PILLAR III DISCLOSURE

Transcription

1 PILLAR III DISCLOSURE

2 1. SCOPE AND APPLICATION Ithala Limited (the Company ) is a wholly owned subsidiary of Ithala Development Finance Corporation Limited. Ithala Development Finance Corporation Limited is not registered as a controlling Company in terms of the Banks Act, and as such Pillar 3 disclosure requirements apply only to Ithala Limited. However, the results of the Company are consolidated with Ithala Development Finance Corporation Limited performance results. The Company does not have any subsidiaries, hence accounting and regulatory reporting is on a single entity basis. As the Company is a wholly owned subsidiary of Ithala Development Finance Corporation Limited there are no known restrictions or major impediments to transfer of funds from the Holding Company to the subsidiary. However, transfer of funds from the subsidiary to the Holding Company is limited to 10% of the qualifying capital and reserves of the Company. 2. CAPITAL MANAGEMENT The objective of capital management is to ensure that the Company maintains an adequate capital in relation to its risk profile. This includes ensuring that capital is held above minimum capital requirements as set by the South African Reserve Bank. The Enterprise Risk Committee (ERC) assists the Board in the discharge of its responsibility regarding capital management. The ERC assesses capital requirements based on the risk profile of the Company and recommends the appropriate capital adequacy ratio to the Board. Key activities include: Setting limits on interbank exposures; Assessing and approving material credit exposures; and Monitoring capital levels against the approved capital Capital adequacy To ensure that the Company maintains adequate capital, Internal Adequacy Assessment Process (ICAAP) is conducted. The objective of the ICAAP is to assess whether there is adequate capital to support business activities, anticipated growth and absorb unexpected losses. The following factors are considered: Current and future minimum capital requirements in accordance with Pillar l; Additional capital requirements for risks not fully covered by Pillar l Pillar II risks; Available capital against required capital; and Ability to raise additional capital, if required. The ICAAP is forward looking and involves identifying the risks that the Company is exposed to, measuring capital requirements for each stand-alone risk taking into account growth targets. The required capital level is calculated by aggregating the various stand-alone risks. In addition stress testing is conducted to test the capacity to absorb unexpected losses. The stress testing results are used to determine the additional capital to be maintained. Page 2

3 Capital adequacy (continued) Capital requirements are calculated using the Standardised Approach for credit risk and Basic Indicator Approach for operational risk. Other relates to other assets, which in terms of Regulation 23 of the Banks Act are grouped with credit risk for the purposes of calculating regulatory capital, effectively using the same approach as for credit risk. Regulatory Capital requirements as at 2011 Exposure Capital requirements Risk weighted exposure 2011 R R R R 000 Credit risk Operational risk Other Capital Adequacy as at 2011 Minimum Actual Capital requirements 2011 R R 000 Capital Adequacy ratio 10% 12.42% 8.32% Primary share capital and reserve funds adequacy ratio 7% 11.63% 5.04% Total risk weighted assets (R 000s) R As at 2011 the capital adequacy ratio was 12.42% ( 2010: 8.32%) The March 2010 capital adequacy level was below the minimum capital adequacy ratio of 10%. The South African Reserve Bank has provided the Company with condonation for trading under these circumstances. The situation has since been rectified as evidenced by the capital adequacy ratio at Capital Structure Tier l capital is made up of issued ordinary shares, share premium and retained income. Tier ll capital includes the subordinated interest free loan from the shareholder. On 20 July 2010, the resolution converting the subordinated shareholder s loan to primary capital was registered by the Registrar of Companies. Page 3

4 Capital Structure (continued) 2011 R' R'000 Share capital Share premium Reserves Prescribed deductions against capital and reserve funds (49313) (30294) Total tier 1 capital Loan from shareholder Less: Subordinated loan percentage restricted to 50% of primary capital - (37777) General provisions Total Tier II capital Total qualifying capital RISK MANAGEMENT The Board of Directors ( the Board ) maintains ultimate responsibility for the risk management of the organisation. The ERC and the Audit Committee assists the Board in discharging its risk management mandate. The inter-relationships of the risks facing the Company necessitate an integrated approach to risk optimisation. The Company addresses these risks inherent in its business activities with the aim of achieving sustained benefit within each business activity and across all business units. The Company is exposed to credit risk, operational risk, interest rate risk, liquidity risk, compliance risk, reputational risk and strategic risk. In managing these risks, a risk based framework is used which involves identification, measurement, monitoring, controlling and reporting to the relevant risk committees. Risk management activities broadly take place simultaneously at the following levels; Strategic level: Encompasses risk management functions performed by the Board of Directors and Senior Management. These include: The definition of risk; Ascertaining the risk appetite; Formulating strategy and policies for managing risk; and Developing adequate systems and controls to ensure that overall risk remains within an acceptable level. Macro Level: Encompasses risk management activities performed by units devoted to risk monitoring and reviews, namely, Risk, Compliance and Internal Audit. RISK MANAGEMENT (continued) Micro Level: Involves risk management within a business area, where risks originate. These are the risk management activities performed by line management to mitigate risk arising from business activities. Risk management in these areas is embedded through adherence to operational procedures and guidelines set by management. Page 4

5 3.1. RISK MANAGEMENT FRAMEWORK The risk management framework encompasses the scope of risks to be managed, processes/systems and procedures to manage risk as well as roles and responsibilities of individuals involved in risk management. The risk management framework includes clearly defined risk management policies and procedures covering risk identification, acceptance, measurement, monitoring, reporting and control. Management is responsible for developing risk management strategies and policies for each risk category. Board committees are responsible for their review and recommendation for Board approval. Risk tolerance levels are set out in the policies. Risk management strategies and policies are used in conjunction with delegated powers of authority, which detail the authority levels for various transactions. Board Committees Appropriate governance and risk structures are in place to assist the Board in discharging its duties and responsibilities. The Board currently has four committees namely Audit Committee, Enterprise Risk Committee, Directors Affairs Committee and the Human Resources and Remuneration Committee. Each Board Committee operates in terms of formally documented terms of reference that are reviewed on an annual basis. The role of the Audit Committee is to review a range of matters which includes overseeing management s processes. The committee has reviewed its terms of reference to adopt amendments as set out in the Corporate Laws Amendment Act. The purpose of the Enterprise Risk Committee (ERC) is to assist the Board of Directors in the discharge of its duties relating risk and capital management. The ERC provides an independent and objective view of information presented by management on risk and capital management. Key activities include review and monitoring of liquidity, interest rate, credit, operational risks and review of adequacy and efficiency of risk management policies, procedures and practices. Executive management through established management sub-committees and through representations made at Board committees provide input on the operational, financial, risk management, compliance, and governance activities of the Company to enable it to achieve effective governance in line with the Company s risk strategy and risk management framework. Page 5

6 3.2. RISK MANAGEMENT STRUCTURE Board of Directors Enterprise Risk Committee (ERC) Audit Committee Executive Committee Combined Assurance Committee Management Credit Committee Asset and Liability Management committee Management Operations Committee 3.3. RISK CATEGORIES The Company is exposed to the following risks: Liquidity risk Liquidity risk relates to exposure to funding mismatches due to contractual differences in maturity dates and the repayment structure of assets and liabilities resulting in the Company not being able to meet its financial obligations. Credit risk Credit risk arises from the potential that a borrower is either unwilling to perform on an obligation or its ability to perform such an obligation is impaired resulting in economic loss to the Company. Interest rate risk Interest rate risk is the potential loss the Company is exposed to as a result of changes in interest rates. It is the risk associated with the margin between the interest rates earned on assets and paid on deposits, and the repricing gap between assets and liabilities. Operational risk The risk of loss resulting from inadequate or failed internal processes, people or systems or from external events including legal risk, but does not include strategic or reputational risk. Compliance risk Compliance risk relates to financial loss, damage to the Company s reputation due to failure to comply with applicable laws and regulations or supervisory requirements. Reputational risk The risk of damage to the Company s image which could result in loss of business or the inability to attract new business. Strategic risk The current or prospective impact on earnings or capital arising from adverse business decisions, improper implementation of decisions or lack of responsiveness to industry changes. Page 6

7 3.4. INTEGRATION OF RISK MANAGEMENT Risks are not viewed and assessed in isolation, not only because a single transaction might have a number of risks but also one type of risk can trigger other risks. Since interaction of various risks could result in diminution or increase in risk, the risk management process recognises and reflects risk interactions in all business activities as appropriate. While assessing and managing risk management will seek to obtain an overall view of risks the Company is exposed to as set out in section RISK MEASUREMENT / MANAGEMENT Exposure to risks is measured as follows: Liquidity risk Liquidity risk is measured by conducting an analysis of net funding requirements, which is determined by analysing future cash flows based on the assumptions on the expected behaviour of assets and liabilities, and off balance sheet items. For details, refer section 3.8. Interest rate risk Interest rate risk emanates from repricing of assets and liabilities resulting from changes in prime interest rate. It is the exposure to loss of income resulting from interest rate changes. For details, refer section 3.9. Operational risk The Board of Directors (the Board) is ultimately responsible for ensuring that operational risk is managed to an acceptable level. The ERC assists the Board in discharging this responsibility. Each and every individual within the organisation is responsible for operational risk as it exists in all products and business activities. Line managers and their teams are responsible for day to day management of operational risk. Operational loss events are recorded to assist in measuring exposure to operational risk. However, measurement of capital requirements is formula driven, as the Company adopted the Basic Indicator Approach. Operational risk is managed through implementation of appropriate internal control systems, supported by staff training. In addition, key controls and procedural manuals as well as formalised delegated powers of authority are in place, and reviewed annually, to assist staff in the execution of their duties. Compliance Risk Audit Committee assists the Board in the discharge of its responsibility regarding compliance risk. The Audit Committee; Approve procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls or auditing matters; Review compliance programme for the year; and Review the level of compliance with relevant legislation, regulations and codes, and with internal policies, procedures and controls. Page 7

8 RISK MEASUREMENT / MANAGEMENT (Continued) The responsibility of the Compliance risk management function is to proactively: Identify, assess, monitor and report on the compliance risks faced by the Company; and Assist, support and advise management in fulfilling its responsibilities to manage compliance risks; The monitoring plan addresses: Critical high compliance risk, focusing on inherent and residual risk levels; Controls in place to manage compliance risks; and Compliance with the laws, regulations and standards. Reputational Risk The ERC is responsible for monitoring the management of all risks as they may impact on the Company s reputation. The Audit Committee monitors customer complaints register to ensure that appropriate remedial actions are taken. At management level, the compliance function monitors the complaints register ensuring that the responsible parties take necessary actions to resolve the complaints. Customer services also play a role in managing reputational risk. Strategy Risk The Board has overall responsibility for strategic risk management of the organisation. The management executive committee is responsible for implementation of the strategy. New projects and new products are approved by the Board. The Enterprise Risk Committee monitors: Performance against the budget, and Progress on projects. Credit risk The maximum exposure is the full amount exposed to credit risk without taking into account any form of collateral against the exposure. For details refer section 3.7, Credit Risk PRINCIPAL ACCOUNTING POLICIES The Company classifies its financial assets as loans and receivables or held-to-maturity financial assets. The Company does not hold financial assets at fair value through profit or loss or available-for-sale assets. Initial recognition Financial instruments are recognised on the statement of financial position when the Company becomes a party to the contractual provisions of the financial instrument. Financial instruments are recognised on the date that the Company commits to purchase or sell the instruments (trade date). Page 8

9 PRINCIPAL ACCOUNTING POLICIES (continued) Financial assets that are classified as loans and receivables for measurement purposes are held at amortised cost. Loans and receivables are measured at amortised cost using the effective interest rate method, less any impairment losses. All financial liabilities are classified as non-trading financial liabilities and are measured at amortised cost. Effective interest rate The effective interest rate is the rate that discounts estimated future cash receipts or payments over the expected life of the financial instrument or a shorter period, where appropriate, to the net carrying amount of the financial instrument. The effective interest rate method takes into account all contractual terms of the financial instrument and includes any fees or incremental costs which are directly attributable to the instrument and is an integral part of the effective interest rate, but not future credit losses. The carrying amount of the financial instrument is adjusted if the Company revises its estimate of receipts or payments. The adjusted carrying amount is calculated based on the original effective interest rate and the change in carrying amount is recorded as interest income or expense. Impairment of financial assets Loans and advances are assessed at each reporting date to determine whether there is objective evidence of impairment. Impairment losses are incurred if there is objective evidence of impairment as a result of one or more events that occurred after initial recognition but before the reporting date that indicates that it is probable that the Company will be unable to collect all amounts due. Losses expected as a result of future events, no matter how likely, are not recognised. The impairment of non-performing advances is based on periodic objective evaluations of advances and takes into account past loss experiences adjusted for changes in economic conditions and the nature and level of risk exposure since the recording of the historic losses. The methodology and assumptions used for estimating future cash flows are reviewed regularly to reduce any differences between loss estimates and actual loss experience CREDIT RISK Credit risk arises from the potential that a borrower is either unwilling to perform on an obligation or its ability to perform such an obligation is impaired resulting in economic loss to the organisation. Exposure to credit risk emanate from the lending activities in the form of home and home improvement loans, cash, personal, property development and commercial property loans. Interbank advances also form part of credit risk exposure Credit Risk Management: organisation and structure Credit Risk constitutes the Company s primary source of risk. Maintaining and effectively managing this risk is essential to the Company. The Company has a strong focus which is underpinned by the credit risk management policy, which is subject to periodic review and approval by the Board. Page 9

10 Credit Risk Management: organisation and structure (continued) The ERC assists the Board in discharging their responsibility regarding Credit risk. The ERC is delegated to approve exposures above R5m. The Management Credit Committee (MCC) ensures that credit risk management strategies and policies are implemented. The MCC which is chaired by the Chief Executive Officer approves deals which are above a certain value threshold as defined by the delegated powers of authority. The Credit Risk Division is responsible for: Credit assessment and approval of loan applications, and monitoring of application scorecards, as is relevant; Monitoring of significant exposures and the various loan portfolios; Collection of exposures which are past due; Monthly credit impairment calculations; Monthly internal reporting; and Completion of Credit Risk Banks Act returns Credit risk reporting Reports are submitted monthly to the Credit Sub-Committee on portfolio analysis, status of significant exposures as well as those meeting pre-defined criteria, credit impairments and related matters. This Sub- Committee meets monthly and is a sub-set of the Management Credit Committee and covers the following reports: Credit granting statistics; Asset growth by product line; Portfolio analysis, including trends; Individually significant exposures including large exposures and watch list exposures; Details of distressed loans; Credit impairment details; and Other related reports Non-performing loans and advances A non-performing loan is an exposure where specific credit impairment is raised against a credit exposure where the credit quality has declined significantly, or an obligation is past due for more than 90 days. An obligation is past due when the borrower has failed to honour it at the point when it fell due Impaired loan and advances, and specific impairments Impaired loans and advances are defined as loans and advances where a specific impairment has been raised. A specific impairment is raised in respect of an asset that has triggered a loss event where the discounted value of the collateral held against the advance is insufficient to cover the total exposure. Such a loss event may be significant financial difficulty of the borrower, a breach of contract, such as a default, or delinquency in interest or principal payments, with aging arrears as the primary driver. Page 10

11 3.7.5 Portfolio credit impairment Portfolio credit impairment represents the impairment on the loans and advances that have not been specifically impaired. These loans and advances have not yet individually evidenced a loss event. A period of time will elapse between the occurrence of an impairment event and objective evidence of the impairment becoming evident. This period is generally known as the emergence period IAS 39 credit impairment model The Company performs periodic back-testing to analyse the behaviour of the loans and advances portfolio. This information is then collated and used to project the future behaviour of the portfolio. In performing the back-testing, various time periods are analysed. The time period chosen for the calculation of credit impairments was 48 months to the reporting date. It is based on the following factors: The consistency of the base period in relation to the prior financial period; Consideration of the prevailing economic conditions; and Prudence in respect of anticipated interest rate changes. This forms the input of the data-set for use in calculating the credit impairment. The data used in the IAS 39 credit impairment model draws from the following factors, determined through back testing: Default rates, which is the percentage of accounts that have migrated to overdue (greater than 3 months in arrears) in the course of the time period being analysed; Ratio of accounts that remained non performing over the back testing period; and Cash Flows of Non-performing loans in the period being analysed. In the current reporting period, there was a change in the approach used to calculate the credit impairment. The change entailed revising the credit spread percentage to zero percent. Management s assertion is that per-account loan pricing factors in the credit risk that the Company takes on-board. The factors and assumptions used in the credit impairment model reflected the economic conditions prevalent at reporting date. The assumption, at reporting date, is that economic recovery was slow and that the economic indicators were not yielding a clear picture of recovery. Thus, economic conditions prevalent at reporting date had not changed fundamentally from those prevalent at the prior reporting period. To calculate the portfolio credit impairment, the following factors are used: default rates, and the ratio of accounts that remained non-performing over the back testing period. These factors are applied, by product type, to residual portfolio exposures after the specific credit impairment. To calculate the specific credit impairment, the factors used are the ratio of accounts that remained nonperforming over the back testing period, discounted cash flows, the net realisable of the collateral and the time to realise collateral. These factors are applied to the collateral value, which for mortgage exposures is reduced by estimated selling costs, to arrive at the net realisable value. In the event that the net realisable collateral value is lower than the ledger balance, a further credit impairment based on the difference, is created. Page 11

12 IAS 39 credit impairment model (continued) Where appropriate for individually significant exposures, there is a variation to the basis for calculation, based on the severity of the delinquency. It may be that the net realisable value is discounted further or that the account exposure is fully impaired. Bond boycott loans are loans granted in arrears where residents boycotted payments for bonds, municipal services and utilities. These loans have been ring-fenced and have been fully impaired Credit Risk Management policy The Credit Risk Management Policy sets out the product limits, concentration limits, product pricing details as well general aspects relating to credit risk management. This policy is approved by the Board and is reviewed annually. The policy forms the framework for the granting as well as the monitoring of credit exposures. At the lending stage, the applicant s repayment ability, cash flows, source of income and credit history is assessed. In addition, emphasis is placed on early identification of loans that pose high credit risk Major types of credit risk exposures The aggregate amount of gross credit exposure after the effect of set-off but mitigating but before the effects of credit risk-mitigation techniques is displayed below: Total Gross Exposure Major Types of Credit Exposures: Total Gross Exposure Page 12 Realisab le Realisab le Outstan ding Impairmen t Carrying Outstandi ng Impairm ent Carrying Mar 31 Mar 31 Mar 31 Mar March March March R'000 R'000 R'000 R'000 R'000 R'000 R'000 R'000 Commercia l Loans Property developme nt loans Housing loans > R500k Sub-total Other loans Total The average amount of gross exposure is determined as the year-end balance over the number of loan exposures outstanding at the end of the reporting period

13 Major types of credit risk exposures (continued) Average Gross Exposures Major Types of Credit Exposures: Average Gross Exposure Outstandi ng Impairme nt Carrying Realisabl e Outstandi ng Impairme nt Carrying 31 March 2010 Realisab le 31 March Mar Mar Mar Mar Marc h R'000 R'000 R'000 R'000 R'000 R'000 R'000 R'000 Commercial Loans Property developmen t loans Housing loans > R500k Other loans Total Geographical distribution of credit exposures The Company operates solely in the province of Kwa-Zulu Natal and lends mainly to individuals in the housing mortgage sector. All exposures are within Kwa-Zulu Natal, South Africa Sectoral Analysis of Loans and Advances The table below shows distribution of exposures based on industry: 2011 % 2011 R % Restated 2010 R 000 Restated Sectoral Analysis Real Estate Construction Retail-mortgage Retail-other Total Page 13

14 Sectoral Analysis of Loans and Advances (continued) The following table is an analysis of financial assets that are past due but not impaired: 2011 Assets that are neither past due nor impaired Assets that are past due but not yet impaired Financial assets that are impaired Credit Impairments Category of Assets Total R 000 R 000 R 000 R 000 R 000 Real Estate Construction Retail-Mortgage Retail-Other Total As at 2010 Category of Assets Assets that are neither past due nor impaired Assets that are past due but not yet impaired Financial assets that are impaired Credit Impairments Total R 000 R 000 R 000 R 000 R 000 Real Estate Construction Retail-Mortgage Retail-Other Total Credit Impairment Reconciliation Portfolio Impairments 2010 Impaired Accounts Written Off Impairments Raised/(Releas ed) 2011 Category of Assets R 000 R 000 R 000 R 000 Real Estate (174) 248 Construction (180) 47 Retail-Mortgage (4414) Retail-Other Total (2692) Page 14

15 Credit Impairment Reconciliation (Continued) Restated 2009 Impaired Accounts Written Off Impairments Raised/(Releas ed) 2010 Category of Assets R 000 R 000 R 000 R 000 Real Estate Construction (36) 227 Retail-Mortgage Retail-Other Total Specific Impairments 2010 Impaired Accounts Written Off Impairments 30 Sept Category of Assets Raised/(Released) 2010 R 000 R 000 R 000 R 000 Real Estate Construction Retail-Mortgage (2479) (1448) Retail-Other (7629) Total (10 108) Restated 2009 Impaired Accounts Written Off Impairments Category of Assets Raised/(Released) 2010 R 000 R 000 R 000 R 000 Real Estate Construction Retail-Mortgage (18213) Retail-Other (1380) Total (19593) Page 15

16 Credit Impairment Reconciliation (Continued) Total Credit Impairments Category of Assets 2010 Impaired Accounts Written Off Impairments Raised/(Released) 2011 R 000 R 000 R 000 R 000 Real Estate Construction Retail-Mortgage ( 2479) (5862) Retail-Other (7629) Total (10108) Category of Assets Restated 2009 Impaired Accounts Written Off Impairments Raised/(Released) 2010 R 000 R 000 R 000 R 000 Real Estate Construction Retail-Mortgage (18213) Retail-Other (1380) Total (19593) Counterparty credit exposures The table below shows the major types of counterparties that the Company is exposed to: Type of counterpar ty credit exposure Outstandin g Impairmen t Carrying Realisable Outstandin g Impairme nt Carrying Realisable R'000 R'000 R'000 R'000 R'000 R'000 R'000 R' Individuals Non individuals Banks Total Counterparty credit exposure includes amounts held at the South African Reserve Bank (SARB) of R104 million ( 2010: R109 million), banks, individual and non-individual loan exposures. Exposures in banks are invested in fixed deposit, call and money market accounts Page 16

17 Credit Impairment Reconciliation (Continued) The ERC approves exposure limits for each bank, and these are reviewed annually. For counter parties other than banks, an exposure limit is set per individual borrower or group of related borrowers to ensure that the Company is not overexposed to any one counterparty. Counterparty credit exposure is in respect of the banking book as the Company does not have a trading book. For a significant part of exposures, other than in banks, the collateral held is mortgage bonds Credit risk mitigation Securities taken to mitigate credit risk: In respect of home, commercial property and property development loans, mortgage bonds over properties and life insurance policies represent collateral. For home improvement loans, the employee s pension represents collateral and all cash loans are secured through deposits or investments. Personal Loans are unsecured. The nature of collateral that is held by the Company in respect of loans and advances to customers is set out below: Product Housing loans, excluding Permission to Occupy Home Improvement loans Cash loans Commercial loans & property development loans Type of collateral Mortgage bond Pledge of pension fund Cession of term investment Mortgage bonds, cession of income and key man insurance policies where required There is collateral concentration risk in that the majority of collateral held is mortgage bond. On statement of financial position netting. Term deposits, namely, fixed and target save deposits placed with the Company are considered eligible financial collateral. On statement of financial position netting is used only on cash loans. ting is applied on cash loans secured by term investments with the Company. In cases where customers do not make regular payments, the term deposits are set-off against loan balances, on maturity. Page 17

18 Credit risk mitigation (continued) Valuation of collateral The value of a loan is dependent on the value of the collateral therefore prior to a mortgage agreement being concluded. The valuation is done according to the guidelines of the Valuers Institute of SA. The value of the collateral is updated annually for the non-performing loans. Performing loan collateral is carried at the value assigned at origination. In respect of home improvement loans granted, the pension/provident proceeds are ceded to the Company and the loan is dependent on the pension/provident amount accumulated at a particular time. The Company may call for extra security in the event that the risk is not properly mitigated by the call collateral Enforcement of collateral In the event of a defaulter failing to rehabilitate an overdue loan, due legal process is followed to realise the collateral. The repossessed properties are made available for sale in an orderly manner to maximise the proceeds from sale Basel ll approach The Standardised Approach has been adopted for credit risk. As the Standardised Approach is one of the simpler approaches that Basel ll offers, it is well suited to the Company s size and level of complexity. Capital requirements for credit risk are determined based on the total risk weighted assets. The various assets are assigned different weightings dependent on their profile Credit Risk Exposures Credit Risk Exposures reflected on the statement of financial position assets: 2011 R' R'000 Cash Statutory liquid assets Deposits with banks Loans and advances to customers Receivables and prepayment Inter-Company loan account with Holding Company (2 868) (1288) Total assets subject to credit risk Letters of undertaking issued Credit risk exposures relating to interbank (deposits with banks) are risk weighted with reference to Fitch International ratings. The international ratings are mapped to risk weightings to determine capital requirements for these exposures. Banks with high ratings attract low risk weightings and consequently lower capital requirements. Page 18

19 Credit Risk Exposures (continued) The table below shows Fitch International ratings and the related risk weightings as at 2011; Exposure Short term Long term Risk Weightings Interbank F1 20% F2 50% A 50% BBB+ 50% BBB 50% Maturity Analysis of Credit Risk Exposures Residual maturity analysis for credit risk exposures is as follows: 2011 Credit Risk Exposure relating to on statement of financial position assets: From 1 to 6 months From 6 months to 1 year From 1 year to 5 years Up to 1 Month After 5 year TOTAL R 000 R 000 R 000 R 000 R 000 R 000 Cash Statutory Liquidity Assets Deposits with Banks Loans and Advances to Customers Receivables and Prepayment InterCompany Loan Account with Holding (2868) (2868) Company 2007 Total Assets subject to credit risk Credit Risk Exposure relating to off statement of financial position assets: Letters of Undertaking Issued Page 19

20 Maturity Analysis of Credit Risk Exposures (continued) 2010 From 1 From 6 to 6 months to months 1 year From 1 year to 5 years Credit Risk Exposure relating to on statement of financial position assets: Up to 1 Month After 5 year TOTAL R 000 R 000 R 000 R 000 R 000 R 000 Cash Statutory Liquidity Assets Deposits with Banks Loans and Advances to Customers Receivables and Prepayment Inter-Company Loan Account with Holding Company (1288) (1288) Total Assets subject to credit risk Credit Risk Exposure relating to off statement of financial position assets: Letters of undertaking issued Loan and advances to customers The following table reflects the split of loans and advances granted into the various categories together with the related credit impairment charge: R 000 R 000 Housing Loans Cash loans Commercial property loans Personal loans Credit impairments for loans and advances (107788) (104695) Loans and advances net of impairment Maturity analysis On Demand Maturing from 1 month to 6 months Maturing from 6 months to 1 year Maturing from 1 year to 5 years Maturing after 5 years Page 20

21 Loan and advances to customers (continued) Exposure per Asset class Segmental analysis by industry of impairments in respect of nonperforming loans 2011 R R 000 Real Estate Construction Mortgage Other Total Age analysis of assets past due but not impaired 2011 R 000 Realisable Less than 30 days 31 to 60 days 61 to 90 days More than 90 days Total Housing loans Cash loans Personal Loans Commercial property loans Total R 000 Less than 30 days 31 to 60 days 61 to 90 days More than 90 days Total Realisable Housing loans Cash loans Personal Loans Commercial property loans Total LIQUIDITY RISK Liquidity risk is the responsibility of the Enterprise Risk Committee (ERC) and Asset and Liability Management Committee at management level. The nature of our business activities exposes the Company to liquidity risk. Liquidity risk exposure is due to contractual differences in maturity dates of assets and liabilities. Liabilities are generally short term with the major part maturing contractually within six months, whereas, assets are long term and the major part falls within the greater than 60 months maturity category. However, under normal circumstances adequate liquidity is maintained as deposits are rolled over and not withdrawn on maturity. Evaluation of sufficiency of liquidity depends largely on the behaviour of cash flows under different scenarios, namely going concern / business as usual and stress situation. Each scenario will consider significant positive and negative liquidity movements that could occur. Page 21

22 LIQUIDITY RISK (continued) Liquidity risk management strategies and processes include: Management of assets and liabilities to ensure sufficient resources to meet approved and anticipated advances, repayment of maturing liabilities, withdrawals and any other commitments which become due in the ordinary course of its business; Maintaining a diversified depositor base and limiting significant exposure to a single depositor or group of related depositors; Preparing cash flow projections regularly to assess available cash against cash requirements and determining funding sources; Maintaining a buffer of liquid assets in addition to statutory requirements; An assessment of the level of compliance with the statutory liquid asset requirements; An analysis of short term liquidity mismatch and the trend; An assessment of sources of liquid funds available for funding such mismatches and LIQUIDITY RISK (continued) Projected cash inflow and outflow estimates and thus the net deficit or surplus over a time horizon. The Company has also introduced a short term personal loan product which in time will reduce the maturity gap between its liabilities and assets. Liquidity risk is measured by conducting an analysis of net funding requirements. funding requirements are determined by analysing future cash flows based on the assumptions of the expected behaviour of assets and liabilities and off balance sheet items. Liquidity position is monitored on a monthly basis and reports are submitted to the Executive Committee on a monthly basis and to all ERC Meetings. 3.9 INTEREST RATE RISK IN THE BANKING BOOK Interest rate risk emanates from repricing of assets and liabilities resulting from changes in prime interest rate. It is the exposure to loss of income resulting from interest rate changes. On balance sheet items namely, assets and liabilities, are both impacted by changes to interest rates irrespective of whether pricing is prime rate linked or not as they all change with interest rate changes, except for fixed rate items. Interest income forms a major part of our income and interest rate changes have a significant impact on our income. Maturity/repricing schedules are used to generate indicators of interest rate risk sensitivity of both earnings and economic value to changing interest rates. This approach is used to assess the interest rate risk of current earnings and is referred to as gap analysis. Management of interest rate risk includes: Measuring and monitoring on an ongoing basis the sensitivity of the Company to interest rate movements and review the impact of such interest rate movement on earnings, net interest income and the statement of financial postion; Recommending the strategic interest rate changes as and when required; and Narrowing the re-pricing gap between assets and liabilities. Page 22

23 INTEREST RATE RISK IN THE BANKING BOOK (continued) Interest rate risk in the banking book is the responsibility of ALCO at management level and ERC at Board level. Interest rate risk management strategy and processes include collaboration between the Finance division and the Treasury function which manages placement of funds and the balance between risk and return. Medium to long term strategy return include initiatives to reduce exposure to interest rate risk. Interest rate risk is measured monthly. Sensitivity analysis measures exposure to interest rate risk and is conducted on a monthly basis. Sensitivity analysis measures the impact of a shock increase or decrease in interest rates. Key assumptions applied in projections and cash flow forecasts are as follows: Levels of repayments (including prepayments due to options embedded in assets and liabilities) from existing clients will continue at a similar rate; As a result of regular rollover of deposits, net deposits (based on historical behaviour) will continue to grow at a certain level, except over the annual festive season during which higher than usual withdrawals are made. Provision for this reduction is made and Based on certain characteristics deposits are split into stable ( permanent in nature ) and volatile, with volatile deposits being deposits that can be withdrawn at any time. The table below demonstrates the re-pricing gap between The Company's assets and liabilities upon the application of a change in market interest rates. The table shows the impact of a 2% increase / decrease in interest rates on the interest income of the Company. The scenario analysis is limited to the impact on interest income and expenditure over the period of 12 months. The application of the change in interest rates is applied to a static balance sheet and is in accordance with Regulation 30 of the Banks Act, Page 23

24 INTEREST RATE RISK IN THE BANKING BOOK (continued) The sensitivity analysis below has been presented on a net interest income basis to reflect the operations of the entity: 3.10 OPERATIONAL RISK Operational risk is the risk of loss resulting from inadequate or failed internal processes, people or systems or from external events, including legal risk, but does not include strategic and reputational risk. Operational risk exists in all products and business activities Responsibility The Board is ultimately responsible for ensuring that operational risk is managed to an acceptable level. The ERC assists the Board in discharging this responsibility. Each and every individual within the Company is responsible for operational risk as it exists in all products and business activities. Line managers and their teams are responsible for day to day management of operational risk. The Management Operations Committee is responsible for ensuring that operational risk is managed to an acceptable level in line with approved parameters Framework At 2011 R'000 At 2010 R'000 Increase: Impact of increase in yield on assets on comprehensive income Increased net interest income percentage 32% 33% Impact of increase in cost of funds on comprehensive income (23220) (22469) Increased net interest income percentage (21%) (20%) Decrease: Impact of decrease in yield on assets on comprehensive income (36825) (30374) Decreased net interest income percentage (33%) (27%) Impact of decrease in cost of funds on comprehensive income Decreased net interest income percentage 19% 19% Interest rate risk is monitored and managed through margin analysis and the monitoring of mismatch levels between the re-pricing of assets and liabilities. Operational risk management framework involves risk identification, assessment and measurement. Various methods are used to identify areas of risk and vulnerability. Risk assessment is conducted to determine the impact such events could have on the organisation. Page 24

25 Regulatory Capital The Basic Indicator Approach was adopted upon Basel ll implementation. Measurement of the Regulatory Capital requirement for operational risk is computed using the following formula; K BIA = [ (GI 1 n X α)]/n Where: K BIA - is the relevant required amount of capital and reserve funds under the Basic Indicator Approach. GI - is the relevant annual positive gross income amount derived during the preceding three-year period. N - is the relevant number of the previous three years in respect of which gross income was positive. α - is a fixed percentage, equal to 15 per cent Management and Monitoring Operational risk is managed through implementation of appropriate internal control systems, supported by staff training. In addition, key controls and procedural manuals as well as delegated powers of authority are in place to assist staff in the execution of their duties. These are reviewed regularly. Risk monitoring includes monitoring of operational risk events and trends. The operational loss events are reported to the Management Operations Committee and Enterprise Risk Committee Insurance The Company s assets are covered by the relevant insurance policies to minimize losses. These insurance policies are renewed annually. Insurance policies are considered to be a complementary tool rather than a substitute for operational risk management Business continuity management The Company maintains a comprehensive business continuity plan Technology risk Technology risk is the risk of failures in systems, errors in the development of programs, inadequate or inaccurate management information as well as inadequate security and contingency planning. Technology is the key enabler for conducting business, resulting in increased reliance thereon which in turn has increased the need for sound management of risks inherent in automated systems. To this end, disaster recovery plans are subject to review on an ongoing basis, thus ensuring that risks are mitigated. The business continuity program identified sub-projects which will enhance the Company s ability to respond to emergencies and disasters as well as facilitate the resumption of critical business activities under abnormal circumstances. Page 25

26 Fraud Prevention The Company is committed to eradicating fraud and to change the traditional role of being re-active and investigating to being pro-active and preventing. Measures in place to ensure that the risk of fraud is minimized include the following; The provision of fraud awareness training; Adherence to a culture of zero tolerance vis-à-vis fraud and theft; Effective management and implementation of policies aimed at governing staff behaviour; Conducting fraud risk susceptibility assessments annually to highlight areas of fraud susceptibility and formulation of appropriate controls and action plans to mitigate identified weaknesses and Establishment of an independent whistle-blowing service, enabling staff to report fraud anonymously. These measures are the subject of ongoing review and refinement designed to minimize loss and improve fraud detection, awareness and control OTHER MATERIAL RISKS COMPLIANCE RISK The management of compliance risk rests with the Compliance function, headed by the Compliance Officer, who monitors and reports regularly on the level of compliance with laws and regulations. Compliance is managed according to Board approved framework, which gives priority to high risk laws and regulations REPUTATIONAL RISK Management of reputation is achieved through sound management of all risks which may impact on reputation. In addition, communication channels to all stakeholders exist to allow timely flow of information STRATEGIC RISK Strategic initiatives are supported by sound due diligence and strong risk management systems. These are well conceived and supported by appropriate communication channels, operating systems and service delivery channels. No new product or service is introduced without prior approval of the Board. Page 26