Risk Management and Capital Adequacy Report Pillar

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1 Risk Management and Capital Adequacy Report Pillar

2 0B Table of contents Page Page Introduction 3 7. Stress tests and economic capital 64 Swedbank in brief 3 Highlights Economic environment 3 Economic Capital 65 CRO's statement 5 Internal Capital Adequacy Assessment Process Pillar 2 1. Risk governance 6 Stress tests 67 Risk profile 6 The adverse ICAAP scenarios 67 Enterprise Risk Management Policy 6 Impact on Swedbank simulation results 68 Three lines of defence 6 Impact on Swedbank REA and capital 69 Risk appetite and framework 7 Externally performed stress tests Capital requirements 9 Appendix A - Swedbank Consolidated Situation 71 Highlights Definitions 78 Capital requirements 10 Terminology and abbreviations 80 Capital planning 12 Regulatory environment - impact on Swedbank 13 Appendix B - Index of Tables and Graphs 82 Capital adequacy tables 16 Appendix C - Subsidiaries Credit risk 21 Swedbank Estonia Consolidated Situation 86 Risk appetite 21 Swedbank Latvia Consolidated Situation 98 Highlights Swedbank Lithuania Consolidated Situation 110 Credit risk in important sectors 22 Swedbank Mortgage AB 122 Credit risk exposures 24 Credit risk by business area 25 Management of credit risk 27 Measurement of credit risk 30 Capital requirements for credit risk 34 Credit risk exposures - retail exposure class (IRB) 35 Credit risk exposures - corporate exposure class (IRB) 37 Credit risk exposures - institutions exposure class (IRB) 39 Credit risk tables 40 Counterparty credit risk Market risk 46 Risk appetite 46 Highlights Management of market risks 47 Measurement of market risk 47 Capital requirements for market risk 48 Market risk exposures Liquidity risk 52 Risk appetite 52 Highlights Funding and liquidity strategy 53 Management of liquidity risk 56 Measurement of liquidity risk 56 Capital requirements for liquidity risk Operational risk 60 Risk appetite 60 Highlights Management of operational risk 61 Capital requirements for operational risk 63

3 3 Introduction This Risk Management and Capital Adequacy Report 2016 (Pillar 3 report) provides information on Swedbank s capital adequacy and risk management. The report is based on regulatory disclosure requirements set out in the Capital Requirements Regulation (Regulation (EU) 575/2013) and the Swedish Financial Supervisory Authority (SFSA) regulation FFFS 2014:12. Information in this report pertains to conditions as of 31 December 2016 for Swedbank Consolidated Situation (see Definitions table in Appendix A) if not otherwise stated. The disclosure is made annually in conjunction with the date of publication of Swedbank s Annual Report. For items where Swedbank has assessed that more frequent disclosures are needed, information is given in the interim reports. Furthermore, this report includes information for significant subsidiaries (Estonia, Latvia, and Lithuania each on a consolidated basis as well as Swedbank Mortgage) in accordance with Article 13 in the Capital Requirements Regulation. The report is part of the capital adequacy framework that builds on three pillars: Pillar 1 provides rules for how to calculate minimum capital requirements for credit risk, market risk and operational risks. The calculation can either be done using prescribed standardised risk measures or based on the bank s own internally used risk measures. Swedbank must fulfil certain requirements in order to use its own internally used risk measures and must seek approval from the SFSA and local supervisors in other countries where it operates. Pillar 2 requires institutions to prepare and document their own internal capital adequacy assessment process (ICAAP). All relevant sources of risk must be taken into account, that is, not only those already included when calculating the minimum capital requirement for credit, market and operational risks. The SFSA will, together with the regulatory supervisory college, make an assessment of the banks ICAAP and may impose additional capital requirements for Pillar 2 risks, meaning risks not covered by the Pillar 1 calculation. Pillar 3 requires institutions to disclose comprehensive information about their risks, risk management and associated capital. This report constitutes the demanded disclosure for Swedbank. Information about the Swedbank corporate governance structure and measures undertaken to manage operations in the consolidated situation is presented in the Swedbank Corporate Governance Report. Information about the Swedbank Board of Directors including directorships and recruitment policy is also disclosed in the Swedbank Corporate Governance Report. Information about risk implications of the remuneration process (and aggregate as well as granular quantitative information on remuneration) is disclosed in the document Information regarding remuneration in Swedbank 2016, which is published in conjunction with the Annual General Shareholders Meeting. All documents mentioned above, as well as the Policy on Gender Equality and Diversity, are available on This report is submitted by Swedbank AB, a public limited liability company with registration number This document has not been audited and does not form part of Swedbank AB s audited financial statements. Swedbank in brief Swedbank is a full-service bank available to all households and businesses in its home markets. With over 7 million private customers and more than 600,000 corporate and organisational customers across its operations, Swedbank is the largest bank in Sweden based on number of customers. The customers are served by 389 branches in Swedbanks four home markets Sweden, Estonia, Latvia and Lithuania and a presence in neighbouring markets such as Denmark, Finland and Norway to support our client base in these markets. Swedbank also operates in financial hubs such as the U.S., South Africa and China. Swedbank consists of four main business segments: (i) Swedish Banking, (ii) Baltic Banking (iii), Large Corporates & Institutions, and (iv) Group Functions & Other. Economic environment Growth in Europe and US was surprisingly resilience during 2016 amid global uncertainties. Labor market continued adding new jobs, inflation was picking up from low levels and sentiment among businesses and consumers strenghend. Manufacturing and services PMIs and consumer confidence increased and pointed a stronger growth in coming months in both Europe and the US. The effects of the financial crisis was slowly dissipated. In the US, the business cycle is maturing. The US has enjoyed 82 months of positive employment growth, the longest spell in history. With a strong labor market, and uptick in wages and stronger balance sheets, the US consumer has become more optimistic which will translate into higher growth in private consumption, a key determinant of US growth. In December 2016 Federal Reserve raised the reporate by 0.25 bp to 0.75 per cent and additional hikes is expected during 2017.

4 4 Expectations are high that Trumponmics will deliver fiscal stimulus and higher growth. In the euro zone, the business cycle is less mature than in Europe and there is hence more room for several more years of catching up. Unemployment has come down signifacantly, 9.6 per cent in December last year lowest level since The business cycle was supported by low interest rates and the ECB quantitative easing which was extended to December The Brittish economy have shown a better performance than expected although uncertainties about Brexit. While growth was at a stronger footing in developed countries, emerging markets showed signs of weakness. China is struggling to balance high debt with slowing growth. India s economy will take a hit following the currency reform, abolishing of higher denominated bills. Russia and Brazil is bouncing back from recession and benefiting from higher commodity prices. Still fundamentals remain weak. Commodity prices picked up last year after several years of decline. The oil price increased sharply from the low levels in the beginning of OPEC decided to cut oil production for the first time since 2008 and the increase in metal prices was boosted by expectations of higher US investments going forward. Swedish economy showed robust growth in 2016, although the speed decelerated somewhat after a substantial strong development in A fast growing population, which in January this year passed the 10 million inhabitants, was an important driving engine in the Swedish economy. The Riksbank's expansionary monetary policy, with a repo rate of percent and the extension of bond purchases had also a positive impact on growth. On average, GDP rose by 3.5 percent in average during last year's first three quarters compared with the same period in The domestic economy was the driving growth engine while it was still sluggish for the export industry. Residential investments rose by nearly 20 percent in 2016 and the number of apartment s permits was at the highest level since the beginning of 1970 s. The lack of housing is, however, troublesome in large parts of the country. The introduction of amortization requirements on new loans from last June led to a slight slowdown in the housing market. Housing prices rose at a more modest pace and credit growth to households cooled. A strong labour market and low interest rates supported the private consumption. The number of newly registered cars reached new record levels. Although labour market strengthened and number of employed increased by last year the labour market is sharply divided. Unemployment is more than twice as high for foreign-born compared to native-born and the shortage of labour became increasingly common in both the private and public sectors. The inflation rate has gradually increased and inflation expectations has picked up, which was positive news for the Riksbank. Inflation rate in December (CPI) was 1.7 percent, the highest level in four years. Riksbank decided in December for an extension of bond purchases by a further six months, but the decision was divided, with two members wanted to finish the purchases entirely. Besides better macro data and less support for further monetary easing boosted the Swedish krona, which can cause headaches for the Riksbank to achieve the inflation target of 2 percent. In the Baltic countries, the increase in GDP slowed in This was most evident in Latvia where GDP growth at an annual rate fell to 0.3 percent in the third quarter, against 2 percent in the second quarter. In Lithuania the growth rate declined from 2.1 to 1.7 percent, while the economy improved slightly in Estonia and grew by 1.3 percent. Fixed investment declined in all three Baltic countries, as a result of delayed finanancial support from EU funds and subdued confidence among businesses and households. Private consumption remained strong, driven by higher wages and falling unemployment. At the end of the year improved macro indicators for the Baltic economies as a result of the ongoing recovery in the rest of Europe. Exports improved in the second half of last year and especially in Estonia. Inflation in the Baltic countries has begun to increase due to higher prices, especially of oil and food. In December, the inflation rate was 2.2 percent in Estonia and Latvia, and 1.7 percent in Lithuania.

5 5 Strenghtened low risk profile, strong capital base and solid liquidity situation maintained despite the challenging low rate environment 2016 proved to be another strong year for Swedbank. Our capital base continued to strengthen on the back of stable profit generation and solid asset quality, while ensuring the bank s low risk level in the balance sheet. This was recognized as Swedbank s rating was upgraded during the year. The persistently strong asset quality in the credit portfolio in Sweden and in the Baltics is demonstrated by the continued low level of loan losses. In Norway however, we will continue monitoring what we perceive as an elevated risk level as a result of the volatile oil price and consequently a low level of investments. We have worked together with our clients in the oil sector and taken proactive steps to restructure parts of our oil-related portfolio. Where needed, necessary credit impairments have been taken aiming to comprise potential future loan losses. Swedbank has been one of the highest capitalised banks in Europe for several years, and during 2016 that position was strengthened even further. Our strong capital position is confirmed by the ICAAP stress test, by the Riksbank and the SFSA stress tests performed during In addition several international stress test also verified Swedbanks strong position, such as the pan-european stress test performed by the European Banking Authority and the International Monetary Fund as part of their Financial Sector Assessment Process. Our liquidity position is equally strong, due to a proactive funding activities and solid investor demand for our bond issuances offerings. In a hypothetical scenario of closed capital markets, our Survival Horizon measure shows strength, as does the Net Stable Funding Ratio (NSFR). From a risk control perspective, focus during 2016 has been to support responsible and sustainable business growth. This has been achieved via proactive activities towards the business to strengthen and prevent undesired risks not least by actively focusing on segments perceived as having an elevated risk. This has been accompanied by further development of steering tools and the risk limit framework and also through the use of a more sophisticated monitoring and control structure. We have further focused on prudent risk management during operational changes as well as taken measures to support our clients in the light of the Swedish housing market and the increased indebtness amongst private individuals. Focus on the rapidly changing regulatory landscape and implementation of new legislation has been important and will continue to be omnipresent part of financial institutions challenges. During 2016, Swedbank set additional focus on digitalisation, emphasizing risks stemming from operating a digitalized bank in several areas such as credit risk, data privacy, fraud and cyber risk. Looking into 2017, we continue to allocate significant resources to manage the scope of digitalisation but also the regulatory requirements, which remain key challenges going forward. We also face several challenges in the external environment, with persistant factors like slow growth in the euro area and the low interest rate enviroment. Geopolitical tensions and effects stemming from UK invoking Article 50 as well the foreign policy of the newly inaugurated US president, are other factors that we are taking into account. We are closely monitoring the oil price and its impact on relevant industries, with special focus given to our Norwegian portfolio, although the lower oil price has a neutral or beneficial impact for most of our customers in all four home markets. Our operating environment thus presents us with a variety of factors to manage. However, our solid capitalisation with one of the strongest CET1 capital ratios among European banks and strong liquidity position combined with our focus on lowrisk assets puts us in a good position to meet these challenges. With this report, we aim to provide readers with an open and clear view of how we work with risk management at Swedbank and how we continue to ensure our low risk and strong capital base. Helo Meigas Chief Risk Officer

6 6 1. Risk governance Swedbank s independent risk organisation is shaped by the three lines of defences and a strong embedded risk culture. This ensures professional risk management and protects us from unintentional and unnecessary risk-taking. Risk profile Swedbank defines risk as a potentially negative impact on the Group s value which can arise due to ongoing internal processes or future internal or external events. The concept of risk includes the probability that an event will occur and the impact it could have on the Group s results, equity or value. The Group shall work towards a sustainable social, environmental and economic development together with its clients and other stakeholders. The Enterprise Risk Management (ERM) Policy, decided by the Board, states that our strategy is to maintain Swedbank s low risk profile which is further concretised by the risk appetite (see Enterprise Risk Management Policy, Risk Appetite and Framework). Swedbank s customer base, which mainly consists of private individuals and small and medium-sized companies in Sweden and in the Baltic countries, is the foundation for the low credit risk. Our low-risk profile is confirmed by low losses, and a low level of impaired loans, despite the challenging external environment during Market risks were kept on a low level throughout the year in spite of volatile markets. In terms of operational risks, no single large loss event occurred, and the accumulated losses declined. Both our internal as well as external stress tests (performed by the European Banking Authority, the Riksbank and the Swedish Financial Supervisory Authority) confirm our low-risk profile. Swedbank s Common Equity Tier 1 (CET1) capital ratio, is among the highest compared to European peers, and correspondingly strong liquidity position. To continuously secure the low risk level, our operations are based on a foundation of professional risk management and control. The risk framework has been developed to secure solid risk awareness and business acumen within all parts of the bank. It originates from the Group s strategy and business planning process, in which risk-based planning is an integrated part. Internal regulations and guidelines are developed to secure strong risk control and steering. The Group s risk limit framework includes risk limits applied for individual risk disciplines from the Board further down to business areas for appropriate steering (see Risk Appetite and Framework). The risk framework also includes well-developed origination standards for prudent lending. Enterprise Risk Management Policy Risk arises in all financial operations, and managing it well is central for success. A strong common risk culture within Swedbank, with decision-making and responsibility kept close to the customer, serves as the foundation for efficient risk management and, consequently, a strong risk-adjusted return. The Board has the ultimate responsibility for Swedbank Group s risk-taking and capital assessment. Through the Enterprise Risk Management (ERM) Policy, the Board provides guidelines for the CEO on risk management and risk control, and how these functions should support the business strategy. The ERM Policy specifies the risk appetite, the concept of three lines of defence, the fundamental principles of risk management, and roles and responsibilities. The Board has also established the Risk and Capital Committee (RCC), the Audit Committee (AC) and the Remuneration Committee (RC) as support in matters related to risk management, governance, capital requirements and remuneration respectively. For further information on these committees, duties, reporting to committees and number of meetings during 2016, see the Swedbank Corporate Governance Report available on Three lines of defence Successful risk management requires a strong risk culture and a common approach that permeates the entire Group. Swedbank builds its approach to risk management on the concept of three lines of defence, signifying a clear division of responsibilities between the risk owners and control functions, i.e. Group Risk, Compliance and Internal Audit.

7 7 Swedbank s risk management Risk appetite and framework The ERM Policy states that Swedbank Group is to maintain a low risk profile, in terms of capital and liquidity. The long-term risk profile is to be managed so that a severely stressed scenario, as defined in the annual Internal Capital Adequacy Assessment Process (ICAAP), should not have a significant negative impact on the CET1 capital ratio. If the impact exceeds the established risk appetite, preventive measures must be taken. The Board establishes the main principles for the Group s risk management and decides on the overall risk appetite. In order to ensure and improve the approach to risk in different operations, the Board has also formulated risk appetites for each main risk type (see below). The risk appetites are further substantialised by limits set by the CEO and complemented by CRO limits, aimed at identifying potential limit breaches at an early stage. Business area limits, constituting the last level in the risk limit framework, are applied where relevant. The risk appetite and limits are designed to secure that the Group sustains its low-risk profile, taking into account the Group s business operations. The risk limit framework structure includes escalation principles in the event of any breaches of the risk appetite or limits. The Group Risk organisation is responsible for ensuring that each key risk is identified, analysed and properly managed. Decisions made on an aggregated level should always be in line with the Group s risk appetite. The Board as well as the CEO are regularly informed on the overall and specific risk profile. Further they are also regularly provided with information regarding the functionality of Swedbank s risk limits and in case of breaches, the actions taken to mitigate the breach The Risk organisation is responsible for providing the business organisation with operational guidance and support, in part by developing and maintaining internal rules and guidelines in each risk category. The CEO has established the Group Risk and Compliance Committee (GRCC), (9 meetings during 2016) to assist in matters related to all categories of risk and compliance. This includes reviewing, monitoring and challenging the Group risk profile in terms of significant exposures, risk trends, stress tests, losses, management actions and performance versus risk appetite, including observance of the risk limit framework. The GRCC also reviews and monitors the management of findings by Compliance, Risk units, Internal Audit and External Audit to secure that these are accurately managed. To further strengthen risk management arrangements in group functions and local business areas, the GRCC is supported by local Risk and Compliance Committees (BARCCs). Individual BARCCs are established in all business areas and relevant group functions, and have the same setup on local level as the GRCC for the Group. Escalation routines are implemented from the BARCCs to the GRCC to secure solid and efficient risk management. Credit risk Swedbank maintains a well-diversified credit portfolio with a low risk profile. All credit activities strive towards a long-term customer relationship and rest on strong business acumen to achieve solid profitability and a sound credit expansion for long-term stability. A basic principle in Swedbank s lending operations is that each business unit bears full responsibility for its transactions and its associated credit risks. Each business unit develops and maintains a balanced credit risk level for the respective credit portfolio, which is achieved by lending to customers with a high debt-service coverage ratio, by maintaining a strong collateral position and by portfolio diversification within and between sectors and regions. Counterparty risk arises as a result of hedging of own market risk and from customer-related trading activities. The Group has a conservative approach when choosing interbank counterparts. In the derivatives business, International Swaps and Derivatives Association (ISDA) or similar agreements are in general established with our customers. Furthermore, the Group restricts the extent of its counterparty risk exposure through several actions such as setting counterparty limits and FX settlement limits. Market risk According to the Group s Risk-policy and the concept of three

8 8 lines of defense, market risk-taking shall only be conducted by units granted permission by Swedbank Group s CEO. The risktaking is limited by a certain risk appetite, established by the Group s Board of Directors. Originating from the risk appetites, respectively, risk limit structures have been created in order to protect Swedbank Group against unintentional losses and excessive levels of market risk. Liquidity and funding risk Swedbank strives to maintain a conservative risk profile with resilience to both short-term and long-term external stress and to maintain an adequate buffer of highly liquid assets to enable it to withstand a prolonged period of liquidity stress without relying on forced asset sales or government intervention. Swedbank shall have a long-term, stable, welldiversified funding and investor base with a wholesale funding that is well diversified across markets, instruments and currencies. Furthermore, it shall strive to avoid maturity mismatch risk in assets funded by unsecured funding. All nonliquid assets, not eligible for covered bond issuance, shall be funded either through customer deposits or through wholesale funding with a maturity, to the largest extent, matching or exceeding that of the assets. Liquidity risk is measured, forecasted and analysed, using various time horizons, to ensure that the Group has adequate cash or cash-equivalents to meet its obligations in a timely manner. The responsibility for managing the Group s liquidity lies with Group Treasury. Group Risk works independently to identify all relevant aspects of liquidity risks, and is responsible for control, measurement, monitoring and reporting liquidity risk exposure across the Group. Operational risk Swedbank shall not experience operational risk-related losses or incidents that have materially negative impact on the Group s funding, capitalisation and third-party credit rating. The maximum level of operational risk is further defined in the risk limits by a stated level of unexpected financial loss, tolerable errors in the financial statement and as specific qualitative statements which relate directly to the operations of the Group. considered in business decisions and, as far as possible, in the pricing of products and services. Managers shall ensure that the operational risks inherent in their respective areas are identified, assessed and properly managed in the day-to-day operations. ALM and capital management In addition to the ERM Policy, Swedbank s Asset, Liability and Liquidity Policy sets out the fundamental principles that apply for the Group s processes and structures to identify and manage the Group s assets and liabilities to build an optimised balance-sheet structure, in order to meet liabilities, absorb losses, safeguard shareholder returns, and maintain public confidence. The Group s capital, funding and liquidity shall be managed in a way that does not create disproportionate constraints on the governance or management of the Group. The CEO has established the Group Asset Allocation Committee (GAAC) to assist in issues related to the management of assets, liabilities, capital and the balance sheet structure. Group Treasury works as an internal bank and provides funding to the business areas, retains capital at Group level or, as directed by shareholders or the Board, returns it to shareholders. To ensure that Treasury can act as an internal bank, an adequate framework comprising principles and instructions for capital allocation and internal fund-transfer pricing is maintained. Compliance For governing, controlling and supporting the proper handling of compliance matters, the CEO relies on Swedbank s Compliance organisation. The Compliance function is responsible for providing assurance to the CEO and the Board that the Group s business is being conducted in accordance with regulatory requirements applicable to the operations subject to authorisation. Compliance s activities are planned and prioritised through a structured and documented process aimed at identifying the key compliance risks in the Group. The current focus areas for Compliance are internal governance, customer protection, market conduct, ethics, conflicts of interest, anti money-laundering activities, counter-terrorist financing activities, and remuneration. Operational risks are to be kept at the lowest possible level taking into account business strategy, market sentiment, regulatory requirements, rating ambitions and the capacity to absorb losses through earnings and capital. They shall be

9 9 2. Capital requirements Swedbank s capitalisation continued to strengthen for the ninth consecutive year. Swedbank has one of the highest CET1 capital ratios compared to other European banks. Our capitalisation makes us resilient and ensures that we are well positioned to meet upcoming capital requirements proposed by international standard setters as well as to continue to grow our business. Capital requirements Capital adequacy rules express the regulatory requirement for how much capital a bank must hold in relation to the risk the bank faces Highlights 2016 Thanks to stable earnings generation, Swedbank s already strong capitalisation further improved throughout the year. Swedbank s Common Equity Tier 1 (CET1) capital ratio was 25.0% as of year-end, which makes the Group well-positioned to meet both current and future capital requirements. In December 2016, Swedbank issued a new Additional Tier 1 capital instruments to further optimise its capital structure. Internal and external stress tests also show that Swedbank remains resilient to crises, not least the Internal Capital Adequacy Assessment Process (ICAAP), which incorporates adverse scenarios more severe than any recent Swedish recessions. Common Equity Tier 1 ratio: 25.0% 2015: 24.1% Common Equity Tier 1 capital: SEK 98.7bn 2015: SEK 93.9bn Risk Exposure Amount: SEK 394.1bn 2015: SEK 389.1bn Common Equity Tier 1 capital requirement: 21.9% 2015: 19.9% Leverage ratio: 5.4% 2015: 5.0%

10 Capital requirements Capital adequacy rules express the regulatory requirement for how much capital a bank must hold in relation to the risk the bank faces. When assessing its capital needs, Swedbank takes into consideration its current and future risk profile, internal risk measurement, and assessment of the risk capital needed. In addition to capital requirements for credit, market and operational risk (i.e. Pillar 1), all other risks, such as interest rate risk in the banking book, concentration risks, pension risks, earnings volatility risk, and strategic risk must be taken into account when assessing the total capital need (i.e. as part of the Pillar 2 assessment). In recent years, Pillar 2 capital charges have increased in importance as a supervisory tool. In particular, the Swedish Financial Supervisory Authority (SFSA) has introduced both a systemic risk buffer and a risk-weight floor for Swedish mortgages within the Pillar 2 framework. In 2016 the SFSA also imposed a temporary additional Pillar 2 capital charge related to revised requirements on banks internal models requiring the banks to anticipate a larger proportion of economic downturns in their estimates of probability of default, as described below. The capital charge will be imposed until the SFSA has approved the banks updates to their models in response to the revised requirements. Under the EU Capital Requirements Regulation (EU Regulation No 575/2013, CRR), a bank s total capital must be equivalent to at least the sum of the capital requirements for credit, market and operational risks, including capital buffers and potential Pillar 2 add-ons. Banks using the internal ratingsbased (IRB) approach shall, at all times, also hold own funds equal to or exceeding 80% of the total minimum amount of own funds that the bank would be required to hold under Basel 1 rules ( Basel 1 floor ). Swedbank fulfills these requirements; see Appendix A, table A1. Other laws and regulations also apply; for example, the Swedish Banking and Finance Business Act require a minimum initial capital of EUR 5m. Furthermore, the CRR includes rules regarding large exposures, i.e. the limitation of exposures to individual customers or groups of customers in relation to total capital. In brief, the total capital is the sum of CET1 capital, Additional Tier 1 (AT1) capital, and Tier 2 (T2) capital. CET1 capital mainly comprises shareholder equity after various adjustments, while Additional Tier 1 capital and Tier 2 capital are mainly made up of subordinated debt. A reconciliation of shareholders equity (according to International Financial Reporting Standards, IFRS) and the regulatory total capital is presented below in Figure In December 2016, Swedbank issued USD 500m in Additional Tier 1 capital to further optimise its capital structure. The issuance was in the form of debt instruments that convert to ordinary shares if the bank s regulatory capital falls below a certain level. The issuance strengthened Swedbank s Tier 1 capital ratio by 1.13 percentage points. Key figures At year-end 2016, CET1 capital ratio (i.e. the CET1 capital in relation to the risk exposure amount), was 25.0% (31 December 2015: 24.1%). CET1 capital increased by SEK 4.8bn, to SEK 98.7bn. The change is mainly attributable to earnings, net of proposed dividend. The accounting for employee benefits (IAS 19) creates volatility in the estimated pension liabilities and decreased the CET1 capital by approximately SEK 1.5bn during The changes in CET1 capital are shown in Figure 2-2 below. The risk exposure amount (REA) increased during the year by SEK 5.0bn, to SEK 394.1bn (31 December 2015 SEK 389.1bn). Credit risk REA increased by SEK 9.4bn during the year. In terms of exposure, there was an increase mainly in corporate and private mortgage exposures in Swedish Banking and LC&I. Negative rating migrations increased REA by a total of SEK 0.2bn. REA decreased by SEK 7.9bn due to improved LGDlevels resulting from higher property values for private residential properties and from improved processes for handling collateral values. Changes in exchange rates increased REA for credit risks by SEK 3.6bn due to depreciation of the Swedish krona. The REA for credit value adjustment (CVA) decreased REA by SEK 2.1bn, mainly driven by decreased exposures. The REA for market risk decreased by SEK 1.4bn. Operational risk decreased REA by SEK 0.9bn compared to the preceding yearend, mainly due to Swedbank s revenue being lower in the rolling three-year period. See Figure 2-3 for changes in REA. Swedbank s leverage ratio was 5.4% on 31 December 2016 (5.0%). Tier 1 capital increased by SEK 8.4bn, to SEK 113.0bn. The change is mainly attributable to earnings, net of proposed dividend, and to issuance of Additional Tier 1 capital in December The issuance of Additional Tier 1 capital impacted the leverage ratio only indirectly, it was not aimed directly at the leverage ratio. The exposures included in the calculation of the leverage ratio decreased by SEK 4.1bn during the year. See Table 2-7 for a full reconciliation of the leverage ratio.

11 11 Figure 2-1: Link between shareholders equity and total capital SEKbn Shareholders' equity Proposed dividend Goodwill & intangible assets Other adjustments CET1 capital Total CET1 Capital Additional Tier 1 capital Total Tier 1 Capital Tier 2 capital Total capital Increase Decrease Figure 2-2: CET1 capital, changes during 2016, Swedbank Consolidated Situation SEKbn Profit (CS) Anticipated dividend IAS 19 Other CET1 changes Figure 2-3: REA, changes during 2016, Swedbank Consolidated Situation SEKbn Exposure change Rating migration (PD) LGD changes Other credit risk CVA risk Market risk Operational risk Increase Decrease

12 12 Figure 2-4: CET1 capital ratio Figure 2-5: Tier 1 capital ratio Figure 2-6: Total capital ratio % 30 % 30 % Basel 2* Basel 3** Basel 2* Basel 3** Basel 2* Basel 3** *As the new capital regulations came into force in January 2014, Swedbank's capital adequacy reporting under Basel 2 ceased from that date. ** according to Swedbank's calculation based on the proposed regulations Capital planning All banks are affected by macroeconomic changes that cannot be fully mitigated by a strong risk culture and risk management. Swedbank is adequately capitalised and has sufficient buffers to ensure a going concern even under adverse conditions. Capital buffers are also necessary to absorb fluctuations of capital under normal conditions due to factors such as volatility in the estimated pension liabilities and variation in foreign currency exchange rates and interest rates. Swedbank conducts stress tests to identify the potential effects of possible, though unlikely, negative scenarios and to assess whether the capital buffer is satisfactory at any given point in time. Capital planning and efforts to sustain satisfactory capitalisation are critical for Swedbank s ability to maintain the market s confidence, and consequently to retain access to cost-efficient funding in the capital market, thus making us able to support our customers. The financial crisis dramatically changed the way regulators, rating agencies and debt investors perceive banks' capitalisation. A large number of regulatory changes have been implemented in recent years, or are about to be implemented, collectively aimed at increasing both the size and quality of the banks' total capital. Stable earnings and strong capitalisation mean that Swedbank is well positioned today and for the future. Swedbank s CET1 capital ratio is among the highest compared to European peers, which is confirmed by the quarterly Risk Dashboard issued by the European Banking Authority (EBA). Swedbank s objective is to, at all times, be sufficiently strongly capitalized to maintain confidence and access to cost-efficient funding in the capital markets, even under adverse market conditions. At the same time Swedbank should uphold an efficient total capital which, by its size and structure, ensures a high return on shareholder equity. Swedbank s standard procedures include a process for reacting to leverage ratio changes and for managing the risk of excessive leverage. In particular, Swedbank takes the risk of excessive leverage into account in the bank s forward-looking capital planning process which is performed at least on a quarterly basis. Other business steering or asset-and-liability management tools may also be considered as a means to affect the total exposure measure and may be accessed should such a need arise. Swedbank assesses that the Group as well as the parent company and its subsidiaries are adequately capitalised. In case of a potential shortfall, a capital injection or measures to reduce risk exposure amount may be performed. In addition to injection of equity capital, the total capital in a subsidiary may also be strengthened through subordinated loans from within the Group. To the extent that non-restricted equity is available in subsidiaries, funds can be transferred back to the parent company as dividends. Swedbank regularly reviews the capitalisation of the entire Group and the individual legal entities. The outcome of such reviews may trigger adjustments deemed necessary to ensure compliance with regulatory requirements and an efficient capital management within the Group. In particular, besides regular dividends and capital contributions in accordance with subsidiaries dividend policies, extraordinary dividends from Swedbank Latvia and Swedbank Lithuania amounting to EUR 570m to Swedbank AB was paid in In addition a capital repatriation of Swedbank Latvia s share capital was made to Swedbank AB of an amount of EUR 368m in Further, there are no current or foreseen material practical or legal impediments to the prompt transfer of own funds or repayment of liabilities to or from the parent company and its subsidiaries. Adequate and comprehensive capital allocation is an essential tool in measuring profitability, from the level of the business area and all the way through to each customer. At Swedbank, shareholder value is seen as an excess return over the cost of capital and is measured by economic profit and risk-adjusted return on capital (RAROC). The principles of capital allocation reflect Swedbank's risk tolerance and capital strategy. Consolidated shareholders' equity is allocated to each

13 13 business area based not only on regulatory requirements, but also on an internal assessment of risk in individual transactions. Regulatory environment impact on Swedbank The regulation of banks is changing rapidly as a consequence of the financial crisis that began in These efforts are coordinated worldwide by the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision. In Europe, this is accentuated by a push to harmonise regulations and supervision practices through the development of a single rulebook and the introduction of pan-european supervisory institutions. Starting from 2014, the European Central Bank (ECB) began directly supervising the largest banks in the euro area; national supervisors continue to monitor the remaining banks. As of 1 January 2015, the ECB s supervision includes Swedbank in Estonia, Latvia and Lithuania. An additional feature that has emerged is that the European capital adequacy legislation includes a framework for macro prudential supervision, aimed at detecting and containing systemic risks. As a consequence, the banks capital requirements may be shifted quite frequently by the national authorities, when deemed necessary to contain systemic risk. Swedish capital requirements The Basel 3 framework for bank regulation was introduced within the EU in 2014 through the EU regulation CRR and the EU Directive CRD IV. In 2014, the SFSA also decided which capital requirements would apply to Swedish banks beyond the minimum level of 7% CET1 capital in accordance with the EU rules. The SFSA s requirements can be summarised as follows: As of 1 January 2015, the four major Swedish banks are assigned a systemic risk buffer of 3% in CET1 capital within the framework of Pillar 1 and a further 2% systemic risk charge within the framework of Pillar 2. A risk-weight floor for Swedish mortgages of 25% applies within the framework of Pillar 2. The countercyclical buffer rate was set to 1% from 13 September 2015, was increased to 1.5% from 27 June 2016, and will be further increased to 2.0% from 19 March Due to the risk-weight floor for the Swedish mortgage portfolio and the countercyclical buffer requirement, Swedbank must maintain additional CET1 capital of SEK 25.9bn for Swedish mortgages within the framework of Pillar 2, corresponding to 6.6 percentage points of the CET1 capital ratio. These figures are forward-looking, i.e. they take into consideration the announced increase in the Swedish countercyclical buffer rate to 2.0% in March In its internal steering, Swedbank allocates capital to its mortgage business equivalent to a 25% risk-weight floor. During 2015, the SFSA clarified its view on the capital requirements for Pillar 2 risks. In particular, in its overall supervisory capital assessment during the course of the annual supervisory review and evaluation process (SREP), the SFSA uses the methods it had presented in May 2015 for assessing capital requirements within the framework of Pillar 2 for credit-related concentration risk, interest rate risk in the banking book, and pension risk. On this basis, Swedbank s CET1 capital requirement for these Pillar 2 risks is estimated at 1.2%, calculated as per 31 December The SFSA has previously stated that it does not intend to make a formal decision on the capital requirement for individual institutions in Pillar 2. As long as a formal decision has not been made, the capital requirement under Pillar 2 does not affect the level at which automatic restrictions on dividend and coupon payments take effect (due to a breach of the combined buffer requirements). In January 2016, the SFSA reiterated its view in a response to an EBA document on this topic. In May 2016 the SFSA adopted revised requirements for Swedish banks calculating risk weights for capital requirements using the internal ratings-based approach, especially with regard to corporate exposures. The SFSA began applying the revisions in its SREP for 2016, which the SFSA finalised at end of September Thus, the revisions have affected Swedbank s capital requirements beginning in the fourth quarter The revisions require banks to anticipate a larger proportion of economic downturns in their estimates of probability of default, which increased Swedbank s CET 1 capital requirement by 0.5 per cent, and to use a so-called maturity floor, which increased Swedbank s CET 1 capital requirement by 0.2 per cent. The total capital requirement for Swedbank, calculated as per 31 December 2016 based on current information, is equivalent to a CET1 capital ratio of 21.9% and a total capital ratio of 27.7%. These figures are forward-looking, i.e. they take into consideration all announced increases in countercyclical buffer rates, including the increase in the Swedish countercyclical buffer rate to 2.0% in March 2017 (see Table 2-1 below). At end-2016, Swedbank s actual CET1 capital ratio and total capital ratio were 25.0% and 31.8%, respectively. This means that there is an adequate buffer above the fully implemented capital requirement to manage volatilities in capital and REA. However, due to the uncertainty related to potential regulatory changes in the future, Swedbank s assessment is that the bank has no excess capital.

14 14 The Basel Committee s review of capital requirements The Basel Committee is working on several policy and supervisory measures that aim to enhance the reliability and comparability of risk-weighted capital ratios and to reduce the potential for undue variation in capital requirements across banks. The measures comprise revisions to the standardised approaches for credit risk and for operational risk, a review of the role of internal models in the capital requirement framework and an introduction of a leverage ratio minimum requirement and of aggregate capital floors for banks that use internal models based on the proposed revised standardised approaches. In particular, in December 2015 the Basel Committee issued its second consultative document on revisions to the standardised approach for credit risk. In this document, the Basel Committee proposes measures aimed at increasing risk sensitivity, increasing comparability of capital requirements under the standardised approach and the IRB approach, and increasing comparability of capital requirements between banks using the standardised approach. In addition, the Basel Committee aims to reduce reliance on external credit ratings by only allowing external credit ratings when they are used in parallel with the bank s own rating of the entities in question. In 2014, the Basel Committee also issued final regulatory text for a new standardised approach for measuring counterparty credit risk exposures, which is included in the European Commission s proposals, as discussed below. Moreover, in January 2016 the Basel Committee completed the Fundamental Review of the Trading Book, a comprehensive revision of the capital adequacy standard for market risk, which is also included in the European Commission s proposals. The new standard implies substantial revisions to both the standardised approach and the internal models approach. Furthermore, in March 2016, the Basel Committee published a proposal for a new standardised measurement approach for operational risk, which would replace all existing approaches for operational risks, including the Advanced Measurement Approach. The leverage ratio is a new non-risk-based solvency requirement introduced through the Basel 3 framework. It is described as a backstop to the risk-based capital requirements. It is intended to constrain excess leverage in the banking system and to provide an extra layer of protection against model risk and measurement error. Since 2014, banks have been required to report the leverage ratio to regulators, and a formal disclosure requirement was introduced as from Q The Basel Committee has communicated that it intends to introduce a binding leverage ratio minimum requirement. The leverage ratio is proposed to be defined as Tier 1 capital divided by total exposures for the calculation of the leverage ratio. The minimum requirement as proposed by the Basel Committee would be calibrated to 3%. For Swedbank, such a requirement is not expected to entail a limitation in the bank s capital planning. Furthermore, the Basel Committee considers introducing a higher leverage ratio requirement for global systemically important banks. However, Swedbank is not a global systemically important bank. As part of its work on strengthening the link between internal models and the standardised approaches, and enhancing comparability of capital requirements across banks, the Basel Committee issued in December 2014 a consultative document on the design of a capital floor framework. The framework would be based on the proposed revised standardised approaches, to limit the risk that capital requirements are too low due to the use of internal models. The new floor framework would replace the current capital floor, based on the Basel 1 standard, for banks using internal models. In March 2016, the Basel Committee proposed constraints on the use of internal model approaches for credit risk. In particular, the Basel Committee proposed to remove the option of using the IRB approaches for certain exposures; to adopt exposure-level, model-parameter floors; and to provide greater specification of parameter estimation practices. The Basel Committee had intended to finalise all those revisions to the Basel III framework, including the calibration of the aggregate capital floors framework and the leverage ratio minimum requirement, at or around the end of However, in January 2017, the Basel Committee announced that it has postponed the finalisation to the near future. There is a high degree of uncertainty with regards to the Basel Committee s final calibration of the proposed new frameworks, and subsequently how and when this will be implemented in the EU and in Sweden. It is thus too early to draw firm conclusions regarding the impact of the potential future capital requirements. For risk-specific information regarding the Basel Committee s review of capital requirements, see Chapter 3 (credit risk and counterparty risk), Chapter 4 (market risk), and Chapter 6 (operational risk) of this report. Bank Recovery and Resolution Directive (BRRD) The BRRD, which allows the authorities to deal with banks in distress, was established in the EU in It was implemented by Sweden through the Swedish Resolution Act in February The crisis management framework set out in the BRRD is intended to prevent crisis situations and improve the ability to deal with crises that may arise. The aim is to reduce the risk that taxpayers will have to bear the cost in the event of a banking crisis. This will be accomplished through the option of what is known as bail-in, which means that shareholders and creditors bear the costs to a greater extent. According to the directive, EU member states shall appoint one or more resolution authorities in each member state. The Swedish government has designated the Swedish National Debt Office (SNDO) as the Swedish resolution authority. The resolution authorities tasks include drawing up resolution plans, taking the decision that a given bank shall enter into resolution, and applying resolution tools. To ensure that banks always have sufficient loss-absorbing capacity, the BRRD also provides for the resolution authorities to set minimum requirements for own funds and eligible liabilities

15 15 (MREL) for each bank, based on, amongst other criteria, its size, risk and business model. The FSB has issued a standard on Total Loss-Absorbing Capacity (TLAC), which sets corresponding requirements for global systemically important banks. Swedbank is not a global systemically important bank. The TLAC requirement will be phased in starting from 1 January There is currently work going on in the EU to implement the TLAC standard in EU legislation. In particular, the European Commission has proposed to incorporate TLAC into the capital requirements framework, as an extension to the own funds requirements and as part of the proposals discussed below. Although TLAC only applies to global systemically important banks, the European Commission has proposed that national resolution authorities should also be permitted to require other banks in a member state, like Swedbank, to have subordinated liabilities, as provided for in the TLAC standard. On 26 April 2016, the SNDO published a proposal detailing its plans for implementing the MREL requirement on Swedish banks. The MREL requirement for systemically important banks in Sweden, such as Swedbank, would be the sum of a loss absorption amount plus a recapitalisation amount. The loss absorption amount would equal the current total capital requirement excluding the combined buffer requirement and the Pillar 2 systemic risk surcharge. The recapitalisation amount would equal the total current capital requirement (i.e. including combined buffer and Pillar 2 requirements). The loss absorption amount could be met with own funds instruments (Common Equity Tier 1, Additional Tier 1 and Tier 2), while the recapitalisation amount could only be met with eligible liabilities (essentially senior unsecured bonds or term deposits from large corporates, having a remaining maturity of at least one year). The SNDO expects to revert earliest in the first quarter of 2017 with final rules for the Swedish MREL implementation. In its proposal, the SNDO communicated that it intended to make the first decisions for the Swedish banks MREL requirements in fall Swedish banks would then have to comply with the MREL requirements starting from Moreover, the SNDO s view is that a requirement that MREL eligible liabilities shall be subordinated to senior liabilities should be introduced eventually. However, since a requirement on subordination would have major consequences for Swedish banks, the SNDO is going to investigate further how and when such a requirement can be introduced. Subordination requirements are also addressed in the European Commission s proposals as discussed below, and the outcome of the proposals will therefore also be relevant in this regard. The SNDO expects to revert also regarding the details of a subordination requirement at the earliest in the first quarter of The Single Resolution Mechanism regulation, which is applicable in the Baltic countries, establishes a centralised resolution approach with a Single Resolution Board being responsible for the overall framework, while national resolution authorities are in charge of implementing the resolution decisions. Swedbank s best understanding and estimates of the SNDO s implementation of MREL shows that Swedbank on a consolidated level already has enough capital and eligible liabilities if the expected initial MREL requirements (excluding any subordination requirement) would be introduced today. However, due to the potential amendment of the requirement in the future, there are still uncertainties regarding the final configuration and level of the MREL requirement, and consequently how this will affect Swedbank s capital requirements. The Swedish Government s focus in its implementation of the BRRD is to build up resilience in the financial system, thereby reducing the likelihood of banks entering into resolution. In accordance with the BRRD, the Government introduced a resolution reserve as a new financing arrangement together with the existing deposit insurance fund and the stability fund, which is intended for the banking system as a whole. The new resolution reserve is financed by fees paid by the banks that could be subject to resolution. Therefore, no fee to the stability fund will be charged going forward. The Government has decided that the target level for the Swedish resolution reserve should be 3% of the total stock of covered deposits in Sweden. This has caused the annual fees to the new resolution reserve to be approximately twice as extensive as the fees formerly paid to the stability fund. The fee for an individual bank is determined by the bank s size and its risk profile based on a methodology defined in an EU regulation. The fee to the resolution reserve is charged starting from In 2016 the fee was set to half the normal size. Swedbank paid an amount of SEK 596m to the Swedish resolution fund in Swedbank is also liable to pay fees to the resolution reserves in the Baltic countries. These fees totaled EUR 4.9m in As part of the crisis management framework, banks need to submit recovery plans annually to their regulators. Swedbank submitted its initial plan to the SFSA in 2013, and has since then submitted updated plans annually. As noted above, resolution authorities have to draw up resolution plans for the banks. In 2016, the SNDO approved its first resolution plan for Swedbank. The European Commission s proposals for amendments to the CRR, the CRD IV and the BRRD On 23 November 2016, the European Commission published legislative proposals for amendments to the CRR, the CRD IV, the BRRD and an amending directive to facilitate the creation of a new asset class of non-preferred senior debt. The proposals cover multiple areas, including the Pillar 2 framework, a binding leverage ratio minimum requirement, mandatory restrictions on distributions, permission for reducing own funds and eligible liabilities, macroprudential tools, the Basel Committee s new standardised approach for measuring counterparty credit risk exposures, the Basel Committee s Fundamental Review of the Trading Book, a new

16 16 category of non-preferred senior debt, the MREL framework and the integration of the TLAC standard into EU legislation as mentioned above. The proposals are to be considered by the European Parliament and the Council of the European Union and therefore remain subject to change. The final package of new legislation may not include all elements of the proposals and new or amended elements may be introduced through the course of the legislative process. Until the proposals are in final form and adopted by the EU and until Swedish legislators and authorities have decided on how the proposals would be implemented in Sweden, it is uncertain how they will affect Swedbank. Capital adequacy tables Table 2-1: Capital requirements (incl. fully implemented buffers and Pillar 2 requirements) 1 Pillar 1 CET1 AT1 T2 Total capital Minimum CET1 requirement 4.5% 1.5% 2.0% 8.0% Systemic risk buffer (P1) 2 3.0% 3.0% Capital conservation buffer (CCoB) 2.5% 2.5% Pillar 2 4 Countercyclical capital buffer (CCyB) 3 1.3% 1.3% 11.3% 1.5% 2.0% 14.8% Mortgage floor 5 6.6% 0.7% 0.9% 8.2% Systemic risk charge (P2) 2.0% 2.0% Individual Pillar 2 charge 2.0% 0.3% 0.4% 2.7% of which Interest rate risk in the banking book 0.7% 0.1% 0.1% 0.9% of which Credit-related concentration risk 0.6% 0.1% 0.1% 0.8% of which Adjustment to estimates of probability of default 5 0.5% 0.1% 0.1% 0.6% of which Maturity floor for corporate exposures 0.2% 0.0% 0.0% 0.3% of which Pension risk 0.0% 0.0% 0.0% 0.0% of which Other 0.1% 0.0% 0.0% 0.1% 10.6% 1.0% 1.3% 12.9% Capital requirements 21.9% 2.5% 3.3% 27.7% Actual capital ratios as of 31 December % 3.6% 3.1% 31.8% 1) Swedbank's estimate based on the SFSA's announced capital requirements, including fully implemented buffers and Pillar 2 requirements. 2) The Other Systemically Important Institution buffer (O-SII buffer) entered into force on 1 January The higher of the systemic risk buffer and the O-SII buffer applies. The O-SII buffer is 2%. 3) The estimate is based on Swedbank's relevant exposures, and the calculation takes into account the impending increases in the countercyclical buffer rates published by the ESRB as of 17 January ) Mortgage floor and systemic risk buffer as of 31 December The individual Pillar 2 charge as of 31 December 2016 according to SFSA s SREP report of 30 September 2016 in relation to REA as of 31 December ) The calculation takes into account the impending increase in the Swedish countercyclical buffer rate to 2.0% in March Table 2-2: Capital adequacy in Swedbank Consolidated Situation SEKm Common Equity Tier 1 capital Tier 1 capital Total capital Risk exposure amount Minimum capital requirement 1) Surplus of capital Common Equity Tier 1 capital ratio, % Tier 1 capital ratio, % Total capital ratio, % Capital requirement Basel 1 floor Total capital adjusted according to rules for Basel 1 floor Surplus of capital according to Basel 1 floor As of 31 December 2015 the Swedbank Consolidated Situation included the Swedbank Group with the following exceptions. In the consolidated accounts, the associated company EnterCard (group) is consolidated according to the equity method. In Swedbank Consolidated Situation, EnterCard is consolidated according to the proportional consolidation method. The insurance companies included in the consolidated accounts, Swedbank Försäkrings AB, Sparia Group Insurance Company Ltd., Swedbank Life Insurance SE, and Swedbank P&C Insurance AS, are not included in Swedbank Consolidated Situation and are instead subject to solvency rules rather than capital adequacy rules. 1) Total minimum capital requirement under Pillar 1, i.e. 8% of total risk exposure amount.

17 17 Table 2-3: Total capital, Swedbank Consolidated Situation Note SEKm Shareholders equity according to the Group balance sheet Non-controlling interests Anticipated dividends Deconsolidation of insurance companies Unrealised value changes in financial liabilities due to changes in own creditworthiness Cash flow hedges Additional value adjustments Goodwill Deferred tax assets Intangible assets Net provisions for reported IRB credit exposures Shares deducted from CET1 capital Defined benefit pension fund assets Total CET1 capital Additional Tier 1 capital Total Tier 1 capital Tier 2 capital Total capital Shareholders equity according to the Group balance sheet This item includes capital contributed by the shareholders, which is reported as share capital and statutory reserves. This item also includes earnings in previous years and in the current year reported via the comprehensive income statement, including the capital part of untaxed reserves. Profit generated during the year is included in CET1 capital as soon as it has been verified by the company s auditor. 2 Non-controlling interests The equity interests of minority equity holders in companies that are fully consolidated, eligible for inclusion in CET1 capital. 3 Anticipated dividends Deduction for estimated dividends. 4 Deconsolidation of insurance companies Deduction of equity capital emanating from the insurance companies in Swedbank Group. The insurance companies are consolidated in the Group but not in Swedbank Consolidated Situation under the capital adequacy rules. 5 Unrealised value changes in financial liabilities due to changes in own creditworthiness Recognised changes in the value of equity arising from financial liabilities (not held for trade or not subject of an effective and documented fair value hedge but reported at fair value) due to changes in own creditworthiness are not eligible for inclusion in the capital. 6 Adjustment for cash flow hedges Recognised changes in the value of equity arising from cash flow hedges are not eligible for inclusion in the capital. 7 Additional value adjustments Adjustment due to the implementation of the EBA s technical standards on prudent valuation. The objective of these standards is to determine prudent values of fair valued positions. 8 Goodwill Goodwill reported on the balance sheet is deducted from CET1 capital. Goodwill emanating from significant holdings of shares is also deducted. Goodwill attributable to shareholdings in foreign subsidiaries can vary due to exchange rate fluctuations. 9 Deferred tax assets Deferred tax assets reported on the balance sheet are deducted from CET1 capital. However, under certain conditions and if below specified threshold levels, parts of deferred taxes can instead be included in Risk Exposure Amount. 10 Intangible assets Intangible assets, other than goodwill, such as the value of acquired customer relationships are deducted from CET1 capital. 11 Net provisions for reported IRB credit exposures Deduction for the negative difference between expected losses calculated within the IRB approach and the reported provisions. The difference arises when losses calculated in accordance with the capital adequacy rules exceed Swedbank s best assessment of loss levels and provision needs according to incurred loss model in financial reporting. Expected losses are calculated in accordance with the capital adequacy regulations and using data from Swedbank s internal risk rating system, where risks are overestimated rather than underestimated. In addition, extra safety margins are applied, which have been built into the risk rating system due to the SFSA s interpretation of the regulations. 12 Shares deducted from CET1 capital Deduction according to CRR from CET 1 capital for certain types of equity shares and contributions, if such holdings exceed specified threshold levels. Swedbank's holdings do not exceed threshold levels, but are instead included in Risk Exposure Amount. During Q4 2014, the European Banking Authority (EBA) published its interpretation of how trading in own shares and capital instruments in the securities operations affects capital. As a result, the maximum holding approved by the SFSA has to be deducted, compared with previous practice where the actual holding was deducted. 13 Defined benefit pension fund assets Net pension assets.

18 18 14 Total CET1 capital Common Equity Tier 1 (CET1) capital consists mainly of equity capital less proposed dividends and deduction for goodwill/intangible assets and deferred tax assets. The ratio of CET1 capital to Risk exposure amount is the CET1 capital ratio. 15 Additional Tier 1 capital Additional Tier 1 capital is made up of subordinated loans whose terms are such that they fulfil requirements in CRR, either fully or according to grandfathering rules, to include them in Tier 1 capital. They may be redeemed or repurchased on approval by the Competent Authority (SFSA). Normally, such approval cannot be given until five years after the loan was issued. Additional Tier 1 capital is also called hybrid capital because the properties of these instruments contain elements of both debt and equity. Interest payments are determined according to the contract, but are allowed only if there are distributable funds. For Additional Tier 1 capital to be fully compliant with CRR (which entered into force 1 Jan 2014), there must be a discretionary right for the issuer to cancel the interest payments. The priority rights of the contribution are subordinated to all other deposits and borrowings including subordinated loans that may not be included as Additional Tier 1 capital. The principal amount of Additional Tier 1 capital can be appropriated to cover losses to the extent that may be required to avoid Swedbank AB being obliged to enter into liquidation. The appropriation is processed by writing down the principal amount fully or partially and converting such amount into a conditional capital contribution, given a resolution hereof is passed at General Meeting and the SFSA has given its permission. For Additional Tier 1 capital to be fully compliant with CRR specific terms around mandatory write-down or conversion to shares when breaching a pre-determined trigger, the CET1 capital ratio level must be included. Additional Tier 1 capital is included in the total capital in accordance with CRR, including grandfathering rules related to such instruments issued under earlier rules and not fully compliant with CRR rules on Additional Tier 1 capital. Since some of the loans are issued in foreign currencies, the size of the Additional Tier 1 capital can vary due to exchange rate fluctuations. For specification of outstanding Additional Tier 1 capital, please see Appendix A, table A2. 16 Total Tier 1 capital Tier 1 capital consists mainly of equity capital less proposed dividends and deduction for intangible assets. Additional Tier 1 capital compliant with CRR is also included. Subject to grandfathering rules in CRR, Additional Tier 1 capital issued under earlier rules may be included in Tier 1 capital. The ratio of Tier 1 capital to Risk Exposure Amount is the Tier 1 capital ratio. 17 Tier 2 capital Tier 2 capital instruments are made up of subordinated loans whose terms are such that they fulfil requirements in CRR, either fully or according to grandfathering rules, to include them in Tier 2 capital. Term reductions are made according to CRR rules if the remaining maturity is less than five years. They may be redeemed or repurchased on approval by the Competent Authority (SFSA). Normally, such approval cannot be given until five years after the loan was issued. Tier 2 capital instruments loans may be included in the total capital because they constitute a subordinated debt, which means that if the obligor is declared bankrupt, the holder would be repaid after other creditors, but before shareholders and holders of Additional Tier 1 capital. In addition, subordinated loans may be used to cover any losses from ongoing operations to prevent liquidation. Since some of the loans are issued in foreign currencies, the size of the Tier 2 capital instruments can vary due to exchange rate fluctuations. For specification of outstanding Tier 2 capital instruments, please see Appendix A, table A2. 18 Total capital The capital base is intended to act as a buffer against the risks to which Swedbank Consolidated Situation is exposed and comprises the sum of CET 1 capital, Additional Tier 1 capital, and Tier 2 capital. The ratio of the Total capital to the Risk Exposure Amount is the Total capital ratio. Table 2-4a: Amount of institution-specific countercyclical capital buffer in Swedbank Consolidated Situation SEKm 2016 Total risk exposure amount Institution-specific countercyclical buffer rate 0.98% Institution-specific countercyclical buffer requirement Table 2-4b: Geographical distribution of credit exposures relevant for the calculation of the countercyclical capital buffer for Swedbank Consolidated Situation as of 31 December 2016 General credit exposures Trading book exposure Securitisation exposures Own funds requirements Exposure value for SA Exposure value for IRB Sum of long and short position of trading book Value of trading book exposure for internal models Exposure value for SA Exposure value for IRB Of which: General credit exposures Of which: Trading book exposures Of which: Securitisati on exposures Total Own funds requiremen t weights Countercyclica l capital buffer rate Sweden % Estonia % Latvia % Lithuania % Norway % Finland % Denmark % USA % Russia % Other countries % Total

19 19 Table 2-5: Capital requirement Swedbank Consolidated Situation SEKm Minimum capital requirement for credit risks, standardised approach Minimum capital requirement for credit risks, IRB Minimum capital requirement for credit risk, default fund contribution 34 4 Minimum capital requirement for settlement risks 0 1 Minimum capital requirement for market risks Trading book of which VaR and SVaR of which risks outside VaR and SVaR FX risk other operations Minimum capital requirement for credit value adjustment Minimum capital requirement for operational risks Additional minimum capital requirements, Article 3 CRR 69 0 Minimum capital requirement 1) Risk exposure amount credit risks Risk exposure amount settlement risks 0 7 Risk exposure amount market risks Risk exposure amount credit value adjustment Risk exposure amount operational risks Additional risk exposure amount, Article 3 CRR 861 Risk exposure amount ) Capital requirement under Pillar 1, i.e. 8% of total risk exposure amount. Table 2-6: Risk Exposure Amount and Own funds requirement, Swedbank Consolidated Situation, 31 Dec SEKm Risk exposure amount Own funds requirement 1) Credit risks, STD Central government or central bank exposures Regional governments or local authorities exposures Public sector entities exposures 60 5 Multilateral development banks exposures 20 2 International organisation exposures 0 0 Institutional exposures Corporate exposures Retail exposures Exposures secured by mortgages on immovable property Exposures in default Exposures associated with particularly high risk 0 0 Exposures in the form of covered bonds 7 1 Items representing securitisation positions 0 0 Exposures to institutions and corporates with a short-term credit assessment 0 0 Exposures in the form of units or shares in collective investment undertakings 0 0 Equity exposures Other items Credit risks, IRB Institutional exposures Corporate exposures of which specialised lending in category of which specialised lending in category of which specialised lending in category of which specialised lending in category of which specialised lending in category 5 0 Retail exposures of which mortgage lending of which other lending Securitisation 0 0 Non-credit obligation Credit risks, Default fund contribution Settlement risks 0 0 Market risks Trading book of which VaR and SVaR of which risks outside VaR and SVaR FX risk other operations Credit value adjustment Operational risks of which Basic indicator approach 0 0 of which Standardised approach Additional risk due to Art 3 CRR Total ) Own funds requirement under Pillar 1, i.e. 8% of total risk exposure amount.

20 20 Table 2-7: Leverage ratio SEKm 2016 Total assets as per published financial statements Adjustment for entities which are consolidated for accounting purposes but are outside the scope of regulatory consolidation Adjustment for fiduciary assets recognised on the balance sheet pursuant to the applicable accounting framework but excluded from the leverage ratio exposure measure in accordance with Article 429(13) of Regulation (EU) No 575/ Adjustments for derivative financial instruments Adjustments for securities financing transactions, SFTs Adjustment for off-balance sheet items Adjustment for intragroup exposures excluded from the leverage ratio exposure measure in accordance with Article 429 (7) of Regulation (EU) No 575/ Adjustment for exposures excluded from the leverage ratio exposure measure in accordance with Article 429 (14) of Regulation (EU) No 575/ Other adjustments Total leverage ratio exposure SEKm 2016 On-balance sheet items (excluding derivatives, SFTs and fiduciary assets, but including collateral) Asset amounts deducted in determining Tier 1 capital Total on-balance sheet exposures (excluding derivatives, SFTs and fiduciary assets) Replacement cost associated with all derivatives transactions (net of eligible cash variation margin) Add-on amounts for PFE associated with all derivatives transactions (mark-to-market method) Exposure determined under Original Exposure Method 0 Gross-up for derivatives collateral provided where deducted from the balance sheet assets pursuant to the applicable accounting framework 0 Deductions of receivables assets for cash variation margin provided in derivatives transactions 0 Exempted CCP leg of client-cleared trade exposures -534 Adjusted effective notional amount of written credit derivatives Adjusted effective notional offsets and add-on deductions for written credit derivatives -666 Total derivative exposures Gross SFT assets (with no recognition of netting), after adjusting for sales accounting transactions Netted amounts of cash payables and cash receivables of gross SFT assets 0 Counterparty credit risk exposure for SFT assets Derogation for SFTs: Counterparty credit risk exposure in accordance with Article 429b (4) and 222 of Regulation (EU) No 575/ Agent transaction exposures 0 Exempted CCP leg of client-cleared SFT exposure 0 Total securities financing transaction exposures Off-balance sheet exposures at gross notional amount Adjustments for conversion to credit equivalent amounts Other off-balance sheet exposures Exemption of intragroup exposures (solo basis) in accordance with Article 429(7) of Regulation (EU) No 575/2013 (on and off balance sheet) 0 Exposures exempted in accordance with Article 429 (14) of Regulation (EU) No 575/2013 (on and off balance sheet) 0 Tier 1 capital Total leverage ratio exposures Leverage ratio 5.4% Choice on transitional arrangements for the definition of the capital measure Transitional definition Amount of derecognised fiduciary items in accordance with Article 429(11) of Regulation (EU) NO 575/ SEKm 2016 Total on-balance sheet exposures (excluding derivatives, SFTs, and exempted exposures), of which: Trading book exposures Banking book exposures of which covered bonds of which exposures treated as sovereigns of which exposures to regional governments, MDB, international organisations and PSE not treated as sovereigns of which institutions of which secured by mortgages of immovable properties of which retail exposures of which corporate of which exposures in default of which other exposures (e.g. equity, securitisations, and other non-credit obligation assets) Note: For definitions of abbreviations, see the table Terminology and abbreviations in the Appendix A.

21 21 3. Credit risk Swedbank s credit portfolio is focused on stable low-risk segments such as private mortgage and real estate corporates in our four home markets. Tight lending standards and close dialogue with customer are key to the sustainability of high quality in our credit portfolio. Credit risk The risk that a borrower will fail to meet their contractual obligations to Swedbank and the risk that pledged collateral will not cover the claim. Credit risk also includes concentration risk, which means large individual exposures as well as significant exposures to groups of counterparties whose probability of default is driven by common underlying factors, such as sector, economy, geographical location, or type of instrument. Counterparty risk is the risk that a Counterparty to a trading transaction will not meet its financial obligations towards Swedbank and that collateral held will not be enough to cover the claims. This definition encompasses repurchase agreements, derivatives and securities financing transactions. Risk appetite The Group shall maintain a well-diversified credit portfolio with a low risk profile. All credit activities shall strive towards a long-term customer relationship and rest on sound business acumen to achieve solid profitability and avoid credit expansion that may endanger the long-run stability of the Group. Total loans net: SEK 1 453bn 2015: 1 371bn Credit impairment ratio: 0.10% 2015: 0.04% Impaired loans net ratio: 0.56% 2015: 0.40% Total exposure: SEK 1 989bn 2015: SEK 1 989bn Credit Risk Exposure Amount (REA): SEK 317bn 2015: SEK 308bn Highlights 2016 Swedbank s strong position withheld in spite of global uncertainties Swedbank s low credit risk and stable loan portfolio was confirmed in Contingencies from the Brexit referendum, the US presidential election, geopolitical uncertainties and economic slowdown in China resulted in uncertainty about the macroeconomic development. However, internal analyses indicate that the direct impact on Swedbank s credit portfolio will be minor from all these factors. Credit impairment and impaired loans remain on low levels. During 2016, Swedbank focused on supporting loan growth in segments with solid economic growth and where forthcoming risks are predicted to stay low. Strong growth in the economies in all our four home markets continued to contribute positively to the credit portfolio development. In 2016 the EBA performed its bi-annual stress test for large EU banks. The result reaffirms Swedbank s strong credit quality and capital situation by showing the lowest impact on CET1 capital ratio of all Swedish banks and a result among the best in Europe. Figure 3-1: Swedbanks historical loan losses %

22 22 Credit risk in important sectors The drop in oil price put pressure on the oil-related exposures Swedbank oil-related exposure are small, they amount to SEK 33bn, of which SEK 28bn are negatively impacted by the low oil-price. Loans net stand for less than 2% of total loans. The oil price has been fairly stable during The OPEC decision to limit oil output in combination with the Trump effect has fueled the oil the last months. However the oil price is still too low for investments to pick up and lead time from investment to oil services companies revenue is long. The companies still suffer from contraction of demand from services. Swedbank is following the market thoroughly and are in a close dialogue with affected customers. First restructuring including all stakeholders, like new equity, prolongation or conversion of bonds to equity extended repayment schedules are done or under progress. Swedbank s customers in oilrelated sectors have all taken actions to adjust their business to the changed market situation. During the year a few customers have failed to fulfill agreed restructuring terms. Provisionings have been made and the loans have been classified as impaired loans. Other restructurings have been classified as performing forbourne exposures. The continued review of all exposures in 2016 has resulted in downgradings of a majority of the exposures. The effect on REA in 2016 for the negative PD-migrations in the oil-sector is about SEK 3.3bn. Private mortgage loans a low risk portfolio Private mortgage loans constitutes Swedbank s largest loan segment; it comprised SEK 783bn at year-end and represents 54% of Swedbank s total loans net. It is a low-risk portfolio with very low losses historically as well as low loss results in stress tests. One reason for the low losses is Swedbank s well-developed credit review process. Prior to a new mortgage being approved, the individual household undergoes a cashflowbased affordability analysis, including a stress test to determine whether the household can afford a significant interest rates increase and handle relevant amortisation. Swedbank s loan portfolio periodically undergoes stress tests. The results in the Swedish portfolio indicate robust solvency among mortgage customers and an average LTV ratio that suggests a low risk of credit impairments. Furthermore, a close relationship to and deep understanding of customers gained via Swedbank's large retail network has helped Swedbank to maintain losses at low levels. On 1 June the Swedish Financial Supervisory Authority (SFSA) introduced an amortisation requirement on new mortgages, similar to guidelines Swedbank introduced in In 2016 Swedbank has introduced further risk reducing measures aiming to slow-down the debt build-up in Swedish households during recent years in the wake of the rise in housing prices, mainly in large cities. At the second half of 2016, prices stagnated somewhat and households indicated that they had lowered their expectations regarding price increases. Figure 3-2: LC&I Shipping & Offshore portfolio, loans gross 10 SEKbn Figure 3-3: Oil-related exposures by internal risk grade Figure 3-4: Private mortgage exposure risk grade distribution SEKbn Def SEKbn Def Swedish Banking Estonia Latvia Lithuania Figure 3-5: Private mortgage, average past-due loans and LTV % of gross volumes Sweden Estonia Latvia Lithuania Past-due loans >60 days (lhs) Average LTV Average LTV (rhs)

23 23 Property Management high lending standards avoid risk in the low yield environment Swedbank s property management portfolio concluded the year with loans net of SEK 223bn (EAD of SEK 256bn). The portfolio consists mainly of well-known customers with whom Swedbank has increased its business relations over time. The Swedish property management portfolio has low risk, which is demonstrated by low historical losses as well as a low number of customers with payment problems. The low risk is confirmed by internal and external stress tests. The low average LTV, 52%, confirms that the portfolio is wellcollateralised, with a sound and low risk profile. The Swedish real estate market is expected to continue to grow in the short-term perspective supported by a growing population, strong urbanisation trend, and low interest rates. High demand for rental apartments continues to prevail in most Swedish municipalities. Modern offices remain in high demand in the larger cities. The market development is driven by the low interest rate environment and good access to capital, which an increased risk taking in new investments. In the Baltic countries, the residential property management market is small since a majority of the apartments are privately owned and not rented. Vacancy rates in commercial real estate have returned to low levels (about 5%). Moderate increases in rental rates are expected. The outlook for 2017 is expected to remain positive, as the market should absorb most of the new supply. When financing properties in the low interest and yield environment, Swedbank focuses on the long term ability to pay stressed interest and proper amortisations and takes a conservative stance regarding LTV levels. Figure 3-6: Property management exposure risk grade distribution SEKbn Def Swedish Banking Estonia Latvia Lithuania LC&I Figure 3-7: Property management by subsegment and country Residential properties SEK 64bn Industrial properties SEK 45bn Commercial properties SEK 88bn Other prop. mgmt. SEK 26bn Sweden Estonia Latvia Lithuania Norway Finland Agriculture - large share of private individual risk Swedbank s loans to customers in the agriculture, forestry and fishing sector amounted to SEK 66bn (EAD 70bn), of which SEK 62bn is counterparties in Sweden. A large share, 52%, of this industry sector, comprises private investment customers who have invested either in forest areas or in former agricultural properties now used only as residences, which reduces the risk to similar private mortgage low risk level. Swedbank s portfolio consists of many small customers included in the retail exposure class with a high share of collateral. The average LTV for Swedish agriculture mortgage lending is 51%. The resilience in the Swedish agriculture portfolio is high. Historical losses are stable on low levels, with only small variations over business cycles. The number of family farmers is declining in Sweden. There is a significant structural trend towards fewer and specialised large farms with higher productivity and increasing investment credit needs. The farms closed down are to a large content converted to residential premises. Overproduction of milk in the EU and globally during the past year has reduced milk prices to very low levels. This has affected milk farmers negatively in 2015 and throughout Problems that now to a large extent have been handled by the farmers in cooperation with the bank. Figure 3-8: Agriculture etc. exposure risk grade distribution SEKbn Def Swedish Banking Estonia Latvia Lithuania LC&I Figure 3-9: Ariculture etc. by subsegment and country SEKbn Private residential Private investm. forestry Growing of crops Milk farmers Raising of livestock Mixed Other Forestry agriculture Sweden Estonia Latvia Lithuania Fishing

24 24 Credit risk exposures Credit risk is the single largest risk discipline for Swedbank. Our lending knowledge and strong local presence, in conjunction with our low-risk strategy, has resulted in low loan losses, despite the external macro challenges around us. In parallel, we have been able to continue the growth in more low-risk segments. The portfolio is well diversified due to the wide customer base of private households and corporates in many different sectors, with a focus on the four home markets. Table 3-1: Key parameters by business area 31 December 2016 Retail - mortgages Swedish Banking Baltic Banking - of which Estonia - of which Latvia - of which Lithuania - of which Investment and Other LC&I Group Functions Exposure, in SEKm Exposure weighted avg. PD (excl defaults), % Exposure weighted avg. LGD, % Average risk weight, % Expected loss on non-defaults in SEKm Retail - other Exposure, in SEKm Exposure weighted avg. PD (excl defaults), % Exposure weighted avg. LGD, % Average risk weight, % Expected loss on non-defaults in SEKm Corporate - Advanced IRB Exposure, in SEKm Exposure weighted avg. PD (excl defaults), % Exposure weighted avg. LGD, % Average risk weight, % Expected loss on non-defaults in SEKm Corporate - Foundation IRB Exposure, in SEKm Exposure weighted avg. PD (excl defaults), % Exposure weighted avg. LGD, % Average risk weight, % Expected loss on non-defaults in SEKm Corporate - specialised lending Exposure, in SEKm Average risk weight, % Expected loss on non-defaults in SEKm 208 Institutions Exposure, in SEKm Exposure weighted avg. PD (excl defaults), % Exposure weighted avg. LGD, % Average risk weight, % Expected loss on non-defaults in SEKm Other IRB exposure classes Exposure, in SEKm Average risk weight, % Total IRB approach Exposure, in SEKm Exposure weighted avg. PD (excl defaults), % Exposure weighted avg. LGD, % Average risk weight, % Expected loss on non-defaults in SEKm Standardised approach Exposure, in SEKm Average risk weight, % Total exposures Exposure, in SEKm Average risk weight, % Note: Exposures according to the capital adequacy framework, IRB approach exposures defined as EAD. Total 2016 Total 2015

25 25 Credit risk by business area Swedish Banking Swedish Banking is Swedbank s largest business area and has SEK 1 217bn in total exposure. Its main business is lending to private individuals, mainly mortgages, and lending to small and medium-sized corporates in Sweden. Tenant-owner Figure 3-10: Swedish Banking, credit exposure by risk grade associations and property management also make up substantial parts of the portfolio. The sensitivity of the portfolio is mainly related to the Swedish economy in general. Figure 3-11: Loans by sector SEKbn Institutions Corporate Retail Def Private Tenant owner associations Agriculture, forestry, fishing Manufacturing Construction Retail Property management Other corporate lending Baltic Banking: Estonia At end-2016, the Estonian part of Baltic Banking had SEK 94bn in total exposure, or 44% of all Baltic Banking exposures. The exposure and sensitivity of this part of the portfolio is related to the Estonian economy in general. The Estonian portfolio performed well in 2016, with a decreased share of problem loans and improved average ratings. Figure 3-12: Baltic Banking: Estonia, credit exposure by risk grade Figure 3-13: Loans by sector SEKbn Institutions Corporate Retail Private Manufacturing Public sector and utilities Retail 5 0 Def Transportation Property management Professional services Other corporates Baltic Banking: Latvia The Latvian part of Baltic Banking has SEK 49bn in total exposure. It thus comprises Swedbank's smallest market in the Baltic business area, and makes up 2.5% of Swedbank s Figure 3-14: Baltic Banking: Latvia, credit exposure by risk grade total exposures. Swedbank's exposure, as well as the sensitivity of the portfolio, is linked to the Latvian economy in general. Figure 3-15: Loans by sector SEKbn Institutions Corporate Retail Private Agriculture etc. Manufacturing Retail 2 Transportation 1 0 Def Property management Professional services Other corporates

26 26 Baltic Banking: Lithuania The Lithuanian part of Baltic Banking has a total exposure of SEK 71bn. Swedbank's exposure, as well as the sensitivity of its portfolio in the country, is related to the Lithuanian economy in general. Figure 3-16: Baltic Banking: Lithuania, credit exposure by risk grade Figure 3-17: Loans by sector SEKbn Institutions Corporate Retail Def Private Agriculture, forestry, fishing Manufacturing Public sector and utilities Retail Transportation Property management Other corporates Large Corporates & Institutions (LC&I) Swedbank s LC&I business area had SEK 319bn in total exposure at end LC&I business includes lending, as well as dealing in financial instruments and products, to large Swedish, international corporate and institutional customers, such as international banks or asset managers. It also includes Swedbank s advisory operations. The sensitivity of the LC&I Figure 3-18: LC&I, credit exposure by risk grade portfolio is related to the Swedish economy, as well as the global economy in general and the European economy in particular. The development of the oil price is highly important for the development of the oil-related portfolio. Figure 3-19: Loans by sector SEKbn Institutions Corporate Retail Manufacturing Public sector and utilities Construction Retail Def Shipping and offshore Property management Professional services Other corporates Group Functions Exposures within Group Functions mainly consist of exposures within Group Treasury, as the latter is responsible for the funding and management of Swedbank s liquidity portfolio. Exposures are credit exposures similar to those of Figure 3-20: Group Functions, credit exposure by risk grade LC&I, meaning exposures to international banks and central banks. At end-2016, total credit risk exposures amounted to SEK 239bn. Figure 3-21: Exposures by sector 40 SEKbn Institutions Corporate Retail Public Sector and Utilities Other Corporates 10 Credit Institutions 0 Def

27 27 Management of credit risk Working with credit exposures To maintain a well-diversified credit portfolio with a low risk profile, and to find a favourable balance between risk and return, Swedbank works continuously to understand customers and their market conditions. We follow up borrowers through regular monitoring and additional periodic credit reviews of corporate customers, financial institutions and sovereigns at least once per year. An essential steering tool in Swedbank is risk-adjusted profitability. The business has full responsibility for the business and its risk. Profitability, in terms of economic profit and risk-adjusted return on capital (RAROC) is measured on all levels, down to individual customers and contracts. This is possible through the use of various models that measure the risk on all individual credit exposures and by allocating capital adequately and comprehensively, making it possible to deliver a correct price on credit agreements. The overall risk appetite is broken down into detailed risk limits and target levels for different industries, geographies and products, but also to certain limits of each borrowers and group of connected borrowers. To safeguard that business performance remains within the risk appetite and that Swedbank maintains a welldiversified credit portfolio with a low risk profile, the CEO and CRO issue steering documents and limits for the credit portfolio. The credit organisation achieves enhanced duality with the business and acts as the second line of defence by participating in credit committees when dealing with credit risk decisions. The credit risk organisation also guides the business organisation by setting a credit risk framework and additional qualitative standards. Figure 3-22: Classification of risks in the credit portfolio Swedbank s risk classification system is central in assessing and monitoring individual credit exposures. The risk profile of the credit portfolio is continuously analysed. For portfolio segments and individual customers where the risk of default appears higher, consequently reviews are performed more frequently. If a customer s risk profile has deteriorated, a number of corrective measures are considered and implemented. The risk classifications system and RAROCcalculation are used as a base when pricing loans and other services. At least annually, Swedbank conducts a thorough and comprehensive stress test of the entire Group (see Chapter 7 of this report for further information on Group-wide stress tests) which includes the entire credit portfolio. Specific stress tests, portfolio analysis or ad-hoc reviews are also conducted to further evaluate Swedbank s loan portfolio and credit risk. These tests provide additional understanding and information on specific segments or exposure types which may be perceived as having a high or increased risk or a high potential impact on the Group. By identifying increased risk levels at an early stage, Swedbank can take swift and appropriate actions for relevant exposures or segments of exposures. Credit portfolio trends and findings from stress tests form an important part of the monthly risk reports that are presented to Group s senior management and the Board of Directors. A sustainability analysis is carried out in all large and mediumsized corporate lending and covers (i) social responsibility (how the company works to ensure respect for human rights, for example in its supply chain, among its employees and in its local community), (ii) human rights, (iii) corruption and (iv) environment (to determine whether there is a structured environmental program). The sustainability analysis is an integral part of the credit analysis. The aim is to assess how risks related to these areas affect Swedbank s and its customers profitability, repayment ability, collateral security value and reputation should they materialise. Repayment capacity and collaterals When Swedbank considers a credit application, a thorough analysis is performed which includes the counterparty s capacity to repay the new credit as well as other credits. According to Swedbank Group s Credit Policy, Swedbank shall strive to obtain adequate collateral. A borrower s cash flow, solvency and collateral are always key variables when lending. This applies to mortgage loans to private customers and property management companies, as well as to securities lending, factoring, lease agreements and all other types of financing. Collateral for granted credits varies depending on the assessed risk and the choice of product. Swedbank uses a variety of collateral types, but the most common type is immovable property, both residential property as well as commercial property. The valuation of collateral is based on a thorough review and analysis of the pledged assets, and is an integrated part in the credit risk assessment of the borrower. The establishment of the collateral value is a part of the credit decision. The value of the collateral is reassessed within periodic credit reviews of the borrower and in situations where the Group has reason to believe that the value has deteriorated or the exposure has become a problem loan. The established value of the collateral shall correspond to the most likely sales price at the date of valuation estimated in a process of high quality and characterised by prudence. For financial collateral, such as debt securities, equities and collective investment undertakings (CIUs), valuation is normally monitored on a daily basis. Credits without collateral are mainly granted for small loans to private customers or loans to large companies with very sound repayment capacity. For the latter, special loan covenants are commonly drawn up which entitle the Group to renegotiate or terminate the

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