Risk and capital management in the Länsförsäkringar Bank Group Pillar III of the Basel II regulatory framework - PDF

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Risk and capital management in the Länsförsäkringar Bank Group 2011 Pillar III of the Basel II regulatory framework Table of contents Introduction...3 Focus of operations...5 Risks and risk management...6

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Risk and capital management in the Länsförsäkringar Bank Group 2011 Pillar III of the Basel II regulatory framework Table of contents Introduction...3 Focus of operations...5 Risks and risk management...6 Capital base and capital requirements... 7 Credit risk... 8 Market and liquidity risks...14 Business risk...16 Operational risks Internal Capital Adequacy Assessment Process (ICAAP) Risk and capital management in the Länsförsäkringar Bank Group 2011 Introduction The aim of this report is to provide detailed information about Läns försäkringar Bank s risks, risk management and capital adequacy in accordance with the reporting requirements (known as Pillar III) stipulated in the Capital Requirements Directive (CRD) through which Basel II was implemented within the EU. Information requirements were introduced in Sweden on the basis of the regulations and general advice FFFS 2007:5 of the Swedish Financial Supervisory Authority. Under the Basel II rules, an option for calculation of the capital requirement for credit risk was introduced by utilising either the Standardised Approach or an internal approach. Since the Basel II rules were introduced, Länsförsäkringar has applied the Internal Ratings-based Approach (IRB Approach) in accordance with a permit issued by the Financial Supervisory Authority. The aim of the new rules was to achieve enhanced transparency and risk management, and thereby greater stability in the financial system. The Advanced IRB Approach provides the greatest opportunities to strategically and operationally manage credit risks and is used for all retail exposures. As of 2010, the IRB Approach is also used for agricultural customers and the foundation IRB Approach is applied to agricultural exposures and the Standardised Approach is used until further notice for other exposures to calculate the capital requirement for credit risk. Changes in the capital requirement will emerge gradually since Basel II contains transition rules involving an adaptation period over a number of years. Future capital adequacy rules (Basel III) Basel III is a new international capital adequacy and liquidity standard that was adopted by the Basel Committee on Banking Supervision in December This third Basel agreement was produced in response to the shortcomings in the current bankingsupervision regulations, which came to the fore during the recent global financial crisis. In brief, Basel III involves higher capitalrequirement levels, changes to what may be credited as capital, changed calculations of capital requirements, new rules regarding liquidity risk and the introduction of a non-risk-sensitive leverage ratio. Basel III will be introduced within the EU through a revised capital requirement directive (CRD IV package), which is expected to come into effect in 2013, be subsequently implemented over a six-year period and be fully implemented by Länsförsäkringar Bank Group Länsförsäkringar Bank AB (publ) is part of the Länsförsäkringar AB Group, with Länsförsäkringar AB (publ) as the Parent Company, which is owned by 23 independent and customer-owned regional insurance companies. The regional insurance companies offer customer products via their three core businesses: banking operations, non-life insurance and life assurance. Länsförsäkringar Bank is 100% owned by Länsförsäkringar AB (publ) ( ). The Bank Group comprises the Parent Company Länsförsäkringar Bank AB (publ) ( ) and the wholly owned subsidiaries Länsförsäkringar Hypotek AB (publ) ( ), Wasa Kredit AB ( ) and Länsförsäkringar Fondförvaltning AB (publ) ( ). All companies have their registered offices in Stockholm. Mission The mission of Länsförsäkringar Bank is, within the Länsförsäkringar AB Group, to conduct business activities, develop products, concepts, channels and tools, and provide service to the regional insurance companies in areas generating economies of scale so that these companies can offer their customers the best possible banking services. Strategy The strategy, which has not been changed since 2000 a few years after the bank was founded in 1996, is to offer banking and insurance services to the regional insurance companies customers. All customer contact takes place at the 125 branches of the 23 regional insurance companies. Customer contact also takes place at Länsförsäkringar Fastighetsförmedling s 143 branches. The strategy for banking operations is primarily based on the Länsförsäkringar Alliance s existing infrastructure: a large customer base, a strong brand, and the value basis and core values of the customer-owned regional insurance companies. Large customer base The Länsförsäkringar Alliance has 3.4 million customers and the prioritised target groups in the banking operations are the 2.9 million private individuals, the 1.8 million home-insurance customers and agricultural customers. The banking offering is tailored to a variety of needs. With the entire banking and insurance offering, customers receive a secure and profitable commitment with Länsförsäkringar, all while the customer relationship is strengthened in the long term. A strong brand Länsförsäkringar has one of the strongest financial brands in Sweden according to the 2011 Anseendebarometern (the Reputability Barometer ).Brand is of major important to customer choice particularly in times of financial crisis. Länsförsäkringar, with its 200- year history, represents security and stability. Local presence Länsförsäkringar s value basis is a key contributory factor to the success of its strategy. These values have been built on a long-term approach and strong core values for many years. The local presence with customer-owned regional insurance companies make Länsförsäkringar accessible to customers in an essentially unique way. Risk and capital management in the Länsförsäkringar Bank Group Objectives Länsförsäkringar Bank s objectives are as follows: Achieve profitable growth Have the most satisfied customers Help increase the percentage of customers who combine their banking and insurance commitments with Länsförsäkringar. A strong position The banking operations business volumes have grown an average of 12% over the past five years. Profitability is stable with a return on equity of 4.8% in 2011 and an average of 4.7% over the past five years. The Bank Group strengthened its position in the Swedish and European capital markets during the year. According to the 2011 Swedish Quality Index, Länsförsäkringar has Sweden s most satisfied retail bank customers for the seventh time in eight years and Sweden s most satisfied retail mortgage customers for the seventh consecutive year. The same survey also revealed that Länsförsäkringar is the bank that best met customer expectations and is perceived to be the most reasonably priced. The number of customers who have chosen Länsförsäkringar as their primary bank rose to 255,000 in 2011, and of these customers, 93% also have at least one insurance policy with Länsförsäkringar. 4 Risk and capital management in the Länsförsäkringar Bank Group 2011 Focus of operations Savings and deposits Länsförsäkringar has a total offering in savings and is growing in the deposits market. During the year, this offering was enhanced with more products and services to provide customers with a greater range of savings and investment products. Under the fund transfer service, which was launched in the spring of 2011, many customers transferred their fund savings to their primary bank Länsförsäkringar during the year. Deposits increased 19% to SEK 50 billion (42) in This increase was primarily attributable to the rising number of customers who have chosen Länsförsäkringar as their primary bank. All types of deposit accounts are increasing. Bank services for small businesses is an offering that has been launched gradually, and growth is healthy and progressing according to plan, primarily in deposits. The market share, measured as deposits from households, rose to 3.8% (3.5) in 2011 and the share of market growth was slightly more than 7%, according to data from Statistics Sweden. Fund market and IPS Länsförsäkringar is Sweden s fifth largest fund company with an unchanged market share in 2011 of 3.9%, according to statistics from the Swedish Investment Fund Association. Fund volumes fell 8% to SEK 67 billion (72) due to the negative trend in asset values in the equities market during the year. A total of 33 (32) mutual funds with different investment orientations are managed. The fund offering comprises funds under Länsförsäkringar s own brand, supplemented with external funds selected by Länsförsäkringar and other funds offered in the market. The majority of own-brand funds have external managers who are also continuously evaluated to ensure that they meet return targets. Selected external funds are also continuously evaluated to ensure that they meet Länsförsäkringar s return targets. The number of new fund savers making monthly deposits rose 11,000 during the year, demonstrating that Länsförsäkringar has an attractive fund offering. The IPS service, Individual Pension Savings, achieved major success again in Volumes continued to increase relatively sharply despite the weak year for the stock market. Equities and other securities The trend in volumes of equities and other securities is steadily growing. The number of deposits rose 11,000 and the volume of capital-protected investments doubled during the year. Household and retail mortgages Länsförsäkringar has a highly attractive mortgage offering and is growing steadily in the market. First-lien mortgages for agricultural properties experienced robust growth and Wasa Kredit s leasing, hire purchase and unsecured loans are steadily increasing. The banking operations loans rose 14% to SEK 134 billion (118) in 2011, of which retail mortgages in Länsförsäkringar Hypotek increased 11% to SEK 89 billion (80). Mortgages up to 75% of the market value on the granting date are deposited with Länsförsäkringar Hypotek and other mortgages are offered by Länsförsäkringar Bank. The market share for household and retail mortgage lending increased to 4.6% (4.4) in 2011 and Länsförsäkringar captured a favourable share of market growth during the year, according to data from Statistics Sweden. The banking operations loans rose 18% to SEK 118 billion (100) in 2010, of which retail mortgages in Länsförsäkringar Hypotek increased 18% to SEK 80 billion (68). First-lien mortgages up to 75% of the market value are deposited with Länsförsäkringar Hypotek and other housing loans with Länsförsäkringar Bank. The market share for household and retail mortgage lending in 2010 increased to 4.4% (4.0) and Länsförsäkringar s share of market growth in 2010 was nearly 9%, according to data from Statistics Sweden. Agricultural loans Länsförsäkringar offers loans to forestry and agricultural properties and is the fourth largest company in agricultural lending in Sweden with a market share that strengthened to 8.5% (7.8) during the year, according to Agricultural Barometer. Agricultural loans rose 21% to SEK 16.7 billion (13.8), of which first-lien mortgages to agricultural properties increased 27% to SEK 13.7 billion (10.8). Some 83% (81) of agricultural customers have at least one insurance policy with Länsförsäkringar. Other loans Wasa Kredit s lending volume rose 12% to SEK 12.0 billion (10.7). All leasing, hire purchase and unsecured loan products increased in 2011 and the largest volume increase was in leasing. Bank cards and payments The number of cards is rising steadily and are being continuously developed to ensure that customers can feel secure and receive good service in their payment services. Income from payment mediation continued to increase in 2011 and bank card transactions accounted for the largest payment transaction volumes. The number of bank cards rose 15% to 306,000 (266,000) and the number of Länsförsäkringar ATMs increased to 98 (88). In-store bank card transactions rose 23% and payment transactions increased to a total of SEK 130 M (108), up 20%. Regional insurance companies own bank The bank offers primarily savings and payment services to the 23 regional insurance companies and the Länsförsäkringar AB Group. Business is expanding and the number of payment transactions rose during the year. The regional insurance companies deposits are also growing at a stable rate. Risk and capital management in the Länsförsäkringar Bank Group Risks and risk management Risk management is to be performed by the employees working in the banking operations. Accordingly, risk awareness is prevalent in all day-to-day business decisions. This decentralised method of working and managing risk is a requirement for compliance with the risk tolerance set forth by the Board. The banking operations are to be characterised by a low risk profile whose lending operations focus on private housing and family-owned agricultural operations. The Bank Group s risks can be divided into the following groups: Credit risk Market risk Liquidity risks Business risk Operational risks Credit risk consists of the counterparty s inability to fulfil its commitments and that Bank Group is affected by a financial loss. Market risks, which primarily comprise interest-rate risk and currency risk, are managed in accordance with a Financial Policy adopted by the Board, which stipulates that interest-rate risks should be as low as possible and that liquidity be invested solely in Swedish securities with high credit quality. Operational risks are measured against a risk-tolerance scale established by the Board. Business risk mainly comprises earnings risk, and pertains to fluctuations in the Bank Group s earning capacity. The overall guidelines for risk tolerance and the strategies for risk-taking state that volume growth and higher profitability should not be generated at the expense of a higher number or greater risks. This requires that risks inherent in the business activities be independently identified, measured, controlled, valued and reported on a continuous basis and that risks be proportionate to the size, product development and growth of the operations. Total risks are complied and compared with the capital in the Bank Group to ensure a favourable level of capitalisation. President The President is responsible for the ongoing administration of the company in accordance with the risk tolerances and risk strategies established by the Board. This means that the President is responsible for ensuring that the methods, models, systems and processes that form the internal measurement, control and reporting of identified risks work in the manner intended and decided by the Board. The President is the Chairman of the Asset Liability Committee (ALCO), whose main task is to follow up on capital and financial matters arising in the Bank Group. Risk Control Risk Control is an independent unit and has an independent position in relation to the corporate operations that it has been assigned to monitor and control. Risk Control is under the supervision of the President and is responsible to the Board of Directors for ensuring that risk policies are complied with, risk limits are monitored and non-compliance is reported to the President and Board. In addition, Risk Control is responsible for the validation of the risk-classification system (the IRB Approach) and its use in the operations. One of the most important tasks of the Risk Control is to work proactively to ensure that the operations have active risk management and that the risk tolerance established by the Board is converted into limits according to which the operations can conduct their activities. Risk Control is responsible for reporting violations of limits to the President and the Board. Risk Control is responsible for continuously reporting to management, the ALCO and Board. For credit risk, these reports include information on developments and trends in exposure amounts, risk weights and capital requirements. For financial risk, these reports primarily contain information about interest-rate risk and liquidity positions. In addition, the reports include information about operational risk. Board of Directors The Board of Directors is ultimately responsible for the Bank Group s operations and, as a result, for safeguarding the Group s assets and creating risk awareness in the Group. The Board achieves this goal, for example, by annually establishing central risk tolerances and risk strategies that ensure a sound and well-balanced process for risk-taking and risk management. Such a process should be characterised by a deliberate focus on changes in the operations and their surroundings. The Board is also responsible for establishing all of the methods, models, systems and processes that form the internal measurement, control and reporting of identified risks. Through the Bank Group s Compliance, Risk Control and Internal Audit functions, the Board is also responsible for ensuring that the company s regulatory compliance and risks are managed in a satisfactory manner. 6 Risk and capital management in the Länsförsäkringar Bank Group 2011 Capital base and capital requirements The bank s Board of Directors decided on a capital adequacy target entailing a Tier 1 ratio of 12 percentage points when Basel II is fully implemented. A deviation of +/ 0.5 percentage points is permitted for the target. The basis for determining the capital adequacy target was the Bank Group s internal capital adequacy assessment process, which considered all risks requiring capital. Consideration was also given to the Tier 1 ratios of comparable financial companies. Internal calculations show that the Bank Group is well capitalised in relation to its total risks. Basel II is scheduled to take full effect in However, in a bill presented in March 2011, the Swedish government proposed an extension of the transition rules. Basel III will make major regulatory changes as expected by the banking sector in recent years. Based on the requirements that have already been announced, Länsförsäkringar deems that the bank will be able to meet the new capital adequacy and liquidity targets. Capital-adequacy analysis SEK M Dec. 31, 2011 Dec. 31, 2010 Tier 1 capital, gross 1) 6, ,773.6 Less intangible assets Less deferred tax assets Less/plus IRB deficit/surplus Tier 1 capital, net 5,747.4, 5,183.0 Tier 2 capital Deductions for Tier 2 capital Total capital base 6, ,928.2 Risk-weighted assets according to Basel II 47, ,944.2 Risk-weighted assets according to transition rules 71, ,161.2 Capital requirement Capital requirement for credit risk according to Standardised Approach Total capital requirement for credit risk according to IRB Approach 2, ,656.4 Capital requirement for operational risk Capital requirement according to Basel II 3, ,515.5 Adjustment according to transition rules 1, ,537.4 Total capital requirement 5, ,052.9 Tier 1 ratio according to Basel II, % Capital adequacy ratio according to Basel II, % Capital ratio according to Basel II 2) Tier 1 ratio according to transition rules, % Capital adequacy ratio according to transition rules, % Capital ratio according to transition rules 2) Special disclosures IRB Provisions surplus (+)/deficit ( ) IRB Total reserves (+) IRB Expected loss ( ) ) of which a Tier 1 capital contribution of SEK 290 M. 2) Capital ratio = total capital base/total capital requirement. SEK M Dec. 31, 2011 Dec. 31, 2010 Credit risk according to Standard Approach Exposures to institutions Exposures to corporates Retail exposures Exposures secured on residential property Past due items Covered bonds Other items Total capital requirement for credit risk according to Standardised Approach Credit risk according to IRB Approach Retail exposures Exposures secured by real es
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