Structural exchange-rate risk

BBVA’s Structural exchange-rate risk management aims to minimize the potential negative impact from fluctuations in exchange rates on the book value and on the contribution to earnings of international investments maintained on a long-term basis by the Group.

The GRM corporate area acts as an independent unit that is responsible for monitoring and analyzing risks, standardizing risk management metrics and providing tools that can anticipate potential deviations from targets. It also monitors the level of compliance with established risk limits, and reports regularly to the Risk Management Committee, the Board of Directors’ Risk Committee and the Executive Committee, particularly in the case of deviation or tension in the levels of risk assumed.

The Balance Sheet Management unit, through ALCO, designs and executes the hedging strategies with the main purpose of minimizing the effect of exchange-rate fluctuations on capital ratios, as well as assuring the equivalent value in euros of the foreign-currency earnings of the Group’s subsidiaries, adjusting transactions according to market expectations and hedging costs. The Balance Sheet Management area carries out this work by ensuring that the Group’s risk profile is at all times adapted to the framework defined by the limits structure authorized by the Executive Committee. To do so, it uses risk metrics obtained according to the corporate model designed by the Risk area.

The corporate model is based on simulating exchange-rate scenarios, based on historical trends, and evaluating the impact on capital ratios, equity and the Group’s income statement. This provides a distribution of the impact on the three core elements, which helps 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 analysis of scenarios, stress testing and backtesting, thus giving a complete overview of the Group’s exposure to structural exchange-rate risk.

In 2011, in an environment of uncertainty and market volatility, particularly in the second half of the year, a policy of prudence has been maintained and hedging has been extended in the currencies with greatest exposure. This has moderated the risk assumed, despite the growing contribution of the “non-euro” area to the Group’s earnings and equity. The average hedging level of the carrying value of the BBVA Group’s holdings in foreign currency is close to 30%. Hedging of foreign currency earnings remained at levels of close to 40%. At the end of the year, there was still significant hedging of forecast foreign currency earnings for 2012.