Risk Management

Effective risk management is key to Landsbankinn's long-term profitability and stability. In 2016, work continued on strengthening risk management at Landsbankinn through improvements to internal processes, analysis, measurement and management of key risks in the Bank's operation.

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Landsbankinn's economic capital decreased significantly in 2016, due amongst other factors to the improved quality of the credit portfolio. Credit risk was well within risk appetite in 2016. The book value of the Bank's credit portfolio increased by ISK 42 bn in 2016, mostly driven by lending to construction and real estate companies and housing loans to retail clients. Foreign exchange risk decreased considerably in line with the Bank's policy. The Bank's liquidity position remains strong.

Risks in the Bank's operation are evaluated using several metrics based on the nature of each risk factor. These metrics are used to determine risk limits, analyse risk factors and changes to them, communicate information and manage risk. Economic capital represents the combined assessment of all risk factors.

The Bank's internal assessment for economic capital need due to credit risk (loans and claims on customers and financial undertakings) decreased by 15% in 2016. The most influential factors are a revaluation of loss-given defaults, implementation of a new rating model for large enterprises and improved quality of the credit portfolio with a lower average probability of default (down from 3.4% to 2.5%). Economic capital based on other risk factors decreased in general during the year and at year-end 2016, it was estimated at 12% lower than the previous year. Risk-weighted assets (RWA) decreased slightly and the ratio between economic capital and RWA was 11.8% at year-end 2016 as compared with 13.0% at year-end 2015.

Landsbankinn is working towards meeting the European Banking Authority's requirements for application of the internal ratings-based (IRB) approach in assessing economic capital for credit risk. The IRB approach influences a financial undertaking's economic capital requirements and thus its financial strength. The use of the IRB approach in assessing economic capital requires special authorisation from the Icelandic Financial Supervisory Authority (FME) along with an exhaustive audit of Landsbankinn's systems and processes. The Bank has applied for authorisation to apply the IRB approach from the FME and work is under way to implement new EBA standards in collaboration with the FME. Authorisation from the FME would allow Landsbankinn to use the IRB approach to assess economic capital for credit risk. This authorisation is granted only to financial undertakings who meet stringent requirements on good governance and a comprehensive credit risk assessment.

Landsbankinn's aggregate market risk increased somewhat in 2016 while FX risk decreased in line with the Bank's policy to reduce open reserve positions. The Bank's liquidity position is good and liquidity ratios are well above limits set by risk appetite and the CBI's requirements. The Bank's aggregate liquidity coverage ratio (LCR) was 128% at year-end 2016 and 743% in foreign currencies.

Landsbankinn's Risk Report

Further details of Landsbankinn's risk management are available in the Risk Report published in tandem with the Annual Financial Statements.
Open Landsbankinn's Risk Report
Defaults by individuals and households
Clear and effective decision-making authority, controlled risk-taking and monitoring by the Board of Directors, CEO and dedicated committees form the cornerstone of risk management within Landsbankinn.

Overview of Landsbankinn's 2016 risk appetite metrics

Risk factor Metric
Credit risk
Expected loss
Average probability of default
Loss given default
Sector concentration
Borrower concentration
Market risk
Interest rate and indexation risk in the banking book
Indexation risk
Liquidity risk Aggregate LCR
Operational risk Operational scope - Real changes to RWA base
Funding risk Net stable funding ratio
Economic capital targets

Organisation of risk management

The Bank has adopted detailed risk rules and developed a governance structure that ensures clear division of responsibility and monitoring of risk management.

Measuring risk appetite and risk limits for the most significant risk factors in the Bank's operation is part of daily management. This has proven useful as a management tool to increase the quality of the Bank's asset portfolio, improve its composition and reduce risk. Risk appetite not only involves setting risk limits but functions as a guide to the attitude the Bank's employees must adopt towards risk.

The Bank's risk limits comply with laws and regulations at any given time. In addition, the Bank sets numerous risk limits for its own operation, not provided for by law or regulations. Landsbankinn has set own targets for its financial position, asset quality, exposure and acceptable long-term profitability. In the pursuit of its goals, the Bank only accepts risks that it understands, is able to evaluate and manage.

In determining risk appetite, risk limits are set for all major aspects of credit, market, liquidity, funding and operational risk, variously detailed according to the nature and variability of each risk factor. The aim is to continue maintaining a stable risk profile in the Bank's balance sheet.

More about risk management

Landsbankinn has in recent years published a Risk Report that complies with the disclosure requirements of Pillar 3 of the Basel II rules. The report provides in-depth information on all aspects of the Bank's risk management and risk assessment methods.

The Risk Report is intended to present a true and fair picture of the Bank's position and it includes key information on scope, exposures, the risk assessment process, equity position and other important and related factors.