66. Business risk management | PKO BP Annual Report 2015

Business risk is defined as the risk of incurring losses due to adverse changes in the business environment, taking bad decisions, the incorrect implementation of decisions taken, or not taking appropriate actions in response to changes in the business environment; this includes in particular strategic risk.

Managing the business risk is aimed at maintaining, on an acceptable level, the potential negative financial consequences resulting from adverse changes in the business environment, making adverse decisions, improper implementation of adopted decisions or lack of appropriate actions, which would be a response to changes in the business environment.

66.1 Business risk identification and measurement

Business risk identification is to recognise and determine factors both current and potential, resulting from current and planned activities of the Group and which may significantly affect the financial position of the Group, generating or change in the Group’s income and expense. Business Risk identification is made:

through the analysis of the results of the annual survey, targeted to senior management staff of the Bank and selected entities of Group,
through the analysis of selected items from the income statement related to the Bank’s income and expense. Only income and expense arising from the Bank's business activity are selected for the analysis, excluding items included in the measurement of other risks.

Business risk identification is performed by identifying and analysing the factors that had an impact on the significant deviations of realisation of income and expense from their forecasted values. Measurement of business risk is aimed at defining the scale of threats related to the existence of business risk with the use of defined risk measures. The measurement of business risk includes:

calculation of internal capital,
conducting stress-tests.

The internal capital for covering business risk of the Bank is determined on the basis of analysis of historical volatility of deviations of realised net business income from their forecasted values, in accordance with the concept of ‘Earnings at Risk’.

The internal capital for covering business risk of the Group entities is determined as the product of:

ratio of internal capital calculation for covering business risk, and
total internal capital, excluding internal capital for covering business risk of the Group’s particular entities.

A ratio of internal capital calculation for covering business risk for the Group entities is determined as the relation of internal capital for covering business risk of the Bank to total internal capital of the Bank (excluding internal capital for business risk of the Bank).

66.2 Forecasting and monitoring of business risk

Forecasting of business risk in the Group is conducted once a quarter on a yearly basis and includes forecast of the level of business risk and internal capital. Once a quarter, the verification of business risk forecast (so-called backtesting) is also performed. Backtesting is based on the comparison of the internal capital amount, estimated for the particular quarter (performance) with the forecast of this capital, estimated in the previous quarter (forecast).

Monitoring of business risk is aimed at diagnose areas for management actions and includes in particular:

strategic levels of business risk tolerance – on a quarterly basis,
stress-tests results – on an annual basis,
internal capital level – on a quarterly basis,
deviations from the implementation of business risk forecast – on a quarterly basis.
results of a survey conducted among senior management staff of the Bank and selected entities of the Group - on an annual basis.

66.3 Controlling of business risk

The purpose of the business risk controlling is to strive for maintaining the level of business risk of the Group at an acceptable level.

Control of business risk involves settting and periodic review of the risk controls in the form of tolerance limits on the business risk along with its thresholds and critical values, adequate to the scale and complexity of the Group.

66.4 Reporting of business risk

Business risk reporting of the Group is conducted quarterly. Reports on business risk are prepared for the ALCO, the RC, the Management Board and Supervisory Board. The reports include in particular:

results of business risk measurement, particularly internal capital, stress-tests results, results of the survey conducted among senior management staff of the Bank and selected entities of the Group,
utilisation level of strategic tolerance limits for business risk,
business risk forecast and forecast backtesting,
level of business risk,
information on business risk in the entities of the Group.

66.5 Management decision concerning business risk

The main tools used in business risk management include:

update of quarterly forecasts of internal capital for business risk, determining and monitoring of deviations of the internal capital for business risk realisation from their forecast,
monitoring of the level of strategic tolerance limit,
conducting the Survey among senior management staff of the Bank and selected entities of the Group