Capital management

FMO aims to optimize development impact. This can only be achieved with a sound financial framework in place, combining healthy long-term profitability and sound capital adequacy. Therefore, FMO seeks to maintain a strong capital position, by means of an integrated capital adequacy planning and control framework, regularly reviewed by the ALCO.

The company has an external and internal ratio to express its capital position. The external ratio is calculated based on the standardized approach of the Basel II regulation; the internal capital ratio is based on the internal economic capital model. Economic capital is the amount of capital allocated as a buffer against potential losses from business activities. The main difference between the internal and external capital requirement is the calculation of the level of capital needed for credit risk on the loan portfolio, which is higher according to the internal model. Under the standardized approach FMO's capital requirement for credit risk is lower than under the internal approach given the fact that the credit assessment is standardized for unrated entities. FMO's portfolio is invested in parties in emerging markets, which results in a riskier credit profile than generally applies to parties in developed economies.

External capital requirement

FMO complies with the Basel II requirements and reports its BIS-ratio to the Dutch Central Bank on a quarterly basis. FMO calculates its external capital requirement for its entire portfolio based on the standardized approach. Of the total capital requirement, 84% is related to credit risk (equity investments included), 11% to market risk and 5% to operational risk. FMO mainly has tier-1 capital; its tier-2 capital consists of the AFS reserve for equity investments. The BIS-ratio equaled 29.4% at the end of 2011 (2010: 29.0%). Under Basel III the leverage ratio will become a mandatory reporting requirement in 2018. The minimum leverage ratio is set at 3%, FMO's leverage ratio equals 25.6%.

At December 31, 2011

At December 31, 2010

Core capital (tier 1)

1,462,643

1,372,507

Additional capital (tier 2)

150,693

85,390

Risk-weighted assets

5,484,025

5,030,925

Tier-1 ratio

26.7%

27.3%

BIS-ratio

29.4%

29.0%

Leverage ratio

25.6%

25.4%

Internal capital requirement

In addition to its external capital requirement, FMO calculates an internal capital requirement. As of January 1, 2012, a new model has been introduced for our internal capital requirement. This model is based on Basel's Internal Ratings-Based (IRB) methodology for measuring credit risk - which is transparent, and best practice among financial institutions.

Credit risk resulting from FMO's emerging market loan portfolio represents FMO's main financial risk. The credit risk of the loan portfolio is determined based on the IRB methodology. The most important input parameters for the IRB model are Probability of Default (PD) and Loss Given Default (LGD). The PD is based on the outcome of FMO's new ratings methodology validated by one of the leading rating agencies. The client is assigned a rating class on a scale of F1 to F21, with the majority of the ratings of FMO clients in the range of F10-F17, or BBB- to CCC+ in S&P-comparable rating terms. The LGD is determined under the Advanced IRB (A-IRB) on the basis of internal expert assessments. LGDs depend on security coverage, liquidity, enforceability of guarantees and on extraordinary circumstances. LGD for senior secured loans is between 20% - 30%, for unsecured loans 40%, and for unsecured subordinated loans 75%. Credit risk for equity is based on the simple risk weight approach. For quantifying the credit risk in FMO's treasury portfolio, the market and operational risk, the Basel II standardized approach is used.

Economic capital includes both Pillar 1 and Pillar 2 risks. As part of Pillar 2, model risk, reputation risk, interest rate risk and concentration risk are included in the assessment of economic capital. Economic capital is calculated using a conservative confidence level of 99.99%. The economic capital at year-end 2011 amounted to €956 million. Since the new model has been implemented as per January 1, 2012, the 2011 numbers are presented in the table below.

At December 31, 2011

Pillar 1

Credit risk emerging market portfolio (99.99% interval)

753

Credit risk treasury portfolio

27

Market risk

47

Operational risk

24

Pillar 2

Concentration risk

30

Interest rate risk in the banking book

41

Reputation risk

32

Model risk

2

Economic capital (Pillar 1 & 2)

956

Available capital

Tier I & II

1,613

Surplus provisioning (capped at 0.6% RWA)1)

64

Total available capital

1,677

1) Surplus provisioning for the loan portfolio is only calculated at total provisioning (€336 mln) minus total expected loss (€142 mln), which equals €194 mln. The amount to be included in the available capital is according to the BIS-guidelines capped at 0.6% risk weighted assets (RWA), which equals €64 mln at December 31, 2011.

Only for comparative purposes FMO calculates its internal capital ratio at a 99.90% confidence level (for pillar I only). Under the new IRB model this ratio equalled 18.8% at December 31, 2011.