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  • Credit Risk
  • Liquidity Risk
  • Market Risk
  • Market Risk

    Market risk is the risk of losses in on and off-balance positions arising from movements in market prices. For Triodos Bank this means changes in interest rates and foreign exchange rates in particular. Triodos Bank doesn’t have a trading book, but interest rate risk is present in the banking book.

    Interest Rate Risk in the Banking Book

    Triodos Bank defines interest rate risk in the banking book (IRRBB) as the risk that changes in prevailing interest rates will adversely affect the market value of assets versus that of liabilities and/or income versus expenses. Triodos Bank identifies the following four main sources of IRRBB:

    • Repricing risk, the risk of adverse consequences due to differences in timing of the impact of interest rate changes on the value and interest of assets and liabilities.
    • Yield curve risk, the risk of adverse consequences which result from a change in the shape of the yield curve.
    • Basis risk, the risk of adverse consequences which result from changes in the difference between two or more rates for different instruments with the same maturity.
    • Option risk, the risk that changes in market interest rates prompt changes in the value or maturity of instruments.

    Interest Rate Risk management and mitigation strategies

    Management of IRRBB starts with the conservative business model of Triodos Bank. The bank uses retail funds to finance clients and projects which aim to improve society and the environment. In addition, the bank maintains solid capital and liquidity buffers to support its resilience.

    The taken level of interest rate risk is managed in a four-stage risk control cycle. In this cycle the relevant definitions, indicators, measurement methods, and analysis for IRRBB are set first. Next, the limits for the main IRRBB indicators are specified in the risk appetite statement. The third stage defines the roles and responsibilities for IRRBB management, model governance, and escalation procedures and exceptions. Lastly, the risks are monitored and reported.

    The new production at the individual branches determines an important part of the risk development. Each branch sets up a budget for the new production three years ahead and updates it quarterly with a forecast. The budgets are consolidated and compliance with the risk appetite is checked. Adherence to the budget means that asset and liability management is predictable and therefore the fulfilment of the budget is closely monitored.

    Triodos Bank is able to steer the volume and interest rate terms of new assets and the interest rate of existing liabilities in order to maintain Triodos Bank’s interest rate risk exposure within desired limits. However, changes in client rates and terms will not be made to the extent that they would materially impair Triodos Bank’s customer service, market position, profitability, capital adequacy and reasonable customer expectations. If necessary Triodos Bank also uses Interest Rate Swap (IRS) contracts to maintain the bank’s IRR exposure within the limits.

    The ALCo is delegated by the Executive Board to monitor and take decisions related to the management of the IRRBB. Additionally, the ALCo approves material changes to IRRBB models and changes to important model assumptions. Finally, the ALCo decides on approval of and monitors adherence to the group-wide pricing framework for retail and business banking products.

    Triodos Bank mainly hedges its IRRBB through its liquidity buffer and derivatives. Firstly, Triodos Bank may decide to change the duration of holdings of liquid marketable investments to maintain the bank’s IRRBB exposure within the limits. This will be used when needed. Secondly, it may enter into IRS contracts to maintain the bank’s IRR exposure within the limits. The use of IRS is subject to hedge accounting.

    One of our main strategic risks is the low interest rate environment. With the slow phasing out of the quantitative easing, low interest rates are likely to continue for some time, with a negative impact on Triodos Bank’s return.

    Main measures

    Triodos Bank uses various indicators to measure interest rate risk. The interest rate risk position is monitored by the ALCo monthly and reported quarterly to the Executive Board. The main IRRBB indicators used are Earnings at Risk, Economic Value of Equity at Risk, Modified Duration of Equity, and Gap analysis. Below follows a brief description:

    • Earnings at Risk: a short-term indicator which shows the effect of an interest rate shock on Triodos Bank’s net interest income over a one year and two-year horizon.
    • Economic Value of Equity at Risk: a long-term indicator which represents the change of the Economic Value of Equity (which is the net present value of the future cash flows of all assets and liabilities) in the event of an interest rate shock.
    • Modified Duration of Equity: an indicator that expresses the sensitivity of the Economic Value of Equity in the event of interest rate changes.
    • Gap analysis: allows to get a quick and intuitive sense of how Triodos is positioned by comparing the values of the assets and liabilities that roll over – or reprice – at various time periods in the future. While a Gap analysis is a good measure of repricing risk, it is not able to measure interest rate risk stemming from options risk, basis risk or yield curve risk. Therefore, Triodos Bank monitors the sensitivity of economic value of the banking book items to interest rate changes for different parts of the yield curve, by calculation of key rate durations.

    Stress scenarios

    Triodos Bank runs a variety of interest rate scenarios to assess its level of interest rate risk. The scenarios are made up of shocks to the market rate. These shocks can vary from parallel shocks to non-parallel shocks, downward to upward shocks, absolute to relative shocks, and instant to gradual shocks. Part of the shocks are prescribed by regulatory guidelines whereas other shocks are developed internally. The interest rate scenarios are reviewed and approved in the ALCo.

    Modelling

    The model used for calculating IRRBB assumes that the balance sheet develops according to the budget/forecasts. In modelling of IRRBB, client behaviour is complex as it depends on many factors and, as a result, IRRBB models in general build on many assumptions. A brief description of relevant assumptions used in Triodos Bank’s IRRBB modelling follows below.

    First of all, behavioural models are used to assess the interest rate risk in savings and current accounts. The interest rate risk stemming from these products is difficult to quantify since these accounts typically have variable interest rates and no fixed maturity. The objective of the models used is to forecast the future outflow of the non-maturing deposits and their sensitivities to market conditions based on historical data, taking into consideration the statistical significance of that data. The model combines the relationship between client interest rates and market interest rates and outflow predictions.

    Secondly, loan prepayments affect interest rate risk on the asset side of the balance sheet and depend on customer behaviour as well. Due to the low interest rate environment and the maturity of the portfolio, prepayments have increased during the last years. Therefore, behavioural assumptions are present in the risk model and the level of prepayments is included in the measurement of IRRBB. Currently, a constant prepayment rate is used, consistent with the forecast made by the branches. Triodos Bank is considering a more sophisticated model, taking into account the correlation between interest rate levels and prepayment behaviour.

    Thirdly, some of Triodos Bank’s loans contain caps and floors to prevent interest rates increasing or decreasing below a certain level. This affects the level of IRRBB in these products and both are taken into account in the economic value and earnings analysis. The economic value of the pipeline, which contains loans with a set interest rate which are committed but not yet remitted, is considered as well.

    Lastly, the measurement method for Economic Value at Risk uses cash flows which contain commercial margins. These margins are used in the discount factors as well to calculate the necessary net present values. The commercial margins are different for different product types and branches.

    The key interest rate risk indicators for 2017 have increased compared to the situation at the end of 2016. The duration of equity increased from 4.4 years at the end of 2016 to 5.6 years at the end of 2017. The one year Earnings at Risk increased from 1.8% at the end of 2016 to 2.4% at the end of 2017 (in case of a decreasing interest rate scenario by 2%, where the resulting market rates are floored at 0%). The Economic Value of Equity (EVE) at Risk increased from 8.5% at the end of 2016 to 10.9% at the end of 2017 (in case of a +2% interest rate scenario). The Outlier Criterion increased from 11.4% at the end of 2016 to 13.7% at the end of 2017.

    For the EUR portfolio, the duration of equity increased from 4.7 years at the end of 2016 to 6.0 years at the end of 2017. The 1 year Earnings at Risk for EUR increased from 1.8% at the end of 2016 to 2.7% at the end of 2017. The EUR EVE at Risk increased from 9.2% at the end of 2016 to 11.5% at the end of 2017.

    For the sterling (GBP) portfolio, the duration of equity increased from 0.3 years at the end of 2016 to 1.4 years at the end of 2017. The 1 year Earnings at Risk for GBP decreased from 1.7% at the end of 2016 to 0.3% at the end of 2017. The GBP EVE at Risk decreased from 9.8% at the end of 2016 to 5.5% at the end of 2017. The EVE at Risk includes the impact of the +200bp shock on the valuation of the embedded floors in the business loans of the UK.

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    2017
    in thousands of EUR

    Floating-rate

    <= 3 months

    <= 1 year

    <= 5 years

    > 5 years

    Total

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Interest-bearing assets

     

     

     

     

     

     

     

     

     

     

     

     

    Cash

    1,365,729

    1,365,729

    Government paper

    26,504

    26,504

    Banks

    215,262

    113

    1,000

    216,375

    Loans

    847,238

    857,681

    961,661

    1,762,596

    2,059,095

    6,488,271

    Hedged loans

    71,700

    73,400

    –44,000

    –101,100

    Interest-bearing securities

    172,883

    244,682

    831,307

    184,976

    1,433,848

    Hedged interest-bearing securities

    69,500

    41,975

    –111,475

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Total

    2,428,229

    1,198,381

    1,321,718

    2,439,428

    2,142,971

    9,530,727

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Interest-bearing liabilities

     

     

     

     

     

     

     

     

     

     

     

     

    Banks

    212

    2,271

    4,017

    30,648

    27,215

    64,363

    Funds entrusted

    35,240

    1,574,167

    2,438,341

    3,057,618

    1,609,363

    8,714,729

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Total

    35,452

    1,576,438

    2,442,358

    3,088,266

    1,636,578

    8,779,092

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    2016
    in thousands of EUR

    Floating-rate

    <= 3 months

    <= 1 year

    <= 5 years

    > 5 years

    Total

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Interest-bearing assets

     

     

     

     

     

     

     

     

     

     

     

     

    Cash

    732,219

    732,219

    Government paper

    53,544

    125,518

    179,062

    Banks

    351,894

    114,635

    1,000

    467,529

    Loans

    884,283

    856,089

    885,764

    1,591,001

    1,351,289

    5,568,426

    Interest-bearing securities

    264,166

    342,617

    802,861

    347,615

    1,757,259

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Total

    1,968,396

    1,288,434

    1,353,899

    2,394,862

    1,698,904

    8,704,495

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Interest-bearing liabilities

     

     

     

     

     

     

     

     

     

     

     

     

    Banks

    212

    719

    4,298

    17,626

    8,727

    31,582

    Funds entrusted

    21,186

    1,446,578

    2,256,884

    2,779,729

    1,510,431

    8,014,808

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Total

    21,398

    1,447,297

    2,261,182

    2,797,355

    1,519,158

    8,046,390

    Notes:

    Only interest bearing assets and liabilities are reported in this table, which results in differences with the balance sheet figures.

    Interest bearing securities and subordinated liabilities are valued at redemption value including bond premium and after deduction of discounts.

    For funds entrusted without a fixed interest rate term, the outcome of the quantitative savings and current account model, as mentioned before, is used.

    All other interest-bearing assets and liabilities are reported as floating rates or are broken down in the maturity calendar by their remaining contractual interest rate term.

    Foreign exchange risk

    Foreign exchange risk is the current or prospective risk to earnings and capital that arises from adverse movements in foreign exchange rates. Triodos Bank’s base currency is the euro. The UK Branch balance sheet and profit and loss account are denominated in GBP. Exchange rate differences arising from translating the UK branch balance sheet to euros are accounted for as a hedge of a net investment in a foreign business unit and are taken directly to shareholders’ equity in the statutory reserve for conversion differences, insofar as the hedge is effective.

    Triodos Bank aims to avoid net currency positions with the exception of those arising from strategic investments. The forward positions in foreign currencies mainly reflect the currency derivatives of Triodos Investment Funds which are nearly fully hedged.

    The foreign exchange position is monitored daily and discussed in the Asset and Liability Committee on a monthly basis. Limits are agreed by the ALCo.

    Foreign currency position

    The following table shows Triodos Bank’s foreign currency position in thousands of EUR as at 31 December.

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    2017
    in thousands of EUR

    Cash position
    Debit

    Cash position
    Credit

    Term position
    Debit

    Term position
    Credit

    Net position
    Debit

    Net position
    Credit

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    GBP

    1,109,863

    1,109,417

    631

    1,077

    USD

    10,692

    827

    389,874

    390,483

    9,256

    NOK

    102

    102

    PEN

    DKK

    15,975

    15,975

    AUD

    1

    1

    SEK

    50

    8,255

    8,255

    50

    INR

    60,341

    60,341

    IDR

    9,600

    9,600

    CNY

    3,315

    3,315

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Total

    1,120,708

    1,110,244

    487,991

    487,969

    10,486

    Net open foreign currency position (total of net positions debit and credit): 10,486

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    2016
    in thousands of EUR

    Cash position
    Debit

    Cash position
    Credit

    Term position
    Debit

    Term position
    Credit

    Net position
    Debit

    Net position
    Credit

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    GBP

    1,081,884

    1,078,536

    642

    3,990

    USD

    8,858

    891

    402,027

    402,721

    7,273

    NOK

    110

    110

    PEN

    DKK

    10,278

    10,278

    AUD

    469

    469

    SEK

    126

    75

    5,744

    5,744

    51

    INR

    56,717

    56,717

    IDR

    6,720

    6,720

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Total

    1,091,447

    1,079,502

    482,128

    482,180

    11,893

    Net open foreign currency position (total of net positions debit and credit): 11,893