Risk and capital adequacy management and risk exposure

Risk and capital adequacy management: key objectives, principles and organisation in a nutshell

The purpose of risk and capital adequacy management is to secure OP Financial Group’s and its institutions’ risk-bearing capacity and, thereby, ensure the continuity of operations. Risk-bearing capacity is made up of good risk management that is proportionate to the extent and complexity of operations and of sufficient capital adequacy based on profitable business operations.

Risk and capital adequacy management involves risk identification, measurement, assessment and mitigation. It also involves determining reliably and independently the size of the capital buffer required for various risks and business operations, and allocating capital systematically in line with current and planned risk-taking. The Group’s liquidity management is also part of risk and capital adequacy management.

OP Financial Group’s strategy outlines the Group’s risk appetite and risk management priorities that help to ensure strategy implementation. According to the strategy, the Group will secure its risk-bearing capacity in all circumstances and keep risk-taking moderate vis-à-vis the risk-bearing capacity. Each Group institution focuses on carrying out its role according to its service capabilities and risk-bearing capacities in accordance with shared business models.

OP Cooperative (the central cooperative) is responsible for the Group's risk and capital adequacy management and for ensuring that the Group’s risk management system is sufficient and kept up to date. The central cooperative issues Group institutions with guidelines for ensuring risk management and ensures, through supervision, that the institutions operate in accordance with official regulations, their own rules, guidelines issued by the central cooperative, OP Financial Group’s internal procedures and procedures that are appropriate and ethically sound for customer relationships. Institutions belonging to OP Financial Group are responsible for their own risk and capital adequacy management in accordance with the nature and extent of their operations.

OP Financial Group's quantifiable risks are restricted by means of limits and a system of control limits that guide operations at Group level, in Group cooperative banks and institutions belonging to OP Cooperative Consolidated. The central cooperative's Supervisory Board has determined risk limits for 2014 concerning OP Financial Group’s capital adequacy as well as for credit, liquidity, market and underwriting risks.

A more detailed description of OP Financial Group’s risk and capital adequacy management principles can be found in Note 2 “OP Financial Group’s risk management and capital adequacy management principles”.

OP Financial Group’s risk exposure

Risk-bearing capacity

OP Financial Group’s risk exposure has remained stable. The Group has a strong risk-bearing capacity sufficient to secure business continuity.

OP Cooperative's Supervisory Board has set limits for capital adequacy as prescribed in the Act on the Supervision of Financial and Insurance Conglomerates, for Common Equity Tier 1 (CET1) under the EU capital requirements regulation and directive, and for risk-based capital adequacy.

The legal minimum requirement for capital adequacy under the Act on the Supervision of Financial and Insurance Conglomerates is 1. On 31 December 2014, the ratio of the capital base to the minimum amount of capital base was 1.89 (2.19). On 31 December 2014, the Group's capital base was EUR 2,984 million (3,764) above the legal minimum.

The legal minimum requirement for CET1 is 4.5%. The Group's CET was 15.1% on 31 December 2014, and the capital base EUR 3,936 million higher than the legal minimum requirement.

Credit risks

The credit risk exposure remained stable despite the weak economic situation. The poor development of the economy nevertheless overshadows the Group's future prospects.

The loan and guarantee portfolio increased in the financial year by EUR 2.6 billion to EUR 73.6 billion. Private customers accounted for 62% and companies and housing corporations 36% of the loan and guarantee portfolio. The amount of receivables over 90 days overdue was EUR 279 million (295), that is, less than a year ago in proportion to the loan and guarantee portfolio. Net impairment loss on loans and other receivables were low, at 0.12% (0.12) of the loan and guarantee portfolio.

OP Financial Group's industry and customer risks are diversified. On 31 December 2014, the largest single counterparty-related customer risk accounted for 6.6% (5.8) of the Group’s capital base. The total amount of significant customer exposure was 23.8% (5.8) of the Group’s capital base. The total amount of significant customer exposure increased as a result of a higher number of customers whose loan capital represents more than 5% of the Group's capital base.

On 31 December 2014, the highest industry risk was 11.8% (11.1) by housing corporations. For more information about intra-Group industry and customers risk limits, see the Financial Statement's Note 60 "OP Financial Group's risk exposure".

Of corporate customer exposure, the investment-grade
exposure represented 49% (46) and the exposure of the lowest two rating categories amounted to EUR 501 million (634), accounting for 1.5% (1.9) of the total corporate exposure.

Of the six main categories for private customer exposure, 81% (77) of the exposures belonged to the top two categories, and 4% (4) in the two poorest.

The ratio of expected losses to exposure at default (EAD) was 0.22% (0.37). Expected losses are an estimate of the average annual losses caused by credit risks calculated using OP Financial Group’s own credit risk models. Updates to the credit risk models reduced the key ratio from the level a year ago.

The majority of OP Financial Group’s country exposure is in EU countries. The distribution of Group exposure is described in more detail in Note 62 of the 2014 Financial Statements.

Information concerning credit risk specified in the EU capital requirements regulation and directive (EU 575/2013) (CRR) are presented in the notes of the 2014 Financial Statements and the Pillar III disclosures.

Liquidity risk

OP Financial Group’s funding and liquidity position is strong. OP Financial Group's access to funding has remained excellent. During the financial year, the Group issued three covered bonds worth EUR 3.0 billion, and other long-term bonds worth a total of EUR 3.5 billion. The loan-to-deposit ratio remained stable throughout the financial year.

OP Financial Group secures its liquidity with a liquidity buffer which consists mainly of deposits with central banks and receivables eligible as collateral for central bank refinancing. The liquidity buffer is managed by a central bank which belongs to OP Financial Group.

The liquidity buffer’s collateral value was EUR 15.5 billion (12.3) on 31 December 2014. The liquidity buffer and other sources of additional funding based on the contingency funding plan are sufficient to cover funding for at least 24 months in the event wholesale funding becomes unavailable and total deposits decrease at a moderate rate.

For more information about the liqudity buffer and its risk exposure, see below under Other Operations.

Market risks

OP Financial Group’s market risk exposure was within the set limits in 2014.

The most significant market risks within Banking are associated with the effect of a change in interest rates on net interest income. The interest rate risk by Banking measured as the effect of a 1-percentage point decrease on a 12-month net interest income decreased during the financial year, due to a fall market interest rates.

No significant changes occurred in the investment risk level of Non-Life and Life Insurance, and the risk exposure has remained stable. The market risk of the liquidity buffer presented under Other Operations grew.

OP Financial Group's biggest currency risk is associated with Non-life and Life Insurance investments. The open net currency exposure by both Life and Non-life Insurance against the euro increased slightly. In Banking, currency risk is centralised within Pohjola Bank plc where the currency risk was low throughout the year.

Investment assets


€ million 31 Dec 2014 31 Dec 2013 Change
Pohjola Bank plc 8,545 8,117 428
Non-life Insurance 3,483 3,168 315
Life Insurance 3,996 3,545 452
Group member cooperative banks 796 950 -154
OP Bank Group Mutual Insurance Company 412 396 16
Total 17,232 16,174 1,058

Operational risks

The most significant operational risks are related to external factors, such as electronic data security and denial-of-service attacks, and outsourcing of operations.

At the turn of the year, OP Financial Group was the target of denial-of-services attack. As a result of the attacks, the Group's services, especially Internet Services, were unavailable. The direct financial consequences of the attacks were moderate considering the entire Group. OP has filed a report of an offence to the police, and the National Bureau of Investigation is investigating the matter. The Group took immediate measures to prevent the effects of similar attacks on service availability.

Underwriting risks

No significant changes took place to the underwriting risks of Non-life Insurance or Life Insurance. Low market interest rates increased the risk level of the discount rate associated with Non-life Insurance's insurance liability.

For more information about the risk exposure and capital adequacy of Non-life and Life Insurance, see the section dealing with business segments, and the 2014 Financial Statements' notes 94–105 (Non-life Insurance) and 107–114 (Life Insurance).

Other risks

Key risks associated with the Group's defined benefit pension plans relate to the discount rate for pension obligation and return on investment assets covering the pension obligation. The increase of net liabilities related to defined benefit pension plans entered in the comprehensive income during the financial year weakened the comprehensive income before taxes by EUR 380 million. The sensitivity of defined benefit pension liability to a change in discount interest is described in the 2014 Financial Statements' Note 39 Provisions and other liabilities, under "Sensitivity analysis of key actuarial assumptions".