Structural exchange-rate risk

The currencies with the greatest capital impact on the BBVA Group underwent widespread appreciations in 2010. The Group’s geographical diversification, in an uncertain economic climate and with public debt crisis episodes in Europe, has had a positive effect on the BBVA Group’s capital ratios, equity and earnings, due to, amongst other factors, the favorable impact of the appreciation of the main currencies against the euro.

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 of the Group’s various subsidiaries while controlling the effects 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 Risk Committee and to the Executive Committee.

Structural exchange rate risk is evaluated using a measurement 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, which determines 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 effects 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 Bank’s risk profile to the guidelines derived from the limits structure authorized by the Executive Committee. Thanks to active management of FX exposure, the favorable evolution of the currencies was taken advantage of in 2010, always keeping risk levels within the established limits, despite high market volatility. The average hedging level of the carrying value of BBVA investments in currencies stood at around 30%, while hedging of foreign currency earnings in 2010 remained at lower levels. In addition to this corporate-level hedging, dollar positions are held at a local level by some of the subsidiary banks. Thanks to a proactive policy in FX management, hedges exist at the closing of the year for both the carrying amounts of the BBVA investments and the expected earnings in America for 2011.