The purpose of risk and capital adequacy management is to secure OP Financial Group’s and its entities’ risk-bearing capacity and, thereby, ensure business continuity. Risk-bearing capacity is made up of effective risk management that is proportionate to the extent and complexity of operations and of adequate capital resources based on profitable business operations.
Risk and capital adequacy management involves risk identification, measurement, assessment and mitigation. It also involves determining reliably and independently the size of the capital buffer required for various risks and business operations, and allocating capital systematically in line with current and planned risk-taking. The Group’s liquidity management is also part of risk and capital adequacy management.
OP Financial Group’s strategy outlines the Group’s risk appetite and risk management priorities that help to ensure strategy implementation. According to the strategy, the Group will secure its risk-bearing capacity in all circumstances and keep risk-taking moderate vis-à-vis the risk-bearing capacity. Each Group entity focuses on carrying out its role according to its service capabilities and risk-bearing capacities in accordance with shared business models.
OP Cooperative (the central cooperative) is responsible for OP Financial Group's risk and capital adequacy management and for ensuring that the Group’s risk management system is adequate and up to date. The central cooperative issues Group entities with guidelines for ensuring risk management and ensures, through supervision, that the entities operate in accordance with official regulations, their own rules, guidelines issued by the central cooperative, OP Financial Group’s internal procedures and procedures that are appropriate and ethically sound for customer relationships. OP Financial Group entities are responsible for their own risk and capital adequacy management in accordance with the nature and extent of their operations.
OP Financial Group's quantifiable risks are restricted by means of limits and a system of control limits that guide operations at Group level, in member cooperative banks and entities belonging to OP Cooperative Consolidated. The central cooperative's Supervisory Board has determined risk limits for 2015 concerning OP Financial Group’s capital adequacy as well as for credit, liquidity, market and underwriting risks.
A more detailed description of OP Financial Group’s risk and capital adequacy management principles can be found in Note 2 “OP Financial Group’s risk management and capital adequacy management principles”.
On 31 December, OP Financial Group’s capital base, calculated according to the Act on the Supervision of Financial and Insurance Conglomerates (FiCo), exceeded the minimum amount specified in the Act by EUR 4,6 billion (3,0). The FiCo buffer was increased by the Group's earnings, Profit Share issues and a decrease in the risk exposure amount (REA) in Banking and, on the other hand, the buffer was decreased by the capital conservation buffer of 2.5% adopted in banking capital adequacy in Finland at the beginning of 2015. The capital conservation buffer increased the consolidated capital adequacy requirement from 8% to 10.5%, calculated as percentage of risk-weighted assets. The ratio of the Group capital base to the minimum capital requirement was 207% (189), with the requirement for the capital conservation buffer reducing the ratio by 54 percentage points. As a result of the buffer requirements, the FiCo solvency does no longer reflect the minimum level of capital base of the FiCo group but the level within which the group can operate without regulatory obligations resulting from buffers below the required level. The former POP Group banks which joined the Group had a minor effect on capital adequacy.
The Group's CET1 ratio was 19.5% (15.1) on 31 December. The issues of Profit Shares increased the CET1 ratio by 2.2 percentage points. In the first quarter, OP adopted updated probabilities of default (PD) according to permission from the supervisor. This adoption improved the CET1 ratio by 0.8 percentage points. Gains arising from the remeasurement of defined benefit pension plans (IAS 19) increased the Group's CET1 ratio by around 0.9 percentage points in the financial year.
OP Financial Group's banking capital adequacy is on a solid basis compared to the statutory requirements and those set by the authorities. The statutory minimum for the capital adequacy ratio is 8% and for the CET1 ratio 4.5%. The requirement for the capital conservation buffer of 2.5% under the Act on Credit Institutions increases in practice the minimum capital adequacy ratio to 10.5% and the CET1 ratio to 7%.
The Group's CET1 capital was EUR 8.2 billion (6.4) on 31 December. CET1 capital was increased by the issue of Profit Shares, Banking performance for the period, IAS 19 items and dividends from the Group's insurance institutions. Profit shares accounted for EUR 2.5 billion of CET1 capital at the end of December.
On 31 December, REA totalled EUR 41.8 billion (42.3), or 1.0% lower than on 31 December 2014. The updated PD values for corporate exposure reduced REA by around 4.2%. In view of the PD changes, the average risk weights of corporate exposures increased slightly. Average risk weights of other major exposure classes went down slightly.
Equity investments include EUR 6.5 billion in risk-weighted assets of the Group's internal insurance holdings.
In October 2015, OP Financial Group received permission from the ECB to treat insurance holdings within the conglomerate as risk-weighted assets according to the previous practice. The method applied to insurance holdings leads to a risk weight of approximately 280%. However, the ECB has the option of cancelling the permission as part of the harmonisation of supervisory options. OP Financial Group's CET1 ratio would decrease by about 0.6 percentage points if the special permission were cancelled and OP transferred to the deduction treatment of insurance holdings. Such a change in treatment would not, however, have any effect on OP Financial Group's real risk-bearing capacity.
The requirements for capital buffers implemented through national legislation will add to capital requirements further. In July 2015, the Financial Supervisory Authority set the requirement for the O-SII buffer for OP Financial Group as an Other Systemically Important Institution at 2%, effective as of 7 January 2016. Upon entry into force, the O-SII buffer will reduce the FiCo capital adequacy ratio by an estimated 22 percentage points. The Group already fulfils the capital conservation buffer requirement. In December 2015, the Financial Supervisory Authority decided not for the time being to impose a countercyclical capital buffer requirement on banks, but began preparations for setting higher risk weights on housing loans in an effort, according to the Authority, to prepare for an increased systemic risk. The Financial Supervisory Authority makes a macroprudential policy decision on a quarterly basis.
The upcoming regulations include a ratio of the degree of indebtedness, the leverage ratio. The leverage ratio of OP Financial Group’s Banking is estimated at about 7.2% based on the existing interpretations, calculated using the December-end figures, with the minimum level in the draft regulations being 3%.
The solvency regulations of the insurance sector changed in early 2016 and are not included in statutory audit in accordance with the Insurance Companies Act that entered into force on 1 January 2016. Changes in the insurance sector’s Solvency II regulations aim to improve the quality of insurance companies’ capital base, improve their risk management, increase the risk-based capital requirements and harmonise insurance sector solvency requirements in Europe. The regulations will on the one hand increase capital requirements, and on the other increase the capital base, which will decrease the capital adequacy ratio on a net basis under the Act on the Supervision of Financial and Insurance Conglomerates.
Due to regulatory changes, the FiCo capital adequacy will decrease from the current 207% to 156% at beginning of 2016.
OP Financial Group is supervised by the ECB. The ECB has imposed on OP Financial Group a discretionary capital requirement buffer as part of the supervisory review and evaluation process (SREP). When taking account of the requirement for CET1 capital, the discretionary capital requirement buffer is 9.75% In view of OP Financial Group's strong capital base and high capital adequacy target, the discretionary capital buffer requirement has no practical implications for the Group's capital adequacy position or business. To OP Financial Group's knowledge, the ECB has imposed on all banks under its supervision a comparable discretionary capital buffer requirement based on the comprehensive assessment uniformly applied to banks.
OP Financial Group’s risk exposure has remained stable. The Group has a strong risk-bearing capacity that secures business continuity.
The strong risk-bearing capacity and moderate target risk exposure level helped to maintain the Group's credit risk exposure stable in a situation where the operating environment remained challenging.
OP Financial Group’s funding and liquidity position is good. OP Financial Group had good access to funding. During the financial year, the Group issued long-term bonds worth EUR 6.5 billion. The loan-to-deposit ratio remained stable during the financial year.
OP Financial Group's market risk exposure was stable during the financial year. The Group's VaR, a measure of market risk, was EUR 174 million (188) on 31 December. The Group's VaR includes the balance sheet total of the insurance institutions, trading, liquidity buffer and the Group Treasury's interest rate risk exposure.
The Group expects its operational risks to be moderate although outsourced services still involve increased risk. During 2015, the Group improved its capabilities to prevent the detrimental effects of denial-of-service attacks and successfully managed to prevent the effects.
Risks associated with the Group's defined benefit pension plans relate to interest rate and market risk, future increases in pension benefits and longer life expectancy. A change in the discount rate for pension liabilities has a substantial effect on the amount of pension liabilities. The decrease in net liabilities related to defined benefit pension plans recognised in other comprehensive income during the financial year improved comprehensive income before tax by EUR 519 million.
Major risks within Banking include credit risk and market risk.
Banking's credit risk exposure remained stable, at a moderate risk level. Doubtful receivables totalled EUR 2.1 billion (1.6). Doubtful receivables refer to receivables that are more than 90 days past due, other receivables classified as risky and forborne receivables due to the customer's financial difficulties. Forbearance measures consist of concessions agreed at the customers' initiative to contractual payment terms towards the customer to make it easier for them to manage through temporary payment difficulties. Member cooperative banks make every effort to find solutions to overcome customers' temporary financial difficulties. Impairment losses remained low, accounting for 0.10% (0.12) of the loan and guarantee portfolio.
During the financial year, the loan and guarantee portfolio increased by EUR 4.2 billion to EUR 77.8 billion. Private customers accounted for 60% (62) of the loan and guarantee portfolio. Of the six main categories for private customer exposure, 83% (81) of the exposures belonged to the top two categories, and 3% (4) to the two lowest.
Corporate customers' (including housing corporations) exposures represented 36% (36) of the loan and guarantee portfolio. Of corporate exposure, the highest rating category 1–5.5 exposure represented 59% (58) and the exposure of the lowest two rating categories amounted to EUR 441 million (501), accounting for 1.2% (1.5) of the total corporate exposure.
No single customer's exposure exceeded 10% of the capital base after allowances and other recognition of credit risk mitigation. The Banking capital base covering major customer exposure amounted to EUR 9.4 billion (7.3).
In the Companies and housing associations sector, the most significant industries measured by exposure were Renting and Operation of Residential Real Estate representing 21.9% (21.6), Renting and Operating of Other Real Estate representing 11.7% (10.7) and Trade representing 9.6% (10.0). A total of 91% of exposures within Renting and Operation of Residential Real Estate were those by housing associations and 16% those guaranteed by general government.
Major risks within Non-life Insurance include underwriting risks associated with claims developments, market risks associated with investments covering insurance liabilities, interest rates used in insurance liability valuation and the difference between the discount rate applied to insurance liabilities and market interest rates.
No significant changes took place in Non-life Insurance's underwriting risks. Non-life Insurance's most significant market risk is associated with increasing insurance liability value and capital requirement resulting from lower market interest rates. Despite volatile long-term market interest rates, the solvency position under Solvency II was clearly stronger at the end of the financial year than the year before. The investment risk level (VaR with 95% confidence) at the end of the financial year was slightly lower than at the turn of the previous year. OP has reduced equity and credit risks associated with the investment portfolio. OP has moderately increased the portfolio duration with respect to hedging insurance liability against interest rate risks. OP has also used interest rate derivatives to hedge against interest rate risk associated with insurance liability.
The key risks associated with Wealth Management are the market risks of Life Insurance's investment assets, the interest rate used for the valuation of insurance liabilities and the faster-than-expected life expectancy increase.
No major changes took place in Life Insurance's underwriting risks. The Life Insurance solvency position under Solvency II was clearly stronger at the end of the financial year than the year before. The insurance portfolio transferred from Suomi Mutual Life Assurance Company (Suomi Mutual) on 31 December 2015 increased the investment portfolio's market value by about EUR 1.3 billion, or about 30%. As a result of the portfolio transfer, the investment risk level (VaR with 95% confidence) increased by around 25%. The market risk level associated with the total balance sheet did not change at the time of the transfer. Before the portfolio transfer, the risk level was at the level recorded at the previous turn of the year. During the financial year, OP reduced equity and credit risk and moderately increased the portfolio duration with respect to hedging insurance liability against interest rate risks. OP has also used interest rate derivatives to hedge against interest rate risk associated with insurance liability.
Major risks exposed by Other Operations include credit and market risks associated with the liquidity buffer, and liquidity risks. The market risk is highest in notes and bonds included in the liquidity buffer.
Despite an increase in investments in the liquidity buffer, market risks (VaR with 95% confidence) decreased slightly during the financial year as a result of allocation changes.
OP Financial Group secures its liquidity through a liquidity buffer which consists mainly of deposits with central banks and receivables eligible as collateral for central bank refinancing. The liquidity buffer and other sources of additional funding based on the contingency funding plan are sufficient to cover funding for at least 24 months in the event wholesale funding becomes unavailable and total deposits decrease at a moderate rate.
OP Financial Group monitors its liquidity and the adequacy of its liquidity buffer using the LCR (Liquidity Coverage Ratio). According to the transitional provisions, the LCR must be at least 60% during the fourth quarter of 2015 and at least 100% from the beginning of 2018. In accordance with the European Commission Liquidity Delegated Act, the calculated estimate of OP Financial Group's LCR ratio was 116% at the end of December.
The liquidity buffer comprises notes and bonds issued by governments, municipalities, financial institutions and companies all showing good credit ratings, securitised assets and loans eligible as collateral. The notes and bonds included in the liquidity buffer are based on mark-to-market valuations.