The Model Validation department undertakes backtesting of all existing risk models. In addition to evaluating the underlying model parameters, ensuring continued applicability of the models for the relevant portfolios, and discussing the model performance with front office and risk users of the models, Model Validation also tests the observed performance of a model (and its components) with the predicted level. A model where the observed results deviate from the predicted results is a candidate for either re-calibration or re-development.
This business model is translated into the following specific ambitions: • ING Bank’s long term ambition is to become a strong predominantly European focussed bank with a low risk balance sheet offering a competitive return on equity of 10% to 13% through low costs and low risks. • Retail Banking will pursue the One Bank strategy: ING Bank will converge to one retail model: ‘easy, fair, and at low costs’. • Commercial Banking will build further on its present strengths: leadership position in core markets (Benelux, Germany and Central and
Step 1. Define ING Bank’s risk ambition ING Bank defines a Bank Risk Appetite Framework in line with its business model and risk ambition, which is currently formulated as following: ING Bank Risk Appetite: ING Bank has the ambition to be and remain a strong bank, resilient to possible adverse events on a standalone basis and able to address such developments based on its own strengths and resources.
Step 2. Setting ING Bank Risk Appetite Statements Based on ING Bank’s risk ambition, specific targets are set for both financial and non-financial risks: Financial risks For financial risks, ING Bank expresses its risk appetite as the tolerance to allow key ratios to deviate from their target levels. Therefore the high level risk ambition is translated into quantitative targets on ING Bank level for solvency risk, liquidity & funding risk and for concentration & event risk.
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Key Control testing forms one of the inputs of the Non-Financial Risk Dashboard (NFRD) which is a report that is a fixed item on the agenda for the meetings of the MBB and the Risk Committee. NFRD provides management at all organisational levels with information on their key operational, compliance and legal risks. NFRD is based on their risk tolerance within their business and a clear description of the risks and responses enabling management to prioritise and to manage operational, compliance and legal risks.
Sector-wide stress testing In addition to the enterprise-wide program, ING takes part in a broad range of stress testing activities that are specific to a particular line of business, portfolio or risk type including market risk, liquidity risk, structural interest rate risk, retail and wholesale credit risk. Test results are used in a variety of decision-making processes including adjustments to certain risk limits, specific portfolios, and business implementation strategies. In October 2012, the European Banking Authority published the results of a capital requirements exercise. These confirmed that the Bank remains well capitalised with a strong core Tier 1 capital ratio.
The following fundamental principles and definitions have been established for the model: • ING Bank uses a one-sided confidence level of 99.95% - consistent with ING’s target debt rating (AA) - and a one-year time horizon to calculate EC; • It is assumed that all currently known measurable sources of risk are included; • The best estimate risk assumptions are as objective as possible and based on proper analysis of statistical data. There is one set of best-estimate assumptions for each risk type to be used at ING Bank; • The EC calculation is based on fair value principles. Where complete and efficient markets exist, fair value is equal to market value; • The EC calculations reflect known embedded options and the influence of customer behaviour in banking products; • The EC calculations are on a pre-tax basis and do not consider the effect of regulatory accounting and solvency requirements on capital levels; and • The framework does not include any franchise value of the business, discretionary management intervention or future business volumes and margins.
ONGOING CHANGES IN THE REGULATORY ENVIRONMENT After the turmoil in the financial markets over the last couple of years and the need for governments to provide aid to financial institutions, financial institutions have been under more scrutiny from the public, supervisors and regulators. The resulting revised regulations are intended to ensure that a crisis in the financial system can be avoided in the future.
Therefore, Basel III and the implications for ING Bank were the central theme in the January 2012 ING Investor Day. The strategy of the Bank focuses on effective balance sheet management in order to meet all the new requirements. The stricter capital requirements will be met by combining strong continued capital generation with RWA containment. To underpin this, ING Bank disclosed its ambition to reach a Basel III Core Tier 1 ratio in 2013 that is greater than 10%. Via strong capital generation and further continuing balance sheet optimisation efforts, also the Basel III Leverage Ratio will be met. To adhere to the new liquidity and funding requirements strong funds entrusted generation and increased long-term funding will be combined with reduced reliance on short-term professional funding and the transformation of the investment book into a liquidity portfolio.
Dutch Mortgages In 2012 the Dutch housing market slowed down significantly due to economic downturn and political uncertainty regarding the housing market. The Dutch housing market is historically characterised by housing shortage, high income tax with deductibility of interest on mortgages, and tax driven mortgage products. Due to elections of a new government in September 2012 and the need of a reduction of the government deficit the tax-deductions where reviewed. During 2012 there was a lack of clarity of the new government plans and economic uncertainty resulting in households postponed buying houses, with a lowering impact on the Dutch house prices. As long as the government plans concerning the total housing market (including reform of the rental market) remain uncertain and consumer confidence is not restored, the housing market coming will not recover early 2013. Although the house prices decreased, the Dutch payment behaviour is good, reflecting in a slightly elevated but still low percentage of non-performing loans by the end of 2012. Given the significant amount of mortgages in our credit portfolio, ING Bank closely follows all developments related to Dutch housing market and its mortgage portfolio.
Business lending Benelux ING Bank’s Business Lending, defined as lending to corporates in the business line Retail Banking, is concentrated within the Benelux. The weak economic environment was reflected by increased risk costs and elevated percentage of non-performing loans. The Netherlands showed the same development as Belgium and Luxembourg, with increased non-performing loans in the categories Builders & Contractors, Food, Beverages and personal care and Transport & Logistics.
Cybercrime 2012 saw an increase in the world-wide cyber threat and more stringent regulations being introduced regarding cyber security of e-banking (e.g. ECB’s Recommendations for the security of Internet Payments). Under the auspices of the Management Board, a Cybercrime Task Force has been set up within ING to ensure a coordinated and effective response to the threat of cybercrime. The Cybercrime Task Force aims to improve knowledge sharing and to structure effective prevention, detection and incident response across ING Bank. The Cybercrime Task Force is chaired by CIO Bank and includes key e-business management, risk, anti-fraud and IT senior management representatives.
In 2012 we have further strengthened our external collaboration against cybercrime with the industry (e.g. national bank associations), law enforcement, government (e.g. Nationale Cyber Security Center) and Internet Service Providers (ISPs). At the beginning and the end of our measures is the customer: we are trying to make the customer aware of the cyber threats/risks and to collaborate with us for a safer internet.
CREDIT RISK The credit risk section provides information on how ING Bank manages, measures and monitors credit risk and will give an insight into the ING Bank portfolio from a credit risk perspective. Prior to providing insight into the portfolio, we will explain how ING Bank ensures that credit risk is properly addressed and managed within ING Bank.
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Credit Risk Appetite and Concentration Risk Framework The Credit Risk Appetite and Concentration Risk Framework enables ING to prevent undesired high levels of credit risk and credit concentrations within various levels of the ING portfolio.
tr u ct u re : Li n es o f B
Credit Risk Appetite Credit risk appetite is the maximum level of credit risk ING Bank is willing to accept for growth and value creation. This credit risk appetite is linked to the overall Bank-wide Risk Appetite Framework. Articulating the credit risk appetite is a complex task that requires balanced views. It can be expressed in quantitative and qualitative measures. Having a credit risk appetite achieves: • Clarity over the credit risks that ING Bank can strategically assume; Focused execution in balancing ING Bank’s credit risk exposures within the boundaries of ING’s strategy, target setting and prudent risk management; • Consistent communication to different stakeholders; • Guidelines how to align reporting and monitoring tools with the organisational structure and strategy; • Alignment of business strategies and key performance indicators of business units with the overall ING Bank credit risk appetite by means of the MTP.
Concentration Risk Framework The concentration risk framework consists of a number of different components to properly manage and control any concentration levels within the ING portfolio.
Problem Loan management A problem loan is a loan where there is a reasonable probability that ING Bank may end up with a loss, unless ING Bank intervenes with specific and significant actions. In other words, in this category, an account or portfolio requires a more intensified approach, which may include renegotiation of terms and conditions and/or business/financial restructuring. Problem loans are managed by the Global Credit Restructuring (GCR) or by the Regional Restructuring Units (RRUs) in the various regions and network banks. GCR, which structurally falls under CRM, is the dedicated corporate department unit at the highest level, entrusted with the management of problem loans. Front Office, including mid- and back office functions, remain fully involved and committed to the management of GCR files. GCR’s management of problem loans can be divided in: I. Watch list: An assessment is made whether there may be deterioration in the risk reward relationship. At this stage, no specific and significant intervention from ING Bank is deemed necessary to ensure that the risk reward relationship improves. For severe cases additional monitoring takes place. Theoretically, accounts with watch-list status carry a risk rating of 1 to 19, but would typically have a rating of 15 to 17; II. Restructuring: A credit enhancement process is needed to achieve a turnaround in the problem loan. This may involve financial and/or business workarounds with the objective of ultimately improving the risk profile. The (credit) relationship is maintained during and after the period of restructuring. Accounts with restructuring status can be rated anywhere in the 15-19 range but typically carry a risk rating of 18 to 19; III. Recovery: An amicable or forceful exit from the (credit) relationship, where the objective is to lower the risk cost as much as possible. All Recovery status accounts are rated 20, 21 or 22. Based on expected cash flows for loans (above a certain threshold) rated between 20 – 22 specific, provisions are taken to minimise ING Bank’s exposure.
RWA CompARison Comparison of RWA and risk weights across institutions is inherently challenging. A recent study classified differences in RWA among banks in 3 categories: 1. Risk based drivers that stem from the differences in underlying risk at the exposure/ portfolio level and in business models/ strategies including asset class mix.
Risk Based Drivers ING Bank portfolio is heavily dominated by secured lending especially in the areas of residential mortgages, structured finance, leasing and commercial real estate. Secured lending tends to have a much lower LGD, given the collateral involved, which is a key driver of RWA. Another key element of the ING business model is the focus on retail exposures collateralised by residential property. The regulatory formula for this exposure class tends to result in the lowest RWA, all other factors being equal.
Regulatory Environment ING Bank is regulated by many host supervisors; however the primary regulating entity in DNB. Several strict interpretations of the Basel Accord are enforced by DNB including the requirement to have at least 85% of the portfolio qualify as AIRB before allowing AIRB implementation. This prevents arbitrage between the different Basel approaches. DNB also has a strict ‘significant change’ policy that requires all changes to the Basel measurement above a threshold to be reviewed and approved by DNB.
Economic Capital (EC) reflects ING Bank’s own view on credit risk, which allows it to be used in decision making processes at transaction level, counterparty level and (sub) portfolio levels. Credit risk and transfer risk capital are calculated on all portfolios which contain credit or transfer risk, including investment portfolios. EC is the minimum amount of capital required to cover for unexpected losses within a 99.95% confidence level and a 12 months’ time horizon. It is used throughout ING Bank in the transactional decision making process (mainly commercial banking), in risk adjusted counterparty and portfolio profitability measurement tools (commercial banking and retail), in investment and divestment decisions, in the country risk framework and in concentration risk management such as risk appetite statements (RAS) and the systemic risk reports (sector concentration report).
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EC is an important ingredient for the risk adjusted return on capital (RAROC) ratio. RAROC is a risk adjusted profitability measure over economic capital and supports transaction decision-making processes (for example through the ING Bank loan pricer tool). RAROC allows measuring the risk adjusted return of different products and structures within different parts of the organisation along one and the same yardstick. Next to Pillar 2 based RAROC, within commercial banking, a Pillar 1 ‘sanity check’ is performed on transaction level. This sanity check is a ‘margin over credit risk weighted asset (CRWA)’ ratio, which should exceed a pre-determined level (hurdle), which is tested in the Front Office ‘green light committees’.
An important characteristic of the CCRM infrastructure and framework is that models are built for several purposes, including EC, RC and Loan Loss Provision. Since these rating models are broadly used throughout the ING Bank organisation it enforces the compliance to the Basel Use Test requirement.
Regulatory downturn based LGD values, including a 10% Residential Mortgages LGD floor
The best rated Sovereign exposures (Credit quality step 1, translated into: internal rated 1 up to and including 4) expressed in local currency are under the partial permanent exemption
EC is calculated using the economic values of rating models (PD, EAD and LGD). In line with regulatory requirements, so-called ‘significant changes’ to these rating models are communicated to the regulator for approval. Significant changes relate to the impact on CRWA (Pillar 1) or to the significance (size) of the model to the ING Bank portfolio.
Economic and Regulatory Capital (Bank diversified only) by risk type Economic Capital Regulatory Capital
Credit Risk Measurement There are two broad ways to measure credit risk within ING Bank’s portfolio, depending on whether the exposure is booked under an ING office which is permitted by the DNB to use the Advanced Internal Rating Based (AIRB) approach, or if it falls under the Standardised (SA) approach. ING Bank does not use the Basel Foundation (FIRB) approach for any portfolio.
Maturity (M): The fourth element is the time to the maturity of the underlying financial obligation. Basel II caps the maturity element at five years, despite the fact that many obligations extend longer than five years.
Credit Risk Models Within ING Bank internal Basel models are used to determine the PD, EAD and LGD for regulatory and economic capital. Bank wide, ING Bank has implemented more than 100 models, including various sub models that may be applicable for a specific portfolio.
Model Life Cycle process stages: Sign-off points: 242 ING Group Annual Report 2012
ING Bank’s probability of default (PD) rating models are based on a 1-22 scale, which roughly corresponds to the same rating grades that are assigned by external rating agencies, such as Standard & Poor’s and Fitch. For example, an ING Bank rating of 1 corresponds to an S&P/ Fitch rating of AAA and a Moody’s rating of Aaa; an ING Bank rating of 2 corresponds to an S&P/Fitch rating of AA+ and a Moody’s rating of Aa1, and so on.
ING Bank as Sponsor In the normal course of business, ING Bank structures financing transactions for its clients by assisting them in obtaining sources of liquidity by selling the clients’ receivables or other financial assets to an SPV. The transactions are often funded by the ING Bank administered multi seller Asset Backed Commercial Paper (ABCP) conduit Mont Blanc Capital Corp. (rated A-1/P-1). Mont Blanc Capital Corp. continues to fund itself externally in the ABCP markets. In its role as administrative agent, ING Bank facilitates these transactions by providing structuring, accounting, funding and operations services. ING Bank also provides support facilities (liquidity and program wide enhancement) backing the transactions funded by the conduit. Mont Blanc is fully consolidated into the ING Bank financial accounts.
The three main purposes of Vortex; • Analysis for decision makers; • Compliance: Vortex is compliant and meets the requirements set by the regulators; • Disclosure: Vortex delivers reports to external rating agencies and investor relations.
ING Bank’s reporting principles The Basel Committee on Banking Supervision (BCBS) released a consultative paper in June 2012, entitled ‘Principles for Effective Data Aggregation and Risk Reporting’. The paper stems from a recommendation made by the Financial Stability Board (FSB) and outlines 11 key principles for global systemically important banks to follow. ING Bank has done a self-assessment and rates itself satisfactory or better on all principles. Nonetheless, gaps have been identified in certain sub-portfolios and actions are being planned to further improve the credit information technology and reporting. The following are the key principles based on which this information is obtained and shared: • Accuracy: Reports made by analysts are peer-reviewed, management reviewed, reconciled with other publications for consistence and validated by responsible departments.
• Timeliness: Up to date information is provided to stakeholders in a timely and dynamic manner to ensure relevance and usefulness in this quickly changing economic environment; • Completeness: ING Bank’s reporting tools capture and aggregate all credit risk data across the banking group providing a complete overview within the depth and scope of ING Bank’s operations and risk profile; • Adaptability: Reporting systems and tools are enabled with various filters and options which allow the reporting department to quickly aggregate risk data to meet a broad range of ad hoc requests; • Auditability: Data, sources and methods used for reporting are maintained in a proper and clear manner which is audited by external sources to ensure credibility and efficiency.
Commercial Banking Retail Banking Benelux Retail Banking International (2) Corporate Line Total ING Bank
As part of the focus on core clients, ING Bank further reduced its relative exposure to central governments and banks and the financial sector while growing the private individual and corporate portfolios. The category Central Banks reduced considerably as less excess liquidity was deposited at Central Banks.
Country Risk In 2012 a more comprehensive Country Risk Framework was implemented which resulted in enhanced disclosure of country risk information. For comparison reasons, we have used the same framework settings for the 2011 figures.
Collateral policies During the assessment process of creating new loans, trading limits, or making investments, as well as reviewing existing loans trading positions and investments, ING Bank determines the amount and type of collateral, if any, that a customer may be required to pledge to ING Bank. Generally, the lower the perceived creditworthiness of a borrower or financial counterparty, the more collateral the customer or counterparty will have to provide. Within counterparty trading activities, ING Bank actively enters into various legal arrangements whereby ING Bank and/or counterparties may have to post collateral to one another to cover market fluctuations of their relative positions. Laws in various jurisdictions also affect the type and amount of collateral that ING Bank can receive or pledge. The type of collateral which is held as security is determined by the structure of the loan or position. Consequently, since ING Bank’s portfolio is diversified, the profile of collateral it receives is also diversified in nature. The one exception is residential mortgages which comprise a significant part of the lending portfolio. Per definition, residential mortgages are collateralised by housing. ING Bank maintains the residential mortgage collateral in its centralised data base and in most cases uses external data to index the market value.
Performing Assets – Cover values including guarantees received** - AIRB Portfolio based
Loan-to-Value (LTV) The LTV ratio relates the total loan amount to the market value of the collateral. The market value is usually the registered value as adopted from the valuation report of a qualified appraiser or valuer. ING Bank has a team of specialists for the valuation of real estate, which is supplemented with external and desk top valuation. In some countries residential mortgages are covered by governmental or commercial insurers. For example the Nationale Hypotheek Garantie (NHG) in The Netherlands, which guarantees the repayment of a loan in case of a forced property sale. The LTV in The Netherlands is relatively high, but is partially compensated by the NHG guaranteed portfolio and other secondary covers, such as life insurance policies, savings and investment products.
ING Bank’s residential mortgage portfolio outstandings amount to EUR 296 billion, making up 39% of the total ING Bank credit risk outstandings. The average LTV of the total residential mortgage portfolio amounts to 79% (2011: 75%).
Neither past due nor impaired 712,020 849,283 Past due but not impaired (1–90 days) (1) 6,579 6,649
Aging analysis (past due but not impaired): ING Bank portfolio, outstandings (1)
In certain circumstances ING grants borrowers postponement and/or reduction of loan principal and/or interest payments for a temporary period of time to maximise collection opportunities and, if possible, avoid default, foreclosure or repossession. When such postponement and/or reduction of loan principal and/or interest payments is executed based on credit concerns it is also referred to as ‘forbearance’. In general, forbearance represents an impairment trigger under IFRS. In such cases, the net present value of the postponement and/or reduction of loan and/or interest payments is taken into account in the determination of the appropriate level of loan loss provisioning as described below. If the forbearance results in a substantial modification of the terms of the loan, the original loan is derecognised and a new loan is recognised at its fair value at the modification date.
In Corporate Banking, (potentially) problematic loans are typically assessed on an individual basis and the occurrence of an impairment (or Basel II) default trigger – including the ‘unlikely to pay’ default trigger. This assessment is done on a quarterly basis, and will lead to the calculation of a loan loss provision whenever ING Bank estimates that not all contractual cash flows will be collected over time – in which case the loan asset is considered no longer ‘money good.’
ING knows three different types of loan assets in which a (definite, non-recoverable) financial loss was incurred.
ING defines a loan as a Troubled Debt Restructuring (TDR) when a combination of the following is applicable (i) the loan is already impaired, (ii) NG Bank will or is likely to incur a loss by means of concessions agreed with the Borrowers and (iii) The company will not be liquidated, i.e. can be restructured and made financially healthy again. Within ING Bank, TDRs have a risk rating of 20. Impaired Borrowers that are unable to reach a consensual restructuring will either repay or will likely end up in liquidation and, in the latter case, be risk rated 21 or 22 (and are not considered to be TDR). Likewise all (potentially) problematic Borrowers, regardless of label being Watch list, Restructuring or Recovery, and where ING has not (yet) agreed to a concession leading to a financial loss, are not considered to be TDRs.
In the Retail Banking environment the (re)modified loan will normally reflect a fair value adjustment as in the Corporate Banking environment. In most cases, the (re)modification will lead to an interest reduction during the tenor of the loan. The financial loss, expressed as Net Present Value loss (or again Fair Value Adjustment), will be calculated as the difference between the market conform interest and the actual agreed interest x the tenor of the (re)modified loan, or NPV((Market Interest - Contractual Interest) x tenor in years). The outcome of this calculation will be deducted from the original carrying value of the loan, the original loan asset will be derecognised and replaced by a new FVA asset with a lower carrying value, reflecting the financial loss incurred.
As per 2012, ING Bank Retail reported EUR 291 million (EUR 1.6 billion in 2011) of Loan Modifications: Retail Banking: Remodified Loans, outstandings and number of clients Outstanding Clients
Netherlands* Mortgages n.a n.a Turkey Consumer Lending & Mortgages 1 19 182 US Mortgages 1,364 3,417 Germany Consumer Lending & Mortgages * ING Domestic Bank Netherlands has a loan modification policy where modified customers are considered in default. These loans are tracked as defaulters and not under the Retail Loan Modification policy. These clients are not included in the above table. This is a conservative approach as most of these clients are current on their obligations. ING is considering to transfer these clients from the default category to remodified loans in order to provide better comparison to other Dutch mortgage providers and other international markets. As per 31 December 2012, the number of modified loans which are tracked as defaulters at ING Domestic Bank Netherlands is around 3,000, which represents around EUR 0.6 billion in outstanding amount.
Private Individuals 4,370 4,790 Real Estate 3,723 2,671 Builders & Contractors 1,087 774 Transportation & Logistics 954 797 Food, Beverages & Personal Care 846 784 General Industries 649 819
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Provisions There are three types of provisions that have to be made and accounted for: • Individually Significant Financial Asset (ISFA) Provisions: for those loans where specific, individualised provisions are still required. These are generally loans that exceed the threshold amount. The threshold amount varies per business unit, but generally is nil in the international units, and EUR 1 million in the ‘home markets’. These provisions are made using an estimated future recovery methodology and then applying a net present value concept. The future cash flows are based on the restructuring officers’ best estimate of when/if recoveries will occur. Recoveries can be from any source, such as the sale of collateral, on-going cash flows, sale of a business/subsidiary, etc. ISFA provisions are all calculated using a common tool across ING Bank.
• Incurred But Not Recognised (IBNR) Provisions: are made for the ‘performing’ loan portfolio as an estimate or proxy for the losses/ defaults that may have already occurred in the portfolio, but which ING Bank has not yet determined or recognised. These provisions are based on a modified expected loss methodology. The primary modification is that the PD time horizon (12 months) is shortened to periods of 3, 6, or 9 months, depending on the type of obligor. Generally, the larger the obligor, the shorter the PD time horizon. IBNR provisions are calculated centrally using a common tool across ING Bank.
ING Bank holds specific and collective provisions of EUR 3,415 million and EUR 1,336 million, respectively (2011: EUR 3,040 million and EUR 1,133 million respectively), representing the difference between the amortised cost of the portfolio and the estimated recoverable amount discounted at the effective rate of interest. In addition, there is EUR 753 million (2011: EUR 777 million) in provisions against the performing portfolio. The 2011 figures are including ING Direct USA and Canada.
Opening Balance 2,039 1,855 1,751 1,641 1,160 1,699 4,950 5,196 Changes in the composition of the group –3 –13 –565 –13 –568 Write-offs –717 –373 –793 –494 –172 –437 –1,682 –1,304 Recoveries 41 66 90 37 11 9 142 112 Increase/(decrease) in loan loss provision 955 479 833 603 337 588 2,125 1,670 Exchange or other movements –14 15 –17 –36 14 –134 –17 –156 Closing Balance 2,304 2,039 1,864 1,751 1,337 1,160 5,505 4,950
Governance Within ING Bank, market risk (including liquidity risk) falls under the supervision of the ALCO function with ALCO Bank as the highest approval authority. ALCO Bank determines the overall risk appetite for market risk. The ALCO function is regionally organised. The business lines Retail Banking (both Benelux and International) and Commercial Banking are represented within the respective regional and local ALCO’s. The ALCO structure within ING Bank facilitates top-down risk management, limit setting and the monitoring and control of market risk. This ensures a correct implementation of the ING Bank risk appetite.
Economic Capital for market risk for the mortgage portfolios within ING Retail Banking (both Benelux and International Banking) and ING Commercial Banking is calculated for embedded option risk (e.g. the prepayment option and offered rate option in mortgages). The embedded options are hedged using a delta-hedging methodology, leaving the mortgage portfolio exposed to convexity and volatility risk.
The nature of market risk Economic Capital, evaluating the impact of extreme stress with a 99.95% confidence level, can sometimes be difficult to evidence in a statistical sound manner with the available historical data. The Economic Capital figures disclosed by ING Bank are a best effort estimate based on available data and expert opinions.
Valuation techniques range from discounting of cash flows to valuation models. Such models may be based on relevant factors such as the market price of underlying reference instruments, market parameters (volatilities, correlations and credit ratings) and customer behaviour. Some of these price factors require various assumptions which imply that valuation models are subjective by nature. According to what valuation technique is used and what assumptions are made, the obtained fair value can be different.
Market Risk Management Product Control has the role to identify or challenge the pricing sources as well as determining the parameters that will be used in the valuation models. When using valuation techniques, the identified sources used for the calculations are independently challenged, reviewed and validated on a regular basis, most of it daily. In order to guarantee the highest quality of the used market data, ING uses a single in house developed infrastructure. Information is received from external data vendors (e.g. Bloomberg, Reuters and others) and plausibility checks are in place to determine the correctness and consistency of the data. Price testing is performed on listed products to assess whether the process of valuation has led to an appropriate fair value of the position.
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Foreign exchange Foreign exchange US Dollar –302 Chinese Yuan 355 Chinese Yuan 178 US Dollar –282 Taiwan Dollar 151 Czech Koruna –155 Russian Ruble –37 Taiwan Dollar –44 Czech Koruna 33 Bulgarian Lev –43
Most important interest rate and credit spread sensitivities (year-end 2012) amounts in thousands of euros 2012 2011(3)
Risk classes 1 (AAA) –4 –124 –5 –16 2–4 (AA) –38 –65 –12 –49 5–7 (A) –42 –247 15 –256 8–10 (BBB) 23 –68 –50 –42 11–13 (BB) –40 –25 –14 –24 14–16 (B) –12 –4 –18 –8 17–22 (CCC and Problem Grade) –47 –2 2 –21 Not rated –1 –16 –1 0 Total –161 –551 –82 –416
Governance: Interest Rate Risk framework The management of interest rate risk follows the Interest Rate Risk in the Banking Book framework as approved by ALCO Bank. This framework describes roles and responsibilities, risk metrics, and policies and procedures related to interest rate risk management are defined. Furthermore, on an overall level, a risk appetite for interest rate risk is set, which is translated into limits for interest rate risk metrics.
By currency Euro 47 –1 US Dollar 3 –66 Pound sterling 1 –11
BPV per currency banking books Amounts in thousands of euros 2012 2011 (1)
(1) Please note that 2011 figures are restated for ING Direct Canada, ING Direct USA, and banking books that were included in trading risk Section in 2011.
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Risk profile – FX Translation result The following table presents the currency exposures in the banking books for the most important currencies: Net banking currency exposures banking books Foreign Investments Hedges Net Exposure
ING Bank has EUR 0.5 billion out of EUR 3.3 billion recorded at fair value through profit and loss. The remaining EUR 2.8 billion is booked at cost or is revalued through equity (with impairments going through profit and loss).
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ING’s liquidity risk framework incorporates all relevant risk principles with regard to the daily and on-going management of liquidity and funding risk. The framework contains the risk boundaries and describes the related metrics to monitor and control on- and off-balance sheet positions, across the major currencies. The framework incorporates a holistic view on managing liquidity and funding risk, whereby the defined risk appetite statements provide guidance to the organisation with regard to size, form and content of the balance sheet.
These risk appetite statements are incorporated in the manner in which liquidity risk is monitored and measured.
• Management of liquidity gaps, taking into account the asset mix and both the secured and unsecured funding opportunities of ING Bank; and
– Liquidity Coverage Ratio (LCR), based on Basel III and draft CRD IV regulation.
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NON-FINANCIAL RISK The Non-Financial Risk (NFR) department encompasses the Operational and Compliance risk management teams. It ensure s appropriate risk controls in these areas by setting clear and accessible policies and minimum standards which are embedded in ING Bank business processes in all business lines. An infrastructure is in place to enable management to track incidents and non-financial risk issues. A comprehensive system of internal controls creates an environment of continuous improvement in managing non-financial risk. ING Bank uses this knowledge (including lessons learned from incidents) to improve the control of key risks.
Governance At all levels in the organisation Non-Financial Risk Committees (NFRCs) are established that identify, measure and monitor the operational and compliance risks of the region or business unit with appropriate quality of coverage (granularity) and to ensure that appropriate management action is taken by the responsible line managers at the appropriate level of granularity. NFRCs, chaired by the CEO of the entity, steer the risk management activities of the first and second line of defence in their entities.
At least once a year business units and departments perform a Risk & Control Self-Assessment with involvement of the business and their Operational Risk, Compliance, Legal and Finance departments.
Based on the results of the risk assessment, response measures must be determined for the identified risks beyond the risk appetite. Risk response actions balance the expected cost for implementing these measures with the expected benefits regarding the risk reduction. Risk response can be achieved through several combinations of mitigation strategies, for example reducing likelihood of occurrence, reducing impact, risk avoidance, risk acceptance or through the transfer of risk. Tracking takes place through ING Bank’s central risk management system.
Internal and External Fraud Risk ING Bank continues its strong commitment to preventing any involvement in Banking Fraud. This requires ensuring sufficient allocation of resources and funds for incident investigation and incident management across all business lines. Phishing and Trojans are increasingly becoming more sophisticated but card skimming also remains an important area of focus for fraud risk.
AMA framework and model In the past two years, ING Bank renewed the different elements of the AMA model and framework: the risk assessment approach, use of a bank wide set of Key Risk Indicators, Risk Appetite Statement, set of Key Controls, registration of risk controls, incidents and issues in a central database and the Operational Risk Capital model. This enables ING Bank and its divisions to manage Operational Risk Capital based on a strong AMA framework and governance.
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Scope The Compliance Risk Management function focuses on managing the risks arising from laws, regulations and standards which are specific to the financial services industry. The Compliance Risk Management function actively educates and supports the business in managing compliance risks such as, but not limited to, money laundering, terrorist financing, sanction and export control compliance, conflicts of interest, proper sales and trading conduct and protection of customer interests.
Extra-territorial regulations Financial institutions continue to be closely scrutinised by regulatory authorities, governmental bodies, shareholders, rating agencies, customers and others to ensure they comply with the relevant laws, regulations and standards. Bank regulators and other supervisory authorities in Europe, the US and elsewhere continue to oversee the activities of financial institutions to ensure that they operate with integrity and conduct business in an efficient, orderly and transparent manner.
ING Bank has had a sanctions policy in place since 2007 and has a mandate to run down any existing commitments. As such, remaining exposure and contacts arise solely in the context of the Bank’s on-going efforts to run down the legacy portfolio of commitments.
Regulatory measures and law enforcement agencies investigations On 12 June 2012, ING Bank entered into a Settlement Agreement with U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) and Deferred Prosecution Agreements with the Department of Justice, the United States Attorney’s Office for the District of 272 ING Group Annual Report 2012
Enhancements implemented are designed with the aim to support the compliance culture and preventing practices of this nature occurring in the future.
Main developments in 2012 Regulator relationships Bank Compliance Risk Management continued its policy of investing in pro-active relationship building with regulators in the jurisdictions wshere ING Bank operates, by striving for an open two-way approach to communication and cooperation in identifying and mitigating compliance risks for ING Bank as well as seeking to contribute to the regulatory debate going forwards.
BUSINESS RISK Business Risk for ING Bank has been defined as the exposure to value loss due to fluctuations in volumes, margins and costs, as well as customer behaviour risk. It is the risk inherent to strategy decisions and internal efficiency. The calculation of Business Risk Capital is done by calculation of two components, (i) Expense risk relates to the (in)flexibility to adjust expenses, when that is needed.
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Risk management within ING is the primary responsibility of the ING Group Chief Risk Officer (CRO). The ING Group Chief Risk Officer has a direct functional line with the Chief Risk Officer of ING Insurance EurAsia and with the Chief Risk Officer of ING Insurance US. The General Manager of Insurance Investments is responsible for winding down the activities within Insurance Investments. The ING Group CRO is supported by the Risk functions of ING Group and by the Group functions Corporate Legal and the Functional Controller Insurance.
ING Risk Management will take these developments into account preparing for the new regulatory environment. The involvement in industry associations such as the CRO Forum, CFO Forum and Pan European Insurance Forum (PEIF) keeps ING close to these developments and enables responsive action in this regard.
RISK GOVERNANCE ING Insurance EurAsia’s risk framework is based on the ‘three lines of defence‘ concept which ensures that risk is managed in line with the risk appetite as defined by the Management Board Insurance EurAsia (MBE) and ratified by the Supervisory Board and is cascaded throughout ING Insurance EurAsia.
The Supervisory Board is responsible for supervising the policy of the MBE and the general course of affairs of the company and its businesses. For Risk Management purposes the Supervisory Board is assisted by two sub-committees: • The Audit Committee assists the Supervisory Board in supervising and advising the MBE with respect to the structure and operation of internal risk management and control systems, as well as compliance with legislation and regulations applicable to ING Insurance EurAsia and its subsidiaries; • The Risk Committee assists the Supervisory Board in supervising and advising the MBE with respect to ING EurAsia’s strategy and its risk policies, including the risks inherent in its business activities.
The MBE is responsible for managing the risks associated with the activities of ING Insurance EurAsia. The MBE’s responsibilities include ensuring the risk management and control systems are effective and ING Insurance EurAsia complying with legislation and regulations. The MBE reports and discusses these topics on a regular basis with the Supervisory Board, and reports to the Risk Committee on a quarterly basis on ING Insurance EurAsia’s risk profile versus its risk appetite.
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Reserve adequacy The ING Insurance EurAsia Group Actuary gives all ING Insurance EurAsia entities instructions and supervises to ensure that the IFRS insurance liabilities of ING Insurance EurAsia are tested for adequacy taking into account the insurance premium rate levels and the uncertainty of future returns on investments. The reserve adequacy test is executed by evaluating insurance liabilities on current best estimate actuarial assumptions plus a risk margin, ensuring that the reserves remain adequate based on these assumptions. The assumed investment earnings are a combination of the run-off of portfolio yields on existing assets and new money and reinvestment rates. For short-term and reinvestments, new money rates are used. For other reinvestments, long-term best estimate assumptions are taken into account. For many products stochastic testing is required, taking the 90th percentile of results as the required level. In the case where deterministic testing is used, the 90% confidence level is achieved by subtracting risk margins of 20% from the best-estimate interest rates or one percent point, whichever is higher.
RISK APPETITE FRAMEWORK Our risk appetite determines what risk our companies wish to acquire, to avoid, to retain and/or to remove. It defines our attitude to risk we would like to and are able to take in the near future and consists of risk preferences, our risk tolerances, our risk limits and controls. The risk appetite is determined for each of our business units. The risk appetite framework combined with our risk measurement framework is the basis for our day to day risk management execution. Business units report regularly on their risk profile.
Risk Appetite A qualitative statement defining the playing field ING Insurance EurAsia wants to act in. Driven by ING Insurance EurAsia’s business strategy.
The risk appetite, tolerance, and limit structure includes the ‘Available Financial Resources over Economic Capital’ ratio (AFR/EC), leverage ratios, IFRS earnings sensitivities, local capital sensitivities, and concentration risks. The AFR/EC ratio is defined as the Available Financial Resources (AFR) over the amount of capital required for the current net asset value to absorb unexpected losses in a scenario based on a 99.5% confidence level with a one year time horizon. The confidence interval and horizon are aligned to Solvency II.
Risk Monitoring ING Insurance EurAsia uses various tools to monitor its risk exposures – ensuring we remain within our risk appetite. A robust risk appetite combined with our governance frameworks ensures timely response to address any exposures that breach our risk appetite. Below we list the main risk controls that are in place to monitor risk and allow management to take risk mitigating actions or revisit our risk appetite to ensure it still lies within our risk capacity: • Financial risks are reported to the Risk Committee of ING Insurance EurAsia at each level of the organisation through Financial Risk
Sales agreements have been reached for Malaysia, Thailand, Hong Kong/Macau and India insurance operations. For Malaysia, the sale was completed in December.
Economic Capital Economic Capital (EC) within ING Insurance EurAsia is defined as the amount of additional assets to be held above the market value of liabilities in order to ensure a positive surplus in case of adverse movements. The Economic Capital model is based on a 99.5% level of confidence interval on a one-year time horizon and is before any adjustment for tax impacts.
Model disclosure ING quantifies the impact of the following types of risk in its EC model: • Market Risk – Most asset are individually (re)valuated under different economic scenarios. The rest of the assets (mortgages) and the financial component of the liabilities are replicated by the business units using a finite set of standard financial instruments. The replication is based on stochastic cash flows produced by the local actuarial systems using a set of economic scenarios. The quality of the replication is monitored by several statistical criteria, including R-squared, and benchmarked against market value sensitivities; • Credit default Risk – Calculated on portfolios which contain credit or transfer risk, including investment portfolios. The EC is calculated based on the following seven drivers: Probability of Default (measure of the standalone creditworthiness of individual debtors), Exposure at Default (estimated size of the financial obligation at the moment of default in the future), Loss Given Default (estimated recovery value of the underlying collateral or guarantees received (if any) and the unsecured part), Industry of the debtor, Country of the debtor, Remaining tenor of the underlying transactions and Type of Assets; • Insurance Risk – Calculated by the business unit for all sub-risks for Life, Morbidity and P&C Risk; • Business Risk – Calculated by the business unit for Persistency, Expense and Premium-rerating Risk; • Operational Risk – Calculated by a corporate risk model for all business units, in alignment with Solvency II Standard Formula.
EC Calculation and aggregation For the EC calculation the risk system (ECAPS) uses a sufficient number of scenarios to simulate market risks and credit default risk. A dependency structure is used to reflect correlations between risk drivers when generating the economic scenarios. The scenarios are calibrated based on the historical time series of the market risk drivers using relevant available historical data. Volatilities and correlations are calibrated to represent the distribution on a quarterly frequency. For each of the scenarios the market value of assets and liabilities and the change in value of the Market Value Surplus (MVS) is recalculated. Sorting the results and selecting the 99.5% worst change in MVS result provides the Economic Capital for the given level of aggregation.
The exclusion of ING Insurance Asia Pacific entities relates to all business units in Asia Pacific, ING’s Insurance and investment management businesses and the reinsured Japan SPVA businesses in corporate reinsurance that have been classified as discontinued operations and that were considered in last year’s EC. Reference is made to Note 23 ’Discontinued operations’.
Economic Capital break-down ING Insurance EurAsia excluding discontinued operations (99.5%) by business line
Insurance Benelux 4,324 4,331 Insurance Central & Rest of Europe 1,082 808 Corporate Line Insurance EurAsia (1) 462 457 Total Insurance EurAsia excluding discontinued operation 5,868 5,596
Risk not mitigated by diversification is managed through concentration and exposure limits and through reinsurance and/or securitisations: • Tolerance limits for non-life insurance risks are set by line of business for catastrophic events and individual risk; • Tolerance limits for life insurance risks are set per insured life and significant mortality events affecting multiple lives such as pandemics; • Reinsurance is used to manage tolerance levels. Reinsurance creates credit which is managed in line with the ING Insurance EurAsia reinsurance credit risk policy; • Catastrophic losses resulting from events such as terrorism are considered to be uninsurable. ING participates in industry pools in various countries to mitigate this risk.
BUSINESS RISK Business risk for insurance is essentially the risk that insurance operations accept as a consequence of participating in the insurance business. In practice this can be defined as the exposure to the possibility that experience differs from expectations with respect to expenses, the run-off of existing business (persistency/renewals), future premium re-rating, etc.
Interest Rate Impact of interest rate changes on the value of assets and liabilities.
AFR & IFRS earnings sensitivities: – Measured by the impact of a 30% upwards and downwards shock relative to the ten year swap rate. Minimum shock is floored at 50 basis points and capped at maximum 150 basis points. Shocks are applied to forward rates up to the last available tenor of the interest rate curve.
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Sensitivities for market risks excluding discontinued operations AFR IFRS Earnings AFR IFRS Earnings
The Available Financial Resources are currently mainly sensitive to declining equity and real estate prices. Compared to 2011 the downward interest rate sensitivity was reduced by hedges put in place in the Benelux. The downward equity sensitivity increased compared to 2011 as a result of reduced positions in equity put options.
During a period of declining interest rates, profitability may suffer as a result of a decrease in the spread between interest rates earned on assets and interest rates credited to insurance policyholders and annuity contract owners. An extended period of declining interest rates may cause ING Insurance EurAsia to change the long term view of the interest rates that can be earned on the investments.
As at 31 December 2012, ING Insurance EurAsia has EUR 3.2 billion of real estate related investments (excluding leverage). ING Insurance EurAsia’s real estate exposure (i.e. including leverage) is EUR 5.3 billion of which EUR 2.9 billion is recognised at fair value through P&L and EUR 2.4 billion is not revalued through P&L, but is either booked at cost or is revalued through equity (with impairments going through P&L). In total, real estate exposure decreased by EUR 434 million, mainly as a result of negative fair value changes (EUR 172 million), disposals (EUR 130 million), sale of ING Insurance Malaysia (113 million) and other decreases such as impairments (EUR 19 million).
CREDIT RISK The main credit risk for ING Insurance EurAsia stems from the bond portfolio. This risk is measured through the credit spread risk economic capital that is part of the market risk methodology. The spread risk captures differences in risk (and diversification) between rating classes and regions. For corporate bonds, the concentration risk on individual issuers is also managed with rating based issuer & lending limits that prevent large exposures in one (group of related) single name(s). An outright loss given default limit serves as the final backstop for corporate exposures. Government exposures are separately monitored. The credit risk profile is monitored and reported in the Investment Risk Dashboard.
The economic capital for credit default risk on residential mortgages, term loans (including private placements) as well as the credit default risk on OTC derivatives, money market lending and reinsurance is measured by looking at each issuer’s probability of default (PD) and stressed loss given default (LGD).
The drop in credit default risk is mainly from aligning the ING Insurance EurAsia’s model with Solvency II guidelines. Note that the lower Economic Capital of the updated credit default model is offset by a lower diversification benefits with other risks.
Largest economic exposures: ING Insurance EurAsia portfolio excluding discontinued operations, by geographic area (1)
(1) This excludes collateralisation of derivative exposures and for security lending/ (reverse) repo’s activities. (2) The cover value for mortgages includes a haircut in case of a forced sale. The value of this haircut is equal to the value of the haircut applied to the 2011 cover values in the table below.
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The below table reflects provisions related to personal loans and mortgages (almost all of the provisions are related to Insurance Benelux).
Increase/(decrease) in loan loss provision 12.1 19.7 Exchange differences –0.3 Other changes –0.2 Closing balance 68.8 80.4
Aging analysis (past due but not impaired) outstandings excluding discontinued operations (1)
Similar to other market risks, liquidity risk falls under the supervision of the Risk Committee. ING Insurance EurAsia maintains a liquidity policy that defines liquidity limits in line with risk tolerances. The Liquidity Management Principles include the following: • Interbank funding markets should be used to provide liquidity for day-to-day cash management purposes; • A portion of assets must be invested in unencumbered marketable securities that can be used for collateralised borrowing or asset sales; • Strategic asset allocation should reflect the expected and contingent liquidity needs of liabilities; and • Adequate and up-to-date contingency liquidity plans should be in place to enable management to act effectively and efficiently in times of crisis.
ING Insurance EurAsia defines three levels of Liquidity Management. Short-term liquidity, or cash management covers the day-to-day cash requirements under normal business conditions and targets funding liquidity risk. Long-term liquidity management considers business conditions, in which market liquidity risk materialises. Stress liquidity management looks at the company’s ability to respond to a potential crisis situation. Two types of crisis liquidity events can be distinguished: a market event and an ING Insurance EurAsia specific event. These events can be short-term or long-term and can both occur on a local, regional or global scale. Depending on the type of event, the policy also defines the composition of the crisis teams.
For Operational Risk ING Insurance EurAsia has developed a framework governing the process of identifying, assessing, mitigating, monitoring and reporting operational risks. The framework is based on the elements of the Enterprise Risk Management model of COSO (Committee of Sponsoring Organisations of the Treadway Commission). The Operational Risk capital calculation is described in the Economic capital section.
The Operational risk function works with the Operational Risk Management (ORM) Scorecard process to evaluate yearly the embedding level of the ORM Framework in each business. Policies and minimum standards governing the framework are kept in the policy house.
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Economic Capital ING Insurance EurAsia (99.5% undiversified) excluding discontinued operations by risk category
MISSION AND OBJECTIVES As a financial services company active in investments, insurance and retirement, ING US is exposed to a variety of risks. The mission of risk management in ING US is to fully integrate risk management into daily business activities and strategic planning. This is achieved by providing value added insights on risk issues to drive informed decision-making that maximises the value of ING US.
ev el ti er b o ar d s tr u ct u re
The Supervisory Board is responsible for overseeing the policies of the Board of ING U.S., Inc., the general course of affairs of the Company and its businesses. For Risk Management purposes the Supervisory Board is assisted by two sub-committees: • The Audit Committee assists in reviewing and assessing ING US’s major risks and the operation of internal risk management and control systems, as well as policies and procedures regarding compliance and its applicable laws and regulations; • The Risk Committee assists in matters related to risk governance, risk policies and risk appetite setting.
To the extent that the committees do not determine otherwise, the Chief Risk Officer (CRO) attends the meetings of both committees. The Board of ING U.S., Inc. is responsible for managing the risks associated with the activities of ING US. The responsibilities of Management ING US include ensuring the risk management and control systems are effective and ING US complies with relevant legislation and regulations. The Board of ING U.S., Inc. reports and discusses these issues on a regular basis with the Supervisory Board, and reports to the Audit Committee on a quarterly basis on ING US’s risk profile versus its risk appetite.
– Advises the Board of ING U.S., Inc. on all financial and non-financial risks. – Approves risk policies, determines risk appetite and monitors limits and tolerances. – Assists the EC by focusing on ING US risk management and capital issues, and partners with the US Investment Committee to review/monitor investment related issues.
– Assist the EC in the oversight of investment related issues for ING US – Determine and monitor investment policies and guidelines for ING US entities, – Review and approve the Strategic Asset Allocation targets of the business units and recommend changes to company policies and investment guidelines that address General Account investments, or other investments for which the company is at risk • Risk committees are established at the ING US and business unit levels. The Risk Committee has a number of sub-committees focussing on different risk areas: – Asset Liability Committee
Product Approval and Review Process A critical aspect of risk management is that all new products are designed, underwritten and priced appropriately. In ING US this is safeguarded by the Product Approval and Review Process (PARP). This standard includes requirements to risk profile, traditional and value-oriented pricing metrics, targets and documentation. The PARP includes requirements to assess market risks, insurance risk, compliance risk, legal risk, credit risk, operational risk as well as assessment of the administration and accounting aspects of the product. Customer suitability is an integral part of the PARP requirements.
• IFRS Earnings; The risk limit framework described above operates within ING Group’s risk limit framework. ING US is in the process of implementing additional risk metrics including one based on U. S. GAAP earnings and another that is a variation on the US regulatory capital sensitivities described herein. ING US also is considering the expansion of its risk limit framework to include various stress scenarios.
Financial Risks For financial risks, the risk tolerance is translated to risk limits assuming moderate stress scenarios. • US Regulatory Capital Requirements sensitivities – The sensitivity, under moderately adverse market and credit stress scenarios, of the excess of available statutory capital above the level targeted by ING US and described in the Regulatory Capital section below; • IFRS Earnings sensitivities – The sensitivity, under moderately adverse market and credit stress scenarios, of realised pre-tax earnings of the insurance operations over a 12-month period.
Financial Risk Dashboard The Financial Risk Dashboard (FRD) is a quarterly report that is discussed at the Risk Committee of the Board of ING U.S., Inc. and the Finance and Risk Committee. The FRD provides a quarterly overview of the main financial risk metrics (IFRS earnings and Regulatory Capital sensitivities) compared to the limits set by management in alignment with the risk appetite.
Non-Financial Risk Dashboard The Non-Financial Risk Dashboard (NFRD) is a quarterly report that is discussed at the meetings of the Supervisory Board, Board of ING U.S., Inc. and ING US management bodies. The NFRD provides management at all organisational levels with information on their key operational, compliance and legal risks. The NFRD is based on defined risk tolerance and a clear description of the risks and responses enabling management to prioritise and to manage operational, compliance and legal risks.
Mortality Within mortality risk there are two main parts: – Positive mortality risk exists when more insureds die than expected, leading to higher claims than expected. – Negative mortality risk exists when insureds live longer than expected, leading to higher claims than expected (moderate shocks are not material to the P&L).
Mitigation In general, insurance risks cannot be hedged (easily) in the financial markets and tend to be mitigated by diversification across large portfolios. Therefore, they are managed at the contract level through standard underwriting policies, product design requirements, independent product approval processes, and risk limitations related to insurance policy terms and conditions agreed with the client.
Risk not mitigated by diversification is managed with concentration and exposure limits and through reinsurance and/or securitisations: • Tolerance limits for life insurance risk are set per insured life and significant mortality and morbidity events affecting multiple lives such as pandemics; • Reinsurance is used to manage risk exposure and exposure to reinsurers is managed according to the ING US reinsurance credit risk policy; • ING US is currently reviewing our mortality concentration limits in order to better assess our need to obtain protection from catastrophic losses resulting from events such as terrorism.
MARkeT RiSk ING US is exposed to market risk to the extent to which the market value of surpluses can be adversely impacted due to movements in financial markets. Changes in financial market prices impact the market value of ING US’s asset portfolio, including derivatives as well as the calculated market value of the insurance liabilities.
– Measured by the worst case impact of a 10% up and down movement for each currency.
FX – Impact of losses related to changes in real estates. – Measured by the worst case impact of a 10% up and down movement for each currency. Real Estate – Impact of losses related to changes in real estate.
The table above exhibits the sensitivity of CB-VA earnings to immediate changes in equity markets. For example, as of 31 December 2012 it is estimated that if equity markets were to immediately increase by 25%, CB-VA would be exposed to an immediate EUR 0.55 billion decrease in IFRS earnings. This immediate sensitivity is not directly comparable to the 12 month sensitivities shown in the preceding table.
Real Estate ING US has a small exposure to direct real estate, which is composed primarily of Home Office real estate and real estate from foreclosed loans.
CREDIT RISK ING US credit exposure arises from the investment of insurance premiums in assets subject to credit risk, largely in the form of unsecured bond investments, investments in private placements and commercial mortgages, as well as in structured finance products. In addition, ING US is exposed to credit counterparty risk exposure in derivatives transactions, sell/repurchase transactions, securities lending/ borrowing and in reinsurance contracts.
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Pre Settlement Risk – Risk of a counterparty defaulting on a transaction before settlement and ING US having to replace the contract by a trade with another counterparty at the then prevailing (possibly unfavourable) market price.
Commercial Banks 4.5% 4.4% Food, Beverages & Personal Care 4.1% 3.6% Chemicals, Health & Pharmaceuticals 3.5% 3.1% Private Individuals 2.5% 2.2%
Securities Lending Business As part of its securities financing business, ING US entities actively enter into agreements to sell and buy back marketable securities. These transactions can take many legal forms. Repurchase and reverse repurchase agreements, buy/sellback and sell/buyback agreements, and securities borrowing and lending agreements are the most common. The amount of marketable securities ING US provided as collateral under these types of agreements was EUR 0.5 billion per 31 December 2012 and EUR 0.8 billion per 31 December 2011. The change is caused by reduced liquidity requirements.
• The entire block of commercial mortgages (EUR 6.6 billion per 31 December 2012) is collateralised with mortgages on real estate properties. The weighted average loan to (most recent) value of this portfolio was 55% per 31 December 2012 which is unchanged from December 2011; • The EUR 11 billion private placement portfolio is partially collateralised with assets pledged to the consortium of lenders. Also, financial covenants that have been agreed with the different borrowers protect us structurally against any kind of subordination. At least 80% of the assets in this portfolio is either structurally unsubordinatable (i.e. implicitly secured), and another 10–20% explicitly secured; • The policy loan portfolio (EUR 1.7 billion per 31 December 2012) is fully collateralised by the cash value of the underlying insurance policies; • The gross counterparty risk exposure to reinsurance companies (EUR 5.7 billion per 30 September 2012) is largely collateralised with assets held in trust (EUR 2.5 billion), letters of credit (EUR 2.0 billion), or funds withheld (EUR 1.1 billion). Please note however that some exposures are over collateralised and that there is a total of EUR 1.6 billion of uncollateralised reinsurance counterparty risk exposure; • Exposure to financial institutions related to OTC derivative-transactions is largely collateralised, in line with ISDA Master Agreements accompanied by Collateral Support Agreements that have been signed with these counterparties. As per 31 December 2012, ING US was holding net collateral of EUR 0.55 billion supporting a market value exposure of EUR 0.70 billion; • Exposures related to Securities Lending, Reverse Repo, and exchange traded instruments are also collateralised.
Problem Loans Problem loans are defined as commercial mortgage loans that are 60 days or more in arrears, as that is the point where there is a probability that the full principal and interest may not collected. ING US does not have any material problem loans. As soon as commercial mortgage loans become non-performing, the collateral is typically liquidated or the loan is sold.
The Operational risk function works with the ING Operational Risk Management (ORM) Scorecard process to evaluate yearly the embedding level of the Operational Risk Management Framework in each business. Policies and minimum standards governing the framework are kept in the policy house. During 2011 Operational Risk started with the implementation of an ING US policy house in preparing for a stand-alone public organisation.
To ensure an independent Operational risk function and the possibility for the Operational risk officers to be impartial and objective when advising business management on Operational Risk, a dual reporting line, directly to ING US Chief Risk Officer and functionally to the next higher level ING Group Operational Risk Officer, is in place. The head of Operational risk ultimately reports directly to the ING US Chief Risk Officer.
REGULATORY CAPITAL For the capital adequacy assessment of ING US domiciled regulated insurance businesses, available capital is measured under US statutory accounting principles and required capital is measured under the US regulatory Risk Based Capital (RBC) methodology defined by the National Association of Insurance Commissioners (NAIC). Commonly in the US an insurer’s financial strength and ability to meet policyholder obligations is measured in terms of the amount of statutory capital held in relation to the ‘Company Action Level’ RBC defined by the NAIC framework. Note that the level of capital required by rating agencies to maintain an acceptable claims paying ability rating is well above the regulatory minimum defined by Company Action Level RBC. Consequently, ING US manages its available capital primarily with respect to capital metrics that are aligned with the models of the various rating agencies.
Sensitivities The table below presents market risk sensitivity figures before diversification between risks.
Taking into account diversification between risk factors, ING US (excluding CB-VA) is exposed to a EUR 0.9 billion decrease in regulatory capital and CB-VA is exposed to a EUR 0.4 billion decrease in regulatory capital within the context of the market and non-market sensitivity analysis. As of 31 December 2011, the comparable amounts were EUR 1.0 billion and EUR 0.3 billion, respectively.
MODEL RISK The US has a rigorous Model Risk Governance framework that is operative at each Business Unit level as well as within the ING US Corporate area. Through this framework all model, methodology and assumption changes are reviewed and approved by a BU Chief Risk Officer or by the US Chief Risk Officer. The US CRO has ultimate authority for Model Risk Governance. Beginning in 2012, the US has targeted 3Q as the quarter to make our routine experience updates. We will also target 3Q for any other planned model, methodology and assumption updates. Below is a summary of the significant model and assumption changes for 4Q 2012 that were approved by the US Model Committee: • The QRM system was approved as a replacement for ECAPS for use in the calculation of Economic Capital and FAS107 disclosure items; • A new methodology was approved to generate EC and Market Consistent scenarios; • Several business units made updates to statutory values as a result of changes in reserve valuation interest rates or changes in their cash flow testing models. The valuation interest rate updates are required by law.
Insurance Investments businesses are managed by the Head of Insurance Investments and supported by the Finance and Risk functions of ING Group. The largest asset is the Brazilian SulAmerica joint venture with a balance sheet value of EUR 366 million (in 2011 EUR 394 million). Winding down financing activities is delegated to ING Group Capital Management.
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Revaluation reserves fixed income & other –8,963 –4,626 –1,746 –355 –3,899 –3,669 Revaluation reserves excluded from Tier 1 (4) –1,691 –2,043 Insurance hybrid capital (5) 476 1,726
Deductions Tier 1 –991 –1,014 Tier 1 capital for Bank 39,975 38,622
Other qualifying capital (6) 7,142 8,502 Insurance Group Directive adjustments (7) –3,209 –2,792 Group leverage (core debt) –7,100 –7,917 Total capital (Adjusted Equity for Group, BIS capital for Bank and IGD capital for Insurance) 56,866 54,369 47,116 47,124 23,322 21,406
IGD Capital 23,322 21,406 Hybrids issued by ING Group –2,438 –2,604 Hybrids issued by ING Insurance –476 –1,726 Revaluation reserve debt securities –9,282 –4,379 Revaluation reserve crediting to life policyholders 5,673 3,493 Required regulatory adjustments 3,208 2,791 Capital base 20,007 18,981
AFR and EC 2011 reconcilation Amounts in billion of euros AFR EC
(1) EC as reported in the Risk Management chapter of the 2011 Annual Report.
Economic Capital position, based on a 99.5% confidence interval Amounts in billion of euros 2012 2011
For the capital adequacy assessment of ING Insurance’s US domiciled regulated insurance business, available capital is measured under US statutory accounting principles and required capital is measured under the US Regulatory Risk Based Capital (RBC) methodology as prescribed by the National Association of Insurance Commissioners (NAIC). For ING’s US domiciled regulated insurance business, the consolidated RBC ratio (available capital/required capital) is estimated to be approximately 526% at 31 December 2012. The actual US consolidated RBC ratio may be different from the estimate since the statutory results are not final until filed with the regulators. For ING Insurance’s US domiciled regulated insurance business, the RBC ratio was 488% at the end of 2011.
ING GROUP The debt/equity ratio of ING Group as at 31 December 2012 was 11.10% (2011: 12.71%).
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BIS ratio (Bank) Year-end actual BIS ratio 16.91% 14.26% Regulatory minimum BIS ratio 8.00% 8.00% Target minimum BIS ratio 10.00% 10.00%
Debt/Equity ratio (Group) Debt/Equity ratio 11.10% 12.71% Target maximum Debt/Equity ratio 15.00% 15.00%
The Tier 1 ratio and the BIS ratio are regulatory requirements. Internally ING manages on the Core Tier 1 ratio, for which the target was raised from 8.0% to 8.5% in 2011 and to 10% in 2012. The actual ratios were 9.62% at the end of 2011 and 11.91% at the end of 2012. As investor focus has shifted from BIS capital to CT1 capital, ING expects the BIS ratio to lose its meaning.
A security rating is not a recommendation to buy, sell or hold securities and each rating should be evaluated independently of any other rating. There is no assurance that any credit rating will remain in effect for any given period of time or that a rating will not be lowered, suspended or withdrawn entirely by the rating agency if, in the rating agency’s judgment, circumstances so warrant. ING accepts no responsibility for the accuracy or reliability of the ratings.
Parent company balance sheet of ING Groep N.V. as at 31 December before appropriation of result 312 ING Group Annual Report 2012
Accounting policies for the parent company annual accounts of ING Groep N.V.
Other includes certain intercompany eliminations between ING Bank N.V. and ING Insurance Topholding N.V.
Result for the year 3,894 3,894 Unrealised revaluations after taxation 118 118 118 Changes in treasury shares 255 255 255 Repurchase premium –375 –375 –375 Transfer to share of associates reserve –293 –293 –293 Transfer to retained earnings 5,766 5,766 –5,766 Employee stock option and share plans –161 –161 –161
The total amount of non-distributable reserves is EUR 13,340 million (2011: EUR 9,042 million).
More than 1 year but less than 5 years 121 125 6 OTHER Guarantees As at 31 December 2012, ING Groep N.V. had no guarantees outstanding on behalf of third parties (2011: nil). ING Groep N.V. has issued statements of liability in connection with Section 403, Book 2 of the Dutch Civil Code and other guarantees for a number of group companies.
To: the Shareholders, the Supervisory Board and the Executive Board of ING Groep N.V.
REPORT ON THE ANNUAL ACCOUNTS We have audited the accompanying annual accounts 2012 of ING Groep N.V., Amsterdam (as set out on pages 90 to 320). The annual accounts include the consolidated annual accounts and the parent company annual accounts. The consolidated annual accounts comprise the consolidated balance sheet as at 31 December 2012, the profit and loss account, statement of comprehensive income, statement of cash flows and statement of changes in equity for the year then ended, and a summary of significant accounting policies and other explanatory notes. The parent company annual accounts comprise the parent company balance sheet as at 31 December 2012, the parent company profit and loss account for the year then ended and the notes, comprising a summary of significant accounting policies and other explanatory notes.
In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the annual accounts in order to design audit procedures that are appropriate in the circumstances. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the annual accounts.
PROPOSED APPROPRIATION Of RESULT The result is appropriated pursuant to Article 37 of the Articles of Association of ING Groep N.V., the relevant stipulations of which state that the Executive Board, subject to the approval of the Supervisory Board, determines what part of the result is to be appropriated to reserves and that the remaining part of the result shall be at the disposal of the General Meeting.
Shareholders’ equity and our net result may be significantly impacted by turmoil and volatility in the worldwide financial markets. Negative developments in financial markets and/or economies may have a material adverse impact on shareholders’ equity and net result in future periods, including as a result of the potential consequences listed above. See ‘—Continued turbulence and volatility in the financial markets and the economy generally have adversely affected and may continue to affect our business and results of operations’ below.
Risk factors 323ING Group Annual Report 2012 1 W h o w e are 2 R
lenders could develop a negative perception of our long- or short-term financial prospects. Similarly, our access to funds may be limited if regulatory authorities or rating agencies take negative actions against us. If our internal sources of liquidity prove to be insufficient, there is a risk that we may not be able to successfully obtain additional financing on favourable terms, or at all. Any actions we might take to access financing may cause rating agencies to re-evaluate our ratings.
Disruptions, uncertainty or volatility in the capital and credit markets, such as that experienced over the past few years, including in relation to the ongoing European sovereign debt crisis, may also limit our access to capital required to operate our business. Such market conditions may in the future limit our ability to raise additional capital to support business growth, or to counter-balance the consequences of losses or increased regulatory capital requirements. This could force us to (i) delay raising capital, (ii) reduce, cancel or postpone payment of dividends on our shares, (iii) reduce, cancel or postpone interest payments on our other securities, (iv) issue capital of different types or under different terms than we would otherwise, or (v) incur a higher cost of capital than in a more stable market environment. This would have the potential to decrease both our profitability and our financial flexibility. Our results of operations, financial condition, cash flows and regulatory capital position could be materially adversely affected by disruptions in the financial markets.
We are subject to the jurisdiction of a variety of banking and insurance regulatory bodies, some of which have proposed regulatory changes in the recent years that, if implemented, would hinder our ability to manage our liquidity in a centralised manner. Furthermore, regulatory liquidity requirements in certain jurisdictions in which we operate are generally becoming more stringent, including those forming part of the ‘Basel III’ requirements discussed further below under ‘—We operate in highly regulated industries. There could be an adverse change or increase in the financial services laws and/or regulations governing our business’, undermining our efforts to maintain this centralised management of our liquidity. These developments may cause trapped pools of liquidity, resulting in inefficiencies in the cost of managing our liquidity, and hinder our efforts to integrate our balance sheet, which is an essential element of our Restructuring Plan.
The frequency and severity of such events, and the losses associated with them, are inherently unpredictable and cannot always be adequately reserved for. Furthermore, we are subject to actuarial and underwriting risks such as, for instance, mortality, longevity, morbidity, and adverse claims development which result from the pricing and acceptance of insurance contracts. In accordance with industry practices, modelling of natural catastrophes is performed and risk mitigation measures are taken. In case claims occur, reserves are established based on estimates using actuarial projection techniques. The process of estimating is based on information available at the time the reserves are originally established and includes updates when more information becomes available. Although we continually review the adequacy of the established claim reserves, there can be no assurances that our actual claims experience will not exceed our estimated claim reserves. If actual claim amounts exceed the estimated claim reserves, our earnings may be reduced and our net results may be adversely affected. Furthermore, claims resulting from a catastrophic event could also materially harm the financial condition of our reinsurers, which would increase the probability of default on reinsurance recoveries. Our ability to write new business could also be adversely affected.
In addition, and as discussed further below under ‘Risks Related to the Group’s Business, Operations, and Regulatory Environment— Operational risks are inherent in our business’, because unforeseeable and/or catastrophic events can lead to an abrupt interruption of activities, our banking and insurance operations may be subject to losses resulting from such disruptions. Losses can relate to property, financial assets, trading positions, insurance and pension benefits to employees and also to key personnel. If our business continuity plans are not able to be put into action or do not take such events into account, our financial condition could be adversely affected.
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For European banks, these requirements will be implemented through the Capital Requirements Directive (‘CRD’) IV, which might deviate in its final state from the original Basel III requirements. While the full impact of the Basel III rules, and any additional requirements for SIFIs or G-SIFIs, if and as applicable to the Group, will depend on how they are implemented by national regulators, including the extent to which such regulators and supervisors can set more stringent limits and additional capital requirements or surcharges, as well as on the economic and financial environment at the time of implementation and beyond, we expect these rules can have a material impact on ING’s operations and financial condition and may require the Group to seek additional capital. Further, the International Accounting Standards Board (‘IASB’) has issued and proposed certain amendments to several IFRS standards during the course of 2012, which changes could also have a material impact on our reported results and financial condition.
• Title II of Dodd-Frank provides that a financial company, such as us, may be subject to a special orderly liquidation process outside the federal bankruptcy code, administered by the Federal Deposit Insurance Corporation (‘FDIC’) as receiver, upon a determination that the company is in default or in danger of default and presents a systemic risk to U.S. financial stability. We cannot predict how ratings agencies or creditors of us or our subsidiaries will evaluate this potential risk or whether it will impact our financing or hedging costs.
Some countries have entered into, and other countries are expected to enter into, agreements (‘intergovernmental agreements’ or ‘IGAs’) with the United States to facilitate the type of information reporting required under FATCA. While the existence of IGAs will not eliminate the risk of the withholding described above, these agreements are expected to reduce that risk for financial institutions and investors in countries that have entered into IGAs. IGAs will often require financial institutions in those countries to report some information on their U.S. accountholders to the taxing authorities of those countries, who will then pass the information to the IRS.
The Intervention Act also includes measures that limit the ability of counterparties to exercise their rights after any of the measures mentioned above has been put into place, with certain exceptions. Also in June 2012, the European Commission published a proposal for a Directive establishing a framework for the recovery and resolution of credit institutions and investment firms (‘Recovery and Resolution Directive’), which includes, among other things, the obligation for institutions to draw up a recovery plan and the obligation for resolution authorities in the member states to draw up a resolution plan, early intervention measures and a European System of financing arrangements.
The Financial Stability Board In addition to the adoption of the foregoing measures, regulators and lawmakers around the world are actively reviewing the causes of the financial crisis and exploring steps to avoid similar problems in the future. In many respects, this work is being led by the FSB, consisting of representatives of national financial authorities of the G20 nations. The G20 and the FSB have issued a series of papers and recommendations intended to produce significant changes in how financial companies, particularly companies that are members of large and complex financial groups, should be regulated. These proposals address such issues as financial group supervision, capital and solvency standards, systemic economic risk, corporate governance including executive compensation, and a host of related issues associated with responses to the financial crisis. The lawmakers and regulatory authorities in a number of jurisdictions in which the Group’s subsidiaries conduct business have already begun introducing legislative and regulatory changes consistent with G20 and FSB recommendations, and the potential impact of such changes on our business, results of operation and financial condition remains unclear.
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Transactions. See ‘Risks related to the Restructuring Plan — The implementation of the Restructuring Plan and the divestments anticipated in connection with that plan will significantly alter the size and structure of the Group and involve significant costs and uncertainties that could materially impact the Group’.
Continued turbulence and volatility in the financial markets and the economy generally have adversely affected and may continue to affect our business and results of operations. General Our business and results of operations are materially affected by conditions in the global capital markets and the economy generally. Concerns over the slow economic recovery, the European sovereign debt crisis, the ability of certain countries to remain in the Eurozone, unemployment, the availability and cost of credit, the level of U.S. national debt and the U.S. housing market, inflation levels, energy costs and geopolitical issues all have contributed to increased volatility and diminished expectations for the economy and the markets in recent years.
International equity markets have also been experiencing heightened volatility and turmoil, with issuers, including ourselves, that have exposure to the real estate, mortgage, private equity and credit markets particularly affected. These events and market upheavals, including extreme levels of volatility, have had and may continue to have an adverse effect on our revenues and results of operations, in part because we have a large investment portfolio and extensive real estate activities around the world. In addition, the confidence of customers in financial institutions is being tested. Consumer confidence in financial institutions may, for example, decrease due to our or our competitors’ failure to communicate to customers the terms of, and the benefits to customers of, complex or high-fee financial products. Reduced confidence could have an adverse effect on our revenues and results of operations, including through an increase of lapses or surrenders of policies and withdrawal of deposits. Because a significant percentage of our customer deposit base is originated via Internet banking, a loss of customer confidence may result in a rapid withdrawal of deposits over the Internet.
As a result of the ongoing and unprecedented volatility in the global financial markets since 2007, we incurred in past years substantial negative revaluations and impairments on our investment portfolio, which have impacted our shareholders’ equity and earnings. During 2010, 2011 and 2012 the revaluation reserve position improved substantially, positively impacting shareholders’ equity. Although we believe that reserves for insurance liabilities are generally adequate at the Group, inadequacies in certain product areas have developed. The aforementioned developments in the global financial markets and in particular the decreasing interest rates resulted in a decrease in our overall reserves adequacy and may further continue to produce reserves inadequacies in the future, potentially leading to reserve strengthening.
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Market conditions observed over the past few years may increase the risk of loans being impaired. We are exposed to declining property values on the collateral supporting residential and commercial real estate lending. We are exposed to the risk that our borrowers (including sovereigns) may not repay their loans according to their contractual terms and that the collateral securing the payment of these loans may be insufficient. We may continue to see adverse changes in the credit quality of our borrowers and counterparties, for example as a result of their inability to refinance their indebtedness, with increasing delinquencies, defaults and insolvencies across a range of sectors. This may lead to impairment charges on loans and other assets, higher costs and additions to loan loss provisions. A significant increase in the size of our provision for loan losses could have a material adverse effect on our financial position and results of operations.
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Our hedging strategy additionally relies on the assumption that hedging counterparties remain able and willing to provide the hedges required by our strategy. Increased regulation, market shocks, worsening market conditions (whether due to the ongoing Euro crisis or otherwise), and/or other factors that affect or are perceived to affect the financial condition, liquidity and creditworthiness of ING may reduce the ability and/or willingness of such counterparties to engage in hedging contracts with us and/or other parties, affecting our overall ability to hedge our risks and adversely affecting our business, operations, financial condition and liquidity.
We may not be able to protect our intellectual property and may be subject to infringement claims. We rely on a combination of contractual rights with third parties and copyright, trademark, patent and trade secret laws to establish and protect our intellectual property. Although we endeavour to protect our rights, third parties may infringe or misappropriate our intellectual property. We may have to litigate to enforce and protect our copyrights, trademarks, patents, trade secrets and know-how or to determine their scope, validity or enforceability. This would represent a diversion of resources that may be significant and our efforts may not prove successful. The inability to secure or protect our intellectual property assets could have a material adverse effect on our business and our ability to compete.
Because we use assumptions about factors to calculate the amount of certain items, the use of different assumptions about these factors may have an adverse impact on our results of operations. The establishment of insurance provisions, including the impact of minimum guarantees which are contained within certain variable annuity products, the adequacy test performed on the provisions for life policies and the establishment of Deferred Acquisition Costs (‘DAC’) and Value of Business Acquired (‘VOBA’) are inherently uncertain processes involving assumptions about factors such as court decisions, changes in laws, social, economic and demographic trends, inflation, investment returns, policyholder behaviour (e.g., lapses, persistency, etc.) and other factors, and, in the life insurance business, assumptions concerning mortality, longevity and morbidity trends. The use of different assumptions about these factors could have a material effect on insurance provisions and underwriting expense. Changes in assumptions may lead to changes in the insurance provisions over time. Furthermore, some of these assumptions can be volatile.
Because we use assumptions to model client behaviour for the purpose of our market risk calculations, the difference between the realisation and the assumptions may have an adverse impact on the risk figures and future results. We use assumptions in order to model client behaviour for the risk calculations in our banking and insurance books. Assumptions are used to determine insurance liabilities, the price sensitivity of savings and current accounts and to estimate the embedded optional risk in the mortgage and investment portfolios. The realisation or use of different assumptions to determine the client behaviour could have material adverse effect on the calculated risk figures and ultimately future results.
ING Insurance has a significant exposure to the take-up of policy options by policyholders. The exposure is greatest for variable annuity business with guarantees deeply in-the-money, policyholder behaviour is difficult to predict and small changes in the proportion of policyholders taking up an option can have a significant financial impact. Furthermore, assumptions about policyholder behaviour are sometimes made for new insurance business without a substantial amount of experiential data. These assumptions may prove imperfect, which can have a material impact on results. See ‘Because we use assumptions about factors to calculate the amount of certain items, the use of different assumptions about these factors may have an adverse impact on our results of operations’.
(2) result in increased surrenders of certain life & savings products, particularly, those with fixed rates below market rates, (3) require us, as an issuer of securities, to pay higher interest rates on debt securities we issue in the financial markets from time to time to finance our operations which would increase our interest expenses and reduce our results of operations, and/or (4) result in decreased fee income associated with a decline in the variable annuity balances invested in fixed income funds.
A significant and sustained increase in inflation has historically also been associated with decreased prices for equity securities and sluggish performance of equity markets generally. A sustained decline in equity markets may: (1) result in impairment charges to equity securities that we hold in our investment portfolios and reduced levels of unrealised capital gains available to us which would reduce our net income and negatively impact our solvency position, (2) negatively impact performance, future sales and surrenders of certain products where underlying investments are often allocated to equity funds, 338 ING Group Annual Report 2012
On 19 November 2012, ING and the Dutch State announced that they reached an agreement with the EC on significant amendments to the Initial Restructuring Plan (‘Amended Restructuring Plan’, and together with the Initial Restructuring Plan, ‘Restructuring Plan’). The Amended Restructuring Plan extended the time horizon and increased the flexibility for the completion of divestments and adjusted other commitments set forth in the Initial Restructuring Plan.
completing divestitures as described in the Amended Restructuring Plan within the timelines set out therein and/or do not succeed in satisfying the commitments with respect to Nationale Nederlanden Bank by year-end 2015 as described in the Amended Restructuring Plan, the Dutch State will re-notify this to the EC who may take any enforcement action, require additional restructuring measures and/or request the Dutch State to appoint a divestiture trustee with a mandate to complete the relevant divestiture with no minimum price.
The limitations required by the EC on our ability to compete and to make acquisitions or call certain debt instruments could materially impact the Group. As part of our Restructuring Plan, we have undertaken with the EC to accept certain limitations on our ability to compete in certain retail, private and direct banking markets in the European Union and on our ability to acquire (i) financial institutions and (ii) businesses insofar this would delay our repayment of the remaining Core Tier 1 Securities held by the Dutch State. These restrictions in principle apply until the earlier of (1) 18 November 2015, and (2) the date upon which more than 50% of the required divestments has been made. We were also required to agree to limitations on our ability to call Tier-2 capital and Tier-1 hybrid debt instruments, which remain subject to authorisations by the EC on a case-by-case basis until the earlier of 18 November 2014 or the repayment of the remaining Core Tier 1 Securities (including the relevant accrued interest on Core Tier 1 coupons and exit premium fees). If the EC does not approve the calling of Tier-2 capital and Tier-1 hybrid debt instruments in the future, this may have adverse consequences for us, result in additional payments on these instruments and limit our ability to seek refinancing on more favorable terms. ING is furthermore restricted to a maximum ratio for mortgage production at ING Retail Banking Netherlands in relation to the mortgage production of Nationale-Nederlanden Bank until year-end 2015. The limitations described above will impose significant restrictions on our banking business operations and on our ability to take advantage of market conditions and growth opportunities. Such restrictions could adversely affect our ability to maintain or grow market share in key markets, as well as our results of operations.
Upon the implementation of the Restructuring Plan, we will be less diversified and may experience competitive and other disadvantages. Following completion of the planned divestments under the Restructuring Plan, we expect to become a significantly smaller, regional financial institution focused on retail, direct and commercial banking in the Benelux region and certain other parts of Europe, as well as selected markets outside Europe. Although we will remain focused on banking operations, we may become a smaller bank than that represented by our current banking operations. In the highly competitive Benelux market and the other markets in which we operate, our competitors may be larger, more diversified and better capitalised and have greater geographical reach than us, which could have a material adverse effect on our ability to compete, as well as on our profitability. The divested businesses may also compete with the retained businesses, on their own or as part of the purchasers’ enlarged businesses. In addition, the restrictions on our ability to be a price leader and make acquisitions and on our compensation policies could further hinder our capacity to compete with competitors not burdened with such restrictions, which could have a material adverse effect on our results of operations. There can be no assurance that the implementation of the Restructuring Plan will not have a material adverse effect on the market share, business and growth opportunities and results of operations for our remaining core banking businesses.
‘Risks Related to the Restructuring Plan — The implementation of the Restructuring Plan and the divestments anticipated in connection with that plan will significantly alter the size and structure of the Group and involve significant costs and uncertainties that could materially impact the Group’; • initiatives we are contemplating may require consultation with various regulators as well as employees and labor representatives, and such consultations may influence the timing, costs and extent of expected savings; • the loss of skilled employees in connection with the initiatives; and • projected savings may fall short of targets.
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To be included when CRR/CRD IV is approved by EU Parliament 5 Summarise prominently the bank’s risk management organisation, processes and key functions
Implemented in the Risk Management section Risk Governance and the corresponding descriptions in the Credit Risk, Market Risk, Liquidity Risk and Non-Financial Risk sections 6 Describe bank’s risk culture, related procedures and strategies Implemented in the Risk Management sections: Risk Governance, Business Model and Risk Profile and the corresponding descriptions in the Credit Risk, Market Risk, Liquidity Risk and Non-Financial Risk sections 7 Describe key risks arising from bank’s business model and activities, the bank’s risk appetite and how it manages these risks
12 Qualitatively and quantitatively discuss capital planning within a more general discussion of management’s strategic planning
Implemented in Pillar 3 in the RWA migration table 14 Present a table showing the capital requirements for each method used for calculating RWAs for credit risk per Basel asset class as well as for major portfolios within those classes
Implemented in Pillar 3 in the PD back-test table that is added to the AIRB section where the predicted PD is compared with the actual default rate per Exposure Class. Model Validation process and results included in RMP and Pillar 3 18 Describe how the bank manages its potential liquidity needs and provide a quantitative analysis of the components of the liquidity reserve held to meet these needs.
Qualitative description included in the Market Risk section of the Risk Management section. Quantitative component to be addressed in future disclosures.
The Pillar 3 information mostly relates to Credit Risk, but also to securitisations and Other Non-Credit Obligation Assets (ONCOA). The requirements are mainly for underlying exposure, risk weighted assets and regulatory capital. As such it relates primarily to the first Basel II pillar, the minimum capital requirement. These regulatory requirements are provided in the next section, including those for market risk and operational risk. The second pillar concerns the banks internally used Economic Capital, and the supervisors review of that capital and the underlying models. Economic Capital, and consequently Pillar 2, is disclosed extensively in the Risk Management section. As such, the text of this Pillar 3 section should be read in conjunction with statements made in the Risk Management section and capital management section of the annual accounts, where there is a comprehensive discussion of Risk Management and Capital Management.
Approaches applied by ING Bank On 1 January 2008, ING Bank adopted the Advanced Internal Ratings Based (AIRB) approach for the majority of its significant portfolios that contain credit risk in accordance with the approvals granted by DNB (Dutch Central Bank), and various local regulators, as required. However, there remains a small portion of the portfolio that is subject to the Standardised Approach (SA). Unlike many regulators, DNB requires institutions to have at least 85% (RWA weighted) of their portfolio on AIRB to qualify for AIRB status. The majority of SA portfolios at ING Bank relate to subsidiaries where the home regulator does not have a robust AIRB framework or requirement. ING continues to explore opportunities to transition additional portfolios from SA to AIRB. ING Bank does not have any portfolios that use the Foundation IRB Approach.
ING Bank uses the AIRB and the Internal Assessment Approach (IAA) for liquidity lines provided to Asset Backed Commercial Paper programs.
In order to prevent large short-term effects on capital requirements, the regulators introduced transition rules (the ‘capital floor’) for institutions implementing the Basel II capital adequacy reporting. For 2012 and 2011 the capital requirement was not allowed to fall below 80% of the capital requirements calculated under Basel I regulations. The additional capital requirements according to the transition rules are EUR 6,475 million for 2012 (EUR 4,673 million in 2011).
The divestments of ING Direct US and ING Direct Canada declined READ by EUR 16.0 billion and EUR 3.8 billion, respectively.
Money market declines (EUR 16.8 billion) were predominantly seen in the Netherlands (EUR 13.8 billion - less deposit given to the Dutch Central Bank) and the US (EUR 4.8 billion - less deposit given to the US Central Bank), while Germany saw an increase of EUR 1.8 billion. The decline in term loans was mainly due to the restructuring of the IABF with the Dutch State, which was previously classified as term loans and now partly as bonds. The IABF needed to be restructured because of the sale of ING Direct US. The IABF is an agreement between ING and the Dutch government on an Illiquid Assets Back-up Facility covering 80% of ING’s Alt-A mortgage securities.
Corporate credit risk disclosure In line with the EDTF recommendations, this table presents READ, segmented by various factors, analysis for exposure class ‘Corporates’. The Industry breakdown for this table is based on the NAICS system (North American Industry Classification System).
The divestments of ING Direct US and ING Direct Canada caused a decline of EUR 2.0 billion and EUR 0.7 billion respectively.
Retail Customer Segment 353,007 400,064 –11.7% Private Persons 321,384 366,529 –12.3% Small Mid-sized Enterprises 22,281 24,539 –9.2%
The divestment of ING Direct US and ING Direct Canada caused declines of EUR 32.7 billion and EUR 22.7 billion, respectively (mainly related to Residential Mortgages), while in Germany the increase of EUR 4.2 billion was mostly due to an increase in the Residential Mortgages portfolio.
A re-segmentation exercise in The Netherlands of small and Medium Size Enterprises from the internal classification of Mid-Sized Corporate to Retail Companies was executed in 2012 as a part of a continuing redesign of the customer approach. Non-performing loans declined by 5.2% due to the sale of ING Direct US which reduced the total non-performing loans portfolio by EUR 912 million. Excluding ING Direct US, non-performing loans would have increased by 12%.
After the sale of ING Direct US and ING Direct Canada, ING Bank’s Residential Mortgage portfolio outstandings decreased to EUR 296 billion which is about 39% of ING Bank’s credit outstandings. The overall LTV of ING Bank’s mortgages increased, which was mainly driven by Dutch and Spanish mortgages, despite stricter underwriting policies. For both portfolios the decline in house prices caused LTV to rise). The LTV in the Netherlands is relatively high, but is partially compensated by the NHG guaranteed portfolio and other secondary covers, such as life insurance policies, savings and investment products.
ING Bank’s Probability of Default (PD) rating models are based on a 1-22 scale, which corresponds to the same rating grades that are assigned by external rating agencies. Risk Ratings (PD) for performing loans (1-19) are calculated in ING Bank with regulatory approved models. Risk Ratings for non-performing loans (20-22) are set on the basis of an approved subjective methodology by the Global or Regional Restructuring unit. For securitisation portfolios, the external ratings of the tranche in which ING Bank has invested are leading. Overall the risk weights of the ING portfolio are a mixture of low risk weights for Sovereigns and Residential Mortgages combined with higher risk weights for Corporates and Securitisations.
READ –22% –14% –7% –14% –3% –12% RWA –7% –12% –10% –27% –1% –14%
Over the course of 2012, both average PD and average LGD increased. This was due to general decrease in credit quality and mostly house prices as several markets experienced economic difficulties. Nonetheless, credit quality remained stable for Belgium and ING Vysya and improved for the Australian Residential mortgages portfolio. Next to that, the relative shift in portfolio composition from higher risk weight exposure classes to lower risk weight exposure classes led to a slight decrease in the overall AIRB risk weight. The low risk density decrease combined with a significant reduction in READ led to a reduction in RWA over 2012.
In order to better quantify the back-testing, ING has analysed the December 31, 2011 portfolio. The sold ING Direct US and ING Direct Canada units are excluded from both the average PD as the default rate, for comparison reasons. The average PD of December 31, 2011 per portfolio is split per Basel II exposure class. The December 31, 2011 portfolio is followed through 2012 to determine the observed default rate. The models are based on long series of historical data. In the back-test the model based PD values are compared against the defaults observed in 2012. This back-test is only representative of the year end 2011 portfolio and can be influenced by small sample sizes or incidents. Nonetheless, the back-test gives a comparison of the predicted PD versus the observed default rate. In the table below, the default rate is based on the weighted average READ of the defaulted portfolio whereas the models are developed on an obligor basis.
Includes the AIRB portfolio only; excludes securitisations, equities and ONCOA. * Average PD includes performing loans only.
Changes in the composition of the Bank –582 –582 Amounts written off –717 –772 –185 –1,675 Recoveries of amounts written off in previous years 21 69 11 101 Addition to loan loss provisions (from income statement) 955 833 337 2,125 Exchange or other movements 5 –17 14 2
Food, Beverages & Personal Care 366 119 485 424 * Includes both AIRB and SA portfolios; excludes securitisations, equities and ONCOA. * Excludes revaluations made directly through the equity account. (1) Sectors with cumulative provisions of less than EUR 50 million are grouped under ‘Other’.
Overall the provision stock remained stable in 2012 but the composition changed significant. Increases in commercial real estate especially in Spain, Netherlands and UK were balanced by decreases in private individuals after the sale of ING Direct US and ING Direct Canada. Weaknesses in small and medium enterprises in the Netherlands continued. While additions to loan loss provisions increased in 2012, continued write-offs marginally decreased the provisioning stock.
Loan loss provision shortfall The Loan loss provision shortfall is the difference between the expected loss (EL) and the loan loss provisions for AIRB exposures. This difference is caused by the different PD time horizons that exist for IAS 39 Loan Provisioning (3, 6, and 9 months) and the 12 month time horizon used for EL and regulatory capital calculation. Basel II requires that the shortfall is deducted from the regulatory capital, 50% from Tier 1 and 50% from Tier 2 capital.
Exposure before and after risk mitigation and after conversion factors in READ 2012 2011
Derivatives by product type The table below is based on the mark-to-market plus (Regulatory) add-on methodology used for calculating Basel II RWA for determining the gross exposures. The Current Exposure Method (the methodology to calculate the READ) together with the other building blocks (PD, LGD and Maturity), allow ING Bank to classify a large part of its derivatives exposures under the AIRB approach. This means that the READ figure listed hereunder is significantly below the notional amount. The mark-to-market plus (regulatory) add-on is recalculated daily to reflect both changes in the markets as well as portfolio composition.
The remaining 12% of the total notional value of OTC derivatives transactions that are not cleared by a CCP, is not supported by a CSA agreement or a Clearing Agreement and mainly relates to Corporates with small credit limits and mainly consists of Interest Rate Derivatives (58%).
The decrease of EUR 2.5 billion in Bond Financing Given is mainly seen in the Institutions portfolio where the READ to mainly UK banks decreased. The remainder of the Securities Financing portfolio remained relatively stable. In terms of READ, the Equity Financing portfolio seems to be larger, but in terms of notional amounts the Equity Financing portfolio is relatively small. This is due to the conservative regulatory haircuts applied for the Equity Financing portfolio.
Maximum exposure to credit risk In line with the EDTF recommendations the following table present our maximum exposure to Credit Risk in the AIRB portfolio and associated collateral held and other credit enhancements (netting and collateral) that do not qualify for offsetting in our financial statements for the periods specified. The netting credit enhancement component includes the effects of legally enforceable netting agreement as well as the offset of negative mark-to-markets from derivatives against pledged cash collateral. The collateral credit enhancement component which is referred to as Cover Values mainly includes real estate, guarantees and collateral in the form of cash. ING records collateral value per facility. For the AIRB portfolio those figures are based on original cover values although some business units attempt to update to current market values. This is inherently difficult in volatile markets. Some facilities will have multiple levels of collateral while others have no collateral. The total figures may not reflect the collateral value per facility.
Credit default swaps ING Bank participates in the credit risk derivative (CDS) trading market, as a net purchaser of credit risk protection from other counterparties. ING Bank has purchased a small amount of credit risk protection for hedging purposes, usually in order to reduce concentration on certain ‘legal one obligor groups’ without having to reduce ING Bank’s relationship banking activities. ING Bank does not actively sell credit default swaps for hedging or investment purposes. Although Basel II rules permit a reduction of credit risk capital under certain circumstances where ING Bank has purchased CDS protection, ING Bank does not currently make use of this provision in determining its Basel II capital base.
SECURITISATIONS The following information is prepared taking into account the ‘Industry Good Practice Guidelines on Pillar 3 disclosure requirements for securitisations’ (the Guidelines) issued by the European Banking Federation and other industry associations on 31 January 2010. It includes qualitative and quantitative disclosures addressing both the exposure securitised as well as securitisations positions held. While quantitative disclosures are limited to those securitisations that are used for the purpose of calculating the regulatory capital requirements under the CRD, qualitative information have a broader scope and give a view on ING Bank’s entire securitisation activity.
Sponsor securitisations In the normal course of business, ING Bank structures financing transactions for its clients by assisting them in obtaining sources of liquidity by selling the clients’ receivables or other financial assets to an SPV. The transactions are funded by the ING Bank administered multi seller Asset Backed Commercial Paper (ABCP) conduit Mont Blanc Capital Corp. (rated A-1/P-1). Despite the conditions in the international money markets Mont Blanc Capital Corp. continues to fund itself externally in the ABCP markets.
Cut-Off Date Most recent date in respect of which determination and allocation of losses have been made pursuant to the legal documentation of the transaction. Information on the performance of ING’s securitised exposures is published regularly.
Outstandings EAD on 31 December of assets that were performing on the Cut-off date.
ASSET BACKED COMMERCIAL PAPER (ABCP) Commercial paper that is collateralised by other financial assets.
BASEL III Regulatory requirements issued by the Basel Committee on Banking Supervision for the solvency calculation and liquidity requirements, which will supersede Basel II. We expect these requirements to start to apply as of 1 January 2014 in Europe, with the full requirements being effective as of 1 January 2018.
COLLATERALISED LOAN OBLIGATION (CLO) A type of CDO which is backed primarily by leveraged bank loans.
CONTROL The power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.
CONVERTIBLE DEBENTURES Debentures with embedded options issued by corporations. The holder has the right to exchange a convertible debenture for equity in the issuing company at certain times in the future according to a certain exchange ratio. Very often, the conversion is callable. This means that it can be repurchased by the issuer at a certain price at certain times in the future. Once the debentures have been called, the holder can always choose to convert prior to repurchase.
CORE DEBT Investments in ING Group subsidiaries minus the equity of the holding company including hybrids.
DISCONTINUED OPERATIONS When a group of assets that is classified as held for sale represents a major line of business or geographical area the disposal group classifies as discontinued operations.
• exchange financial instruments with another company under conditions that are potentially favourable; or
• certain contract that will or may be settled in ING’s own equity instruments.
FINANCIAL LIABILITY Any liability that is a contractual obligation: • to deliver cash or another financial asset to another company; or • to exchange financial instruments with another company under conditions that are potentially unfavourable; or • certain contracts that will or may be settled in ING’s own equity instruments.
FOREIGN EXCHANGE RATE RISK Probability of loss occurring from an adverse movement in foreign exchange rates.
(even in bankruptcy) and cannot be paid to the reporting enterprise, unless either the proceeds represent surplus assets that are not needed for the policy to meet all the related employee benefit obligations or the proceeds are returned to the reporting enterprise to reimburse it for employee benefits already paid.
PRE-SETTLEMENT RISK Pre-settlement risk arises when a counterparty defaults on a transaction before settlement and ING Group has to replace the contract by a trade with another counterparty at the then prevailing (possibly unfavourable) market price. The pre-settlement risk (potential or expected risk) is the cost of ING Group replacing a trade in the market. This credit risk category is associated with dealing room products such as options, swaps, and securities financing transactions. Where there is a mutual exchange of value, the amount of outstanding is generally based on the replacement value (mark-to-market) plus potential future volatility concept, using an historical 7 year time horizon and a 99% confidence level.
Financial glossary continued 375ING Group Annual Report 2012 1 W h o w e are 2 R
WARRANT A financial instrument that gives the holder the right to purchase ordinary shares.
General information 377ING Group Annual Report 2012 1 W h o w e are 2 R
These publications are available on www.ing.com. The publications can be ordered on the internet: www.ing.com, button ‘Publications’, by fax: +31 411 652 125, or by mail: P.O. Box 258, 5280 AG Boxtel, the Netherlands.
ING Groep N.V. Bijlmerplein 888, 1102 MG Amsterdam P.O. Box 1800, 1000 BV Amsterdam The Netherlands
General information continued 379ING Group Annual Report 2012 1 W h o w e are 2 R
ING Groep N.V. Bijlmerplein 888 1102 MG Amsterdam P.O. Box 1800, 1000 BV Amsterdam The Netherlands