46.8. Capital management

The capital management process applied by the Group has been adopted for the following purposes:

• ensuring the safe and secure functioning by maintaining the balance between the capacity to undertake risk (limited by own funds), and the risk levels generated,
• maintenance of capital for covering risk above the minimum stated levels in order to assure further business operations, taking into consideration the possible, future changes in capital requirements and to safeguard the interests of shareholders,
• maintenance of the optimal capital structure in order to maintain the desired quality of risk coverage capital,
• creation of value to shareholders by the best possible utilization of the Group funds.

The Group has put in place a formalized process of capital management and monitoring. The Finance Division under the Chief Financial Officer is responsible for functioning of the capital management process in the Bank. The ultimate responsibility for capital management is allocated to the Management Board of the Bank, supported by the Assets, Liabilities and Risk Management Committee, which approves the capital management process. The Supervisory Board supervises the capital management system, in particular approves the capital management strategy. The Capital Management Strategy defines the objectives and general rules of the management and monitoring of the Group’s capital adequacy, such as the guidelines concerning risk coverage sources, preferred structure of capital for risk coverage, long-term capital targets, capital limits system and sources of additional capital under contingency situations.

The Group has also implemented, as part of the capital management policy, the capital contingency plans which establish rules and obligations in the event of crisis appearance or further development that would significantly reduce capitalization level of the Bank or Group. The policy defines the principles of supervision including split of responsibilities for the purpose of early and consistent management in case of crisis situation development.

The capital adequacy of the Group is controlled by the Assets, Liabilities and Risk Management Committee and Management Board of Bank. Periodic reports on the scale and direction of changes of the capital ratios together with indication of potential threats are prepared for the Supervisory Board, Management Board and for the Assets, Liabilities and Risk Management Committee. The level of basic types of risks is monitored according to the external limits of the banking supervision and the internal limits of the Group. Analyses and evaluations of directions of business activities development are performed assessing the compliance with capital requirements. Forecasting and monitoring of risk weighted assets, own funds and capital ratios constitute an integral part of the planning and budgeting process, including stress tests.

The Group also has a capital allocation process in place, with an aim of guaranteeing the shareholders a safe and effective return on invested capital. On one hand, the process requires capital allocations to products/clients/business lines, which guarantee profits adequate to the risks taken, while on the other hand taking into consideration the cost of capital associated with the business decisions taken. Risk-related efficiency ratios are used in the analyses of income generated compared against the risk taken as well as for the optimization of capital usage for different types of operations.

Calculations of the regulatory capital requirements were performed based on Regulation of the European Parliament and of the Council (EU) No 575/2013 of June 26, 2013 on prudential requirements for credit institutions and amending Regulation (EU) No 648/2012, together with further amendments, as well as Commission Implementing Regulations or Delegated Regulations (EU) (Regulation 575/2013).

The Group defines components of own funds in line with the binding law, particularly with Regulation 575/2013 and The Banking Act of 29 August 1997 with further amendments.

According to law, Group is required to maintain minimal values of capital ratios resulting from Pillar 1 level (Regulation 575/2013), capital requirement of Pillar 2 resulting from The Banking Act and combined buffer requirement resulting from Act on macro-prudential supervision.

Minimal value of capital ratios on Pillar 1 level are:

• Total capital ratio (TCR) in amount of 8%,
• Tier 1 capital ratio (T1) in amount of 6%,
• Common Equity Tier I capital ratio (CET 1) in amount of 4.5%.

On Pillar II, Pekao Group has no additional capital requirement (P2R).

Combined buffer requirement as at 31 December 2023 consists of:

• Capital conservation buffer in amount of 2.5%,
• Countercyclical capital buffer in amount of 0.02%,
• Other systemically important institution buffer in amount of 1%,
• Systemic risk buffer in amount of 0% (according to the Regulation of the Minister of Finance, the systemic risk buffer was abolished on 19 March 2020. The buffer value applicable until that date was 3% of the total risk exposure amount for all exposures located only in the territory of the Republic of Poland).

In total, Group is required to maintain:

• Total capital ratio (TCR) in amount of 11,52%,
• Capital ratio Tier 1 (T1) in amount of 9,52%,
• Common Equity Tier (CET 1) in amount of 8,02%.

As at 31 December 2023 total capital ratio of the Group amounted at 16,8% (as of 31 December 2022 – 17,8%).

To assess the internal capital adequacy of the Group, the Group applies methods designed internally.

The Group takes the following risks into consideration:

• credit risk,
• operational risk,
• market risk,
• liquidity risk,
• business risk (including the risk of macroeconomic condition changes and strategic risk),
• compliance risk,
• reputational risk,
• model risk,
• excessive leverage risk,
• bancassurance risk,
• ESG risk (Environmental, Social and Governance).

For each risk deemed material, the Group develops and applies adequate economic capital measurement or assessment methods for the risk evaluation. The Group applies the following methods:

• qualitative assessment – applied in case of risks which are difficult to measure (compliance, reputational and bancassurance risks) with potencial capital coverage in other risks areas,
• assessment by estimation of capital buffer, for risks that are not easily quantifiable however some aggregate assessment of their impact is possible (model risk and business risk),
• quantitative assessment – applied for risks which can be measured with the use of economic capital (other risk types apart from liquidity risk and excessive leverage risk) or based on other risk-specific measures (liquidity risk and excessive leverage risk).

Preferred methods of measuring risks and determining the resulting capital requirements are Value at Risk models, based on assumptions derived from the Group’s risk appetite. The models are developed in compliance with the best market practices and regulatory requirements and supplemented with stress tests and/or scenario analyses. In the case of risk types for which such methodologies have not been finally developed or implemented, the Group uses regulatory models supplemented with stress tests or simplified measurement methods.

The determination of the capital buffer to cover business risk, which includes the risk of changes in macroeconomic conditions and strategic risk, is made on the basis of an analysis of the impact of the economic slowdown scenario on economic capital over the forecast horizon, including the impact of changes in interest rates and credit spreads on net interest income and on changes in the valuation of portfolios classified as HTCS (Held to Collect and Sell – classification according to IFRS9).

Model risk is estimated using results of model validation and scenario analyses making it possible to evaluate the impact of potential model inconsistencies on its output. Based on the aggregated output, the model risk capital buffer is determined.

Economic capital for ESG risk is estimated as part of the quantification of credit, operational and market risks, depending on and adequately to the identified ESG risk factors in individual risks.

The procedure of estimating capital needs starts with the calculation of economic capital, separately for each material quantifiable risk identified by the Group. Next, economic capital figures for individual risks are aggregated. Then, the amount is increased by the capital buffer for model and business risks. The sum of economic capital and the capital buffer constitutes the internal capital of the Group.