Financial risk

Investment risk

Investment risk is defined as the risk that actual investment returns will be lower than expected returns, and includes credit, equity, concentration and counterparty credit risks.

Credit risk

Definition

Credit risk is defined as the risk that the bank will suffer an economic loss because a customer fails to meet its obligations in accordance with agreed terms.

Risk appetite and governance

For FMO’s emerging market loan portfolio, adverse changes in credit quality can occur due to specific customer and product risk, or risks relating to the country in which the customer conducts its business. The main source of credit risk arises from investments in emerging markets and off-balance instruments such as loan commitments and guarantees.

Credit risk management is important when selecting and monitoring projects. In this process, a set of investment criteria per sector and product is used that reflects minimum standards for the required financial strength of FMO’s customers. This is further supported by credit risk models that are used for risk quantification, calculations of expected credit loss allowance, and the determination of economic capital use per transaction. Funding decisions depend on the risk profile of the customer and financing instrument. For credit monitoring, FMO’s customer are subject to annual reviews at a minimum. FMO also monitors customers that are identified due to financial difficulties through a quarterly watch list process to proactively manage loans before they become non-performing. For distressed assets, the Special Operations department actively manages workout and restructuring.

FMO has set internal appetite levels for non-performing loans and specific impairments on loans. If any of the metrics exceed the appetite levels, Credit will assess the underlying movements and analyze trends per sector, geography and any other parameter. Credit will also consider market developments and peer group benchmarks. Based on the analysis, Credit will propose mitigating measures to the IRC. If any of the indicators deteriorate further, the Risk department will be involved to assess to what extent the trend is threatening FMO’s capital and liquidity ratios.

Developments

FMO has embarked on an overhaul of its credit risk policy and processes. The objective is to implement a more aligned and effective portfolio management framework across the organization. Implementation has started in 2021 via the Investment Risk project, which continued in 2022 and 2023.

In 2022, FMO has fundamentally redesigned the Investment Risk Policy and has adjusted internal processes and systems accordingly. The new Investment Risk Policy has been approved by the Investment Risk Committee (IRC) in December 2022 and is to be formally implemented in February 2023. Prior to the implementation, all Front Office, Credit and Special Operations staff are to be trained. The main changes include strengthening the governance framework, alignment amongst key prudential policies, and enhancing loan monitoring framework.

Exposures and credit scoring

The following table shows FMO's total gross exposure to credit risk per year-end. The exposures, including derivatives, are shown gross, before impairments and the effect of mitigation using third-party guarantees, master netting, or collateral agreements. Regarding derivative financial instruments, only the ones with positive market values are presented. The maximum exposure to credit risk increased during the year to €8.57 billion as of year-end 2022 (2021: €8.09 billion).
There was a increase in short term deposits at the DNB accompanied by a material increase of €421 million in FMO’s credit exposure from loans to the private sector in emerging markets, which increased to €5.51 billion. 

• 1 The lower the credit rating, the higher the F-rating in FMO’s terminology and the worse the creditworthiness of the customers, and vice versa.
• 2 In this example, the final rating considering the country cap cannot be more than three notches better than the country rating.

When measuring the credit risk of the emerging market portfolio at customer level, the main parameters used are the credit quality of the counterparties and the expected recovery ratio in case of defaults. Credit quality is measured by scoring customers on various financial and key performance indicators. FMO uses a Customer Risk Rating (CRR) methodology. The model follows the EBA guidelines regarding the appropriate treatment of a low default portfolio and uses an alternative for statistical validation to perform the risk assessment of the models when there is limited or no default data.

The CRR models are based on quantitative and qualitative factors and are different for respective customer types. The models for banks and non-banking financial institutions use factors including the financial strength of the customer, franchise value, and the market and regulatory environment. The model for corporates uses factors including financial ratios, governance, and strategy. The project finance model uses factors such as transaction characteristics, market conditions, political and legal environment, and financial strength of the borrower.

Based on these scores, FMO assigns ratings to each customer on an internal scale from F1 (lowest risk) to F20 (default) representing the probability of default. This rating system is equivalent to the credit quality rating scale applied by Moody's and S&P. Likewise, the loss given default is assigned by scoring various dimensions of the product specific risk and incorporating customer characteristics. The probability of default and loss given default scores are also used as parameters in the IFRS9 expected credit loss model. Please refer to the 'Significant accounting policies' section, for details of the expected credit loss calculation methodology.

The majority of our gross loan portfolio (67 percent ) remains in the F11 to F16 ratings categories. 

Credit quality analysis

Apart from on-balance finance activities, FMO is also exposed to off-balance credit-related commitments. Guarantees, which represent contingent liabilities to make payments if a customer cannot meet its obligations to third parties, carry similar credit risks as loans. Most of the guarantees are quoted in US dollars. Guarantees on export facilities are collateralized by the underlying letters of credit, and therefore carry less credit risk than direct uncollateralized borrowing. The following table shows the credit quality and the exposure to credit risk of the financial guarantees for the period. The increase in financial guarantees is mainly driven by portfolio growth in Nasira Guarantee in 2022 (€230 million) compared to the previous year (€163 million).

• 1 Financial guarantees represent €138,359 classified as contingent liabilities and €180,836 classified as irrevocable facilities as per the 'Irrevocable and contingent liabilities' note.

• 1 Financial guarantees represent €69,341 classified as contingent liabilities and €136,450 classified as irrevocable facilities as per the 'Irrevocable and contingent liabilities' note.

Additionally, irrevocable facilities represent commitments to extend finance to customers and consist of contracts signed but not disbursed, yet which are usually not immediately and fully drawn.

The following table shows the credit quality and the exposure to credit risk of the loan commitments are part of the irrevocable facilities for the period.

• 1 Loan commitments for which no ECL is calculated (fair value loans or expired availability date).

Non-performing loans

A customer is considered non-performing when it is not probable that the customer will be able to pay his payment obligations in full without realization of collateral or calling on a guarantee, regardless of the existence of any past-due amount or of the number of days past due.
This situation is considered to have occurred when one or more of the following conditions apply:

• The customer is past due more than 90 days on any outstanding facility;

• An unlikeliness to pay (UTP) trigger is in place that automatically leads to NPL;

• An impairment analysis, done upon a UTP trigger that possibly leads to NPL, results in an impairment higher than 12% on any outstanding facility;

• There are additional criteria for a customer to enter NPL status in case of Forbearance. If a customer with (No) Financial Difficulty - Forbearance status under probation is extended additional forbearance measures/ concessions or becomes more than 30 days past-due, it shall be classified as non-performing. This only applies if the customer has been non-performing while it was forborne.

NPL is applied at customer level.

During 2022, NPLs in FMO increased from 9.5 percent as of 31 December 2021 to 11.9 percent as of 31 December 2022.  In euro terms, the NPLs increased from €483 million to €653 million.  The largest contributors to the growth were the developments in Ukraine and Sri Lanka. As of 31 December 2022, the combined NPLs in these 2 countries amounted to €154 million (2021: 0), or approximately 24 percent of total NPLs.

NPLs remain concentrated in a few large facilities. Top three NPLs are 16 percent of the total (2021: 18 percent), top ten are 48 percent (2021: 46 percent). As a result, a limited number of large new NPLs result in large movements in the NPL percentage. In terms of sector, NPLs are highest in Energy, in absolute terms at €227 million (2021: €181 million), followed by AFW at €184 million (2021: €77 million), Diverse Sectors at €143 million (2021: €178 million), and FI at €106 million (2021: €47 million). In relative terms (as percentage of the exposure in that sector) NPLs remain highest in Diverse Sectors at 34 percent, followed by AFW at 21 percent, Energy at 16 percent and FI at 4 percent. FMO stopped providing loans to Diverse Sector customers in 2017. NPLs excluding other sectors are 10.1 percent.

NPLs remain highest in India at €93 million. In response to the high NPL levels in India, FMO tightened the investment process for new loans in this country in 2017. Although India’s part of NPLs decreased from 27 percent on 31 December 2018 to 14 percent as of 31 December 2022, it is deemed too early to conclude whether the measures taken resulted in improved performance in India, considering the long lead times between approval, signing and defaults. In 2022, NPLs increased most significantly in Ukraine to 14 percent of total NPLs (2021: 0 percent) as a result of the war which started in February 2022. NPLs also increased in Sri Lanka, to 9 percent of total NPLs (2021: 0 percent). The latter was due to deterioration of the country’s risk profile. 

NPL levels in FMO’s portfolio partially reflect long recovery periods, which are inherent in markets where FMO operates.

Past due information related to FMO’s loans portfolio is presented in the tables below.

The table below presents the distribution of Stage 3 loans according to regions and sectors. 

Modified financial assets

Changes in terms and conditions usually include extending the maturity, changing the interest margin and changing the timing of interest payments. When the terms and conditions are modified due to financial difficulties, these loans are qualified as forborne. Refer to paragraph related to 'Modification of financial assets' in the 'Accounting policies' section.

The Credit department reviews modified loans periodically in accordance with the watch-list process. When a loan is deemed no longer collectible, it is written off against the related loss allowance. In 2022, FMO’s write-offs including disposals equaled to €89.8 million (2021: €50.2 million).

The following table provides a summary of FMO’s forborne assets, both classified as performing and non-performing, as of December 31, 2022.

The following table shows the movement of gross outstanding amount and ECL impact of Stage 2 and Stage 3 loans that were restored during 2022. 

The table below includes Stage 2 and Stage 3 assets for which terms and conditions were modified including the related net modification result.

Credit risk mitigation

As per December 31, 2022, the total carrying value of the FMO’s loan portfolio is €5.1 billion; of which €1.5 billion is guaranteed by either the Dutch Government or highly rated guarantors. The following table shows a breakdown of guarantee amounts received and carrying values of guaranteed loans per credit ranking of the guarantors.

The total carrying value of defaulted (Stage 3) loans in FMO’s loan portfolio is €315 million; of which €137 million is guaranteed by either the Dutch Government or highly rated guarantors. The following table shows a breakdown of guarantee amounts received and carrying values of guaranteed loans.

Equity risk

Definition

Equity risk is the risk that the fair value of an equity investment decreases. It also includes exit risk, which is the risk that FMO’s stake cannot be sold for a reasonable price and in a sufficiently liquid market.

Risk appetite and governance

FMO has a long-term view on its equity portfolio, usually selling its equity stake within a period of 5 to 10 years. FMO can accommodate an increase in the average holding period of its equity investments and thereby wait for markets to improve again to materialize exits. The equity investment portfolio consists of direct investments, largely in the financial institutions and energy sectors, co-investments with aligned partners (mainly in cooperation with funds) and indirect investments in private equity funds. Equity investments are approved by the Investment Committee. In close cooperation with the Credit and Finance departments, the Private Equity department assesses the valuation of equity investments on a periodic basis which are approved by the IRC. Diversification across geographical area, sector and equity type across the total portfolio is evaluated before new investments are made. Based on this performance and the market circumstances, direct exits are pursued by involving intermediaries. In the case of co-investments, our fund managers initiate the exit process as they are in the lead. Exits are challenging due to limited availability of liquidity in some markets and the absence of well-developed stock markets.

The risk of building an equity portfolio is driven by two factors:

• Negative value adjustments due to currency effects (EUR/USD and USD/local FX), negative economic developments in emerging markets (EM) and specific investee related issues. This would negatively affect the profitability of FMO.

• Liquidity of the portfolio – in case FMO is not able to liquidate (part) of its maturing equity portfolio by creating sufficient exits for its direct and co-investment portfolio. This is also reflected in the fund portfolio where some fund managers have to hold longer to their portfolio due to the lack of good exit opportunities.

Developments

Following a recovery in 2021, equity market conditions in 2022 were challenging. Facing high inflation, aggressive monetary policy tightening by central banks, and the effects of the war in Ukraine, major stock markets dropped by at least 10 percent. The USD strengthened significantly against the EUR until September after which the EUR recovered some ground. Due to the strength of the USD, also emerging markets currencies weakened affecting the valuation of our portfolio. All these factors affected private equity deal activity and valuations negatively.

Despite the difficult circumstances, we still received distributions from fund managers (€88 million). In addition, we received a record amount of dividends in 2022 (€41 million) versus €22 million in 2021 as we received several large dividends and banks started to pay dividends again. Direct exits were lower (€35 million) as deals did not materialize.

In 2022, our committed equity portfolio (including associates) increased to €3.0 billion (2021: €2.8 billion) mainly due to the strengthening of the USD (€84 million gain) and an increase in committed not disbursed related to new fund investments (€61 million). This was offset by lower valuations of equity investments and associates (€92 million loss), mainly driven by investments exposed to the war in Ukraine. Despite challenging market circumstances for technology investments, our Venture Capital portfolio increased in total by €48 million, of which €19 million are new investments.  The percentage of direct investments versus fund investments dropped from 43 percent to 42 percent because we did more fund investments in 2022.

Exposures

The total outstanding equity portfolio on December 31, 2022, amounted to €2.6 billion (2021: €2.3 billion) of which €1.3 billion (2021: €1.1 billion) was invested in investment funds.

The equity portfolio is left unhedged for FX risk. For more information please refer to the 'Currency risk' and 'Structural hedge' sections.

Concentration risk

Definition

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 FMO’s health or ability to maintain its core operations or trigger material change in FMO’s risk profile.

Risk appetite and governance

Strong diversification within FMO’s emerging market portfolio is ensured through stringent limits on individual counterparties (single and group risk limits), sectors, countries and regions. These limits are monitored by Risk, reviewed regularly and approved by the IRC and the SB. Diversification across countries, sector and individual counterparties is a key strategy to safeguard the credit quality of the portfolio.

Developments

Following a 6.6 percent GDP growth of the developing economies in 2021, a more gradual increase of 3.7 percent , is expected for 2022 and 2023 (IMF WEO October 2022). Although the pandemic-related pressures on economies mostly subsided, supply-chain disruptions because of the war in Ukraine, rising inflation driven by commodity prices and accompanying central bank actions weighed on economies. FMO monitored its portfolio throughout 2022 and will continue to do so. Given FMO's diverse exposure across more than 70 markets, it is well positioned to mitigate the negative effects of specific country crises. 

Referring to lack of progress in addressing illicit financial flows, Financial Action Task Force (FATF) added Myanmar to blacklist in October 2022. The blacklisting triggered Event Driven Review (KYC) processes for 10 investments to ensure that FMO does not run unacceptable risks. For 1 investment, links to the Myanmar Junta and sanctioned parties have been identified. As a result, this customer is deemed unacceptable and FMO works on accelerating an exit. FMO follows guidance from Ministry of Foreign Affairs regarding Myanmar, and FMO’s IRC closed the country to new business in February 2021.

Following the devastating earthquakes of February 2023 in Turkey and Syria, we reached out to all of our customers in Turkey (currently we have no exposure in Syria). A number of our customers have part of their assets in the wider area affected by the earthquake, but the preliminary assessment did not result in any reclassification of our credit risk. Monitoring of potential future impact will be a key point of attention in the first half of 2023.

Conflict in Ukraine

On 24 February 2022 Russia invaded Ukraine. The move followed shortly after Russian President Putin recognized two Eastern-Ukrainian provinces as independent states and invaded those areas for a peacekeeping mission. Since then, largescale missile attacks in Ukrainian cities have been carried out and parts of the country are controlled by Russian troops. The UK, US and EU have imposed sanctions on Russia and taken actions to restrict the ability of the Russian state and government to access capital and financial markets. Flights from and to Russia are halted. Belarus has also been targeted with sanctions.

FMO has been active in Ukraine for decades. As per year-end 2022, FMO’s direct exposure in Ukraine is on 13 customers, operating within two of the three FMO’s strategic sectors, Energy and Agribusiness Food and Water. No direct exposure in the Financial Industry sector is held in Ukraine. Gross value of outstanding loan principals is EUR 90 million, for which EUR 43 million impairment is recognized so far. In 2022, exposure on 2 customers, totaling EUR 45 million, was written-off. Total value loss recognized throughout 2022 in the loan portfolio amounts to EUR 82 million. Outstanding EUR 13 million guarantees, given by FMO for its customers, got EUR 10 million impaired in 2022. Though the cost price of the outstanding equity investments is EUR 51 million, its total fair value decreased to EUR 23 million as per the year-end. FMO made EUR 50 million loss in 2022 due to its equity portfolio in Ukraine. Overall, FMO recognized EUR 137 million loss in 2022 from its investments in Ukraine.

FMO has no direct exposure and a limited indirect exposure to Russia. Furthermore, FMO has no cash or derivative contract in Russian Ruble or Ukrainian Hryvnia. The exposure towards Belarus is around EUR 18 million, in equity. Macro-economic stress tests have been performed to assess the financial impact of the war-driven developments on FMO’s liquidity position and capital ratios in FMO’s ICLAAP for 2022 and 2023. These assessments showed that, even in a strongly adverse scenario, FMO remains widely above all regulatory requirements and internal appetite. Furthermore, FMO now applies a much higher scrutiny to new investments to countries in Europe and Central Asia, which are more likely to be impacted by the conflict.

Country, regional and sector exposures 

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 is in place to minimize concentration risk in the portfolio as a whole. Country limits range from 8 percent to 22 percent of FMO’s shareholders equity, depending on the country rating, with higher limits in less risky countries. The assessment of the country rating (F-rating scoring in line with internal credit risk rating) is based on a benchmark of external rating agencies and other external information.

In determining the limit within a country for investments, the committed portfolio amount as well as underlying transaction specific elements - which may lead to effective reduction of country risk - are considered. The figure below provides an overview of the diversification over the countries of FMO’s gross outstanding in the loan portfolio.

In general, the loan portfolio remains well diversified across different countries. The single largest country exposure is under 10 percent of the total loan book. The three largest country exposures in the loan book at the end of 2022 were India, Turkey, and Georgia, together 21 percent of the total loan exposure. In 2022, the rating of Turkey is downgraded one notch, while Georgia and India’s rating remained stable.  Noteworthy changes in country ratings are downgrades of the Europe & Central Asia region to F15 (2021: F14), Latin America & The Caribbean region to F14 (2021: F13), El Salvador to F19 (2021: F16), Ghana to F20 (2021: F16), Nigeria to F16 (2021: F15), Pakistan to F17 (2021: F16) and Sri Lanka to F20 (2021: F18).

In addition to country risk limits, FMO has limits to ensure adequate diversification across sectors and regions. Below an overview of the gross exposure of loans distributed by region and sector is given.

Single and group risk exposures 

Regarding single and group risk exposures, FMO has set stringent internal limits where the maximum loss possible for one single customer or group is set as a percentage of FMO’s shareholders’ equity. At year-end, all exposures are well within these limits. These internal single and group risk limits are more stringent than the regulatory limits such as the ones foreseen under the CRR norm of 25 percent of eligible regulatory capital.

Climate-related risk 

Climate-related risk is not a separate risk type but an external causal factor of FMO’s existing risk types and represented as such in FMO’s internal taxonomy. FMO defines climate-related risk as the risks posed by direct exposure to climate change, or indirect exposure through counterparties that may potentially be affected by, or contribute to, climate change. These include two strongly interlinked perspectives:

• An inside-out perspective, defined as the impact by FMO and its customers to climate (which is mainly covered by the ESG risk framework);

• An outside-in perspective, defined as the impact on FMO due to physical and transition risks, 

• • Physical risks arise from the physical effects of climate change, either chronic or acute 

  • Transition risks arise from the uncertainty related to the timing and speed of the process of adjustment to an environmentally sustainable economy. These risks can materialize through policies and regulations, technology, market developments, or behavioral changes.

In 2021 FMO began a project to embed climate-related and environmental risks within the organization based on the ECB Guide on Climate Related and Environmental Risks. In 2023, this project will be merged with the EU sustainable finance project to assess sustainability regulations holistically

FMO focused on the development of an integrated and consistent climate risk framework. This not only assesses FMO’s current portfolio and new investments, but also includes looking at how climate risks impact strategy, creating awareness, and organizing training. For further information, please also refer to the separate Task Force on Climate-related Financial Disclosures (TCFD) report.

Counterparty credit risk

Definition

Counterparty credit risk in the treasury portfolio is the risk that FMO will suffer economic losses because a counterparty fails to fulfill its financial or other contractual obligations from open positions in the portfolio.

Risk appetite and governance

The main responsibility of FMO’s Treasury department is to fund the core business of FMO and to efficiently and effectively mitigate risks in line with Treasury’s mandate. Treasury's portfolio aims to maintain a liquidity buffer such that FMO can serve its liquidity needs in regular and in stressed circumstances. The Treasury department does not have its own trading book and does not actively take open positions in the pursuit of profits. FMO aims to balance between keeping losses within its limited risk tolerance and supporting FMO's business strategy, thereby minimizing credit risk and concentration risk in the treasury portfolio, derivative portfolio, and several bank accounts.

The Treasury department is responsible for day-to-day counterparty risk management. The Risk department is the second line of defense and responsible for assessing, quantifying, and monitoring counterparty risk daily. Limit excesses and material findings are reported to the ALCO on a monthly basis, together with recommended mitigations and actions. The Risk department is also responsible for updating policies and processes and for setting up limits, including minimum credit rating requirements, exposure limits, and transaction limits. The policies, processes, relevant parameters, and limits are reviewed and approved by the ALCO annually.

Developments 

There have been developments in the transition of LIBOR as well as rates for other currencies to new benchmark rates affecting the valuations of transactions with all counterparties. For more details, please refer to the ‘Interest rate risk' in the 'Banking book’ section.

Exposures

Counterparty risk exposures in FMO’s treasury portfolios originate from short-term investments (deposits, investment in money market funds, commercial papers (CP's), and collaterals related to transacted derivatives), interest-bearing securities (e.g., bonds), and transacted derivatives for hedging purpose. The tables below show outstanding positions as of 31 December.

Supra-nationals are international organizations or unions in which member states delegate part of their national powers to a collective decision-making body.

FMO mitigates its counterparty credit risk through various means. Minimum requirements of credit quality are set for counterparties of treasury activities. Netting and collateral agreements are also utilized to reduce counterparty credit risk originating from derivative transactions. FMO has Credit Support Annexes (CSAs) with all derivative counterparties. Additionally, part of the derivative portfolio, particularly EUR and USD interest rate swaps, is cleared through central counterparties, as required by the European Market Infrastructure Regulations.

The exposure of derivative financial instruments is presented for only derivatives with positive market value, netted with derivatives with a negative market value if it concerns the same counterparty. For this reason, the total amount shown in the table above does not equal the exposure presented in other tables.

The tables below include financial assets and financial liabilities that:

• are offset in the consolidated balance sheet of FMO; or

• are subject to an enforceable master netting arrangement or similar agreement that covers similar financial instruments, irrespective of whether they are offset in the consolidated balance sheet.

FMO receives and pledges only cash collateral with respect to derivatives.

Liquidity risk

Definition

Liquidity risk is defined as the risk for FMO not being able to fulfill its financial obligations due to insufficient availability of liquid means.

Risk appetite and governance

FMO’s risk appetite is to maintain adequate liquidity buffers to fulfill FMO’s current and future financial obligations all times. The appetite follows a similar rationale as for capital and it is aimed to maintain enough liquidity to ensure FMO would never need to fall back on the guarantee provided by the Dutch State to our investors. To realize this ambition, minimum liquidity requirements apply as prescribed by the regulator.

FMO’s liquidity risk policy framework is built on four pillars:

1. Survival period and minimum liquidity buffer under stress

2. Maturity matched funding

3. Diversified funding

4. Regulatory ratio requirements

FMO’s risk appetite levels are defined to ensure a minimum buffer above the seven-months minimum survival period under stress, a liquidity coverage ratio (LCR) above 135 percent, a Net Stable Funding Ratio (NSFR) above 110 percent, and restrictions on failed funding periods and cost of wholesale funding above peers. Additional thresholds such as matching funding, funding diversification and liquidity in specific currencies are also in place for managing and monitoring the risk profile of the bank. These monitoring metrics are delegated to the Director Risk and the Director Treasury and are subject to a formal sign- off procedure and reported to the ALCO. The ALCO is also responsible for approving the liquidity risk policy.

FMO has a conservative liquidity policy and funding strategy that is well suited to its business. Stress tests are conducted on FMO’s liquidity position on a weekly basis to ensure this conservative position is maintained. During the Internal Liquidity Adequacy Assessment Process (ILAAP), FMO performs additional stress tests, including scenarios provided by DNB and reverse stress testing. A continuous review is performed on the liquidity position, FMO’s assumptions, internal expectations and external market conditions to ensure that FMO’s liquidity planning is accurate.

The liquidity contingency plan sets out FMO’s strategy for addressing liquidity needs in the case of a crisis, ensuring that various sources of emergency liquidity are available to meet all current and future financial obligations, while avoiding excessive funding costs, incurring unacceptable losses and significantly changing the business profile. The liquidity sources include a long-term bond portfolio and a portfolio of short-term instruments such as cash, Money Market Funds, Commercial Paper (CP) and Treasury Bills. The long-term bonds and CP can be used as collateral in repurchase agreements to obtain short-term cash from the ECB or commercial parties.

Developments 

FMO's liquidity position remained comfortably above regulatory requirements and internal managerial limits in 2022, with an LCR never falling below 281 percent. As a result of strong USD appreciation and interest rate movements, FMO had €473 million collateral outflow in 2022, leading to a higher amount of funding than what was projected in the 2022 funding plan.

FMO updated its liquidity stress scenario that is used for survival period calculation in 2022 in line with market developments. As the FX market volatility surged, FMO now holds higher liquidity to cover for collateral outflows from derivatives portfolio in case of an extreme market stress. Furthermore, the new scenario promotes holding more immediately-available liquidity – such as cash in DNB, instead of relatively fewer liquid bonds.

Over the past few years, FMO has established a key role in local currency frontier markets and is keen to continue issuances in 2023, developing capital markets in line with its mandate. In total, FMO issued approximately €259 million of equivalent funding in local currency transactions during 2022.

Liquidity position

Throughout the course of 2022, FMO's liquidity position has been compliant with internal and regulatory metrics.

The following table shows the categorization of the balance sheet per maturity bucket. This table shows the timing of the undiscounted principal cash flows, and not the market values, per instrument. The totals per instrument may therefore differ from the totals on the balance sheet. Expected cash flows resulting from irrevocable facilities being drawn are not included in the liquidity gap. For internal liquidity planning and management, cash flows from irrevocable facilities are included in the cash flow forecasts.

The tables below are based on the final availability date of the contingent liabilities and irrevocable facilities.

• 1 FMO expects that not all of these off-balance items will be drawn before expiration date.

FMO complies with DNB’s Pillar 2 liquidity requirements methodology for Less Significant Institutions (LSIs) which have been applied from the Supervisory Review and Evaluation Process (SREP). The liquidity requirements are a survival period of at least 6 months based on internal stress testing methodology, a Net Stable Funding Ratio (NSFR) of 100 percent and a specific Liquidity Coverage Ratio (LCR) requirement of 100 percent. FMO's internal liquidity appetite levels include a safety cushion over and above the minimum requirements as described in the section above.

Following the risk appetite, FMO's liquidity position has been well above regulatory requirements and internal appetite levels throughout 2022. Per the reporting date, FMO has a survival period exceeding 12 months, an LCR of 439 percent (2021: 970 percent) and a NSFR of 114 percent (2021: 117 percent).

FMO’s major liquidity exposures are in EUR and USD currencies. However, some transactions are denominated – and may be settled – in local currencies. These exposures are specifically hedged using financial instruments to minimize liquidity and settlement risks.

Funding and sustainability bonds 

Treasury aims to ensure good market access by diversifying FMO’s funding sources. The result of this is a balanced funding mix in terms of currency, instrument and maturity.

Eurodollar (i.e., USD investors outside the United States) constitute key markets for FMO. Treasury has identified USD and EUR as strategic funding markets. Other markets to attract funding include Australia, Sweden, UK, Japan and local frontier currencies. Typical investors in FMO debentures and notes, either through public or private issuances, hold these instruments till maturity. Except for our Tier II issuance, FMO funding is plain vanilla and generally senior unsecured funding. 

ESG bonds are an important part of FMO’s funding strategy, which accounted for about 43 percent of the funding portfolio in 2022. In October 2022 FMO priced a successful €500 million five-year fixed rate sustainability bond. FMO has accelerated this EUR sustainability bond issue, originally planned for Q1 2023, due to additional funding need stemming from a strong pipeline towards year-end and an outflow of cash collateral. The new sustainability bond has been issued under FMO’s Sustainability Bonds Framework (SBF), and proceeds will be used to finance or refinance eligible green and social projects, or to repay a note issued under the FMO’s Sustainability Bond Framework.

Market risk

Market Risk is the risk that the value and/or the earnings of the bank decline because of unfavorable market movements. At FMO, this includes interest rate risk and currency risk.

Interest rate risk in the banking book

Definition

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 rate-sensitive income and expenses, affecting its net interest income (NII).

Risk appetite and governance

FMO has no trading book and all assets (loans and investments) are part of the banking book. FMO’s policy is to match assets and liabilities within defined limits. As the loan portfolio is more granular, loans are pre-funded and new funding is obtained periodically and matched to the asset portfolio in terms of expected maturity and interest rate sensitivity. Interest rate risk arises from the residual tenor mismatch, mismatch in fixed rate assets funded by floating rate liabilities, and differences in reference rates or currencies resulting in basis risk. FMO has little optionality in its portfolio and has no material exposure to rates-driven prepayment risk. The volatility of the market value of assets and liabilities over the holding period due to interest rate movements is of less concern as these are held until maturity.

Interest rate risk management falls under the responsibility of the ALCO. The Treasury department acts as the first line of defense and is responsible for the day-to-day management of interest rate risk and daily transactions. The quantification, monitoring and control of market risk is the responsibility of Risk. Interest rate risk is monitored using earnings-based metrics and value-based metrics.

Earnings-based methods capture short-term effects of interest rate re-fixing or re-pricing that may impact net interest incomes. The metrics below are used for this purpose.

• The interest rate gap provides a static overview of the full balance sheet’s repricing and refinancing characteristics. The gap is monitored over different time buckets where limits are in place both per bucket and on a cumulative level, for all currencies (aggregate and currency-by-currency).

• Net Interest Income (NII) at Risk provides a dynamic projection of net interest income sensitivity to yield curve shocks. FMO monitors NII at Risk on a two-year forward-looking basis and applies different scenarios simultaneously that allow for identification of basis risk as well.

Economic value methods capture changes in net present values of assets, liabilities and off-balance sheet items to changes in yield curves. Value-based metrics measure long-term effects of interest rate changes over the full tenor of the balance sheet. The following economic value metrics are calculated:

• Basis Point Value (BPV) provides the change in market value of assets, liabilities and interest-rate risk sensitive off-balance items for a one basis point change in yield curves. Limits are in place for the whole balance sheet, and for main currencies (EUR and USD) separately.

• Delta Economic Value of Equity (delta EVE) provides changes in the economic value of the shareholder’s equity given certain shifts in yield curves. The impact of a 200 basis-points parallel shifts and SA-IRRRB scenarios are reported. 

The interest rate gap and BPV exposure are monitored on weekly basis against limits set by the ALCO. BPV limits are defined dynamically to accommodate a 200 basis-points shock within 5 percent of Tier I. The delta EVE limit is defined in the Risk Appetite Framework and set at 5 percent of Tier I. The NII at Risk limit is defined based on 5 percent 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.

Developments  

In 2022 and 2023, FMO will transition its USD LIBOR loan portfolio to either Term SOFR or daily compounded SOFR. All preparations, such as legal templates, system amendments, tooling, data, instructions, training, and internal and external communications is ongoing or already finalized. The business has started to engage with our customers to discuss the conversion approach and the first loan contracts have already been transitioned. FMO adhered to the ISDA 2020 Fallback Protocol for transitioning its derivatives portfolio. During 2022 FMO has successfully transitioned its TRY loan and derivatives portfolio referencing TRLIBOR to the new risk-free rate in Turkey, TLREF. By the end of June 2023 all USD LIBOR contracts must be remediated into SOFR contracts.

The table below summarizes the maximum amount of exposures per financial instrument category impacted by IBOR reform as per December 31, 2022.

Exposures

The limits with respect to interest rate risk were not breached in 2022. The following table summarizes the interest re-pricing characteristics for FMO’s assets and liabilities.

• 1 Fair value of individual components (e.g. individual swap legs) of derivative financial instruments is allocated to the relevant interest re-pricing category.

• 1 Fair value of individual components (e.g. individual swap legs) of derivative financial instruments is allocated to the relevant interest re-pricing category.

Currency risk

Definition

Currency risk is defined as the risk that changes in foreign currency exchange rates have an adverse effect on the value of FMO’s financial position and future cash flows. FMO also reviews currency risk in terms of impact on the capital ratios.

Risk appetite and governance

FMO offers loans and attracts funding in a wide range of currencies. This is done to provide financing in the currency best fitting FMO’s customers and to reduce currency risks on their side.

FMO has limited appetite for currency risk. 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 percent of shareholder’s equity for the total open position across all currencies. Both the individual and overall open positions are monitored by Risk on a daily basis. Additionally, FMO maintains a deliberately unhedged foreign currency position for the purpose of structural hedge which is reported to the ALCO monthly. Please refer to the 'Structural hedge' sub-section for further details.

Developments

In spite of FX markets volatility due to the war in Ukraine and post-COVID-19 monetary policy, global recession and commodities prices shocks our positions remain within limits. No material developments occurred in 2022.

Exposures

Individual and total open currency positions were within risk appetite in 2022. The table below illustrates that the currency risk sensitivity gap per December 2022 is almost completely part of FMO's equity investments and investments in associates.

• 1 Fair value of individual components (e.g. individual swap legs) of derivative financial instruments is allocated to the relevant currency category.

• 1 Fair value of individual components (e.g. individual swap legs) of derivative financial instruments is allocated to the relevant currency category.

As described above, FMO’s loan assets in local currencies, such as Indian Rupee (INR), are fully swapped to the US Dollar on a cash flow basis. The positions in these currencies are therefore fully hedged. For IFRS reporting, however, the loans are recorded at (amortized) cost, while the related swaps are recorded at fair value, leading to an accounting mismatch in these currencies.

• 1 The sensitivities employ simplified scenarios. The sensitivity of profit & loss account and shareholders’ equity to possible changes in the main foreign currencies is based on the immediate impact on the financial assets and liabilities held at year-end, including the effect of hedging instruments.
• 2 Shareholders’ equity is sensitive to equity investments valued at fair value through other comprehensive income.

Structural hedge

FMO maintains a deliberately unhedged foreign currency position in private equity investments to manage the volatility of the capital ratio. These foreign currency positions act as an economic hedge against an adverse effect of the exchange rate on the regulatory capital ratios. A depreciation of FMO's reporting currency (euro) can significantly affect the capital ratio since FMO’s assets - and hence also the risk weighted assets - are mainly denominated in foreign currencies. The long open position in the equity portfolio thereby functions as a partial hedge for FMO’s regulatory capital ratios. In addition, the uncertainty in the size and the timing of the cash flows for equity investments makes micro-hedging less effective, hence these positions are better fit for use as a capital ratio hedge.