Report of the Directors ...................................................... In providing its customers with financial solutions and products SEB assumes various risks that must be managed. The Group’s profitability is directly dependent on its ability to evaluate, manage and price these risks, while maintaining an adequate capitalisation to meet unforeseen events. As a consequence, risk management is always a prioritised area for the Group, continuously under development. Board supervision, an explicit decision-making structure with a high level of risk awareness among the staff, common definitions and principles, controlled risk-taking within decided limits and a high degree of transparency in external disclosures are the cornerstones of the Group’s risk and capital management. To secure the Group’s financial stability, risk and capital related issues are identified, monitored and managed early on. This is an integral part of the long-term strategic planning and operational business planning processes performed throughout the Group. SEB views the macro economic environment as the major driver of risk to the Group’s earnings and financial stability. SEB uses scenario stress testing to assess the consequences of a deteriorating economy and applies conservative risk parameters in its estimation of capital needs. 2007 highlights 2007 was a year of exceptional turbulence on the financial markets. The year closed in the midst of a crisis that was caused by a com bination of factors: ..........a sharp decline in the price of historically stable assets such as U.S. residential mortgages due to uncertainty about losses on the U.S. sub-prime market, ........a drying-up of liquidity in certain financial markets and ..........an apparent loss of market confidence in bank disclosures and management capacity. This has forced banks to strive for a strong capitalisation and a stable and diversified funding base. Drawing on its diversified funding network and strong financial position, SEB was able to finance its on-going business without paying undue costs. Actions during the year to maintain a strong balance sheet included the raising of core capital contribution securities, increased utilisation of covered bonds as a high-quality funding source and an increased match-funding requirement with respect to net cash inflows and outflows, well beyond the normal three-month horizon. Moreover, SEB upheld continuous and comprehensive communications with the market regarding its financial situation to keep the confidence of customers, investors and the general public. The sharp decline in prices on fixed-income securities, particularly asset-backed securities and bonds issued by investment banks, reduced the value of SEB’s holdings. The Bank posted mark-to-market losses on these portfolios during the second half of 2007. The turbulent market conditions triggered active riskmanagement actions such as restructuring of the portfolios. The Bank’s strict investment criteria for its securities holdings ensured valuations of all its assets to the satisfaction of both auditors and supervisors; market prices were applied to all individual holdings without using any mark-to-model approach. Effects on the Group’s profit and loss account and equity are treated in the Financial Review of this report, on pp 20–25. Another area of public attention has been the economic situation in the Baltic countries, with current account deficits, rapid credit growth and high inflation. Still, SEB has confidence in the longterm viability of the Baltic economies, and in the growth potential of the Group’s business in Estonia, Latvia and Lithuania. To consolidate its own business and to avoid contributing to an overheating of the local economies, SEB has continued to tighten its credit policy and increased its focus on risk-based capitalisation and pricing. Based on an in-depth analysis and scenario stress testing of the current situation, SEB concludes that while lower earnings growth and higher credit losses are likely compared to the last few years as a consequence of the adjustment of the macro economic situation in the region to more sustainable levels, the Bank’s Baltic business does not pose a threat to the Group’s financial viability. The situation in each country is closely monitored. During the year, SEB has updated its processes for allocation of internal capital to divisions and business units, and rolled-out a new generation of the Group’s credit portfolio model. This will enhance the decision support tools and the information available for business units, as well as for the active portfolio management performed centrally. Basel II going live EU and national authorities are now implementing the Basel II capital adequacy rules; in Sweden the new regime is in effect since 1 February 2007. SEB from the start applies the Internal Ratings Based (IRB) approach for reporting of banking, corporate and household mortgage portfolios in Sweden and Germany – corresponding to more than 70 per cent of the total credit volume. This first step in the transition to Basel II reduced the overall riskweghted assets (RWA) by some 17 per cent (before the effect of transitional floors). As concerns the Baltic operations, SEB has received approval to apply the IRB approach for retail, corporate and interbank exposures in Latvia and Lithuania, which correspond to 5 per cent of the total credit volume. Regarding operational risk, SEB has applied for supervisory approval to report according to the advanced approach as it gets available from 2008. The application is based on SEB’s long-time experience and expertise in operational risk management, including incident reporting, operational loss reporting, capital modelling, quality assessment of processes etc. Effective operational risk management will lower the regulatory capital requirement. SEB continues to analyse and report the RWA and capital ratios according to both Basel I and Basel II. The quality of the Group’s credit portfolio and the internal risk management culture translate into substantial RWA reductions for the Group – though limited by supervisory floors during the first years of the regime. In 2007, a 5 per cent RWA reduction is permitted; in 2008 and 2009 10 and 20 per cent respectively. However, this cannot be equated with a similar capital release, due to the framework’s increased business cycle sensitivity, supervisory evaluation and rating agency considerations. Careful capital management will be necessary during the transition period (see graph on next page). Risk organisation and responsibility The Board of Directors establishes the overall risk and capital policy, strategy and limits, based on the review and recommendation of its Risk and Capital Committee, which in turn is supported by the work of the Group Asset and Liability Committee and the 34 SEB ANNUAL REPORT 2007
