Risk Management Report Jyske Bank 2008
You can read the report and view the tables and charts on Jyske Bank's web site
www.jyskebank.info
Introduction
The object of this risk management report is to give the reader insight into the
Jyske Bank Group's risk and capital management procedures and the regulatory
capital requirements.
First the report describes the Group's risk management organisation and approach
to risk followed by a description of the risk and capital management procedures.
The description introduces the risks to which the Group is exposed, dealing in
detail with the following risks: credit risk, market risk, liquidity risk and
operational risk.
As will be evident, the advanced internal ratings-based risk management approach
and a strong capital base are essential to the Group, so risk management is an
integral part of the Group's day-to-day management and its strategic
decision-making.
Appendix 1 is a glossary with brief definitions of the main concepts used in the
report.
Appendix 2 sets out supplementary information and tables.
The risk and capital management organisation at Jyske Bank
Overall responsibility
The Supervisory Board lays down and regularly reviews the overall policies,
guidelines and principles for risk and capital management and regularly receives
reports on exposure and the utilisation of allocated risk limits.
Treasury, Finance and Risk Management is in charge of overall financial and risk
management as well as asset and liability management. The business unit consists
of:
- functions responsible for the Group's own securities portfolio and asset and
liability management (Treasury);
- functions responsible for Group financial management and for the
implementation of adviser-oriented financial and risk management tools
(Finance);
- functions whose task is to measure, monitor, analyse, model and report Group
risk exposure and capital position (Risk Management).
Jyske Bank's risk management organisation
To view the chart Jyske Bank's risk management organisation. please visit Jyske
Bank's web site www.jyskebank.info
The functions which enter into transactions and assume risk are segregated from
those which are in charge of overall risk management.
Risk management
The business unit Risk Management checks that the Group's exposure does not
exceed the limits laid down by the Supervisory Board.
Risk Management also submits new risk management principles and policies to the
Executive Board and the Supervisory Board for approval. Moreover, Risk
Management is responsible for the implementation of these principles and
policies with a view to improving both risk management and capital allocation.
Day-to-day management of Group credit risk is undertaken by account managers and
the central credit department, whereas the overall monitoring of the Group's
aggregate credit exposure is undertaken by Risk Management.
Treasury is responsible for the day-to-day management of Group market risk.
Investments made by Treasury are in general based on macroeconomic principles
and are thus of a long-term nature.
Treasury undertakes strategic liquidity management.
Heads of units are responsible for operational risk management in their own
unit. The management of significant Group operational risks is monitored by Risk
Management.
At quarterly meetings of the Group Risk Committee, subjects with relation to the
following are discussed:
- regulatory requirements for capital-adequacy calculation;
- internal procedures for risk measurement and management;
- the Group's capital base, the solvency requirement, and capital and liquidity
reserves (with attached contingency plans);
- allocation of risk capital to business units and risk types;
- material changes of the model set-up for risk management, and the annual
re-estimate and validation of this setup.
Group market risk positions are assessed at monthly meetings of the Asset and
Liability Committee. The Committee must ensure that the Group's actual market
risk profile coincides with the intended market risk profile.
The business unit Risk Management
Risk Management's organisation is illustrated in the below chart.
To view The Division's view on risk chart, please visit Jyske Bank's web site
www.jyskebank.info
The Division's view on risk
The core element of the view on risk is the Group setup for economic capital,
which is described in more detail later in the report. In general terms,
economic capital expresses the maximum probable loss over a given period with a
given probability. Economic capital is thus a VaR setup (over a 1-year horizon)
for those risk types to which the Group wishes to apply quantitative modelling;
that is, all main risk types.
However, the risks extend beyond the next twelve months, and there are elements
which the VaR setup does not take into account. To get an overview of the
Group's aggregate risk profile, the Group setup for economic capital is
therefore supplemented with macroeconomic stress tests, partial sensitivity
analyses, top-down analyses, expert assessments, etc.
Day-to-day operations and the overall picture of risk are subject to monitoring
and reporting, and the underlying quantitative models are constantly reviewed,
validated and improved.
The business unit thus consists of five functions
Credit Risk
Credit Risk is responsible for monitoring the Group's credit risk exposure of
every kind. Monitoring involves
- credit reviews of the Group's domestic and international units and the Group's
financial subsidiaries as well as reviews of data quality at the Group's
domestic units and Jyske Finans;
- monitoring of Group credit risk and reporting to management and external
interested parties (including the Danish Financial Supervisory Authority) of
impairment charges/provisions;
- assignment of credit ratings made by experts and monitoring of credit ratings
and the collateral values of specific asset types.
Market Risk
Market Risk is responsible for ensuring ongoing development of the Group's risk
measurement and risk management tools in relation to market risk and
counterparty risk. Market Risk monitors and reports on the utilisation of market
risk limits at division and Group level.
Moreover, the department ascertains whether the Group's financial risk can
safely be limited, either by quantification (applying fair risk calculation
principles) or by the formulation of qualitative limitation possibilities.
Economic Capital
Economic Capital is responsible for the development and operation of, and
reporting on, the Group's aggregate economic capital. This comprises
- the integration of all material risk types contained in the setup for economic
capital;
- Jyske Bank's credit portfolio model with its attached pricing and risk tools;
- the operation and development of the Group's setup for operational risk.
Quantitative Research
Quantitative Research is responsible for developing, maintaining, re-estimating,
and validating the quantitative models used for quantification and structuring
the various risk types which make up the Group's overall risk.
The result of this work is evidenced in re-estimation and validation
documentation which is sent to the Group Risk Committee.
Solvency and Regulation
Solvency and Regulation is responsible for supervising the above-mentioned
validation and re-estimation processes and thus acts as a control unit in
relation to the Group's AIRB setup under the Capital Requirement Directive.
In addition, the function is responsible for Group ICAAP. Against that
background, the Treasury Division prepares solvency proposals for the
Supervisory Board. Finally, the function is responsible for stress-testing and
compliance with risk-related regulations - including the conceptual
responsibility for the Group's setup for impairment charges, large commitments
and regulatory capital.
Capital management
The objective of capital management is to manage the Group's aggregate risk in
relation to the capital available to the Group. The description below is based
on the Group's overall capital management objectives and on the capital
measurements used for the purpose.
In the following section about economic capital we describe the quantitative
methods used to reach Jyske Bank's own assessment of the most important risks.
Capital management objective
Jyske Bank's capital management objective is a solvency ratio sufficient for the
Group to continue its lending activities during a period of difficult business
conditions. The available capital must be such that regulatory capital
requirements are met during such a situation, and it must be possible to weather
heavy unexpected losses. For that purpose, a higher capital reserve is held than
required by law.
The Group's capital planning and capital management objective are adapted to the
prevailing economic situation and to the legislation in force, under which share
buy-back is prohibited and Danish banks are subject to a number of quantitative
restrictions with regard to lending etc. The Group therefore focuses on the
following objectives:
- maximum consolidation
- optimisation of risk-adjusted items with due regard to the business strategy,
the risk targets of the Group and the economic situation
Capital management concepts
This section describes the concepts used in the calculation of Jyske Bank's
capital. Basically, the Group's activities generate a requirement for capital.
The requirement is determined partly by regulation, partly by the Group's
capital objective. The requirement for capital and the capital available to the
Group, i.e., the capital base, are balanced and matched in the capital planning
of the Group. The chart below illustrates the most important capital concepts.
To view the Capital concepts chart, please visit Jyske Bank's web site
www.jyskebank.info
Capital concepts
The capital base reflects the capital available to the Group; it must at all
times be higher than the adequate capital base and the minimum capital
requirement.
The minimum capital required is the amount of capital that the Group must hold
to maintain its banking licence. The calculation of the minimum capital
requirement is based on regulatory formulas which prescribe how risk-adjusted
assets must be calculated. The minimum capital requirement is 8% of the
risk-adjusted assets.
The adequate capital base expresses the Group's own assessment of the capital
requirement given the Group's risk profile. This calculation rests on three
elements:
1. the first element is a model which calculates risk for a one-year horizon for
the Group's most important risks;
2. the second element is an evaluation of other circumstances - such as the need
for a precautionary buffer, and risks which the model for economic capital is
deemed unable to quantify appropriately;
3. the third element is a buffer to meet cyclical changes, which should look at
a wider horizon and at the effects on risk as well as earnings.
The capital concepts are described in more detail in the following sections.
In addition to the three capital concepts, capital requirement is often
mentioned. The capital requirement is the bigger of the adequate capital base
and the minimum capital requirement. Currently the minimum capital requirement
is higher than the adequate capital base of the Group. The capital buffer is the
difference between the capital requirement and the capital base. Finally, the
solvency need describes the adequate capital base in per cent of risk-adjusted
assets.
Capital base
The capital base consists of core capital and supplementary capital. The size of
the core capital depends, among other things, on the profit for the year,
subordinated loan capital and the Group's dividend and share buy-back policies.
The Group's solvency ratio is the capital base in per cent of risk-adjusted
assets.
To view the Capital base table, please visit Jyske Bank's web site
www.jyskebank.info
The consolidation basis for accounting objectives meets the provisions about
consolidation laid down in S.12 of the Danish Financial Business Act. Fast
transfer of capital resources or repayment of claims between the parent and its
subsidiaries can be made, to the extent allowed by the solvency and liquidity
situation of the subsidiaries.
Minimum capital requirement
The calculation of the minimum capital requirement rests on the risk types
credit, market and operational risk. At Jyske Bank the minimum capital
requirement to cover credit risk accounts for by far the greatest part, cf. the
table below.
To view the Minimum capital requirement for credit, market and operational risk
table, please visit Jyske Bank's web site www.jyskebank.info
Jyske Bank has been approved for the advanced internal rating-based method. The
approval includes the application of advanced methods for calculating the
minimum capital requirement for the bulk of the Group's credit portfolio.
To view the the Minimum capital requirement by exposure category table please
visit Jyske Bank's web site www.jyskebank.info
The comparatively big changes in the distribution of retail exposures on
sub-categories is mainly due to a change in the distribution methodology in
2008, so the changes do not reflect actual shifts in the credit portfolio
composition. Moreover, the increase under securitisation was solely caused by a
re-classification of part of the Group's trading portfolio in 2008. The rise was
thus not caused by new positions.
Credit exposure calculated according to the AIRB approach accounts for 67%,
while 33% is calculated according to the standard approach, cf. the chart below.
70% of the exposure according to the standard approach refers to exposure to
central governments and institutions.
To view Exposure by approach table, please visit Jyske Bank's web site
www.jyskebank.info
Note: Out of Real property (AIRB), retail exposure accounts for DKK 22,922m
(73%) and small corporates for DKK 8,452m (27%), and out of Other retail (AIRB),
retail exposure accounts for DKK 12,554m (67%) and small corporates for DKK
6,177m (33%).
The application of the advanced approach means that the capital calculation
reflects to a higher degree than earlier the credit risk that applies
specifically to Jyske Bank's credit portfolio. Switching to the AIRB approach
caused a reduction of 29% in Jyske Bank's minimum capital requirement for credit
risk by end-2008. Among other things, this is because by far the largest part of
the Jyske Bank Group's credit exposure is to customers with high credit ratings,
cf. the chart below. Moreover, Jyske Bank's credit portfolio has a high
proportion of personal customers, and extensive collateral has been provided.
Jyske Bank's credit portfolio is described in detail in the section about credit
risk.
To view the the Exposure by credit ratings table please visit Jyske Bank's web
site www.jyskebank.info
Note: the creditworthiness of Jyske Bank's customers is rated on a scale from 1
to 14.
For additional exposure statements we refer to Appendix 2.
Plans have been agreed with the Danish Financial Supervisory Authority about the
gradual implementation of the AIRB approach for the credit portfolio of the
subsidiary Jyske Finans, which accounts for 5.1% (EAD) of the Jyske Bank Group's
exposure.
Market risk is calculated according to the standard approach for calculating the
minimum capital requirement and operational risk according to the standard
indicator approach. Additional internal advanced methods have been prepared for
the calculation of both of these risk types. These methods are used, inter alia,
for calculating the adequate capital base.
Adequate capital base
Because of the new Capital Requirement Directive (CRD), Jyske Bank has initiated
an Internal Capital Adequacy Assessment Process (ICAAP) which rests on and
challenges existing risk valuations, measurements and assessments. The
objective is to determine Jyske Bank's adequate capital base This means that
all material risks must be considered, including risks beyond the one-year
horizon used for determining economic capital, and stress scenarios for the
economic development should also be considered.
Under current regulation, Group exposure must be assessed in relation to
seventeen risk types. The mapping between those seventeen risk types and the
five risk types which Jyske Bank uses is illustrated in the chart below.
Chart of risk types
To view the Chart of risk types, please visit Jyske Bank's web site
www.jyskebank.info
Every year an exhaustive assessment of the seventeen risk types is made with the
object of determining Jyske Bank's adequate capital base. The results are
summarised in an ICAAP report. Re-assessment is made at least every quarter.
The use of the economic capital model and the need for an additional buffer for
changes in the business cycle are described below.
Stress-testing and the need for an additional buffer for business-cycle changes
Jyske Bank uses stress-testing in a number of respects: stress-tests which can
be characterised as analyses of the impact on the risk calculation of various
parameters as well as extensive scenario-based stress-tests of, e.g., the impact
of changes in the business cycle. Exactly scenario-based stress-testing forms
the basis for determining whether an additional buffer in addition to the
adequate capital base is necessary. Stress-testing is also used intensively in
capital planning analyses.
The processes involved in scenario-based stress-testing are illustrated in the
chart below. Projections of economic indicators are made on the basis of the
macroeconometric model ADAM (Statistics Denmark). Moreover, Jyske Bank has
developed a number of models which translate developments in macroeconomic
indicators into consequences for loss, earnings and balance-sheet items.
Model for scenario-based stress-testing
To view the Model for scenario-based stress-testing, please visit Jyske Bank's
web site www.jyskebank.info
The stress-test analyses rest on a number of relevant macroeconomic scenarios
which often reflect recession-like conditions for the Danish economy. The choice
of recession themes rests on an assessment of the areas deemed to be most at
risk and the circumstances which are of the highest importance for the Group's
exposure to risk at the time.
The stress-test scenarios have been divided into two types:
1. recession scenarios used for an evaluation of whether a buffer over and above
the adequate capital base to offset cyclical changes is required;
2. deep-recession scenarios are used for determining the Group's capital target
for the short and long term.
Scenarios applied by Jyske Bank
--------------------------------------------------------------------------------
| | 2009 - 2011 | Purpose |
--------------------------------------------------------------------------------
| Recession | Stagnating demand at home and | Additional buffer over |
| | abroad and falling asset | and above the adequate |
| | values | capital base to offset |
| | | the effect of cyclical |
| | | changes |
--------------------------------------------------------------------------------
| Deep recession | The same as above with more | Capital planning analyses |
| | deeply negative projections | |
| | for the Danish economy. Such | |
| | an adverse scenario is | |
| | estimated to exist once in 25 | |
| | years | |
--------------------------------------------------------------------------------
The objective of the stress-test analyses is to determine whether the risk level
in a recession can be covered by capital, given the Group's earnings, capital
policy and objective as well as its risk targets. It is therefore crucial to
determine the circumstances for which the Group wishes to hold capital. For this
purpose, regulation requires the application of stress-testing for a mild
recession scenario as a minimum.
The regulatory recession scenario is defined at Jyske Bank as a year of zero GDP
growth within a projection horizon of four years.
Real GDP growth
To view the graph Real GDP growth, please visit Jyske Bank's web site
www.jyskebank.info
The stress-test scenarios typically reveal a need for higher economic capital as
a natural consequence of the expected credit quality deterioration in a stress
situation. Moreover, earnings in the scenarios must be expected to fall
resulting in poorer consolidation capability for the Group.
The chart below illustrates the economic capital, the minimum capital
requirement and the capital base (assuming that expected profits are
consolidated in full) in a stress scenario It will be evident that the projected
capital base of all the years is considerably higher than the economic capital.
Minimum capital requirement, adequate capital base, and capital base
To view the Minimum capital requirement, adequate capital base, and capital base
chart, please visit Jyske Bank's web site www.jyskebank.info
Note: *) inclusive of interim rules for the Capital Requirement Directive
As described earlier, the adequate capital base reflects Jyske Bank's own
assessment of the minimum capital required for the Group to continue in business
at the current activity level, in view of one-year horizons and the stress
scenarios.
The adequate capital base is thus determined on the basis of the Group's
economic capital (inclusive of additional amounts for other risks and a
precautionary buffer). Whether this capital level is adequate, is tested by
considering the consequences for the Group of a recession scenario. If the
economic capital plus a buffer is a sufficient capital level, the Group must not
become insolvent at this capital level within the analysis horizon of four
years. Such an analysis must therefore address the consequences for earnings as
well as the economic capital within the analysis horizon.
The chart below illustrates such an analysis.
The capital base (which for the first year amounts to economic capital plus
buffers) is projected by adding the profit for the year under the recession
scenario. This is illustrated by the line. Then the economic capital is
projected under the recession scenario (illustrated by the columns).
Should the economic capital plus a precautionary buffer, if any, at any time
within the analysis horizon exceed the projected capital base, it is necessary
to add a buffer for changes in the business cycle to the adequate capital base.
This is the case in the chart below, where the capital base during the period
2009-2010 drops below the projected economic capital during a recession
scenario.
Buffer to meet changes in the business cycle
To view the Buffer to meet changes in the business cycle chart, please visit
Jyske Bank's web site www.jyskebank.info
Note: exclusive of buffer for changes in the business cycle
The final assessment of adequate core capital is consequently:
Adequate capital base = economic capital + precautionary buffer + buffer for
cyclical changes
Economic Capital
As described earlier, economic capital is the core element in the management of
the Group's risk and capital structure and is a central element of day-to-day
risk management
Economic capital is the minimum capital required to support the level of risk
assumed by the Group at a 12-month horizon. For the Group, economic capital
covers 99.97% of unexpected losses over a 12-month horizon, corresponding to the
level of AA-rated banks.
One of the benefits of economic capital is the fact that it comes up with an
aggregate figure for all risk types, products and business units, which takes
into consideration correlation effects at various levels. It thus produces one
unified risk figure expressed in a single unit of value.
Since 2002 when economic capital and RAROC principles were introduced in the
Group, we have made amendments to address the changed risk circumstances and
know-how in that respect. The main point is that the capital reflects the
Group's risk for the next year.
The overall risk position of the Group
The Group pursues the objective that the economic capital must accommodate all
material risks. The risk picture of the Group is therefore assessed
continuously, and it is considered whether additional risks should be quantified
in the economic capital. Moreover, all risks expressed in the capital are tested
and validated to ensure that risk is at all times reflected accurately.
Economic capital includes advanced quantification of the four main risk types
which the Group is exposed to: credit risk, market risk, operational risk and
business risk. Each main type comprises various other risk types. Credit risk
includes concentration risk, migration risk as well as counterparty risk, and
market risk covers interest-rate, currency, commodity and equity risk. Under
operational risk, the Group's image and control risks are dealt with.
Diversification is taken into account within individual risk types and between
risk types. However, the calculation of the Group's adequate capital base does
not yet take into account diversification between risk types.
Risk management and capital management
RAROC is the Group's principal performance measurement tool. It is also a
management tool for calculating the risk-adjusted return on capital, economic
capital being used as a measure of risk.
The Group now uses RAROC-based methodology at all levels, from profitability
assessment of single transactions to profitability assessment at customer,
branch, division, business unit and Group level.
Reporting
Economic capital is allocated to the Group's various divisions and business
units with due respect for the overall management of Group activities.
RAROC statements give a strategic overview of the risk and profitability
involved in the Group's various activities. Developments in the general credit
quality of the portfolio, concentration risk, collateral values etc. are
examined carefully in this regard.
Economic capital and RAROC at division and business unit level are calculated
quarterly and reported to the Group Risk Committee and to the managements of
business units which determine activities for follow-up and any initiatives to
reduce risk. If Group risk changes materially, this is reported immediately to
the Executive Board or the Group Risk Committee.
Customer profitability
RAROC is also applied at customer and product level to measure profit, to assess
profitability as well as for pricing new loans. It is therefore essential that
the Group is able to calculate economic capital at customer and facility level.
RAROC calculations and the facilities for price fixing are made available in a
customer profitability system where relevant employees and managers have access
to current risk-adjusted profitability calculations at various levels.
The profitability system takes into account the composition of the Group's
credit portfolio, which means that concentration effects and diversification
effects are reflected direct in the profitability calculations of new loans. If
the Group grants loans to customers in sectors and countries which are already
strongly represented in the Group's credit portfolio, a higher economic capital
and therefore lower profitability will, other things being equal, be assigned.
Moreover, the system incorporates fixed and variable costs as well as funding
costs. The funding costs depend, among other things, on the term of the loan.
Development in economic capital
Group economic capital at end-2008 was calculated at DKK 6.8bn against DKK 6.2bn
at the end -2007, up by 10%. The capital consisted of 74% for credit risk, 13%
for market risk, 4% for operational risk and 9% for business risk.
To view the Economic capital table, please visit Jyske Bank's web site
www.jyskebank.info
The increase in the economic capital was mainly caused by higher credit and
market risks, primairly due to the financial turbulence which prevailed during
the second half of 2008.
The financial turbulence has affected credit risk in three respects. First, the
general credit quality has deteriorated (rising PD), secondly the value of
collateral has fallen - particularly the collateral value of financial
instruments - and finally the credit exposure (measured by EAD) has risen,
mainly because of rising counterparty risk and the calculated exposure to loan
commitments. Moreover, the development of the economic credit capital for
credit risk was affected by the fact that Jyske Bank implemented a new advanced
model setup in the fourth quarter, for the purpose of determining the value of
guarantees. Guarantees are now recognised as collateral and their collateral
value is determined under consideration of the merits of each guarantee and the
relevant guarantor's circumstances. The effect of this has offset the fall in
the value of other collateral types. Therefore the aggregate value of the
Group's collateral rose slightly in 2008.
To view the Development in economic capital, credit exposure
chart, please visit Jyske Bank's web site www.jyskebank.info
Note: index 100: economic credit capital, end-2007
The market risk capital rose by 16% in 2008 as a result of the strong increase
in market volatility. For equity and currency risk the risk level has been
lowered, while the risk level for interest rates remained moderate.
Group operational risk fell in the course of 2008. However, the fall masks
changes in the model basis which, in isolation, caused a reduction in the
economic capital. Moreover, the capital fell thanks to improved controls and
bought insurance cover. In certain areas, operational risk rose because of
market developments and stricter rules about the provision of advisory service.
Modelling of risk types in relation to economic capital
The various risks covered by economic capital make very different demands on
portfolio risk modelling. The system which makes the calculations therefore
features various models specifically designed to reflect the characteristics of
individual risk types.
The Group's credit portfolio model is handled by means of "Moody's KMV's
Portfolio Manager" which is fully integrated in the Group. For market risk a
parametric VaR setup is used which, together with operational risk and business
risk, is based on internally-developed models.
The various models are described below and under the individual risk sections
later in this report.
Credit Risk
To support the objective of managing Group credit risk at portfolio level, Jyske
Bank uses an advanced credit portfolio model across all business units and
customer segments.
The model is based on a Merton setup with customer credit quality measured as
the ratio between the value of a customer's assets and liabilities, relative to
asset value volatility. 'Default' occurs if the value of assets is lower than
the value of the liabilities.
The model quantifies capital for default risk as well as for the risk of loss of
value due to deteriorating customer credit quality. The latter risk is called
migration risk and expresses the probable migration of customer credit quality
until maturity. Such a model setup is typically referred to as 'mark-to-market-
based'. Models which exclusively quantify default risk are termed
'default-only'.
All the credit exposure of the Group is included straight into the model's
calculation, including guarantees, bonds and derivatives. For derivatives whose
future credit exposure is stochastic, a set-up for determining the expected
positive exposure (EPE) is used.
In its calculations, the portfolio model takes into account the specific
characteristics of individual customers and exposures. The basic elements in
that respect are PD, LGD, EAD, maturity, expected cash flow profiles and
uncertainty about loss in case of default. The correlation between the customers
in the portfolio is modelled by means of a factor model using information about
customers' activities in countries and sectors as well as sensitivity to general
systematic risk.
The loss distribution is addressed by 'Monte Carlo simulation'.
Based on the simulated loss distribution, economic capital is determined and
allocated to each facility of the portfolio.
Market Risk
The Group uses Value at Risk to quantify risk on its market risk positions.
Value at Risk expresses the maximum loss that the Group is likely to suffer over
a given period at a certain level of probability. For the economic capital a
horizon of one year and a probability of 99.97% are used.
The model is parametric and is based on an enhanced Risk Metrics setup. All
positions are translated into a number of risk factors for equity, interest-rate
and currency risk, and volatilities and correlations for those risk factors are
calculated daily. The VaR approach is specially modified to reflect the embedded
prepayment risk of Danish mortgage bonds.
Operational risk
Operational risk is monitored and managed and capital provided for it on the
basis of a scenario approach with focus on large exposures of material
importance to the Group.
The portfolio model uses Monte Carlo simulation which, in the calculations, uses
data from the scenario analyses in the form of assessments of the severity and
frequency of loss for each risk scenario. The model is based on the assumption
of independent risk scenarios ensured in the scenario definitions.
The model calculates the amount of economic capital to be held for each risk
scenario. Capital is allocated to the business units according to an
internally-developed allocation model.
Business risk
Jyske Bank calculates economic capital in connection with business risk on the
basis of an internally-developed model.
Risk materialises as an unexpected loss of earnings. Losses may be caused by
various events, for instance new legislation and keener competition which
damages business or causes the business foundation to dwindle or disappear.
Economic capital is calculated on the basis of a mapping of Group activities
against benchmark companies whose activities extend only to business risk.
Assuming that the capital held by those benchmark units reflects the risk
assumed by the units, the corresponding economic capital for business risk is
calculated for the Group.
Credit Risk
Credit risk is the risk of loss arising from customers' or counter-parties'
failure to meet their payment obligations towards the Group.
Credit risk is managed on the basis of the Group's credit risk models which
include PD, LGD and EAD modelling. The models are used intensively for various
purposes, e.g. in connection with advisory service provided to customers, and in
management reporting. This will be described in more detail below.
Credit policy
Credit risk is managed through Jyske Bank's credit policy whose objective is to
keep Group losses at an acceptable level in relation to the capital base and
business volume of the Group, given the general trend in the Danish economy.
Customer transactions with the Group must generate a satisfactory long-term
return according to RAROC principles.
Specific credit policies have been formulated for all areas in which the Group
assumes credit risk, and credit risk levels and undesirable types of business
have been identified. The central element in the assessment of the
creditworthiness of corporate customers is their ability to service debt out of
cash flow from operations in combination with their financial strength. For
personal customers, factors such as net income, expenses and assets are
important. The policies are regularly adjusted to meet current requirements and
adapted to the management tools available to account managers and the monitoring
functions.
Group commitments by size, sector and geographical area are constantly monitored
and analysed with a view to reducing the risk associated with specific high-risk
sectors and geographical areas.
Credit organisation
Jyske Bank attaches great importance to its decentralised credit-granting
process. Lending limits have been delegated to account mangers so that the
majority of decisions are made decentrally. Limits are delegated to account
managers individually on the basis of perceived competence and requirement.
Decisions about commitments exceeding the limits granted to account managers are
made centrally.
Group credit quality in terms of overall risk, single commitment risk and
satisfactory risk diversification is monitored on the basis of quantitative
models as well as on the credit quality of each department and on the basis of a
review of selected large commitments. Moreover, risk monitoring includes
qualitative as well as quantitative control of data used in risk and RAROC
calculations.
Large exposures
Large commitments are monitored currently in accordance with S.145 of the Danish
Financial Business Act. They may not exceed 22% of the Group's capital base (the
regulatory maximum is 25%). Commitments larger than 10% of Group capital base
are monitored currently. Under the Act, the sum of commitments which
individually exceed 10% of the Group's capital base may not exceed 800% of the
capital base. Currently the ratio is 58.9 (63.7 at end-2007), and the
development bears out the Group's desire to reduce the number of large
exposures. The Group has five exposures which exceed 10% of the capital base.
To view the Exposures in excess of 10% of the capital base chart, please visit
Jyske Bank's web site www.jyskebank.info
The credit-rating process
Credit procedures are adjusted to match the level of risk on individual
commitments. Two central elements in the credit-granting procedure are PD and
credit rating.
PD reflects the probability of a customer defaulting in the course of the next
twelve months. 'Default' occurs when the obligor is considered unlikely to pay
his obligations. By far the most customers are awarded a PD on the basis of
statistical credit scoring models developed internally in the Group.
Very large enterprises and enterprises within special sectors are, however,
awarded a PD on the basis of an assessment by an independent expert. Examples
are real property companies, financing companies, financial institutions and
central governments. In those cases external ratings, if available, will be
taken into account in the internal credit rating of the customer. Jyske Bank has
therefore developed its own mapping between external ratings and the Group's own
ratings, which takes into account differences in risk methodologies and
definitions.
Many factors are relevant for the calculation of a customer's PD. Specific
factors are considered, but we also take into account economic factors external
to the customer. The calculation of PD therefore takes into account financial
data, changes in transaction data, management and market circumstances,
industrial assessments, etc. Also included are specific warning signs in
relation to the credit of the customer, his payment profile and history.
In order to reach the best possible overview of customer credit quality, PD is
mapped into internal credit ratings. Jyske Bank's credit ratings are on a scale
from 1 to 14, 1 being the highest credit quality (the lowest PD) and 14 the
lowest credit quality (the highest PD). The scale is constant over time so that
customers migrate up or down depending on their current PD. PD is calibrated to
the long-term level of default rates measured back to the mid-eighties when the
latest major recession began.
If the credit rating calculated by the model is considered to be inadequate,
independent credit experts may review the credit rating at the request of the
relevant account manager.
Credit exposure
Credit exposures are quantified by means of EAD. EAD reflects the exposure at
default, should the customer default in the course of the next twelve months. A
customer's EAD depends on customer-specific factors and the specific products
held by the customer. For most product types, EAD is calculated on the basis of
statistical models, but a few product types are based on expert models.
For loans and advances, the only element of uncertainty is the time until
possible default. Uncertainty is higher, however, for credit facilities under
which the customer may draw up to a maximum. In those cases the amount drawn by
the customer at the time of loss is estimated. This can be modelled by
customer-specific factors and the circumstances of the commitment and the
outstanding balance.
Guarantees and credit commitments are special products in that a certain event
must take place before the product is utilised. It is therefore material to
assess the probability of the product being utilised and the extent to which it
is likely to be utilised within the next twelve months. In this regard, the EAD
parameters are based mainly on expert assessments. The Group's customers have
experienced very few default events over time, so the record is too meagre for
statistical modelling.
For derivatives, EAD is calculated according to the EPE method. Please read
about this under counterparty risk.
Below is shown Jyske Bank's credit exposure measured as EAD broken down on a
number of characteristics
To view the Exposure by credit rating chart, please visit Jyske Bank's web site
www.jyskebank.info
Note: exposure is stated as the expected exposure at default (EAD). The chart is
for Jyske Bank and is exclusive of exposures with banks and central governments
whose rating is typically 1 or 2. EAD for defaulted customers classified by
Jyske Bank as representing high or full risk is not distributed on the 14 rating
classes. Exposure to those customers accounts for 1.8% of Jyske Bank's aggregate
exposure.a The unrated part of the exposure (not shown) at Jyske Bank accounts
for 4.0%.
To view the Average exposure by categories of exposures table, please visit
Jyske Bank's web site www.jyskebank.info
Note: average exposure is calculated on the basis of quarterly observations made
in 2008. Exposure for 2007 is stated at end-2007 since no historical data were
gathered for 2007.
Lending growth slowed throughout 2008 and was negative in the fourth quarter.
The development was most pronounced for the two major exposure categories,
corporate and retail exposure.
To view the Exposure by residual maturity table, please visit Jyske Bank's web
site www.jyskebank.info
The proportion of loans and advances with more than one year to maturity was
reduced over 2008, and at end-2008 it was 33.0% which compares with 34.9% at
end-2007. Residual maturities were reduced, particularly for exposure to
institutions and corporate customers.
To view the Exposure by sector table, please visit Jyske Bank's web site
www.jyskebank.info
To view the Exposure by sector (retail) table, please visit Jyske Bank's web
site www.jyskebank.info
The sector breakdown of the portfolio has been largely unchanged for the past
twelve months. There have been minor shifts: among other things, the exposure to
the sectors "Finance and insurance" and "Property admin. and service" was
marginally reduced.
In Appendix 2, supplementary tables show credit risk broken down in various
respects - including geographical breakdown. The appendix also shows the Group's
exposure to specialised lending.
Counterparty risk
Counterparty risk is the risk of loss due to a counterparty failing to fulfil
his obligations. Counterparty risk is generated when the Group trades
derivatives with customers.
The Group's policy for managing counterparty risk distinguishes between small
and large counterparties. The latter group includes financial institutions. The
basic principles for measuring risk for these customer types are identical, yet
the management of large counterparty risk has been extended with additional
management parameters.
Principles of measurement and credit granting
The Group's counterparty risk is measured for the risk types interest-rate,
equity, currency and commodity risk. The principles for these are described in
the section about market risk.
In its management and monitoring of large counterparty exposures, the Group also
calculates settlement risk. This risk arises in connection with settlement of
derivatives transactions when one party performs under a contract whereas the
other party fails to perform. To reduce settlement risk, all transactions will
as far as possible take place through CLS (Continuous Linked Settlement), some
form of clearing centre, or via individual netting agreements.
Jyske Bank calculates its daily exposure to individual counterparties within the
Group's counterparty management systems, and these exposures are included in
risk management in line with other credit exposures. Counterparties are granted
lines after risk assessment of the individual counterparty; the current
utilisation is calculated from the customer's exposure to individual risks. The
lines awarded are reviewed at least once a year or in case of a change in the
creditworthiness of the respective counterparty.
Contractual basis
For its lines for transactions involving derivatives, the Group endeavours to
reduce risk by means of
- ISDA or other agreement which gives the Group the right of netting market
values of derivatives trades
- CSA or other agreement which entitles the Group to additional security, should
the negative market value of the counterparty (debt to Jyske Bank) exceed an
agreed maximum
- CLS, in which case settlement risk is eliminated, clearing being effected
through a third party which guarantees settlement
Agreements with financial counterparties will most often be reciprocal, which
means that Jyske Bank must put up security for the counterparty if the market
value in favour of the counterparty exceeds an agreed limit.
Where only short-term derivatives are traded (term up to six months) an
agreement about additional security may be waived after individual assessment.
Counterparty risk on derivatives and the calculation of economic capital
Capital must be set aside for counterparty risk on derivatives in accordance
with regulatory requirements (the Capital Requirement Directive) as well as in
connection with internal risk management (the Bank's economic capital model).
The regulatory minimum capital is calculated according to the mark-to-market
approach with attached netting method. The method involves the calculation of a
credit equivalent corresponding to the positive market values after netting plus
a weighting for the underlying instrument or commodity.
Group counterparty exposure according to the mark-to-market method is shown in
the table below.
To view the Counterparty exposure by sector table, please visit Jyske Bank's web
site www.jyskebank.info
Within the Group's internal risk management, another and more nuanced setup is
used. Derivatives are complex because their future cash flow profile is unknown.
The model used has the basic objective of estimating future cash flow and
exposure profiles, given market values and the volatility of counterparty
products. The method is called the EPE (Expected Positive Exposure) method.
Naturally, netting is taken into account in these measurements.
In support of the credit assessment and to limit risk, it will be considered
whether to demand collateral. As a main rule, customers are required to provide
full or partial collateral for their commitments. Collateral is therefore a
main element of the Group's assessment of loss in case a customer defaults
(LGD).
LGD is the part of the Group's total exposure to a customer which the Group
expects to lose if the customer defaults within the next twelve months. A
customer's LGD depends on specific factors concerning the customer, but also on
the commitment and the collateral provided. Overall, LGD also depends on Jyske
Bank's ability to collect receivables and liquidate collateral.
The modelling of LGD at Jyske Bank is divided into two main areas: secured and
unsecured debt. With unsecured debt the proportion of a customer's unsecured
debt which the Group will be able to collect is estimated. Customer-specific
circumstances and other circumstances with regard to the commitment are decisive
for the size of LGD. With secured debt the expected proceeds from liquidation of
collateral is estimated. Here the type of collateral held by Jyske Bank is
decisive as well as the liquidity of the assets. With rare assets Jyske Bank
obtains an expert estimate of the proceeds, whereas statistical estimates are
used for more frequent asset classes such as vehicles, real property and
financial securities.
The models relating to real property and vehicles include on-going updating of
the collateral value taking into account, among other things, market-related
changes in value, and wear and tear. Listed securities are measured daily.
In the calculation of economic capital we use LGD estimates which reflect the
Group's long-term loss rates. In the calculation of the minimum capital
requirement LGD estimates are used which reflect the expected loss rates in case
of an economic downturn.
The LGD estimates are based on the value of collateral provided. The value of
collateral provided, which reduces credit risk, is set out below.
To view the Collateral by type table, please visit Jyske Bank's web site
www.jyskebank.info
In addition to the above values, collateral has been provided for loans and
advances of DKK 4,047m under a number of other guarantee types.
In 2008 a new system was developed for the calculation of the collateral value
of guarantees. Consequently no comparative data for 2007 are available. In 2007,
loans and advances totalling DKK 35,463m had been guaranteed, and loans and
advances totalling DKK 2,188m were supported by bank guarantees.
The proportion of the Group's exposure covered by guarantees is set out below.
The values stated are the exposures for which guarantees have been provided and
are not to be confused with the realisation value of the guarantees in question.
To view the Exposure secured by guarantees table, please visit Jyske Bank's web
site www.jyskebank.info
Re-estimation and validation of credit-risk models
Whether based on statistical models or on expert opinions, the models behind the
calculations of PD, LGD and EAD are as a minimum re-estimated and validated once
annually. The re-estimation ensures that the models will continue to reflect the
latest changes in data so that they yield as exact and updated information as
possible. The validation includes stability testing, back-testing and
benchmarking, and its objective is to reveal any areas which require special
attention.
The purpose of stability testing is to monitor whether the estimated parameters
of the models are stable over time. The identification of structural breaks and
systematic parameter changes is an important aspect when the models are applied
to such long-time horizons as is the case with credit risk.
The purpose of back-testing is to compare a model's predictions with what
actually happened. It is important to adjust for the fact that it is often
necessary to compare long-term estimates with short-term realisations. For
example, PD for a given credit rating category is calibrated to a long-term
level, whereas realisations are measured for the short term (1-year horizon).
The analysis is therefore dependent on the point in the business cycle at which
the short-term realisations are measured.
Benchmarking is necessary for comparing the models with other models. Where
external models can meaningfully be compared with the internally-developed
models, those external models are used in the benchmarking analysis.
Alternatively, internally-developed benchmarks are used for testing and
monitoring the models.
Impairment charges for loans and advances
Jyske Bank recognises impairment of loans and advances where there is objective
evidence of impairment in accordance with IFRS. On an ongoing basis - at least
once a quarter - account managers assess the need for risk codes to be applied.
Individual loan impairment
Jyske Bank divides individual loan impairment into two: impairment of
significant and of non-significant loans and advances. Impairment is recognised
as the difference between the carrying amount before impairment and the present
value of anticipated future payments. The estimated future cash flow for
significant loans and advances is based on an assessment of the likely outcome.
Collective loan impairment
Collective loan impairment is calculated in a rating-based impairment setup,
where all customers not treated individually are grouped for collective
impairment on the basis of, among other things, their credit ratings at the time
of calculation. Jyske Bank's models for calculating collective impairment use
adjusted loss parameters developed for use in the Group's economic-capital
model. For the purpose of calculating impairment, the parameters have been
adjusted in a number of respects to comply with IFRS.
The calculation of impairment is based on the net deterioration of credit
quality at the portfolio level since the time of establishment of the relevant
commitments. The net increase is used in the calculation of collective
impairment at Jyske Bank, and for each impairment group, impairment is
calculated on the basis of the net decrease in future cash flows since
establishment.
Objective evidence of collective impairment is deemed present when data are
observed for a segment which indicate a decline in the future payments from that
segment. In those cases, collective impairment is calculated as the discounted
extraordinary expected net loss on that segment.
Provisions for guarantees and other liabilities
A provision is made when it is deemed likely that a commitment will cause a
drain on the Group's resources and the liability can be measured reliably.
Jyske Bank's provisions for guarantees and other liabilities include guarantees
in favour of business partners or at the request of customers of the Group,
derivatives, and undrawn credit commitments.
On the basis of historical loss experience, the Group makes an estimate of the
costs involved in meeting claims under guarantees or costs caused by customers
defaulting on their obligations under transactions involving derivatives. The
estimate includes an assessment of the risk associated with relevant types of
guarantees and the current risk of loss on uniform segments of customers.
Provisions are made for the estimated loss.
Write-offs
When a loss is deemed unavoidable, the estimated loss is written off
immediately.
Risk categories
Jyske Bank's exposures at risk are broken down into three categories: low-,
high- and full-risk exposures. The two last-mentioned risk categories represent
defaulted customers who are no longer deemed capable of meeting their
obligations towards the Group in full. Therefore they are no longer awarded a
credit rating. The risk categories are used in the Group's assessment for
impairment process.
The Group's impairment charges, provisions and write-offs recognised in
accordance with the Danish Executive Order on the Presentation of Financial
Statements are stated in the following tables.
To view the Loan impairment charges, provisions for guarantees, and write-offs
table, please visit Jyske Bank's web site www.jyskebank.info
A net amount of DKK 1,082m was charged as write-offs, loan impairment charges
and provisions for guarantees; the item in 2007 was positive at DKK 74m. The
rise mainly reflects the change in the economic trends in Denmark, just as also
the global financial crisis has had a negative effect on developments. Yet the
overall effect on operations has been modest in comparison with earlier changes
in economic trends.
Under core earnings, a net amount of DKK 975m was charged as write-offs, loan
impairment charges and provisions for guarantees; in 2007 the item was positive
at DKK 74m. Under Impairment charges for loans and advances, and provisions for
guarantees, DKK 109m was charged in relation to the Danish Private Contingency
Association.
The Group's total loan impairment allowance amounts to DKK 1.537m which, in a
historical perspective, is still low. The allowance amounts to 1.1% of the
Group's total loans, advances and guarantees.
To view The Group's total EAD, impairment charges and provisions table, please
visit Jyske Bank's web site www.jyskebank.info
Note: in accordance with IFRS, loan impairment and provisions at DKK 1,537m was
calculated on the basis of loans and advances with objective evidence of
impairment, including collective impairment of loans and advances with objective
evidence of impairment. Since the impairment process includes exposures which
are not defaulted or past due, the impairment charges and provisions for loss on
guarantees in CRD relation account for only DKK 1,169m, as will be evident from
the below tables.
To view Sector breakdown of defaulted exposures including past due exposures,
please visit Jyske Bank's web site www.jyskebank.info
Note: the operating item over the year broken down by sector refers to exposures
subject to individual impairment in accordance with IFRS, which are considered
to be defaulted for the purposes of calculating the Group's capital requirement.
The operating item for the Group's other value adjustments/impairment charges
was negative at DKK 173m over the year and the total operating item for the year
was DKK 660m.
As was the case for the value adjustment, defaulted exposures increased in the
course of 2008, reflecting the trend of the Danish economy.
Geographical breakdown is shown in Appendix 2, which also sets out information
about country distribution, undrawn commitments etc. for defaulted exposures.
Market Risk
Market risk is the risk of loss as a consequence of a change in the market value
of the Group's assets and liabilities caused by price changes in the financial
markets.
Jyske Bank assumes market risk as a result of position-taking in the financial
markets and usual banking operations such as deposit-taking and lending. The
calculation of Jyske Bank's market risk includes all products which involve one
or more of the undermentioned risks.
Interest-rate risk is the risk of loss caused by changing interest rates
Currency risk is the risk of loss caused by changing exchange rates
Equity risk is the risk of loss caused by changing equity prices
Commodity risk is the risk of loss caused by changing commodity prices
Volatility risk is the risk of loss caused by changing volatilities
Certain financial instruments include elements of credit risk. This type of
credit risk is managed and monitored in parallel with market risk.
Policy and responsibility
The Supervisory Board of Jyske Bank lays down the overall guidelines for market
risk and delegates authority to the Executive Board. The guidelines support the
overall strategic guidelines of the Supervisory Board's risk profile within
market risk. The authority is further limited before being delegated to the
heads of Treasury and Jyske Markets, which are the sole units of Jyske Bank that
may assume significant market risk.
The limits delegated to Jyske Markets are such that they mainly support the
daily trading volume. Strategic positions are mainly taken in Treasury as
reflected by the limit delegated to the unit.
Operations in accordance with the respective limits are supported by detailed
procedures for both Jyske Markets and Treasury.
To be able to follow market developments closely and adjust for any
discrepancies between the Group's actual risk profile and the desired risk
profile, monthly meetings are held by the Group Asset and Liability Committee.
The meetings are attended by several members of the Executive Board and by
representatives from Treasury and Jyske Markets.
Monitoring and reporting
All risk positions are monitored daily by the Market Risk department, which is a
function separate from customer-oriented functions. The Executive Board is
immediately notified of any positions which exceed the pre-determined limits or
are in conflict with the risk management policy. The Supervisory Board and
Internal Audit are notified immediately if positions exceed the overall
authority of the Executive Board.
The utilisation ratios of the various units are reported monthly to the
Executive Board and the Supervisory Board.
Market risk types
Jyske Bank handles several types of market risk every day. Every risk type has
its own special characteristics and is managed by means of individual risk
measurements as well as overall through the Group's VaR model. To hedge market
risk derivatives are used which cannot solely be managed under the
above-mentioned risk measurements. For instance, it does not hold for non-linear
products such as currency and interest-rate options. The management of those is
therefore supplemented by risk measurements developed in accordance with
conventional option theory.
Interest-rate risk
Interest-rate risk is measured daily on the basis of duration. This measurement
is defined as the interest-rate risk resulting from a general one percentage
point increase in interest rates (Interest-rate risk 1). Duration denotes the
percentage gain or loss if all rates of interest (across all currencies and all
yield curves) simultaneously rose by one percentage point. The calculation is
based on the entire portfolio of interest-rate-related instruments of both
Treasury and Jyske Markets.
Because of Jyske Bank's exposure to Danish mortgage bonds, an advanced risk
management model has been developed, which takes into account the embedded
prepayment option. Danish mortgage bonds are widely issued with an embedded
right of prepayment at par. Consequently, standard risk indicators such as
duration are not optimal unless adjusted for this embedded prepayment right.
Risk management includes the calculation of and limits to OAS (Option-Adjusted
Spreads) positions.
Interest-rate risk is calculated on the basis of agreed payments. The customer
and the Group are assumed to make the agreed contractual payments, although
certain fixed-rate loans may be prepaid. Interest-rate risk 1 is adjusted for
this option element. Jyske Bank has no fixed-rate balances without an agreed due
date.
In addition to Interest-rate risk 1, Jyske Bank calculates a Jyske Bank-specific
Interest-rate risk 2. This is because Interest-rate risk 1 is in several
respects deemed to be too simplistic. For instance, Interest-rate risk 1 does
not take into account risk attached to spread transactions involving
interest-rate positions in various instruments and currencies. Interest-rate
risk 2 is calculated as Interest-rate risk 1 plus an addition for yield curve
risks, volatility risks, country risks, and basis risks.
Currency risk
Currency risk is calculated in accordance with the rules on capital adequacy
laid down by the Danish Financial Supervisory Authority. Currency indicator 1 is
calculated as the sum of the numerically higher of long or short positions in
each currency, translated into DKK. Exposures in respect of indicator 1 are
reported to the authorities on a quarterly basis.
Currency indicator 1 does not take into account the fact that some currencies
are more volatile and perhaps less liquid than others. For management purposes
Jyske Bank therefore uses a weighted currency indicator 1 (Jyske Currency
Indicator).
Equity risk
Equity risk is calculated as a risk A and a risk B.
Equity risk A is put at 10% of net equity exposure; net exposure is calculated
as positive exposure less negative exposure. Equity risk A is therefore an
indication of the loss/gain in the event of a 10% change in global equity
prices.
Equity risk B is calculated as 10% of the numerical equity exposure. This risk
measurement thus expresses the gross exposure, as it shows the loss at a 10%
negative price change on total positive exposure and a simultaneous 10% positive
price change on total negative exposure.
The Jyske Bank share and other financial sector shares etc. are not included in
equity risks A and B. Besides equity risk A and B, the Jyske Bank group applies
limits to individual exposures to shares with the objective of limiting
concentration risk. The proportion of Jyske Bank shares is also limited.
Commodity risk
Commodity risk is calculated as a risk A and a risk B.
Commodity risk A is calculated as the net commodity exposure; net exposure is
calculated as positive exposure less negative exposure. There is thus a right of
set-off across commodity types and due dates.
Commodity risk B is calculated as the aggregate numerical commodity exposure.
This risk measurement thus states gross exposure; the right of set-off applies
only to contracts for the same underlying commodity with the same due date.
Derivatives and embedded options
The use of derivatives plays an important role in market risk calculation and
management, both to the Bank's customers and the Bank itself. Market risk on
these instruments is included in the Group's recognition of market risk.
The risk on non-linear derivatives and products with embedded options cannot be
stated adequately by means of the above-mentioned risk measurements - the
instruments involved are primarily interest-rate and currency options and
mortgage bonds. Instead delta, gamma and/or vega risk of those positions is
calculated.
Exposure to credit risk on financial instruments
Exposure to credit risk on financial instruments relates to the Group's bond
holdings. The credit element is not reflected in the market risk measurements
and must therefore be managed apart.
Jyske Bank manages its exposure to credit risk on financial instruments by means
of a pre-defined concentration risk limit expressed as the credit quality of the
instruments as defined by ratings awarded by recognised international rating
agencies. On the basis of the credit quality of the paper, concentration risk is
calculated for rating classes and bond types. This means that there are
different limits dependent on whether the paper is a government or corporate
bond or a structured bond (CLO/CDO).
Finally, a concentration risk limit has been defined for individual exposures.
Value at Risk
The calculation and monitoring of market risk is based on the Value-at-Risk
model. Value at Risk expresses the anticipated maximum risk of loss over a
period based on historical price and correlation developments. Risk limits for
VaR have been defined and delegated.
The model is a parametric VaR based on an enhanced Risk Metrics model.
Volatilities and covariances in the model are estimated on the basis of data
going back six months. The data are weighted so that the latest observations
carry the highest weight. The VaR approach has been modified to reflect the
embedded prepayment risk involved in Danish mortgage bonds.
VaR is calculated with a time frame of one day, and with 99% probability, and is
defined as Daily Earnings at Risk (DEaR). A DEaR of 99% indicates a 1%
probability of a day's actual market value adjustments exceeding the DEaR value.
There is a statistical chance of 2-3 days in the course of the year when the
Group's market value adjustments exceed the DEaR estimated by the VaR model.
Such an occurrence is termed an outlier.
Back-testing
To assess the accuracy of the VaR model, daily back-testing is conducted where
estimated VaR is compared with the actual daily market value adjustment of
market risk-related positions. Back-testing is conducted and reported for 99%
DEaR.
Jyske Bank has applied VaR in its risk calculations since 2001. Since then there
has been an average of 2 outliers annually within a band of 1-3 outliers, which
substantiates the validity of Jyske Bank's VaR model.
Scenario-based stress-testing
For its monthly paper for the Asset and Liability Committee, Treasury prepares
scenario-based stress tests of its positions. However, these tests do not have
any direct influence on the calculation of the economic capital and are not
applied directly in the limit structure.
Sensitivity analyses
Jyske Bank extensively holds offsetting positions across markets. The
worst-case scenario is that the prices of all long (positive) positions decline
whereas the prices of short (negative) positions increase. The effect on the
Income Statement of such a negative price trend, calculated at a negative
interest-rate change of 0.5 percentage point, is shown in the table below. The
table also shows the Group's sensitivity to a one percentage point rise in the
interest-rate level as well as its sensitivity to a global 10% fall in equity
prices. The sensitivity analyses express an other-things-being-equal situation,
which is unlikely to occur in reality.
To view the Sensitivity analyses table, please visit Jyske Bank's web site
www.jyskebank.info
*The scenario corresponds to the Group's 'Interest-rate risk 1'
**EUR are not included in the calculation
This is a mild stress scenario. "Negative" means that the prices of long
positions fall, while those of short positions rise. All calculated per
currency.
Solvency requirement
The table below shows the solvency requirement for the Group with regard to
market-risk positions.
To view the Solvency requirement, market risk table, please visit Jyske Bank's
web site www.jyskebank.info
Shares not held for trading
The shares not included in the trading portfolio are not included in the
calculation of equity risk A and B. The shares are primarily financial-sector
shares relating to the ordinary operating activities of the Group. There are no
plans of a resale.
To view the Shares not held for trading table, please visit Jyske Bank's web
site www.jyskebank.info
Shares not held for trading form part of the basis for Jyske Bank's ordinary
business activities.
The shares are stated at fair value as described in the accounting policies of
the Group's annual report. Unrealised capital gains/losses have influenced the
operating income of the year.
Liquidity risk and liquidity management
Liquidity risk is the risk of Jyske Bank not being able to generate or obtain
sufficient liquidity at a reasonable price to meet its payment obligations or
ultimately being unable to meet its obligations as they fall due.
Liquidity risk occurs when there is a maturity mismatch between the Group's
liabilities and assets. Management determines the liquidity risk acceptable to
the Group, expressed as the balance between the risk level and Jyske Bank's
costs of managing liquidity risk.
Objective and overall setup
The overall objective of Jyske Bank's liquidity management is to ensure adequate
liquidity for the timely fulfilment of Jyske Bank's payment obligations at
reasonable funding costs. The fulfilment of this overall objective is ensured by
compliance with the following sub-objectives and policies:
1. a strong and stable deposit basis which ensures stable long-term funding of
the Group's lending activities;
2. high credit ratings at international rating agencies;
3. active participation in the international money markets and access to
international capital markets through borrowing programmes; this and high credit
ratings ensure that the Group has access at all times to a highly diversified
and professional funding base;
4. maintenance of a considerable buffer of highly liquid securities which,
together with prudent management of the outflow of capital market funding,
ensures that the Group can operate over a one-year period without being
dependent on funding in the capital markets. For the short and medium term, the
buffer can thus eliminate the effect of an adverse liquidity situation.
In line with the guidelines of the Basel Committee, the Group's liquidity
management is built on
- gap analysis of future cash flows;
- stress tests integrated in the limit structure;
- Liquidity contingency plan.
Management and monitoring
The Supervisory Board has adopted a liquidity policy which, among other things,
defines a specific critical survival horizon for the Group during an adverse
stress scenario. On the basis of the pre-set limits, the Executive Board has
defined specific operational limits for Jyske Markets and Treasury. Jyske
Markets and Treasury are responsible for monitoring and managing liquidity on a
daily basis in compliance with the delegated limits and guidelines which ensure
that the liquidity policy and risk profile adopted are observed. In addition,
Treasury must ensure that specific guidelines and limits governing the liquidity
of assets are adhered to and that the Group's sources of funding are
diversified.
Liquidity positions are monitored on a daily basis for observance of the
delegated limits. Liquidity positions that exceed authorised limits are promptly
reported to the Executive Board.
Short-term liquidity management
Short-term liquidity management is undertaken by Jyske Markets. Jyske Markets is
an active player in the international money markets of all major currencies and
related derivatives. Moreover, Jyske Markets is a market-maker in the
Scandinavian inter-bank money markets. Jyske Markets has been granted specific
limits for short-term funding in the interbank and wholesale fixed-term markets
and for the maximum placement of longer-term deposits in the same markets.
Strategic liquidity management
Treasury undertakes strategic liquidity management. Strategic management rests
on measurements of the Group's liquidity position in various stress scenarios.
The measurements are based on gap analyses of individual payments. The financial
asset side of the liquidity balance is broken down and grouped in order of
liquidity, whereas the financial liabilities side is grouped according to
expected run-off risk in various scenarios.
While the gap analyses basically build on the contractual maturity of each
individual payment, allowance is made for the fact that the actual maturities of
part of the balance deviate from the contractual maturities. The gap analyses
therefore apply scenario-specific expectations of customer behaviour in those
cases where contractual maturities are not considered to give a true and fair
view of the actual maturities of deposits or loans. In relevant stress scenarios
the liquidity reserves are used as a buffer to cover negative payment gaps.
The purpose of integrating stress scenarios into the limit structure of
delegated authority is to ensure that the Group can at all times meet its
obligations and pursue its operations for a specific time horizon, in case a
crisis occurs during which the Group is unable to use a material part of its
normal funding sources.
Treasury is responsible for ensuring that the Group can at all times meet the
critical survival horizon in the three scenarios used in strategic management.
Scenario 1 - hard Jyske Bank-specific stress scenario which is monitored daily
A hard Jyske Bank-specific stress scenario with a short critical survival
horizon: the Group must be able to withstand non-market access to a broad part
of its price- and credit-sensitive funding sources. In addition to failure to
obtain refinancing in the capital markets, the scenario assumes a run-off of all
large wholesale and retail deposits on demand as well as fixed term.
Scenario 2 - broad sector stress scenario which is monitored currently
A broad general capital and money-market crisis which to a certain extent
spreads to retail customers and results in drawdown by large corporate customers
of unutilised lines and commitments. At the same time, growth in deposits is
assumed to stagnate and possibilities of obtaining refinancing in the
international capital markets to dry out. The target is a horizon of six months,
during which time basic banking activities must be maintained.
Scenario 3 - soft sector stress scenario which is monitored currently
A soft non-Jyske Bank-specific capital market crisis with a survival horizon of
at least one year. The Group must be able to withstand non-market access to the
capital markets defined as the inter-bank, commercial paper and EMTN markets,
while at the same time funding normal growth of the loan portfolio.
To view the Liquidity position and run-off graph, please visit Jyske Bank's web
site www.jyskebank.info
Liquidity contingency plan
The liquidity contingency plan comes into force if the Group can only meet the
internally delegated limits at very high costs or is ultimately unable to do so
within the critical horizons. The contingency plan stipulates a detailed set of
management reports, and it determines a broad range of initiatives that might
strengthen the Group's liquidity position.
In the course of 2008, Jyske Bank at no time had any difficulty in meeting the
stress-based internally delegated limits and guidelines.
The Group's liquidity reserve
Jyske Bank's total holdings of securities consist of a trading portfolio held by
Jyske Markets, and Treasury's portfolio of securities. The trading portfolio is
a function of the customer-related business of Jyske Markets and ultra-short
operational liquidity management. Treasury's holding of securities consists of a
portfolio of securities with market risk positions and a strategic portfolio of
liquid securities. The liquidity portfolio is to ensure that the Group's
strategic liquidity risk profile is observed and to even out swings in the
Group's market risk positions.
In the fourth quarter of 2008, Jyske Bank made use of the possibility of
re-classifying parts of the trading portfolio at amortised cost instead of
market value, cf the Corporate Announcement of 3 November 2008.
The Bank's liquidity reserve consists solely of assets which are not pledged as
security or used in the day-to-day operations of the Group. Such assets may be
sold immediately or pledged as security for loans and are therefore a swift and
efficient source of liquidity. The availability of secured funding does not
depend on Jyske Bank's creditworthiness, but solely on the quality of the assets
that can be offered as security. The measurement of the Group's liquidity
reserve takes into account any impairment of the relevant assets.
Jyske Bank's holding of securities is divided into five groups in order of
liquidity:
1. ultra-liquid assets (DKK-denominated assets which can be used in repo
transactions with the Danish central bank): certificates of deposit with the
Danish central bank, Danish government and mortgage bonds;
2. very liquid assets (EUR-denominated assets which can be used in repo
transactions with the European Central Bank (EUR): European government and
mortgage bonds and senior financial instruments;
3. liquid assets: as 2., but denominated in currencies other than EUR;
4. other liquid assets: other low-risk liquid bonds;
5. relatively illiquid assets: emerging-market bonds, corporate and mortgage
bonds, and shares.
Jyske Bank has adopted a general policy for the size and quality of its
liquidity reserve, which is adjusted to suit the Group's balance sheet
composition and risk profile. Specific guidelines have been laid down for the
securities which are included in the strategic portfolio of liquid securities.
In practice, the liquidity reserve policy means that the large majority of the
reserve consists of assets from liquidity group 1, alternatively group 2. It is
thus the Group's policy that it must be possible to meet the limit of the
survival horizon of stress scenario 1 merely by freeing assets from liquidity
groups 1 and 2.
At end-2008 the Group's liquidity reserve amounted to almost DKK 38bn inclusive
of the Group's syndicated loan facility of EUR 500m - at end-2007 the reserve
was DKK 36bn.Certificates of deposit with the Danish central bank amounted to
DKK 12bn; and the remainder of the reserve consisted of highly liquid Danish
mortgage bonds.
The Group's liquidity reserve according to S.152(1)(2) of the Danish Financial
Business Act has constantly been high. At the end of December, the liquidity
ratio was 19.9%, corresponding to a liquidity surplus of 99.9%; at end-2007 the
surplus was 102.1%.
Funding
Jyske Bank's primary source of funding is deposits from customers. The Group has
a sound and well-diversified customer deposit base, and at the end of December
2008 bank deposits funded 89% of the bank loans against 78% at end-2007.
The Group's sources of funding include the inter-bank market, the wholesale
fixed-term market, bilateral agreements, the markets for commercial paper and
European medium-term notes.
Funding via the inter-bank and wholesale fixed-term markets is obtained through
Jyske Markets as part of the short-term operational liquidity management. In
addition, Jyske Markets funds its own wholesale-related activities by taking up
unsecured loans in the wholesale fixed-term and inter-bank markets. Continued
activity in the above-mentioned markets enhances the possibility of refinancing
short-term positions and is a natural part of Jyske Markets' business.
In 2006, Jyske Bank established a EUR 500m revolving syndicated loan facility
with Citigroup Corporate and Investment Banking, Deutsche Bank AG, London
Branch, J.P. Morgan plc and SOCIÉTÉ GÉNÉRALE Corporate & Investment Banking
acting as Lead Managers. Fifteen banks committed themselves under the facility.
Aligned to Moody\s rating scale on a conservative basis, the weighted credit
rating of the facility at end-2008 was Aa2. The facility will be used as a
standby source of immediate funding, also under unfavourable market conditions.
Capital market funding through capital market programmes
Treasury is responsible for the Group's long-term structural liquidity risk
profile, which includes the management of the Group's overall balance sheet
structure. The Group's balance sheet is monitored daily by Treasury. So as to
meet both the internal limits and the longer-term strategic guidelines,
monitoring aims to prevent a build-up of funding mismatches in the balance
sheet. To manage the long-term strategic risk profile, two capital market
programmes are utilised, which ensure flexibility with regard to maturity,
currency, interest rate (fixed/floating) and investor base.
To view the Capital market programmes - figures in billions table, please visit
Jyske Bank's web site www.jyskebank.info
The French-regulated CP programme was established to strengthen the
diversification and depth of our short- and medium-term liquidity procurement so
as to meet the Group's liquidity target. Funding under the facility will
typically have a maturity of 3-6 months. The maximum maturity is one year. At
end- 2008, funds drawn under the facility amounted to DKK 8.9bn (EUR 1.2bn).
Since the programme was launched, Jyske Bank has generated a wide knowledge of
the Group's CP programme among investors. The general CP market was hit by the
crisis in the international financial and money markets. Even so, the Group's
funding under the programme was maintained at a satisfactory level during 2008.
To view the graph, please visit Jyske Bank's web site www.jyskebank.info
For long-term funding in the international capital markets, the Group has
utilised a Euro Medium Term Note Programme (EMTN) since 1999. The typical
maturity of senior debt is between two and ten years. At end-2008, the Group had
issued notes for a total of DKK 30.6bn (USD 5.6bn) under the programme. The
primary investor segment for bonds issued under the Bank's EMTN programme is
well diversified throughout Europe. The Group works continuously to maintain its
investor base and to increase investor awareness of Jyske Bank well in advance
of a possible need to raise funds. At end-2008, Jyske Bank had five outstanding
benchmark bonds in the market:
To view the Benchmark issues at 31.12.2008 table, please visit Jyske Bank's web
site www.jyskebank.info
Despite the money-market crisis in 2008, Jyske Bank has been able to use the
EMTN programme for long- and medium-term funding in the international capital
markets. In 2008, the Group's funding requirement in the international capital
markets was fully covered by means of minor private placements.
Credit ratings
The Group's credit ratings are material to the price of liquidity and capital as
well as to funding flexibility in the form of access to a broad investor base.
Standard and Poor's as well as Moody's left the Group's ratings unchanged in
2008, although they changed the outlook from stable to negative in September and
November, respectively, mainly as a result of their view on the Danish economy.
To view the Credit ratings table, please visit Jyske Bank's web site
www.jyskebank.info
Operational risk
Jyske Bank monitors and actively manages operational risk to reduce the risk of
operational events resulting in material loss. Focus is mainly on the Group's
largest risks involving high potential losses.
Operational risk is defined as the risk of loss caused by
- inadequate or failed internal processes;
- human errors or system failure;
- external events.
Identification, assessment and monitoring of risk
Jyske Bank has adopted a scenario-based method of analysis. Analyses are
prepared by a function under Risk Management that is separate from
customer-oriented functions.
Scenario analyses chart the Group's largest operational risks by analysing
central processes and events that could cause loss. An assessment of the
effectiveness of the control environment will reveal risks which are
insufficiently covered by existing controls. Moreover, the scenario analyses
propose ways in which operational risks can be reduced, and they are therefore
efficient tools which management and the responsible units can use in risk
management.
All the risk scenarios which may cause direct or indirect loss of more than DKK
5m or which could materially damage the Group's image are analysed. The
scenarios are identified in cooperation with management, with reference to
internal and external events.
Currently 50-60 scenarios have been defined, which cover all the Group's
business areas. The scenarios cover a broad range of risks such as the provision
of incorrect advice, trading errors, errors in models or in internal and
external reporting. Also, the risk of internal fraud including rogue trading and
external fraud is analysed. Operational risks at important business partners are
also covered, including the risk of discontinuation of IT operations at JN Data
or breakdown at clearing partners.
Developments in operational risk are monitored continuously to ensure the best
possible basis for risk management, including the calculation of the appropriate
economic capital. Monitoring rests on the following elements:
- on-going dialogue with management to ensure that all the material operational
risks of the Group are reflected in the risk scenarios;
- evaluation of existing risk scenarios, risk exposure and control environments
in co-operation with experts from the business units;
- monitoring of risk indicators which reflect developments in individual risk
scenarios;
- losses exceeding DKK 5,000 caused by operational errors or events are
registered, monitored, analysed and reported regularly for the purpose of
optimising processes and reducing future losses.
Extraordinary evaluations of existing risk scenarios are made at the request of
management or when deemed relevant because of extraordinary internal or external
events.
Management of operational risk
The Executive Board and the relevant business unit directors are in charge of
operational risk management, which is an integral part of daily operations and
proceeds through a system of comprehensive policies and controls established
with the object of securing the best possible processing environment. On the
basis of regular scenario reporting of the Group's operational risks, management
considers the Group's exposure on an ongoing basis and decides whether to
introduce initiatives to reduce operational risks.
In addition to in-depth scenario reports, management receives six-monthly
evaluations of the risk scenarios accompanied by error statistics and a
description of relevant internal and external events. Extraordinary evaluations
are reported as required.
Appendix 1: Glossary
To view the glossary, please visit Jyske Bank's web site
www.jyskebank.info
Appendix 2: supplementary tables
To view the supplementary tables, please visit Jyske Bank's web site
www.jyskebank.info