3 Risk developments

For a detailed overview of FMO’s risk governance and risk management approach please refer to the section "Risk Management" in FMO’s consolidated annual accounts as of 31 December 2021. The risk developments in the first half year of 2022 are disclosed below.

3.1 Capital adequacy 

FMO complies with the CRR/CRD requirements and reports its capital ratios to the Dutch Central Bank on a quarterly basis. FMO calculates the capital requirement for its entire portfolio based on the standardized approach. At the end of June 2022, the Total Capital ratio is 24.6%.

The inclusion of the remaining 2021 profit into the own funds is partly offset by the effects of the increased production during the first half year, resulting in a higher Risk Weighted Assets (RWA) and higher deductions from own funds.

FMO’s capital ratio remains above the combined ratio of the Supervisory Review and Evaluation Process (SREP) minimum and FMO’s internal requirements. 

• 1 _{Following specific provisions in the CRR, FMO is required to deduct from its regulatory capital significant and insignificant stakes for subordinated loans and (in)direct holdings of financial sector entities above certain thresholds. These thresholds correspond to approximately 10% of regulatory capital. Exposures below the 10% thresholds are risk- weighted accordingly.}

3.2 Credit risk

According to a June 2022 World bank report , Russia’s invasion of Ukraine has led not only to a humanitarian catastrophe, but also caused a deep regional slowdown and substantial negative global spillovers, such as continued supply bottlenecks and rising inflation. While the World bank still expected 4.1% growth for 2022 in January 2022, against 5.7% in 2021, in this more challenging context, global growth is now projected to slow down more sharply to 2.9% in 2022 and 3% in 2023-24. Growth in Emerging Markets is projected to roughly halve in 2022, slowing from 6.6% in 2021 to 3.4%.  

FMO’s portfolio has also been affected by these developments, particularly in the Ukraine itself. During the first half of 2022, FMO's NPL ratio increased from 9.5% to 11.1%. The increase is caused entirely by new NPL's in Ukraine, which as of 30 June 2022 amounted to €96.5 million, after a write off of €40 million of an exposure located in Russian occupied territory. The total impairment on loans in the Ukraine at end June 2022 (including write offs) amounted to €99 million.

Excluding NPL’s in Ukraine, the NPL percentage would be 9.3%. So far the impact of the war on our portfolio outside the Ukraine has been limited.  FMO made a detailed assessment of our exposures in the ECA region, but no new non-performing Exposures were identified. New NPLs in 2022 outside Ukraine only amounted to €3 million.

The impact of the COVID-19 pandemic on FMO's NPL levels remains relatively limited. None of the new NPL's were caused primarily by COVID-19 pandemic.

Past due information related to FMO’s portfolio loans and receivables are presented in the table below. This categorization does not apply to financial assets other than loans, including interest-bearing securities and short-term deposits.

All Interest Bearing Securities (credit quality of AA or higher) and Banks (credit quality of BBB- or higher) are classified as Stage 1. An amount of € 72 thousand is calculated for the ECL of both asset classes as per June 30, 2022.

The following table shows the credit quality and the exposure to credit risk of the loans to the private sector at amortized cost and fair value at June 30, 2022.

The following table shows the credit quality and the exposure to credit risk of the financial guarantees on June 30, 2022.

• 1 _{Financial guarantees represent €97,963 classified as contingent liabilities and €152,900 classified as irrevocable facilities as per Note 'Irrevocable and contingent liabilities'}

• 1 _{Financial guarantees represent €69,341 classified as contingent liabilities and €136,450 classified as irrevocable facilities as per Note 'Irrevocable and contingent liabilities'}

The following table shows the credit quality and the exposure to credit risk of the loan commitments to private sector on June 30, 2022. These represent contracts signed but not disbursed yet.

• 1 _{Loan commitments for which no ECL is calculated (Fair Value loans or expired availability date).}

• 1 _{Loan commitments for which no ECL is calculated (Fair Value loans or expired availability date).}

The following tables show the changes in loans, financial guarantees and loan commitments. 

The full contractual amount of assets that were written off during the current and prior reporting period are still subject to enforcement activity.

• 1 _{Total financial guarantees represent €97,963 classified as contingent liabilities and €152,900 classified as irrevocable facilities, as per Section 8 Commitments and Contingent Liabilities.}

• 1 _{Total financial guarantees represent €123,216 classified as contingent liabilities and €101,963 classified as irrevocable facilities, as per Section 8 Commitments and Contingent Liabilities.}

The modelling methodologies, assumptions and inputs applied in determining ECL in the current period are consistent with those applied in the financial year ending December 31, 2021.

The macroeconomic scenarios’ model was updated following the publication of the new macroeconomic outlook data by the International Monetary Fund (IMF) in April 2022 (2021: October). The updates of the model based on GDP forecast, caused new point-in-time adjustments to probability of defaults in the impairment model, leading to an increase of €2.9 million in combined stage-1 and stage-2 impairment charge.

• 1 _{Loans to private sector in this table include amounts related to ECL allowances for off balance loan commitments (refer to note 6).}

• 1 _{Loans to private sector in this table include amounts related to ECL allowances for off balance loan commitments (refer to note 6).}

FMO continues to support clients by undertaking several forborn measures.

3.3 Equity investment risk 

The first half of 2022 was characterized by the Russian invasion on Ukraine. Inflation, which was already high before the invasion due to disruptions in the supply chain and high consumer demand after COVID-19 pandemic, went up world-wide as prices for fossil fuels and food substantially increased.  As it is expected that the economy in Europe will be impacted more because of the Russian invasion due to gas shortages the EUR weakened substantially versus the USD.

Re-measurement of fair values of the equity portfolio (excluding results from sales) amounted to €113 million profit (YE December 2021: €98 million). Underlying factors contributing to this profit were a strengthening of the USD versus EUR contributing €123 million and a decrease of the value of the portfolio of €10 million. The loss was caused by €67 million from the Ukraine portfolio and higher valuations of the Venture Capital portfolio, the general PE fund portfolio and some changes in the direct equity portfolio contributing to total €57mln.  Per June 30, 2022, the equity investments portfolio amounts to €2.2 billion (December 31, 2021: €2.0 billion). In addition, dividend income amounts to €32 million.

3.4 Concentration risk 

Concentration risk is the risk that FMO’s exposures are too concentrated within or across different risk categories. Concentration risk may trigger losses large enough to threaten the institution’s health or ability to maintain its core operations or trigger material change in institution’s risk profile. Strong diversification within FMO’s emerging market portfolio is ensured through stringent limits on individual counterparties, sectors, countries, and regions.

Country risk

Country risk arises from country-specific events that adversely impact FMO’s exposure in a specific country. Within FMO, country risk is broadly defined. It includes all relevant factors that have a common impact on FMO’s portfolio in a country such as economic, banking and currency crises, sovereign defaults, and political risk events. To ensure diversification within FMO’s emerging market portfolio across regions, a country limit framework is in place to mitigate concentration risk from the perspective of the portfolio as a whole.

During the first half of 2022, country risk in FMO’s markets has generally increased as a result of the Ukraine - Russia war. The impact of the war is worldwide and has resulted into high inflation, higher interest rates, supply chain disruptions and increasing risk aversion.
Moreover, Sri Lanka is affected by a deep economic crisis followed by high inflation, massive protests, and collapse of the government. Most noteworthy rating downgrades in the first half of 2022 occurred for Ukraine, Belarus, Sri Lanka and El Salvador. The rating downgrade of Ukraine affected the valuations of our equity and loan portfolio across all sectors for Ukrainian customers. These rating downgrades could lead to tighter investment limits for particular countries. Finally, individual client ratings may be influenced as a consequence.

3.5 Market risk - Currency Risk

FMO continued the limited appetite for currency risk in 2022. Exposures are hedged through matching currency
characteristics of assets with liabilities, or through derivative transactions such as cross-currency swaps and FX forwards conducted with either commercial parties or with The Currency Exchange Fund (TCX Fund N.V.). Most currency exposures are hedged to US dollars on a micro-hedge basis, whereby the US dollar position is managed on a portfolio basis accordingly. FMO does not take any active positions in any currency for purpose of making a profit. Each individual currency is managed within a strict position limit and an overall appetite level is set at 1% of shareholder’s equity for the total open position across all currencies. Individual exposures and total open currency positions were within risk appetite in 2022. FMO maintains a deliberately unhedged foreign currency position which stems from the private equity investments, and which serves the purpose of a structural hedge for our capital ratio.

Interest Rate Risk in the banking book 

Interest rate risk is the risk of potential loss due to adverse movements in interest rates. Changing interest rates mainly
influence the fair value of fixed interest balance sheet items and affect the bank’s earnings by altering interest ratesensitive income and expenses, affecting its net interest income (NII). FMO continued to have low appetite for interest rate risk in the first half of 2022. FMO does not take any active interest rate positions for the purpose of making a profit.

The interest rate gap and BPV exposure are monitored on weekly basis against limits set by the ALCO. The delta EVE limit is defined in the Risk Appetite Framework and set at 5% of Tier I. The EaR limit is defined in the Risk Appetite Framework set at 5% of projected net interest income. The interest rate positions were within risk appetite in 2022. In spite of rising rates in the United States, Europe and globally our positions remain within limits.

3.6 Compliance risk 

In 2021, FMO  completed its financial economic crime (FEC) enhancement project. This included an extensive Know Your Customer (KYC) file remediation, tailored to the specific requirements of developing and emerging economies. The external validation, which was overall positive, identified several recommendations that FMO will follow up on in 2022. For certain compliance themes, such as anti-bribery and corruption, as well as sanctions and unusual transactions, awareness sessions (refreshers) were organized with targeted front-office departments.

FMO received the Dutch Central Bank's (DNB) conclusions and observations. Follow-up on DNB’s recommendations and findings has been initiated. We are determined to continue to improve in the regulatory domain and to ensure that the changes we implement are tailored to the day-to-day realities and complexities of the markets we are active in.

Several additional measures have been taken since the start of 2022 in relation to sanctions involving Russia/Belarus to ensure FMO’s funds are not directly or indirectly provided to sanctioned parties. These measures include, among others, setting up of a Sanctions Working Group, increased frequency of adverse news screenings and communication has been done with specific customers in the affected regions and industries.

End of 2021, FMO started a project to further develop and enhance privacy data protection capabilities including engaging a dedicated privacy officer and privacy champions within various departments. Specific trainings will be deployed to stimulate awareness. The project is on track and aims to finish in 2022. The privacy officer monitors FMO's privacy compliance periodically. The privacy officer is involved in i.e. change management activities and new projects to advise on privacy risks and risk mitigation.

3.7 Regulatory risk

On 27 October 2021, The European Commission published proposals for reforms to the Capital Requirements Regulations (CRR-3) and Capital Requirements Directive (CRD6). These draft regulations focus on three main parts: 1) the implementation of the finalized Basel III reforms into European legislation, 2) new rules requiring banks to systematically identify, disclose and manage sustainability risks (ESG risks) as part of their risk management, and 3) stronger enforcement tools for supervisors overseeing EU banks. The first two parts are of relevance to FMO, and closely monitors the regulatory developments while these new regulations are being drafted and discussed at a European level.

With regards to the European translation of the Basel III standard, updates were included on the use of internal models, recalibrations to the standardized approach for credit risk, operational risk, CVA and market risk. Important elements for FMO include the envisaged implementation date (1 January 2025) and the change in treatment for private equity exposures under the standardized approach for credit risk. Under the current draft foreseen risk weight will increase from the current 150% to 250% if the intended holding period is greater than 3 years, rather than 400% when falling under the speculative equity classification.

The CRR-3 and CRD-6 proposals also included several amendments in relation to ESG risk. Most notably, according to the draft FMO is required to start disclosing ESG risks as part of its Pillar 3 disclosures on an annual basis starting in 2025, and the proposal also added ESG risks into the scope of the Supervisory Review and Evaluation Process, the annual assessment of banks conducted by banking supervisors. A more elaborate description of the relevant changes expected from CRR-3 and CRD-6 can be found in FMO’s 2021 annual report.