The FX market remained volatile throughout 2009, with a final quarter in which the general appreciation in Latin American currencies, of particular relevance in the case of Mexico and Chile, and of the dollar against the euro, helped close a positive year in terms of the impact on BBVA’s capital ratios and equity by changes in exchange rates.
These market variations have an effect on the Group’s solvency ratios and its estimated earnings whenever there is exposure deriving from the contribution of subsidiary entities operating in “non-euro” markets. The Asset/Liability Management unit, through ALCO, actively manages structural exchange rate risk using hedging policies that aim to minimize the effect of FX fluctuations on capital ratios, as well as to assure the equivalent value in euros of the foreign currency earnings contributed by the Group’s various subsidiaries while controlling the impact on reserves.
The Risk area acts as an independent unit responsible for designing measurement models, making risk calculations and controlling compliance with limits, reporting on all these issues to the Board of Director’s Risk Committee and to the Executive Committee.
Structural exchange rate risk is evaluated using a quantitative model that simulates multiple scenarios of exchange rates and evaluates their impacts on the Group’s capital ratios, equity and the income statement. On the basis of this exchange-rate simulation, a distribution is produced of their possible impact on the three core items that determine their maximum adverse deviation for a particular confidence level and time horizon, depending on market liquidity in each currency. The risk measurements are completed with stress testing and backtesting, which give a complete view of exposure and the impacts on the group of structural exchange rate risk.
All these metrics are incorporated into the decision-making process by Asset/Liability Management, so that it can adapt the Entity’s risk profile to the guidelines derived from the limits structure authorized by the Executive Committee. Active management of FX exposure kept the risk level within the reasonable limits set for 2009. These incorporated a greater restriction in terms of earnings risk, which is tolerable in an environment of high FX volatility. The average hedging level of the carrying value of the Group’s holdings in foreign currency is close to 50%. As in previous years, hedges of foreign currency earnings also remained high in 2009. At the end of the year, there were significant hedges of foreign currency earnings forecast for 2010.
