,288 | - | 197,288 |
| Term deposits with credit institutions | 36 | 1,364 | 1,031 | 20 | 1,384 | 919 | 516 | 33 | 952 |
| Loans | 36 | 3,586 | - | - | 3,586 | 3,384 | - | - | 3,384 |
| Cash | 39 | 9,443 | 8,684 | 4 | 9,447 | 7,936 | 7,040 | 3 | 7,939 |
| Buy-sell-back transactions | 36 | 4,117 | 1,651 | - | 4,117 | 4,657 | 1,127 | - | 4,657 |
| Derivatives | 35 | 6,706 | 6,706 | - | 6,706 | 5,453 | 5,448 | - | 5,453 |
| Financial assets exposed to other price risk | 3,896 | 2,339 | 5,241 | 9,137 | 2,676 | 1,486 | 5,059 | 7,735 | |
| Equity instruments | 36 | 2,306 | 770 | 5,209 | 7,515 | 1,818 | 636 | 5,031 | 6,849 |
| Derivatives | 35 | 1,590 | 1,569 | 32 | 1,622 | 858 | 850 | 28 | 886 |
| Total | 364,800 | 318,694 | 6,273 | 371,073 | 346,208 | 299,769 | 6,280 | 352,488 | |
The following table presents financial assets of banks and at client’s risk, by the item in which they are classified in the consolidated financial statements:
| Financial assets of banks and financial assets at client’s risk | Note | 31 December 2021 | 31 December 2020 | ||
| Bank Pekao i Alior Bank | Financial assets at client’s risk | Pekao and Alior Bank | Financial assets at client’s risk | ||
| Loan receivables from clients | 34 | 215,008 | - | 197,288 | - |
| Financial derivatives | 8,275 | 32 | 6,298 | 28 | |
| Investment financial assets | 86,727 | 6,237 | 89,143 | 6,249 | |
| Measured at amortized cost | 53,432 | 20 | 37,321 | 33 | |
| Debt securities | 50,750 | - | 35,678 | - | |
| Government securities | 43,770 | - | 29,806 | - | |
| Domestic | 43,770 | - | 29,806 | - | |
| Fixed rate | 38,644 | - | 26,965 | - | |
| Floating rate | 5,126 | - | 2,841 | - | |
| Other | 6,980 | - | 5,872 | - | |
| Fixed rate | 2,224 | - | 2,128 | - | |
| Floating rate | 4,756 | - | 3,744 | - | |
| Buy-sell-back transactions | 1,651 | - | 1,127 | - | |
| Term deposits with credit institutions | 1,031 | 20 | 516 | 33 | |
| Measured at fair value through other comprehensive income | 32,425 | - | 50,131 | - | |
| Equity instruments | 513 | - | 396 | - | |
| Debt securities | 31,912 | - | 49,735 | - | |
| Government securities | 22,171 | - | 37,248 | - | |
| Domestic | 22,171 | - | 37,248 | - | |
| Fixed rate | 14,868 | - | 29,254 | - | |
| Floating rate | 7,303 | - | 7,994 | - | |
| Other | 9,740 | - | 12,487 | - | |
| Fixed rate | 4,445 | - | 4,764 | - | |
| Floating rate | 5,295 | - | 7,723 | - | |
| Measured at fair value through profit or loss | 870 | 6,217 | 1,691 | 6,216 | |
| Equity instruments | 249 | 377 | 232 | 376 | |
| Participation units and investment certificates | 8 | 4,832 | 8 | 4,655 | |
| Debt securities | 613 | 1,008 | 1,451 | 1,185 | |
| Government securities | 403 | 965 | 1,415 | 1,145 | |
| Domestic | 403 | 959 | 1,415 | 1,139 | |
| Fixed rate | 291 | 956 | 1,117 | 1,136 | |
| Floating rate | 112 | 3 | 298 | 3 | |
| Foreign | - | 6 | - | 6 | |
| Fixed rate | - | 6 | - | 6 | |
| Other | 210 | 43 | 36 | 40 | |
| Fixed rate | 4 | 3 | 3 | - | |
| Floating rate | 206 | 40 | 33 | 40 | |
| Cash | 8,684 | 4 | 7,040 | 3 | |
| Total financial assets of banks and financial assets at client’s risk | 318,694 | 6,273 | 299,769 | 6,280 | |
In its investing activities, the PZU Group uses derivatives as a tool to mitigate risk (with or without hedge accounting) and to facilitate efficient management of the investment portfolio.
The PZU Group’s exposure to derivatives is presented in section 35.
Exposure to debt securities issued by governments other than the Polish government
| Carrying amount of debt securities issued by governments other than the Polish government | 31 December 2021 | 31 December 2020 |
| Lithuania | 845 | 910 |
| Romania | 227 | 221 |
| Ukraine | 163 | 132 |
| Latvia | 155 | 169 |
| Croatia | 154 | 173 |
| Hungary | 134 | 144 |
| Indonesia | 132 | 129 |
| Italy | 118 | 2 |
| Russia | 90 1) | 100 |
| Mexico | 88 | 68 |
| Bulgaria | 87 | 90 |
| Panama | 76 | 78 |
| Columbia | 76 | 104 |
| Peru | 74 | 58 |
| Brazil | 70 | 83 |
| Kazakhstan | 60 | 62 |
| Saudi Arabia | 59 | 57 |
| South Africa | 58 | 55 |
| Philippines | 56 | 48 |
| Uruguay | 55 | 55 |
| Dominican Republic | 53 | 53 |
| Other | 3682) | 278 3) |
| Total | 3,198 | 3,069 |
1) All exposure to debt securities issued by the Russian government was sold by 25 February 2022.
2) The line item “Other” includes bonds issued by 50 countries with respect to which the balance sheet exposure does not exceed the equivalent of PLN 50 million.
3) The line item “Other” includes bonds issued by 39 countries.
Exposure to debt securities issued by corporations and local government units
| Carrying amount of debt securities issued by corporations, local government units and National Bank of Poland | 31 December 2021 | 31 December 2020 |
| K. Financial and insurance activities, of which: | 8,375 | 10,699 |
| Foreign banks | 4,777 | 7,069 |
| National Bank of Poland | 1,870 | 2,275 |
| Companies from the WIG-Banks Index | 553 | 555 |
| O. Public administration and defense, compulsory social security, of which: | 5,354 | 5,872 |
| Domestic local governments | 5,345 | 5,859 |
| D. Electricity, gas, steam, hot water and air conditioning production and supply, of which: | 2,329 | 2,409 |
| Companies from the WIG-Energy Index | 1,614 | 1,732 |
| C. Manufacturing, of which: | 1,818 | 1,144 |
| Production and processing of crude oil refining products | 766 | 647 |
| N. Administrative and support service activities | 1,006 | - |
| H. Transportation and storage | 801 | 603 |
| E. Water supply; sewerage, waste management and remediation activities | 413 | 382 |
| J. Information and communication | 377 | 307 |
| I. R. Accommodation and food service activities (including: WIG – hotels and restaurants), and arts, entertainment and recreation activities | 335 | 365 |
| F. Construction | 305 | 246 |
| L. Real estate activities | 285 | 235 |
| M. Professional, scientific and technical activity | 196 | 184 |
| B. Mining and quarrying | 185 | 252 |
| G. Wholesale and retail trade services; repair services of motor vehicles and motorcycles | 47 | 57 |
| Total | 21,826 | 22,755 |
7.5.3.1. Interest rate risk
7.5.3.2. Foreign exchange risk
7.5.3.3. Equities prices risk