Capital adequacy is the maintenance of a level of capital by the PKO Bank Polski SA Group exceeds the higher of: the sum of regulatory capital requirements (the so-called pillar 1) and the sum of internal capital requirements (the so-called pillar 2).

The objective of capital adequacy management is to continuously maintain capital on a level that is adequate to the risk scale and profile of the Group's activities.

The process of managing the Group’s capital adequacy comprises:

• identifying and monitoring of all of significant risks,
• assessing internal capital to cover the individual risk types and total internal capital,
• monitoring, reporting, forecasting and limiting of capital adequacy,
• performing internal capital allocations to business segments, client segments and entities of the Group in connection with profitability analyses,
• using tools affecting the capital adequacy level (including: tools affecting the level of equity, the scale of equity item reductions and the level of the loan portfolio).

The main measures of capital adequacy are:

• the capital adequacy ratio whose minimum level in accordance with the Banking Law is 8%,
• the ratio of equity to internal capital whose acceptable minimum level in accordance with the Banking Law is 1.0,
• the capital adequacy ratio of common equity Tier 1 (Common Equity Tier 1 Ratio).

As at 31 December 2013 compared with 31 December 2012, the Group’s capital adequacy ratio increased by 0.69 pp. to the level of 13.58%, mainly due to an increase in the Group’s own funds for the purposes of capital adequacy.

The level of the Group’s capital adequacy in 2013 remained at a safe level, significantly above the statutory limits.

64.1. Own funds for capital adequacy purposes

Own funds for the purposes of capital adequacy are calculated in accordance with the provisions of the Banking Law and Resolution of the Polish Financial Supervision Authority No. 325/2011 of 20 December 2011 on deductions from own funds, their amount, their scope and conditions of their deduction from a bank's own funds, other statement of financial position items included in supplementary funds, their amount, their scope and conditions of inclusion in the bank’s supplementary funds, deductions from supplementary funds, their amount, their scope and conditions of their deduction from supplementary funds and the scope and manner of treating the activity of banks that are members of holdings in calculating own funds (Official Journal of PFSA No. 13, item 49).

Own funds comprise basic funds, supplementary funds and short-term capital.

Basic funds (so-called Tier 1) are comprised of the following items:

1. principal funds comprising: share capital, reserve capital, other reserve capital,
2. general banking risk fund,
3. unappropriated profits from previous years,
4. net profit prior to approval and net profit for the current reporting period, calculated based on appropriate accounting standards, decreased by any expected charges and dividends, in amounts not exceeding amounts audited by certified public accountants, in accordance with the Banking Law, Article 127.2, Point 2c.

Basic funds are reduced by deducting the following items:

1. intangible assets stated at carrying amount,
2. the Bank’s equity exposures to financial institutions, lending institutions, domestic banks, foreign banks and insurance companies – in the amount of 50% of the value of such exposures,
3. unrealised losses on debt, equity instruments and other receivables classified as available for sale,
4. negative currency translation differences from foreign operations,
5. negative amounts in respect of adjustments on revaluation of assets in the trading portfolio. 

Supplementary funds (so-called Tier 2) are comprised of the following items:

1. subordinated liabilities,
2. unrealised gains on debt and equity instruments classified as available for sale – in the amount of 80% of their pre-tax value,
3. positive currency translation differences from foreign operations.

Moreover, the supplementary funds are reduced by 50% of the value of the Bank’s equity exposures to financial institutions, lending institutions, domestic banks, foreign banks and insurance companies. If the amount of reduction would result in supplementary funds falling below nil, the excess above the value of the supplementary funds is subtracted from the basic funds.

The own funds of the Group include also short-term capital.

In addition, the following items are included in the calculation of consolidated own funds of the Group:

1. goodwill of subsidiaries,
2. non-controlling interests in equity. 

Information on the structure of the Group’s own funds is presented in the table below:

64.2. Capital requirements (Pillar 1)

The Group calculates capital requirements in accordance with the Resolution No. 76/2010 of the Polish Financial Supervision Authority dated
10 March 2010 on scope and detailed principles of setting capital requirements in connection with the individual risk types (Official Journal of PFSA No. 2, item 11 dated 9 April 2011 with subsequent amendments):

• in respect of credit risk – using the standard method,
• in respect of the Bank’s operational risk – using the advanced method (AMA), and for Group entities - the basic index approach (BIA),
• in respect of market risk - using the basic methods.

The scale of the Bank’s and the Group’s trading activities is significant, therefore the total capital requirements constitute sum of the capital requirements for:

1. credit risk – including credit risk of the banking book and counterparty credit risk,
2. market risk – including foreign exchange risk, commodities price risk, equity securities price risk, specific risk of price of debt instruments, general risk of interest rates,
3. operational risk,
4. other types of capital requirements in respect of:

• • settlement and delivery risk,
  • the risk of exceeding the exposure concentration limit and the large exposure limit,
  • the risk of exceeding the capital concentration threshold.

The table below presents the Group’s exposure to particular types of risk. 

An increase in the capital requirement in 2013 in respect of credit risk resulted from a significant increase in the volume of loan portfolio (statement of financial position and off-balance-sheet exposures) by approx. 4%.

A decrease in the capital requirement in respect of market risk by approx. 34% to the level of PLN 327 million includes mainly issue of corporate bonds underwriting and a corporate bonds portfolio (total decrease in the requirements on these bonds amounted to approx. by 57%).

The Bank’s capital requirement in respect of operating risk for both 2013 and 2012 was calculated under the advanced measurement approach (AMA), and a requirement on operating risk of the Group entities was calculated under the basic index approach (BIA). A slight decrease of the requirement in respect of operating risk from PLN 660 million (as at 31 December 2012) to PLN 631 million (as at 31 December 2013) occurred.

The Group calculates capital requirements on account of credit risk according to the following formula:

• in case of statement of financial position items – a product of a carrying amount, a risk weight of the exposure calculated according to the standardised method of credit risk requirement and 8% (considering recognised collaterals),
• in case of granted off-balance sheet liabilities – a product of nominal value of liability (considering value of provisions for the liability), a risk weight of the product, a risk weight of off-balance sheet exposure calculated according to the standardised method of credit risk requirement and 8% (considering recognised collaterals),
• in case of off-balance sheet transactions (derivative instruments) – a product of risk weight of the off-balance sheet exposure calculated according to the standardised method of credit risk requirement, equivalent in the statement of financial position of off-balance sheet transactions and 8% (the value of the equivalent in the statement of financial position is calculated in accordance with the mark-to-market method).

Risk-weighted amounts divided into portfolios (on account of credit risk of instruments included into banking portfolio, counterparty credit risk and specific risk of instruments from the trading portfolio) as at 31 December 2013 and as at 31 December 2012 are as follows:

64.3. Internal capital (Pillar 2)

The Group calculates internal capital in accordance with the Resolution No 258/2011 of the Polish Financial Supervision Authority of 4 October 2011 on detailed principles for functioning of risk management system and internal control system and detailed terms of estimating internal capital by banks and reviewing the process of estimating and maintaining internal capital and the principles for determining the variable salary components policy for persons holding managerial positions in the Bank (Official Journal of PFSA No. 11, item 42 as at 23 November 2011). Internal capital is the amount of capital estimated by the Group that is necessary to cover all of the identified significant risks characteristic of the Group’s activities and the effect of changes in the business environment, taking account of the anticipated risk level.

The internal capital in the PKO Bank Polski SA Group is intended to cover each of the significant risk types:

• credit risk (including default and concentration risk),
• currency risk,
• interest rate risk,
• liquidity risk,
• operational risk,
• business risk (taking into consideration strategy risk).

Materialisation of macroeconomic changes risk, model risk and compliance risk is reflected in the estimates of internal capital for covering the types of risk: credit, interest rate, currency, operational and business.

The Bank regularly monitors the significance of the individual risk types relating to the activities of the Bank and other Group’s subsidiaries.

The internal capital for covering the individual risk types is determined using the methods specified in the internal regulations. In the event of performing internal capital estimates based on statistical models, the annual forecast horizon is adopted and a 99.9% confidence level. The total internal capital of each entity of the Group is the sum of internal capital amount necessary to cover all of the significant risks for the entity. The total internal capital of the Group is the sum of internal capital amount of the Bank and all Group entities. The correlation coefficient for different types of risk and different Group entities used in the internal capital calculation is equal to 1.

In 2013, the relation of the Group’s own funds to its internal capital remained on a level exceeding both the threshold set by the law and the Group’s internal limits.

64.4. Disclosures (Pillar 3)

In accordance with § 6 of the Resolution No. 385/2008 of the Polish Financial Supervision Authority dated 17 December 2008, on the detailed principles and methods for banks to disclose qualitative and quantitative information concerning capital adequacy and the scope of the information to be announced (Official Journal of PFSA of 2008, No. 8, item 39 with subsequent amendments). The PKO Bank Polski SA, which is the parent company within the meaning of § 3 of the resolution, publishes information about capital adequacy in a separate document on an annual basis, not later than within 30 days of the date of authorisation of the annual financial statements by the Ordinary General Shareholders’ Meeting.

Details of the scope of capital adequacy information disclosed, the method of its verification and publication are presented in the
PKO Bank Polski SA Capital Adequacy Information Policies, which are available on the Bank’s website (www.pkobp.pl).