Consultancy Oliver Wyman was commissioned
by Banco Sabadell to conduct a stress test
to measure the resilience of its balance sheet
in the period June to December 2016.
In anticipation of tests of balance-sheet resilience under different stress scenarios which the European Central Bank is to carry out on European banks in 2014 in coordination with the European Banking Authority, Banco Sabadell engaged consultancy Oliver Wyman to conduct its own internal stress test. The test measured the resilience of Banco Sabadell’s balance sheet in the period June 2013 to December 2016 under two specified macroeconomic scenarios: one central and one pessimistic. The result was that, over the test period, Banco Sabadell was found to have a loss absorption capacity and a capital surplus (to cover losses in the loan book and the foreclosed asset portfolio) of 24,800 million and 5,800 million, respectively, under the central scenario and 25,300 and 2,400 million under the pessimistic scenario.
The chief categories of risk inherent in the business of Banco Sabadell and its group are credit risk, market risk and operational risk.
The accurate and efficient management and control of risk is critical to realizing the aim of maximizing shareholder value while ensuring an appropriate degree of financial strength. The management and control of risk comprises a broad framework of principles, policies, procedures and advanced evaluation methodologies, integrated within an efficient decision-making structure. These are fully and clearly set out in the Annual Accounts, the Report of the Directors, the Report on Corporate Governance and the Basel Pillar 3 Disclosures, all of which can be found on the group’s web site.
Banco Sabadell complies with guidelines drawn up under the Basel Capital Accord, a fundamental principle of which is that a bank’s capital requirements should be more closely related to risks actually incurred, based on internal risk measurement models which have been independently validated. The Bank has supervisory approval for the use of its own internal models in estimating its regulatory capital requirements (see Figure F3 & F4).
Credit risk
Credit risk is the possibility that losses may be incurred as a result of borrowers failing to meet their obligations or through losses in value due simply to deterioration in borrower quality.
To maximize the business opportunities provided by each customer and to guarantee an appropriate degree of security, responsibility for monitoring risks is shared between the relationship manager and the risk analyst, who are thus able to obtain a comprehensive view of each customer’s individual circumstances.
The Board of Directors delegates powers and discretions to the Risk Control Committee, which then sub-delegates authority at each level. The addition of controls on these authority thresholds to loan approval management systems ensures that the powers delegated at each level are appropriate to the expected loss estimates for all loan applications by business customers.
The establishment of effective processes for managing existing risk exposures also benefits the process of managing past due accounts, since the early identification of probable default cases ensures that measures can be taken proactively. With an early warning system, the quality of a risk can be monitored in an integrated way and risks transferred to recovery specialists who are best equipped to determine the most suitable type of recovery procedure in each case (see Figure F1 & F2).
F1 Business loan portfolio.
Credit rating profile
F2 Individual customer loan portfolio.
Credit rating profile
F3
Allocation of economic capital (by type of risk)
1 | Credit risk | 80% |
2 | Structural risk | 7% |
3 | Operational risk | 8% |
4 | Market risk | 1% |
5 | Other risks | 4% |
F4
Overall risk profile by customer category (distribution of credit risk exposures)
1 | Large corporates | 17.14% |
2 | Midsize businesses | 11.63% |
3 | Small businesses | 9.80% |
4 | Retailers and sole proprietors | 2.12% |
5 | Mortgages | 27.52% |
6 | Consumer loans | 1.08% |
7 | Banks | 3.93% |
8 | Sovereigns | 17.32% |
9 | Other | 9.45% |
F5
Credit risk
(distribution by geography)
1 | Spain | 92.76% |
2 | Other European Union | 3.44% |
3 | USA & Canada | 2.69% |
4 | Rest of world | 0.41% |
5 | Latin America | 0.59% |
6 | Other | 0.11% |
F6
Counterparty risk
(distribution by credit rating)
1 | AAA / Aaa | 0.00% |
2 | AA+ / Aa1 | 0.00% |
3 | AA / Aa2 | 0.00% |
4 | AA- / Aa3 | 1.12% |
5 | A+ / A1 | 31.40% |
6 | A / A2 | 14.12% |
7 | A- / A3 | 1.62% |
8 | BBB+ / Baa1 | 3.24% |
9 | BBB / Baa2 | 10.14% |
10 | BBB- / Baa3 | 16.86% |
11 | BB+ / Ba1 | 2.66% |
12 | BB / Ba2 | 11.74% |
13 | Resto | 7.09% |
F7
Counterparty risk
(distribution by geography)
1 | E.M.U. | 60.88% |
2 | Rest of Europe | 9.00% |
3 | Other USA & Canada | 27.55% |
4 | US Investment banks | 1.57% |
5 | Rest of world | 1.00% |
Country risk
This is the risk of incurring loss from exposures to sovereign borrowers or to persons domiciled in a particular country, for reasons connected with national sovereignty or the economic situation of the country. Country limits are approved by the Risk Control Committee and are constantly monitored to ensure that any deterioration in the political, economic or social situation in a country can be detected in good time (see Figure F5).
Credit risk in market trading
This is the risk associated with trading in financial instruments in market transactions with financial counterparties and in the fixed-income portfolio. Banco Sabadell has a system in place for assessing and managing these risks which allows compliance with approved limits to be monitored and controlled on a daily basis. In addition, to mitigate exposure to counterparty risk Banco Sabadell maintains netting agreements negotiated with the majority of its counterparties. The collateral provisions of these agreements ensure that exposure to such counterparties is significantly reduced (see Figure F6 & F7).
Market risk
Discretionary market risk
Discretionary market risk arises from the possibility of loss in the value of financial asset positions due to variations in any of the factors affecting market risk (stock prices, interest rates, exchange rates or credit spreads).
Discretionary market risk is measured, in most cases, by the VaR (Value at Risk) method, which allows the risks on different types of financial market transaction to be analysed as a single class. VaR limits are approved by the Risk Control Committee and are assigned on a top-down basis, with the overall limit being divided into sub-limits for different business units and risk factors down to individual portfolio level. In addition to VaR limits other types of limit are applied, such as sensitivity, nominal value and stop-loss limits; these, along with VaR, ensure that a complete assessment of market risk exposure can be obtained. Market risk is monitored on a daily basis and reports on current risk levels and on compliance with the limits assigned to each unit are sent to the relevant control functions. The following graph (F8) shows the movement of the 1-day VaR for trading operations by the group’s treasury market operations in the year 2013 at a 99% confidence level.
Structural interest rate and liquidity risk
Interest rate risk
Interest rate risk is caused by changes, as reflected in the position or the slope of the yield curve, in the interest rates to which asset, liability and off-balance sheet positions are linked. Gaps or mismatches arise between these items because of differences in repricing and maturity dates so that rate changes affect them at different times; this in turn affects the robustness and stability of results. The sensitivity of net interest income and shareholders’ equity to a 100 basis point change in interest rates for the years 2012 and 2013 is illustrated in the following diagram (F9).
Liquidity risk
This can be defined as the possibility of the Bank’s being unable to meet payment commitments, even if only temporarily, due to a lack of liquid assets or of its being unable to access the markets to refinance debts at a reasonable cost. Liquidity risk may be caused by external factors such as a financial market downturn, a systemic crisis or reputational issues, or internally, by an excessive concentration of maturing liabilities. Banco Sabadell keeps a close watch on day-to-day changes in its liquid asset position and holds a diversified portfolio of such assets. It assesses the quality of its portfolio of liquid assets by studying the sensitivity of these assets to different scenarios. In addition, liquidity gap analysis is used to manage foreseeable mismatches between cash inflows and outflows over a medium-term horizon.
The Bank carries out regular liquidity stress testing exercises to enable it to assess inflows and outflows of funds and the impact of these flows on its cash position under different scenarios. It has a contingency plan to respond to unexpected scenarios that could cause an immediate funding requirement.
F8 Market risk 2013 (€Mn.)
- VaR
- Interest rate
- Exchange rate
- Equity
- Credit spread
Operational risk
Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from unforeseen external events. Banco Sabadell pays particular attention to operational risk and has implemented a management, measurement and oversight framework that fulfils the conditions necessary to opt for the use of an advanced model for calculating regulatory capital charges for operational risk.
Senior managers and the Board of Directors play a direct, hands-on role in managing operational risk by approving the management framework and its implementation as proposed by an Operational Risk Committee made up of senior managers from different functional areas of the company; they also ensure that regular audits are carried out on the management strategy being applied, the reliability of the information being reported, and the internal validation tests required by the operational risk model. The group has a specialized central unit to manage operational risk, whose main functions are to coordinate, supervise and drive forward the identification, assessment and management of risks by process managers in line with Banco Sabadell’s process-based approach.
The database contains historical records of actual losses resulting from operational risk going back to 2002. It is constantly being updated as information is received on losses and also on recoveries, whether resulting from the Bank’s own efforts or from insurance provision.
Compliance risk
Compliance risk is the risk of incurring legal or administrative sanctions, significant financial loss or reputational damage as a result of an infringement of laws, regulations, internal procedures and banking industry codes of conduct.
The Banco Sabadell group has installed a more robust and effective control infrastructure in all areas where a compliance risk may be present, such as prevention of money laundering and the financing of terrorism, market abuse, internal codes of conduct and investor protection (MiFID). Key actions implemented in 2013 included the following:
Constantly updated anti-money laundering, Know-your-Customer and customer acceptance systems and procedures.
Expanded and more rigorous measures to bring greater transparency to all dealings with customers, particularly in the marketing of products and the terms of contracts.
Improving investor protection by implementing new procedures to evaluate the timeliness and suitability of investments.
Establishing stronger mechanisms for detecting possible market abuse.
Strengthening the system for overseeing compliance with the group’s Internal Code of Conduct for trading on the securities market.
Driving and verifying implementation of the Foreign Account Tax Compliance Act (FATCA).
F9 Structural interest rate risk
(interest rate sensitivity)
- Sensitivity of net interest income (€Mn.)
- % Sensitivity of shareholders’ equity (%)