REG - Bank of Cyprus Hldgs - Interim Financial Report 2022-4
31/08/2022 07:16
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RNS Number : 7204X Bank of Cyprus Holdings PLC 31 August 2022
Additional Risk and Capital Management Disclosures
30 June 2022
The Group is exposed to risks which it monitors, manages and mitigates through
various control mechanisms. Information relating to Group's risks and risk
management in relation to credit risk, market risk, liquidity and funding risk
as well as capital management is set out in the Notes 29-32 to the
Consolidated Condensed Interim Financial Statements (the 'Consolidated
Financial Statements'). This report includes additional disclosures on the
principal and emerging risks faced by the Group and capital management
disclosures.
The Board of Bank of Cyprus Holdings PLC is responsible to ensure that a
coherent and comprehensive Risk Management Framework for the identification,
assessment, monitoring and controlling of all risks is in place. The framework
provides the infrastructure, processes and analytics needed to support
effective risk management. It also ensures that material risks are identified,
including, but not limited to, risks that might threaten the Group's business
model, future performance, liquidity, and solvency. Such risks are taken into
consideration in defining the Group's overall business strategy ensuring
alignment with its risk appetite. In setting its risk appetite, the Group
ensures that its risk bearing capacity is considered so that the appropriate
capital levels are always maintained. To that end, a consolidated risk report
and risk appetite dashboard is regularly reviewed and discussed by the Board
and the Risk Committee (RC) to ensure the risk profile is within the approved
risk appetite. In case violations occur, the Risk Appetite Framework provides
the necessary escalation process to analyse the materiality and nature of the
breach, notify the appropriate authorities, and decide the necessary
remediation actions to address the issue.
1. Credit risk
Credit risk is the risk that arises from the possible failure of one or more
customers to discharge their credit obligations towards the Group. Further
information relating to Group risk management in relation to credit risk is
set out in Note 29 of the Consolidated Financial Statements.
1. Credit risk (continued)
The tables below present the analysis of loans and advances to customers in
accordance with the EBA standards.
Gross loans and advances to customers Accumulated impairment, accumulated negative changes in fair value due to
credit risk and provisions
30 June 2022 Group gross customer Of which: NPEs Of which exposures with forbearance measures Accumulated impairment, accumulated negative changes in fair value due to Of which: NPEs Of which exposures with forbearance measures
credit risk and provisions
loans and advances1(,2)
Total exposures with forbearance measures Of which: NPEs Total exposures with forbearance measures Of which:
NPEs
€000 €000 €000 €000 €000 €000 €000 €000
Loans and advances to customers
General governments 44,378 - - - 26 - - -
Other financial corporations 174,189 3,580 11,882 3,451 4,843 1,945 1,987 1,837
Non-financial corporations 5,361,255 233,781 995,209 180,397 114,923 87,353 71,111 63,413
Of which: Small and Medium sized Enterprises3 (SMEs) 4,160,333 98,901 717,119 49,933 64,946 45,695 29,244 24,098
Of which: Commercial real estate(3) 3,991,472 138,290 865,497 101,831 78,620 62,745 52,075 47,626
Non-financial corporations by sector
Construction 564,688 15,778 16,468
Wholesale and retail trade 954,744 27,177 20,090
Accommodation and food service activities 1,193,029 15,634 5,691
Real estate activities 1,126,110 104,041 34,535
Manufacturing 402,314 11,891 5,581
Other sectors 1,120,370 59,260 32,558
Households 4,788,502 339,810 350,019 198,411 104,430 87,974 56,400 51,196
Of which: Residential mortgage loans(3) 3,775,109 286,371 305,225 174,196 68,110 61,333 44,098 40,603
Of which: Credit for consumption(3) 576,421 48,719 54,353 28,482 27,108 20,726 12,430 11,021
10,368,324 577,171 1,357,110 382,259 224,222 177,272 129,498 116,446
Loans and advances to customers classified as held for sale 551,806 549,681 238,195 236,260 304,599 304,131 114,640 114,205
Total on-balance sheet 10,920,130 1,126,852 1,595,305 618,519 528,821 481,403 244,138 230,651
1. Excluding loans and advances to central banks and credit institutions.
2. The residual fair value adjustment on initial recognition (which relates
mainly to loans acquired from Laiki Bank and is calculated as the difference
between the outstanding contractual amount and the fair value of loans
acquired and bears a negative balance) is considered as part of the gross
loans, therefore decreases the gross balance of loans and advances to
customers.
3. The analysis shown in lines 'non-financial corporations' and 'households'
is non-additive across all categories as certain customers could be in both
categories.
1. Credit risk (continued)
Gross loans and advances to customers Accumulated impairment, accumulated negative changes in fair value due to
credit risk and provisions
31 December 2021 Group gross customer Of which: NPEs Of which exposures with forbearance measures Accumulated impairment, accumulated negative changes in fair value due to Of which: NPEs Of which exposures with forbearance measures
credit risk and provisions
loans and advances(4)(,)(5)
Total exposures with forbearance measures Of which: NPEs Total exposures with forbearance measures Of which:
NPEs
€000 €000 €000 €000 €000 €000 €000 €000
Loans and advances to customers
General governments 45,357 - - - 29 - - -
Other financial corporations 127,889 4,771 12,759 4,487 3,393 1,909 1,948 1,658
Non-financial corporations 5,209,599 277,309 1,009,094 215,157 144,252 115,869 86,847 79,329
Of which: Small and Medium sized Enterprises6 (SMEs) 4,052,571 123,558 734,362 71,269 83,757 60,892 39,263 32,499
Of which: Commercial real estate(6) 3,968,375 171,215 900,697 136,257 100,301 82,872 69,309 64,282
Non-financial corporations by sector
Construction 512,952 28,418 21,224
Wholesale and retail trade 964,891 40,457 28,586
Accommodation and food service activities 1,137,443 4,323 3,351
Real estate activities 1,210,664 106,841 31,821
Manufacturing 326,535 14,354 8,094
Other sectors 1,057,114 82,916 51,176
Households 4,755,100 434,040 430,007 238,066 153,865 136,902 70,667 64,589
Of which: Residential mortgage loans(6) 3,734,448 369,147 372,141 208,387 112,711 105,764 56,145 52,219
Of which: Credit for consumption(6) 581,197 54,238 61,824 31,165 28,824 22,167 13,290 11,430
10,137,945 716,120 1,451,860 457,710 301,539 254,680 159,462 145,576
Loans and advances to customers classified as held for sale 555,789 553,620 245,452 243,495 305,419 304,665 118,094 117,377
Total on-balance sheet 10,693,734 1,269,740 1,697,312 701,205 606,958 559,345 277,556 262,953
4 Excluding loans and advances to central banks and credit institutions
5 The residual fair value adjustment on initial recognition (which relates
mainly to loans acquired from Laiki Bank and is calculated as the difference
between the outstanding contractual amount and the fair value of loans
acquired and bears a negative balance) is considered as part of the gross
loans, therefore decreases the gross balance of loans and advances to
customers.
6. The analysis shown in lines 'non-financial corporations' and 'households'
is non-additive across all categories as certain customers could be in both
categories.
2. Liquidity and funding risk
Liquidity risk is the risk that the Group does not have sufficient financial
resources to meet its commitments as they fall due. This risk includes the
possibility that the Group may have to raise funding at high cost or sell
assets at a discount to fully and promptly satisfy its obligations.
Funding risk is the risk that the Group does not have sufficiently stable
sources of funding or access to sources of funding may not always be available
at a reasonable cost and thus the Group may fail to meet its obligations,
including regulatory ones (e.g. MREL)
Further information relating to Group risk management in relation to liquidity
and funding risk is set out in Note 31 of the Consolidated Financial
Statements.
2.1 Encumbered and unencumbered assets
Asset encumbrance arises from collateral pledged against secured funding and
other collateralised obligations.
An asset is classified as encumbered if it has been pledged as collateral
against secured funding and other collateralised obligations and, as a result,
is no longer available to the Group for further collateral or liquidity
requirements. The total encumbered assets of the Group amounted to
€4,719,053 thousand as at 30 June 2022 (31 December 2021: €4,489,424
thousand).
An asset is classified as unencumbered if it has not been pledged as
collateral against secured funding and other collateralised obligations.
Unencumbered assets are further analysed into those that are available and can
potentially be pledged and those that are not readily available to be pledged.
As at 30 June 2022, the Group held €18,120,570 thousand (31 December 2021:
€17,468,507 thousand) of unencumbered assets that can potentially be pledged
and can be used to support potential liquidity funding needs and €1,322,620
thousand (31 December 2021: €1,324,118 thousand) of unencumbered assets that
are not readily available to be pledged for funding requirements in their
current form.
The table below presents an analysis of the Group's encumbered and
unencumbered assets and the extent to which these assets are currently pledged
for funding or other purposes. The carrying amount of such assets is disclosed
below:
30 June 2022 Encumbered Unencumbered Total
Pledged as collateral Which can potentially be pledged Which are not readily available to be pledged
€000 €000 €000 €000
Cash and other liquid assets 66,579 9,636,320 513,958 10,216,857
Investments 1,369,471 710,487 22,719 2,102,677
Loans and advances to customers 3,283,003 6,461,497 399,599 10,144,099
Non-current assets held for sale - - 347,698 347,698
Property - 1,312,266 38,646 1,350,912
Total on-balance sheet 4,719,053 18,120,570 1,322,620 24,162,243
31 December 2021
Cash and other liquid assets 102,463 8,958,427 461,625 9,522,515
Investments 1,260,158 859,383 19,622 2,139,163
Loans and advances to customers 3,126,803 6,248,132 461,470 9,836,405
Non-current assets held for sale - - 358,951 358,951
Property - 1,402,565 22,450 1,425,015
Total on-balance sheet 4,489,424 17,468,507 1,324,118 23,282,049
2. Liquidity and funding risk (continued)
2.1 Encumbered and unencumbered assets (continued)
Encumbered assets primarily consist of loans and advances to customers and
investments in debt securities. These are mainly pledged for the funding
facilities of the European Central Bank (ECB) and for the covered bond (Notes
20 and 31 of the Consolidated Financial Statements for the six months ended 30
June 2022 respectively). Encumbered assets include cash and other liquid
assets placed with banks as collateral under ISDA agreements which are not
immediately available for use by the Group but are released once the
transactions are terminated. Cash is mainly used to cover collateral required
for (i) derivatives and (ii) trade finance transactions and guarantees issued.
It may also be used as part of the supplementary assets for the covered bond.
BOC PCL maintains a Covered Bond Programme set up under the Cyprus Covered
Bonds legislation and the Covered Bonds Directive of the Central Bank of
Cyprus (CBC). Under the Covered Bond Programme, BOC PCL has in issue covered
bonds of €650 million secured by residential mortgages originated in Cyprus.
The covered bonds have a maturity date on 12 December 2026 and interest rate
of 3-months Euribor plus 1.25% on a quarterly basis. On 9 August 2022, BOC PCL
proceeded with an amendment to the terms and conditions of the covered bonds
following the implementation of Directive (EU) 2019/2162 in Cyprus. The
covered bonds are listed on the Luxemburg Bourse and have a conditional
Pass-Through structure. All the bonds are held by BOC PCL. The covered bonds
are eligible collateral for the Eurosystem credit operations and are placed as
collateral for accessing funding from the ECB.
Unencumbered assets which can potentially be pledged include Cyprus loans and
advances which are less than 90 days past due. Balances with central banks are
reported as unencumbered and can be pledged, to the extent that there is
excess available over the minimum reserve requirement. The minimum reserve
requirement is reported as unencumbered not readily available to be pledged.
Unencumbered assets that are not readily available to be pledged primarily
consist of loans and advances which are prohibited by contract or law to be
encumbered or which are more than 90 days past due or for which there are
pending litigations or other legal actions against the customer, a proportion
of which would be suitable for use in secured funding structures but are
conservatively classified as not readily available for collateral. Properties
whose legal title has not been transferred to the Company or a subsidiary are
not considered to be readily available as collateral. Non-current assets held
for sale are also reported as not readily available to be pledged.
Insurance assets held by Group insurance subsidiaries are not included in the
table above or below as they are primarily due to the insurance policyholders.
The carrying and fair value of the encumbered and unencumbered investments of
the Group as at 30 June 2022 and 31 December 2021 are as follows:
30 June 2022 Carrying value of encumbered investments Fair value of encumbered investments Carrying value of unencumbered investments Fair value of unencumbered investments
€000 €000 €000 €000
Equity securities - - 188,906 188,906
Debt securities 1,369,471 1,326,865 544,300 530,668
Total investments 1,369,471 1,326,865 733,206 719,574
31 December 2021
Equity securities - - 208,775 208,775
Debt securities 1,260,158 1,267,666 670,230 668,201
Total investments 1,260,158 1,267,666 879,005 876,976
2. Liquidity and funding risk (continued)
2.2 Liquidity regulation
The Group has to comply with provisions on the Liquidity Coverage Ratio (LCR)
under CRD IV/CRR (as supplemented by Delegated Regulations (EU) 2015/61), with
the limit set at 100%. The Group has to also comply with the Net Stable
Funding Ratio (NSFR) calculated as per the Capital Requirements Regulation II
(CRR II), with the limit set at 100%.
The LCR is designed to promote the short-term resilience of a Group's
liquidity risk profile by ensuring that it has sufficient high-quality liquid
resources to survive an acute stress scenario lasting for 30 days. The NSFR
has been developed to promote a sustainable maturity structure of assets and
liabilities.
As at 30 June 2022, the Group was in compliance with all regulatory liquidity
requirements. As at 30 June 2022, the LCR stood at 299% for the Group
(compared to 298% at 31 December 2021) and was in compliance with the minimum
regulatory requirement of 100%. As at 30 June 2022 the Group's NSFR was 160%
(compared to 147% at 31 December 2021) and was in compliance with the minimum
regulatory requirement of 100%.
2.3 Liquidity reserves
The below table sets out the Group's liquidity reserves:
Composition of the liquidity reserves 30 June 2022 31 December 2021
Internal Liquidity Reserves Liquidity reserves as per LCR Delegated Regulation (EU) Internal Liquidity Reserves Liquidity reserves as per LCR Delegated Regulation (EU)
2015/61 LCR eligible 2015/61 LCR eligible
Level 1 Level 2A Level 1 Level 2A
€000 €000 €000 €000 €000 €000
Cash and balances with central banks 9,731,376 9,731,376 - 9,064,840 9,064,840 -
Placements with banks 157,879 - - 118,752 - -
Liquid investments 383,760 223,609 111,649 500,930 304,758 147,562
Available ECB Buffer 213,818 - - 80,786 - -
Total 10,486,833 9,954,985 111,649 9,765,308 9,369,598 147,562
Internal Liquidity Reserves present the total liquid assets as defined in BOC
PCL's Liquidity Policy. Liquidity reserves as per LCR Delegated Regulation
(EU) 2015/61 present the liquid assets as per the definition of the
aforementioned regulation i.e. High-Quality Liquid Assets (HQLA).
Under Liquidity reserves as per LCR, balances in Nostro accounts and
placements with banks are not included, as they are not considered HQLA (they
are part of the LCR Inflows).
Liquid investments under the Liquidity reserves as per LCR are shown at market
values reduced by standard weights as prescribed by the LCR regulation. Liquid
investments under Internal Liquidity Reserves include additional unencumbered
liquid bonds and are shown at market values net of haircuts based on ECB
methodology and haircuts.
Current available ECB buffer is not part of the Liquidity reserves as per LCR.
2. Liquidity risk and funding (continued)
2.3 Liquidity reserves (continued)
Following the outbreak of COVID-19, the ECB has adopted a broad set of policy
measures to mitigate the economic impact of the crisis and to ensure that its
directly supervised banks can continue to fulfill their role in funding the
real economy.
In March 2022, the ECB announced the steps for the gradual phasing out of the
temporary pandemic collateral easing measures. The gradual phasing out is
scheduled to be concluded in three steps starting from July 2022 and will be
completed by March 2024 and gives banks time to adapt to the adjustments to
the collateral framework. In the first step, starting on 8 July 2022, the
ECB halved the temporary reduction in collateral valuation haircuts across all
assets from the current 20% adjustment to 10%. In the second step, in June
2023, the ECB expects to implement a new valuation haircut schedule based on
its pre-pandemic risk tolerance level for credit operations, phasing out the
temporary reduction in collateral valuation haircuts completely. In the third
step, in March 2024, the ECB will, in principle, phase out the remaining
pandemic collateral easing measures.
The package also contained measures that provided liquidity support to the
euro area financial system, such as significant favourable amendments in the
terms and characteristics of TLTRO III. The favourable TLTRO III borrowing
terms were not extended post June 2022. Furthermore, a new series of
additional longer-term refinancing operations, called Pandemic Emergency
Longer-Term Refinancing Operations (PELTROs), was introduced. The last TLTRO
III and PELTROs operations took place in December 2021.
3. Other risks
3.1 Operational risk
Operational risk is defined as the risk of a direct or indirect impact/loss
resulting from inadequate or failed internal processes, people actions,
systems or external events. The Group includes in this definition compliance,
legal and reputational risk.
The Group recognises that the control of operational risk is directly related
to effective and efficient management practices and high standards of
corporate governance. To that effect, the management of operational risk is
geared towards maintaining a strong internal control governance framework and
managing operational risk exposures through a consistent set of management
processes that drive risk identification, assessment, control and monitoring.
The main objectives of operational risk management within the Group are: (i)
raising operational risk awareness and building the appropriate risk culture,
(ii) providing adequate and timely information to the Group's management at
all levels in relation to the operational risk profile at a company, unit and
activity level, so as to facilitate decision making for risk control
activities, and (iii) mitigating operational risk to ensure that operational
losses do not cause material damage to the Group's franchise and that the
impact on the Group's profitability and corporate objectives is contained.
Operational risks can arise from all business lines and from all activities
carried out by the Group and are thus diverse in nature. To enable effective
management of all material operational risks, the operational risk management
framework adopted by the Group is based on the three lines of defence model,
through which risk ownership is dispersed throughout the organisation. The
first line of defence comprises of management and staff who have immediate
responsibility of day-to-day operational risk management and own the risk.
Each business unit owner is responsible for identifying and managing all the
risks that arise from the unit's activities as an integral part of their first
line responsibilities.
3. Other risks (continued)
3.1 Operational risk (continued)
The second line of defence comprises of the Risk Management function whose
role is to provide inter-alia operational risk oversight and independent and
objective challenge to the first line of defence, supported by other
specialist control and support functions including the Group Compliance
Division and Information Security functions. The third line of defence
comprises of the Internal Audit function, which provides independent assurance
over the integrity and effectiveness of the risk management framework
throughout the Group.
Business resilience is treated as a priority and as such the Group places
significant importance on continuously enhancing the business continuity
arrangements, to ensure timely recovery in the case of events, such as the
COVID-19 pandemic, that may cause disruptions to the business operations.
According to the Pandemic Incident Management Plan, which was invoked
following the COVID-19 outbreak, Business Continuity arrangements have been
put in place, which include splitting the operations of the critical units at
separate locations other than their main business sites along with remote
access from home capabilities as applicable. BOC PCL has withdrawn the
Business Continuity arrangements approach with effect from the end of May
2022. Capabilities to employees that support the critical units is still
available and ready to be used if needed.
All the controls are undertaken as usual and no additional losses or incidents
have been identified as a result of the pandemic.
Further to the actions taken in response to the COVID-19 pandemic, ongoing
activities/initiatives towards further enhancements of Operation Risk
Management (ORM), involved inter alia the following: (i) provision of a fraud
risk awareness seminar to staff and top-management, (ii) establishment of the
specialised Fraud Risk Assessment framework, going beyond the current Risk
Control Self-Assessment (RCSA) process, and (iii) ongoing reviews and
enhancements of the internal ORM policies, procedures and the ORM database.
As a result of the customers' accelerated shift towards digital channels, the
Fraud Risk Management unit further strengthened BOC PCL's current external
fraud prevention controls and framework.
Third-Party and Outsourcing risk can arise from a third party's failure to
perform as expected due to reasons such as inadequate capacity, technological
failure, human error, un-satisfactory quality of service, unsatisfactory
continuity of service and/or financial failure. The Group has a dedicated unit
under the ORM Function, the Third-Party Risk Management Unit, which is
responsible to perform risk assessments on all outsourcing, strategic and
intragroup arrangements of the Group. As part of the risk assessment, the team
identifies and monitors the effective handling of any potential
gaps/weaknesses. The risk assessment occurs prior to signing an
outsourcing/strategic/intragroup arrangement, prior to their renewal or
annually.
Operational risk loss events are classified and recorded in the Group's Risk
and Compliance Management System (RCMS) system, which serves as an enterprise
tool integrating all risk-control data (e.g. risks, loss incidents, Key Risk
Indicators) to provide a holistic view with regards to risk identification,
corrective action and statistical analysis. During the six months ended 30
June 2022, 15 loss events with gross loss equal to or greater than €1,000
each were recorded including incidents of prior years (mostly legal cases) for
which losses materialised in the first six months of 2022 (six months ended 30
June 2021: 55 loss events).
The Group strives to continuously enhance its risk control culture and
increase the awareness of its employees on operational risk issues through
ongoing staff training (both through physical workshops and through
e-learning).
The Group also maintains adequate insurance policies to cover for unexpected
material operational losses.
3. Other risks (continued)
3.2 Regulatory risk
The Group conducts its business subject to on-going regulation and
supervision. The associated regulatory risk is the risk that new laws and
regulations enacted or changes in existing ones are not identified, and / or
the failure to comply with regulatory requirements. This could lead to,
amongst other things, increased operational costs for the Group and limitation
on BOC PCL's capacity to lend. Moreover, Regulatory risk could have a material
adverse effect on the business, financial condition, results, operations and
prospects of the Group.
There is strong commitment by the management of the Group for an on-going and
transparent dialogue with the Regulators (amongst others the ECB, CBC etc). A
dedicated Executive Steering Group chaired by the CEO has been set up which
ensures proper procedures are in place for managing regulatory risk and
oversee the Group's regulatory obligations. This is ensured through the
Regulatory Affairs department that acts as primary contact point with the
Regulators maintaining a holistic view of the regulatory requests and monitors
the regulatory agenda to ensure all regulatory matters are handled
appropriately and are brought to the attention of management in a timely
manner.
3.3 Political risk and geopolitical uncertainty
Cyprus is a small, open, services-based economy, with a large external sector
and high reliance on tourism and international business services. As a result,
external factors which are beyond the control of the Group, including
developments in the European Union and in the global economy, or in specific
countries with which Cyprus maintains close economic and investment links,
most notably the UK and Russia, can have a significant impact on domestic
economic activity. In particular, the Ukraine war poses risks for continued
supply disruptions and elevated energy prices, even the risk of the war
spreading.
Cyprus' risk profile has been improving as seen in upgrades of its sovereign
credit rating and improved economic fundamentals. Higher inflation and
tightening monetary policy have a negative impact on spending and consumption
and therefore weigh negatively on the overall risk profile of the country. But
this is offset by improvements in various fiscal indicators. The budget
deficit narrowed in 2021 and the ratio of debt to GDP dropped steeply from its
Covid-driven elevated levels of the year before. Financial conditions will be
tightening as the ECB will be raising rates further in the foreseeable future
in order to tame inflation, but that will be affecting overall debt service
costs only gradually. Debt sustainability would depend on growth, the budget
balance, but also on interest rates which determine debt service costs. Low
average interest rates currently, are the result of large-scale asset
purchases by the ECB over a long period of time, and ample liquidity in
sovereign bond markets. The tightening of monetary policy, or developments
that can lead up to the fragmentation of the euro area sovereign bond market,
can increase debt service costs and risk the sustainability of public debt.
The risk of bond market fragmentation has increased as a result of the Ukraine
crisis and the sanctioning of Russia.
The Cypriot economy, similar to the European and global economy, is facing a
variety of headwinds at present. Surging inflation is weighing on consumers'
purchasing power and business sentiment. External demand is slowing as the US
begins its monetary tightening cycle and China continues its zero-covid
policy, while spill-over effects from the war in Ukraine damage growth
worldwide via higher commodity prices and disrupted supply chains. On the
positive side, tourism sectors benefit from a rebound in tourist inflows and
more robust demand for services now that the COVID-19 restrictions from
earlier in the year have been rolled back. Nonetheless, there is a risk that
the economy will prove less resilient than expected. Russian gas cut-offs to
major western European countries prompting further energy price spikes could
further negatively impact the economy, or the European Central Bank's monetary
tightening from July could hit economic activity and investor sentiment harder
than expected. In this scenario, growth will slow abruptly and the probability
of dipping into negative territory rises. The winter of 2022/23 could be
challenging, with high energy prices coinciding with cold temperatures and the
impact of monetary tightening feeding through more strongly. Slower growth
would likely be a Europe-wide phenomenon, dampening external demand, and
unemployment could rise as firms scale back their ambitions.
3. Other risks (continued)
3.3 Political risk and geopolitical uncertainty (continued)
In the banking sector there has been significant progress since the crisis of
2012-14, in terms of the regulatory framework, balance sheet restructuring,
operational and strategic streamlining and capital adequacy. Non-performing
loans dropped steeply from more than 48% of gross loans at the end of 2014 to
11.4% at the end of March 2022. Total loans outstanding dropped from near four
times GDP to less than one GDP at the end of 2021. However, banking sector
risks have been rising in the more recent period as a result of the double
shock of the COVID-19 pandemic and the war in Ukraine.
Political risk remains elevated as Cyprus' political landscape is increasingly
fragmented and polarised which makes it harder to build consensus for reform.
Political risk remains high also because of the continuing division of the
island. This risk category evaluates a range of political factors relating to
political stability and effectiveness that could affect a country's ability
and commitment to service its debt obligations. The political risk rating
informs the ratings for sovereign risk, currency risk and banking sector risk.
Geopolitical and macroeconomic uncertainties remain elevated with multiple
risks as follows:
· the ongoing Russian-Ukraine war and the sanctioning of Russia will
have profound effects on the Russian economy and serious macroeconomic
implications for the European Union and the world economy at large. As a
result of the crisis in Ukraine and sanctions, supply chains have been
disrupted causing shortages in agricultural commodities and metals. Energy
prices have risen, and, despite fluctuations, energy markets remain tight, and
prices will stay higher for longer. As Russian supplies of natural gas to
Europe are cut, while efforts to secure alternative sources take time, the
prospect of energy shortages in Europe in the coming winter rises,
· the mobility restriction measures in China and the imbalances in the
production process in many industries due to the COVID-19 outbreak,
· a prolongation and/or exacerbation of the ongoing inflationary wave,
especially in the energy and food sectors, and its impact on economic growth,
employment, public finances, household budgets, firms' production costs,
external trade and banks' asset quality,
· the political crisis in Italy following the resignation of prime
minister Mario Draghi on July 21, jeopardises future reforms.
However, the risks coming from the geopolitical upheaval could be potentially
mitigated with coordinated measures at the European level, as per the pandemic
precedent.
Tensions between Cyprus and Turkey can escalate, as long as the Cyprus problem
remains unresolved, and the two communities - Greek Cypriots and Turkish
Cypriots - fail to find common ground to return to the negotiating table.
Cyprus' offshore oil and gas exploration activities in its exclusive economic
zone, have met with Turkey's objections, who among other are disputing some of
the maritime areas to the west of Cyprus as part of its continental shelf. The
risk of escalating tensions and possible confrontation, deters investment in
the oil and gas sector. As a result, the required infrastructure investment
for the exploitation of Cypriot offshore gas fields which were discovered in
2011, has been slow.
Given the above, the Group recognises that unforeseen political events can
have negative effects on the Group's activities, operating results, and
financial position.
3.4 Information security and cyber risk
Information security and cyber-risk is a significant inherent risk, which
could cause a material disruption to the operations of the Group. The Group's
information systems have been and will continue to be exposed to an increasing
threat of continually evolving cybercrime and data security attacks. Customers
and other third parties to which the Group is significantly exposed, including
the Group's service providers (such as data processing companies to which the
Group has outsourced certain services), face similar threats.
3. Other risks (continued)
3.4 Information security and cyber risk (continued)
At the same time, the Group has an internal specialised Information Security
team which constantly monitors current and future cyber security threats
(either internal or external, malicious or accidental) and invests in enhanced
cyber security measures and controls to protect, prevent and appropriately
respond against such threats to its systems and information.
The Group collaborates with industry bodies, the National Computer Security
Incident Response Team (CSIRT) and intelligence-sharing working groups so as
to be better equipped with the growing threat from cyber criminals.
In addition, the Group maintains insurance coverage which covers certain
aspects of cyber risk and it is subject to exclusion of certain terms and
conditions.
Advanced social engineering attacks were used by attackers for credentials
stealing and malware dissemination during the COVID-19 pandemic. The Group's
cyber security systems have protected the Group from such threats and are
continually improved by strengthening detection, response and protection
mechanisms in order to continually contain such threats and keep risks within
the Group's appetite thresholds.
Current geopolitical tensions may also lead to increased risk of cyber-attack
from foreign state actors. In particular, the Russian invasion of Ukraine and
the imposition of sanctions on Russia by Switzerland, the US, the EU, the UK
and others may result in increased risk of cyber-attacks.
3.5 Business and strategic risk
Business model risk arises from changes in the external environment including
economic trends and competition. The Group's performance is dependent on the
economic conditions and prospects of Cyprus. A deterioration of the
macroeconomic environment stemming from the pandemic or other factors such as
the Ukrainian crisis, pose downside risks for the financial performance of the
Group.
The Group faces intense competition in the markets in which it operates,
primarily originating from other commercial banks, branches and subsidiaries
of foreign banks, and insurance companies offering savings, insurance and
investment products. It also faces competition from financial technology
companies. The Group remains today the biggest local banking organisation in
Cyprus and a systemically important institution.
Any intensification of competition as a result of more competitive interest
rates being offered on deposits and advances compared to those offered by the
Group, may create pressure on Group profitability.
In order to mitigate the business model risk, the Group has a clear strategy
with specific objectives, including actions to diversify income sources,
developed within the risk appetite of the Group and closely monitored on a
regular basis. The Group also closely monitors current and emerging risks
within the business environment, while remaining ready to explore
opportunities that complement its strategy. In addition, regular stress
testing takes place to assess the Group's capital and liquidity adequacy.
3. Other risks (continued)
3.6 Legal risk
The Group may, from time to time, become involved in legal or arbitration
proceedings which may affect its operations and results. Litigation risk
arises from pending or potential legal proceedings and regulatory
investigations against the Group (Note 25 of the Consolidated Financial
Statements for 30 June 2022). In the event that legal issues are not
properly dealt with by the Group, this may result in financial and/or
reputational loss to the Group. The Group has procedures in place to ensure
effective and prompt management of Legal risk including, among others, the
risk arising from regulatory developments, new products and internal policies.
The Legal Services department monitors the pending litigation against the
Group and assesses the probability of loss for each legal action against the
Group based on International Accounting Standards. It also estimates the
amount of potential loss where it is deemed as probable. Additionally, it
reports pending litigation and latest developments to the Board of Directors.
3.7 Insurance risk and re-insurance risk
Insurance risk is the risk that an insured event under an insurance contract
occurs and there is uncertainty with respect to the amount to be paid and the
timing of the resulting claim. By the very nature of an insurance contract,
this risk is largely random and therefore unpredictable.
The Group, through its subsidiaries EuroLife Ltd ('EuroLife') and General
Insurance of Cyprus Ltd ('Genikes Insurance' or 'GI'), provides life insurance
and non-life insurance services, respectively, and is exposed to certain risks
specific to these businesses. Insurance events are unpredictable and the
actual number and amount of claims and benefits will vary from year to year
from the estimate established using actuarial and statistical techniques.
The above risk exposure is mitigated by the Group through the diversification
across a large portfolio of insurance contracts. The variability of risks is
also reduced by careful selection and implementation of underwriting strategy
guidelines, as well as the use of reinsurance arrangements. Although the Group
has reinsurance coverage, it is not relieved of its direct obligations to
policyholders and is thus exposed to credit risk with respect to ceded
insurance, to the extent that any reinsurer is unable to meet the obligations
assumed under such reinsurance arrangements.
For that reason, the creditworthiness of reinsurers is evaluated by
considering their solvency and credit rating and reinsurance arrangements are
monitored and reviewed to ensure their adequacy as per the reinsurance policy.
In addition, counterparty risk assessment is performed on a frequent basis.
Both EuroLife and Genikes Insurance perform their annual stress tests (ORSA)
which aim to ensure, among others, the appropriate identification and
measurement of risks, an appropriate level of internal capital in relation to
each company's risk profile, and the application and further development of
suitable risk management and internal control systems.
3.8 Digital transformation and technology risk
Technology risk arises from system downtimes impacting customer service which
may be due to inadequate, failed, or unavailable systems, use of outdated,
obsolete and unsupported systems, or systems which do not fully support the
requirements of business. The Group is implementing its Digital Transformation
Programme, involving changes to, or replacement of critical and/or outdated
systems.
Digital transformation risk arises as banking models are rapidly evolving both
locally and globally and available technologies have resulted in the
customers' accelerated shift towards digital channels. Money transmission and
data driven integrated services are also forecast to rapidly evolve in the
coming years. How the Group adapts to these developments could impact the
realisation of its market strategies and financial plans.
In the context of the overall business strategy, the Group assesses and
develops its complementary technology strategy to support operations and
mitigate these risks. The Group's policies, standards, governance and controls
undergo ongoing review to ensure continued alignment with the Group's strategy
for digital transformation. In order to achieve this, the Group engages with
appropriate external experts.
3. Other risks (continued)
3.9 Climate Risks
Climate-related and environmental (C&E) risks may impact the financial
services sector to varying degrees over the short, medium and long term. The
extent to which physical and transition risk might impact a financial services
firm will vary depending on firm business model, customer base, location as
well as the transition process to a low-carbon economy.
• Physical risk refers to the financial impact of a changing
climate, including more frequent extreme weather events and gradual changes in
climate, as well as of environmental degradation, such as air, water and land
pollution, water stress, biodiversity loss and deforestation. Physical risk is
categorised as 'acute' when it arises from extreme events, such as droughts,
floods and storms, and 'chronic' when it arises from progressive shifts, such
as increasing temperatures, sea-level rises, water stress, biodiversity loss,
land use change, habitat destruction and resource scarcity. This can directly
result in, for example, damage to property or reduced productivity, or
indirectly lead to subsequent events, such as the disruption of supply chains.
• Transition risk refers to an institution's financial loss that
can result, directly or indirectly, from the process of adjustment towards a
lower-carbon and more environmentally sustainable economy. This could be
triggered, for example, by a relatively abrupt adoption of climate and
environmental policies, technological progress or changes in market sentiment
and preferences.
The Group has a dedicated team involved in developing the Group's
Sustainability agenda considering the Group's approach to environmental,
social and governance (ESG) issues, and the Risk Management Function is
closely aligned with this initiative.
Managing C&E risks is a key area of focus under the 'Environment' Pillar
of BOC PCL's ESG strategy. In the EU, the ECB released guidance in November
2020 on how banks should manage C&E risks. The guidance sets out 13
supervisory expectations for institutions when formulating and implementing
their business strategy, governance and risk management frameworks with the
ultimate aim of encouraging greater transparency in C&E risk disclosures.
In 2021, the Group has developed a C&E Risks Implementation Plan, which is
being updated, covering each of the ECB's priorities, including actions to
address gaps highlighted in the self-assessment, across a multi-year timeline.
This plan was developed following engagement with key stakeholders from across
the Group.
A number of actions have been initiated and are to be initiated for
implementation in 2022 as part of the Group's implementation plan including:
· Risk identification and materiality assessment - an initial
exercise has been completed which:
- Identified the parts of BOC PCL's Corporate and SME portfolios
that might be sensitive to transition risks,
- Identified and qualitatively assessed the C&E risks that are
relevant for Cyprus and BOC PCL.
· Data gap analysis: the analysis focused primarily on the
immediate gaps in relation to the 2022 ESG Pillar III disclosures. Actions
have been planned for the second half of 2022 to create the necessary fields
in core systems and initiate data collection. It is expected that additional
data needs will arise in relation to the incorporation of C&E risks in the
credit underwriting process as well as the evolving ESG Pillar III disclosure
requirements
· Carry out further ESG relating training across all levels of
BOC PCL.
· Incorporation of C&E risks in the credit underwriting.
· The introduction of a suite of Climate Risk metrics.
· Development of an approach to measure the impact assessment of
climate risk (including data requirements and identification of data proxies
from external sources and/or data gathering from clients) on the business
model.
3. Other risks (continued)
3.9 Climate Risks (continued)
The Group successfully completed the 2022 ECB supervisory Climate Risk Stress
Test. The objective of the exercise was to assess how prepared banks are for
dealing with financial and economic shocks stemming from climate risk. ECB
considers the test as a learning exercise for banks and supervisors alike. It
aims to identify vulnerabilities, best practices and challenges banks face
when managing climate-related risk. This is not a pass-or-fail exercise, nor
does it have direct implications for banks' capital levels. The results will
feed into the Supervisory Review and Evaluation Process (SREP) from a
qualitative point of view. Lessons learned will be integrated into the
development of BOC PCL's internal stress tests capabilities going forward.
4. Capital management
The primary objective of the Group's capital management is to ensure
compliance with the relevant regulatory capital requirements and to maintain
healthy capital adequacy ratios to cover the risks of its business and support
its strategy and maximise shareholders' value.
The capital adequacy framework, as in force, was incorporated through the
Capital Requirements Regulation (CRR) and Capital Requirements Directive (CRD)
which came into effect on 1 January 2014 with certain specified provisions
implemented gradually. The CRR and CRD transposed the new capital, liquidity
and leverage standards of Basel III into the European Union's legal framework.
CRR establishes the prudential requirements for capital, liquidity and
leverage for credit institutions. It is directly applicable in all EU member
states. CRD governs access to deposit-taking activities and internal
governance arrangements including remuneration, board composition and
transparency. Unlike the CRR, member states were required to transpose the CRD
into national law and national regulators were allowed to impose additional
capital buffer requirements.
On 27 June 2019, the revised rules on capital and liquidity (Regulation (EU)
2019/876 (CRR II) and Directive (EU) 2019/878 (CRD V)) came into force. As an
amending regulation, the existing provisions of CRR apply, unless they are
amended by CRR II. Certain provisions took immediate effect (primarily
relating to Minimum Requirement for Own Funds and Eligible Liabilities
(MREL)), but most changes became effective as of June 2021. The key changes
introduced consist of, among others, changes to qualifying criteria for Common
Equity Tier 1 (CET1), Additional Tier 1 (AT1) and Tier 2 (T2) instruments,
introduction of requirements for MREL and a binding Leverage Ratio requirement
(as defined in the CRR) and a Net Stable Funding Ratio (NSFR).
The amendments that came into effect on 28 June 2021 are in addition to those
introduced in June 2020 through Regulation (EU) 2020/873, which among other,
brought forward certain CRR II changes in light of the COVID‑19 pandemic.
The main adjustments of Regulation (EU) 2020/873 that had an impact on the
Group's capital ratio relate to the acceleration of the implementation of the
new SME discount factor (lower RWAs), extending the IFRS 9 transitional
arrangements and introducing further relief measures to CET1 allowing to fully
add back to CET1 any increase in ECL recognised in 2020 and 2021 for
non-credit impaired financial assets and phasing in this starting from 2022
and advancing the application of prudential treatment of software assets as
amended by CRR II (which came into force in December 2020). In addition,
Regulation (EU) 2020/873 introduced a temporary treatment of unrealized gains
and losses on exposures to central governments, to regional governments or to
local authorities measured at fair value through other comprehensive income
which the Group elected to apply and implemented from the third quarter of
2020.
In October 2021, the European Commission adopted legislative proposals for
further amendments to CRR, CRD IV and the BRRD (the '2021 Banking Package').
Amongst other things, the 2021 Banking Package would implement certain
elements of Basel III that have not yet been transposed into EU law. The
2021 Banking Package includes:
· a proposal for a Regulation (sometimes known as 'CRR
III') to make amendments to CRR with regard to (amongst other things)
requirements on credit risk, credit valuation adjustment risk, operational
risk, market risk and the output floor;
· a proposal for a Directive (sometimes known as 'CRD
VI') to make amendments to CRD with regard to (amongst other things)
requirements on supervisory powers, sanctions, third-country branches and ESG
risks; and
4. Capital management (continued)
· a proposal for a Regulation to make amendments to CRR
and the BRRD with regard to (amongst other things) requirements on the
prudential treatment of G-SII groups with a multiple point of entry resolution
strategy and a methodology for the indirect subscription of instruments
eligible for meeting the MREL requirements.
The 2021 Banking Package is subject to amendment in the course of the EU's
legislative process; and its scope and terms may change prior to its
implementation. In addition, in the case of the proposed amendments to CRD and
the BRRD, their terms and effect will depend, in part, on how they are
transposed in each member state. As a general matter, it is likely to be
several years until the 2021 Banking Package begins to be implemented
(currently expected in 2025); and certain measures are expected to be subject
to transitional arrangements or to be phased in over time.
The CET1 ratio of the Group as at 30 June 2022 stands at 14.59% and the Total
Capital ratio at 19.49% on a transitional basis. The ratios as at 30 June 2022
include reviewed profits for the six months ended 30 June 2022.
The minimum CET1 and Total Capital requirements are set out in the tables
below.
Minimum CET1 Regulatory Capital Requirements 2022 2021
Pillar I - CET1 Requirement 4.50% 4.50%
Pillar II - CET1 Requirement 1.83% 1.69%
Capital Conservation Buffer (CCB)* 2.50% 2.50%
Other Systematically Important Institutions (O-SII) Buffer 1.25% 1.00%
Minimum CET1 Regulatory Requirements 10.08% 9.69%
* Fully phased in as of 1 January 2019
Minimum Total Capital Regulatory Requirements 2022 2021
Pillar I - Total Capital Requirement 8.00% 8.00%
Pillar II - Total Capital Requirement 3.26% 3.00%
Capital Conservation Buffer (CCB)* 2.50% 2.50%
Other Systematically Important Institutions (O-SII) Buffer 1.25% 1.00%
Minimum Total Capital Regulatory Requirements 15.01% 14.50%
* Fully phased in as of 1 January 2019
The ECB has also provided non-public guidance for an additional Pillar II CET1
buffer (P2G).
The minimum Pillar I total capital requirement ratio is 8.00% and may be met,
in addition to the 4.50% CET1 requirement, with up to 1.50% by AT1 capital and
with up to 2.00% by T2 capital.
The Group is also subject to additional capital requirements for risks which
are not covered by the Pillar I capital requirements (Pillar II add-ons).
Applicable Regulation allows a part of the said Pillar II Requirements (P2R)
to be met also with AT1 and T2 capital and does not require solely the use of
CET1.
4. Capital management (continued)
In the context of the annual SREP conducted by the ECB in 2021 and based on
the final 2021 SREP decision received in February 2022, the P2R was set at
3.26%, compared to the previous level of 3.00%. The additional P2R add-on of
0.26% relates to ECB's prudential provisioning expectations as per the 2018
ECB Addendum and subsequent ECB announcements and press release in July 2018
and August 2019. This component of the P2R add-on takes into consideration
Project Helix 3. It is dynamic and can vary on the basis of in-scope NPEs and
level of provisioning. The ECB has also provided revised lower non-public
guidance for an additional Pillar II CET1 buffer. The new SREP requirements
are effective from 1 March 2022.
The Group is subject to a 3% Pillar I Leverage Ratio requirement.
The above minimum ratios apply for both BOC PCL and the Group.
The capital position of the Group and BOC PCL as at 30 June 2022 exceeds both
their Pillar I and their Pillar II add-on capital requirements. However, the
Pillar II add-on capital requirements are a point-in-time assessment and
therefore are subject to change over time.
The CBC, in accordance with the Macroprudential Oversight of Institutions Law
of 2015, sets, on a quarterly basis, the CCyB rates in accordance with the
methodology described in this law. The CBC has set the level of the CCyB rate
for risk weighted exposures in Cyprus at 0.00% for the year 2021 as well as
for the nine months up to September 2022. The CCyB for the Group as at 30 June
2022 has been calculated at 0.00%.
In accordance with the provisions of this law, the CBC is also the responsible
authority for the designation of banks that are Other Systemically Important
Institutions (O-SIIs) and for the setting of the O-SII Buffer requirement for
these systemically important banks. BOC PCL has been designated as an O-SII
and the CBC initially set the O-SII Buffer at 2.00%, revised to 1.50% in
November 2021 with effect from 1 January 2022. This buffer is being phased in
gradually, having started from 1 January 2019 at 0.50% and increasing by 0.50%
on 1 January 2020 and by 0.25% on 1 January 2022, until being fully
implemented on 1 January 2023 with the phasing-in by another 0.25%.
The EBA final guidelines on SREP and supervisory stress testing and the Single
Supervisory Mechanism's (SSM) 2018 SREP methodology provide that the own funds
held for the purposes of Pillar II Guidance (P2G) cannot be used to meet any
other capital requirements (Pillar I, Pillar II requirements or the combined
buffer requirement), and therefore cannot be used twice.
As part of the relaxation measures following the COVID-19 outbreak, on 12
March 2020, the ECB and the EBA also announced that banks are temporarily
allowed to operate below the level of capital defined by Pillar II Guidance
(P2G), the CCB and the CCyB. In July 2020, the ECB committed to allow banks to
operate below P2G and the CBR until end of 2022, without automatically
triggering supervisory actions. In February 2022, the ECB announced that it
will not allow banks to operate below the level of capital defined by their
P2G beyond December 2022.
4. Capital management (continued)
The capital position of the Group and BOC PCL as at the reporting date (after
applying the transitional arrangements) is presented below:
Regulatory capital Group BOC PCL
30 June 31 December 30 June 31 December
2022(7) 2021(8) 20229 2021(8)
€000 €000 €000 €000
Transitional Common Equity Tier 1 (CET1)(10) 1,546,079 1,619,559 1,516,432 1,592,455
Transitional Additional Tier 1 capital (Additional T1) 220,000 220,000 220,000 220,000
Tier 2 capital (T2) 300,000 300,000 300,000 300,000
Transitional Total Regulatory Capital 2,066,079 2,139,559 2,036,432 2,112,455
Risk weighted assets - credit risk(11) 9,584,900 9,678,741 9,602,565 9,697,351
Risk weighted assets - market risk - - - -
Risk weighted assets - operational risk 1,015,488 1,015,488 995,450 995,450
Total risk weighted assets 10,600,388 10,694,229 10,598,015 10,692,801
Transitional % % % %
Common Equity Tier 1 ratio 14.59 15.14 14.31 14.89
Total Capital ratio 19.49 20.01 19.22 19.76
Leverage ratio 6.92 7.45 6.82 7.35
The capital ratios of the Group and BOC PCL as at the reporting date on a
fully loaded basis are presented below:
Group BOC PCL
Fully loaded12
30 June 31 December 30 June 31 December
2022(7) 2021(8) 2022(9) 2021(8)
% % % %
Common Equity Tier 1 ratio 13.86 13.75 13.58 13.49
Total capital ratio 18.80 18.69 18.52 18.43
Leverage ratio 6.60 6.80 6.49 6.70
During the six months ended 30 June 2022 CET1 ratio was negatively affected
mainly by the phasing in of IFRS 9 and other transitional adjustments on 1
January 2022, provisions and impairments, the payment of AT1 interest, the
movement in the fair value through OCI reserves and other movements and was
positively affected by pre-provision income. As a result, the CET1 ratio has
decreased by 55 bps during the six months ended 30 June 2022.
The ECB, as part of its supervisory role, completed an onsite inspection and
review on the value of the Group's foreclosed assets with reference date 30
June 2019. The findings relate to a prudential charge which will decrease
based on BOC PCL's progress in disposing the properties in scope. The amount
is being directly deducted from own funds since 30 June 2021. There was no
significant movement in the amount deducted since 31 December 2021. As a
result of the prudential charge deducted from own funds as at 30 June 2022,
the impact on the Group's CET1 ratio is 36 bps.
7. Includes reviewed profits for the six months ended 30 June 2022.
8. As per 2021 Annual Financial Report and Pillar III Disclosures for the year
ended December 2021.
9. Includes unaudited/unreviewed profits for the six months ended 30 June
2022.
10. CET1 includes regulatory deductions, comprising, amongst others,
intangible assets amounting to €29,541 thousand for the Group and €25,072
thousand for BOC PCL as at 30 June 2022 (31 December 2021: €30,032 thousand
for the Group and €26,452 thousand for BOC PCL). As at 30 June 2022 an
amount of €13,024 thousand is considered prudently valued for CRR purposes
and it is not deducted from CET1 (31 December 2021: €15,394 thousand).
11. Includes Credit Valuation Adjustments (CVA).
12. IFRS 9 and application of the temporary treatment of certain FVOCI
instruments in accordance with Article 468 of CRR fully loaded.
4. Capital management (continued)
In April 2021, the Company issued €300 million unsecured and subordinated
Tier 2 Capital Notes (the 'New T2 Notes') and immediately after, the Company
and BOC PCL entered into an agreement pursuant to which the Company on-lent to
BOC PCL the entire €300 million proceeds of the issue of the New T2 Notes on
terms substantially identical to the terms and conditions of the New T2 Notes.
At the same time, BOC PCL invited the holders of its €250 million Fixed Rate
Reset Tier 2 Capital Notes due January 2027 (the 'Old T2 Notes') to tender
their Old T2 Notes for purchase by BOC PCL, after which Old T2 Notes of €43
million remained outstanding.
At a meeting held on 30 November 2021, the Board of Directors resolved to
exercise BOC PCL's option to redeem the remaining nominal amount outstanding
of the Old T2 Notes. The outstanding Old T2 Notes were redeemed on 19 January
2022.
Transitional arrangements
The Group has elected in prior years to apply the 'static-dynamic' approach in
relation to the transitional arrangements for the initial application of IFRS
9 for regulatory capital purposes, where the impact on the impairment amount
from the initial application of IFRS 9 on the capital ratios is phased in
gradually. The 'static-dynamic' approach allows for recalculation of the
transitional adjustment periodically on Stage 1 and Stage 2 loans, to reflect
the increase of the ECL provisions within the transition period. The Stage 3
ECL remains static over the transition period as per the impact upon initial
recognition.
The amount added each year for the 'static component' decreases based on a
weighting factor until the impact of IFRS 9 is fully absorbed back to CET1 at
the end of the five years. The cumulative impact on the capital position as at
31 December 2021 was 50% and since 1 January 2022 at 75% of the impact on the
impairment amounts from the initial application of IFRS 9. This will be fully
phased in (100%) by 1 January 2023.
Following the June 2020 amendments to the CRR in relation to the dynamic
component a 100% add back of IFRS 9 provisions was allowed for the years 2020
and 2021, reducing to 75% in 2022, to 50% in 2023 and to 25% in 2024. This
will be fully phased in (100%) by 1 January 2025. The calculation at each
reporting period is made against Stage 1 and Stage 2 provisions as at 1
January 2020, instead of 1 January 2018. The calculation of the 'static
component' has not been amended.
In relation to the temporary treatment of unrealized gains and losses for
certain exposures measured at fair value through other comprehensive income,
Regulation EU 2020/873 allows institutions to remove from their CET1 the
amount of unrealized gains and losses accumulated since 31 December 2019,
excluding those of financial assets that are credit-impaired. The relevant
amount is removed at a scaling factor of 100% from January to December 2020,
reduced to 70% from January to December 2021 and to 40% from January to
December 2022. The Group applies the temporary treatment from the third
quarter of 2020.
Capital requirements of subsidiaries
The insurance subsidiaries of the Group, the General Insurance of Cyprus Ltd
and Eurolife Ltd, comply with the requirements of the Superintendent of
Insurance including the minimum solvency ratio. The regulated UCITS management
company of the Group, BOC Asset Management Ltd, complies with the regulatory
capital requirements of the Cyprus Securities & Exchange Commission
(CySEC) laws and regulations. The regulated investment firm (CIF) of the
Group, The Cyprus Investment and Securities Corporation Ltd (CISCO), complies
with the minimum capital adequacy ratio requirements. From 2021 the new
prudential regime for Investment Firms ('IFs') as per the Investment Firm
Regulation (EU) 2019/2033 ('IFR') on the prudential requirements of IFs and
the Investment Firm Directive (EU) 2019/2034 ('IFD') on the prudential
supervision of IFs came into effect. Under the new regime CISCO has been
classified as Non-Systemic 'Class 2' company and is subject to the new IFR/IFD
regime in full. The payment services subsidiary of the Group, JCC Payment
Services Ltd, complies with the regulatory capital requirements.
4. Capital management (continued)
Minimum Requirement for Own Funds and Eligible Liabilities (MREL)
The Bank Recovery and Resolution Directive (BRRD) requires that from January
2016 EU member states shall apply the BRRD's provisions requiring EU credit
institutions and certain investment firms to maintain a minimum requirement
for own funds and eligible liabilities (MREL), subject to the provisions of
the Commission Delegated Regulation (EU) 2016/1450. On 27 June 2019, as part
of the reform package for strengthening the resilience and resolvability of
European banks, the BRRD ΙΙ came into effect and was required to be
transposed into national law. BRRD II was transposed and implemented in Cyprus
law in early May 2021. In addition, certain provisions on MREL have been
introduced in CRR ΙΙ which also came into force on 27 June 2019 as part of
the reform package and took immediate effect.
In December 2021, BOC PCL received notification from the SRB and CBC of the
final decision for the binding MREL for BOC PCL, determined as the preferred
resolution point of entry. As per the decision, the final MREL requirement is
set at 23.74% of risk weighted assets and 5.91% of Leverage Ratio Exposure
(LRE) (as defined in the CRR) and must be met by 31 December 2025.
Furthermore, BOC PCL must comply since 1 January 2022 with an interim
requirement of 14.94% of risk weighted assets and 5.91% of LRE. The own funds
used by BOC PCL to meet the Combined Buffer Requirement (CBR) are not eligible
to meet its MREL requirements expressed in terms of risk weighted assets. BOC
PCL must comply with the MREL requirement at the consolidated level,
comprising BOC PCL and its subsidiaries. The decision is subject to annual
review by the competent authorities, updated also as changes in capital
requirements become effective.
The MREL ratio calculated according to the SRB's eligibility criteria
currently in effect, and based on internal estimate, stood at 18.61% of RWAs
as at 30 June 2022 and at 9.28% of LRE as at 30 June 2022. The ratios as at 30
June 2022 include unaudited/unreviewed profits for the six months ended 30
June 2022. The MREL ratio expressed as a percentage of RWAs does not include
capital used to meet the CBR amount which stood at 3.75% as at 30 June 2022
and is expected to increase to 4.00% on 1 January 2023.
The MREL requirement is in line with BOC PCL's expectations and funding plans.
5. Internal Capital Adequacy Assessment Process (ICAAP),
Internal Liquidity Assessment Process (ILAAP), Pillar II and Supervisory
Review and Evaluation Process (SREP)
The Group prepares annual ICAAP and ILAAP packages. Both reports for 2021 have
been completed and submitted to the ECB at the end of April 2022 following
approval by the Board of Directors.
The Group also undertakes quarterly reviews of its ICAAP results (with
reference date 30 June and 30 September) as well as on an ad-hoc basis if
needed, which are submitted to the ALCO and the Risk Committee of the Board of
Directors, considering the latest actual and forecasted information. During
the quarterly review, the Group's risk profile and risk management policies
are reviewed and any material changes/developments since the annual ICAAP
exercise are assessed in terms of capital adequacy. The annual ICAAP for 2021,
the quarterly ICAAP reviews undertaken in 2021 and a review performed in the
first quarter of 2022, indicated that the Group has sufficient capital and
available mitigants to support its risk profile and its business and to enable
it to meet its regulatory requirements, both under a baseline and stress
conditions scenarios.
The Group also undertakes a quarterly review for the ILAAP through quarterly
stress tests submitted to the ALCO and the Risk Committee of the Board of
Directors. Any material changes since the year-end are assessed in terms of
liquidity and funding. The quarterly review identifies whether the Group has
an adequate liquidity buffer to cover the stress outflows. The Group's ILAAP
analysis demonstrates that the volume and capacity of liquidity resources
available to the Group are adequate. Both the annual ILAAP for 2021 and the
quarterly ILAAP reviews, undertaken in 2021 and 2022, indicated that BOC PCL's
liquidity position is at a very comfortable level. BOC PCL maintains liquidity
resources which are adequate to ensure its ability to meet obligations as they
fall due under ordinary and stressed conditions.
5. Internal Capital Adequacy Assessment Process (ICAAP),
Internal Liquidity Assessment Process (ILAAP), Pillar II and Supervisory
Review and Evaluation Process (SREP) (continued)
The ECB, as part of its supervisory role, has been conducting the SREP and
other inspections (onsite/ off-site/ targeted reviews/ deep-dives) on the
Group. SREP is a holistic assessment of, amongst other things, the Group's
business model, internal governance and institution-wide control arrangements,
risks to capital and adequacy of capital to cover these risks and risks to
liquidity and adequacy of liquidity resources to cover these risks. The
objective of the SREP is for the ECB to form an up-to-date supervisory view of
the Group's risks and viability and to form the basis for supervisory measures
and dialogue with the Group. As a result of these supervisory processes,
additional capital and other requirements could be imposed on the Group,
including a revision of the level of Pillar II add-ons, as the Pillar II
add-ons capital requirements are a point-in-time assessment and therefore
subject to change over time.
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