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.
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.
|Average probability of default|
|Loss given default|
|Interest rate and indexation risk in the banking book|
|Liquidity risk||Aggregate LCR|
|Operational risk||Operational scope - Real changes to RWA base|
|Funding risk||Net stable funding ratio|
|Economic capital targets|