T a b l e o f C o n t e n t s Annual Report 2002

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3 Table of Contents 3 Table of Contents 4 Address of the President and Chairman of the Board 6 The Time Line 9 Market Position 10 Regional Network Development 12 Development of Corporate Banking Business 14 Lending Business 18 Provision of Foreign Economic Activities of Ukrainian companies 20 Transactions in Securities 19 Development of Retail Business 21 Interbank Business 27 Information Technology Development 26 Management of Risks, Liquidity Provision 29 Staff Development 31 Core Operation Performance 35 Bank and Society

4 4 Ринкова позицiя Dear Shareholders, Colleagues, and Partners, Dear Shareholders, Colleagues, and Partners, We are pleased to deliver you this information on our core operation performance in The 11th year of our operations appeared to be somewhat complicated and rather successful for our Bank. Thusme decline in the economic growth pace, stronger competition in the banking sector, radical changes in banking services system for the budget funds cannot but affect the development of the domestic financial and banking system. At the same time, based on the results of the last year, owing to the balanced development strategy we managed to considerably strengthen our leadership in the Ukrainian banking system, increased our market share in the banking market of Ukraine by all major performance indicators. Fedir Shpig Oleksandr Derkach So, as of January 1, topped the Ukrainian banks' rating by the amount of total assets, which approach bln. UAH. As many times before, the Bank has confirmed the leadership by the authorized capital size which reached 500 mln. UAH in the last year, i.e. nearly 100 mln. USD. In addition, the Bank continues to be a leader among Ukrainian banks in lending for the real sector of economy: last year, companies received from the Bank nearly 10 bln. UAH in loan facilities. At the same time, we welcomed and kept providing our comprehensive services to nearly 40,000 corporate clients, whose total number in 2002 exceeded 170,000. These are companies operating in such sectors as agroindustrial complex, trade and services, metallurgy, oil and gas complex, shipbuilding, advanced technology, etc. At the same time, the Bank has kept the position among the largest state-owned retail banks. Today, we provide individuals in all regional and district centers, localities and cities of regional subordination with full range of banking services, from traditional money transfer, loans and deposits to the most up-to-date banking products. First and foremost, this was made possible by our nation-wide network of regional divisions, one of the largest among Ukrainian commercial banks, whose formation at the base level was completed in the last year. In addition, has always been and today remains a

5 5 Ринкова позицiя leader in domestic banking system by implementation of the most up-to-date technology. Last year, we completed development of Ukraine's unique and only telecommunication network having the total cost over 40 mln. UAH. Along with this,, the first among the domestic banks, started deployment of the state-of-the-art Western software suite Bankmaster RS, that cardinally improves the process of banking service provision to broad circles of clients and has already proved its efficiency in the leading banks of 60 countries worldwide. Undoubtedly, everything we managed to accomplish with our joint effort in the last year is only the next stage of our operations building the strong foundation of reliability, stability, and profitability for our Bank, its further development and future achievements. This is further improvement and expansion of our banking service offerings, their utmost reach to all citizens of Ukraine irrespective of their location in the country, active support of the real sector of economy and facilitation of economic growth in the state, most efficient protection of interests for our investors and shareholders. Sincere thank goes to you for all your work, cooperation with our Bank, for trust in our Management and the strategy of further development for the Bank they have devised. The fact is that together with everyone who understands and supports this strategy, trusts in the future of our Bank, we are and will be capable of further dynamic developing, strengthening our positions, protecting the interests of our shareholders and clients, ultimately contributing into the national economy development. Yours faithfully, Fedir Shpig, National Deputy of Ukraine, President, Yours faithfully, Oleksandr Derkach, Chairman of the Board,

6 6 The Time Line F e b r u a r y and Ukrainian Mail Company Ukrposhta signed an agreement on provision of services to individuals for payment of Western Union money transfer. M a r c h March 27: Joint Stock Post Pension Bank Aval celebrated the 10th Anniversary since inception. For their strong achievements in professional activities and long-term work, Ivan Pinchuk, Vice-Chairman of the Board and Oleksandr Milay, Director of Lugansk Regional Department, were awarded with the Order of Merit, Degree III by the Decree of the President of Ukraine Leonid Kuchma. Ivan Voloshok, First Vice-Chairman of the Board and Gennady Malashenko, Director of Dnipropetrovsk Department of the Bank, were awarded the honorary rank of Deserved Economist of Ukraine For their professionalism and contribution into the development of the national agroindustrial complex, the employees of the Bank were collectively awarded the Honorary Diploma by the Cabinet of Ministers. The Cabinet of Ministers of Ukraine, the Verkhovna Rada and the National Bank of Ukraine awarded a number of directors of regional departments and individual employees with the Honorary Diploma and memorable insignia for their special merits to the Ukrainian people, strong personal contribution into development of Ukraine and their utmost professionalism, long-term fruitful work in the banking system of Ukraine. F. I. Shpig, President of the Bank was reelected as the National Deputy of Ukraine. A p r i l The Bank entered the market with such new banking products as interest options being an obligation of the seller to extend an interbanapril. The Bank entered the market with such new banking products as interest options being an obligation of the seller to extend an interbank loan whose amount, interest rate, and term are discussed when the option is sold. M a y Ernst & Young auditors provided their opinion on the satisfactory financial condition of the Bank. According to the auditor opinion, capital adequacy of the Bank reaches %, that nearly 2 times exceeds the minimum level, specified by the National Bank of Ukraine and recommended by the Basel Convention. The Bank started providing currency transfers for our own Aval Express money transfer system. The Bank was recognized the winner of the

7 7 The Time Line 2002 tender determining the agent bank for repayment of the debt to individuals being the creditors of Bank Ukraina. J u n e The Bank started implementation of Ukraine's largest project of integrated banking system for retail business powered by Bankmaster RS software. The Bank started long term lending of Ukrainian importers in the framework of agreement with Bankgesellschaft Berlin (Germany) on purchase of capital construction products. The Bank's corporate site in the Internet ranked 2nd in the Corporate Site category at III Kyiv International Advertising Festival. J u l y The Bank successfully repaid the debts to 42,000 depositors of Bank Ukraina in the amount of 182 mln. UAH by employing the channels of our own unique Aval Express money transfer system. EBRD has confirmed to the Bank the limit for International Trade Assistance Program which enables the Bank to provide confirmation services for documentary credits and bank guarantees, issued by the participants of the Program, in the amount of 6 mln. USD. Natalia Lyakh, Chief Accountant at the Bank's Sevastopolsky Branch was recognized the Grand Master of Accounting and awarded the Honorary Diploma based on the results of All-Ukrainian Special Event Ukraine's Best Accountant, held by the editorial board of All About Accounting newspaper. A u g u s t The Bank started implementation of the project for sales of prepaid mobile communication services, IP telephony, and Internet access via the regional branch network. S e p t e m b e r Oleksandr Derkach, the Chairman of the Board of the Bank was ranked in the 10 Best Top Managers in Ukraine rating organized by Partner magazine and validated by Ernst & Young auditors. The total number of the Bank's ATMs approached 300. The payment card issue totaled more than 700,000. O c t o b e r listed in Top 100 Banks in Central and Eastern Europe rating provided by Standard&Рооr's agency. Credit Rating independent rating agency started assigning loan ratings to the Bank.

8 8 The Time Line Lugansk Department implemented 2002's largest payroll project for employees of Alchevsky Steel & Iron Works (22,000 cards). N o v e m b e r EBRD extended to the Bank the next tranche in the amount of 3 mln. USD under the Microlending Program and extended a direct loan facility in the amount of 10 mln. USD for financing of agricultural companies. introduced a package of target programs for medium term lending to companies of agroindustrial complex for purchase of fixed assets: agricultural machinery, equipment, other fixed assets D e c e m b e r Oleksandr Derkach, Chairman of the Board of the Bank was ranked 8th in the Best Top Managers in Ukraine rating styled Top Management and 1st in Best Top Manager in Banking sector of Ukrainian Investment Newspaper. The authorized capital of the Bank set a record for the Ukrainian banking system 500 mln. UAH.

9 9 Market Position The last year developments in Ukraine's banking sector operations have shown the competition in all groups of banks strengthened considerably. In 2002, medium and small banks achieved appreciably higher growth rates in their core operations. In addition, the top banks continued to demonstrate reduction in the difference between core competitors. By the results of the reported year, the Bank strengthened the leadership in the Ukrainian banking system, having increased the share by core performance indicators in the banking market of Ukraine. banks by the growth rates in deposits of individuals, which reached 110 %, whereas in the banking system this indicator was a modest 70 %. A similar situation exists with the funds of legal entities: the Bank's growth rates since the beginning of the year have reached 43 % against 38 % in the banking system. The Bank has re-confirmed the leader status by the authorized capital size which reached 500 mln. UAH in the last year, i.e. nearly 100 mln. USD, a threshold, which no Ukrainian bank has ever managed to achieve. In particular, as of January 1,2003, the Bank topped the Ukrainian banks rating by the value of assets which reached bln. UAH. The growth in the amount of lending for legal entities and individuals extended by the Bank, outpaced those of the banking system: the growth in the Bank's loan portfolio for legal entities in 2002 was 90 %, whereas the banking system shown 43 %. Thus, since the beginning of the year, the loan portfolio of the Bank grew by 1.9 bln. UAH and approached 4 bln. UAH. is one of the largest lenders for real sector of the national economy, in particular such strategic industries as agriculture, food industry, shipbuilding, etc., where the share of loans extended by the Bank approaches % of the total loan investments. took the lead over other

10 10 Regional Network Development In the course of all 10 years of operations, the Board of the Bank has been giving proper credit to regional network development. Only in the first year since the day of the Bank foundation, there was established 12 branches in different cities across Ukraine. By degrees, the Bank has been implementing a policy assuming the establishment in each and every region of the network structures, capable of competing in local markets and providing the premium quality banking services to all client categories, from the largest corporations to pensioners and students. Thus, in July 2002, the establishment of the base regional network neared completion. In the end of the year, the number of regional divisions of the Bank, located in all regional and district centers and cities of regional subordination, reached 1226, with their majority providing the full range of banking services in conformity with the effective law. There are 25 regional departments and branches of the Bank, each being a medium tier bank; some of them could even be ranked among top twenty Ukrainian banks by a number of indicators. At the same time, the Bank continued ongoing escalation of the client service quality standards, improvement of communication and technical provision of the structural divisions, offering more complete range of banking products via this regional network. In June of the reported year, the Bank started implementation of Ukraine's largest project for integrated banking system in retail business backed by Bankmaster RS software. This project, among other things, provides for establishment of new, more efficient from the advanced banking technology point of view, models of the Bank's branch network and fundamentally new approach towards deployment of banking products and client services for both the head office of the Bank and the regional branches. In addition, last year the Bank started implementation of the project for mass sales of lending products via the network of divisions, in a view to ensure the utmost reach of the banking services to private client households. The total amount of the Bank's investment into the regional network development in the last year reached 100 mln. USD; the Management plans to invest 50 mln. more into the network development in However, even today these investments prove to be completely justified. Today, the regional network is responsible for the lion share of the total growth in the credit and debit transactions made by the Bank. Share of the Bank's Regional Divisions in the Total Value of Credit and Debit Transactions Balance on Client Accounts 77% Funds of Individuals 78% Amount of Loans Extended to Clients 73% Earnings 68%

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12 12 Development of Corporate Banking Business In 2002, welcomed 37,000 companies and organizations. At the same time, the total number of corporate clients grew to 172,000. client offerings include the full range of banking instruments based on the needs, sectors, specific features of business and current financial performance, etc., developing if necessary, custom-tailored systems of settlement with contractors, raising of funds at the stock markets, lending, etc. So, in case of temporary interruption in the circulating assets flows, for instance, at seasonal production fluctuations or production facility upgrade or purchase of fixed assets, the Bank offers the clients diverse options of lending, proceeding from the additional resource requirement, specific features of businesses and financial performance. Such instruments include the general loan agreements for companies regularly raising loan resources for their operations, technical loans, including, among other things, those intended to accelerate settlement in foreign currencies or repayment of accounts receivable/payable, overdraft, factoring, long-term loans, etc. For companies in need of promissory notes for settlement with contractors, the Bank offers discounting of promissory notes thus enabling receipt of funds under the promissory notes before maturity, or lending on the security of such promissory notes. At the same time, the Bank actively helped the clients to raise funds from socalled alternative sources, i.e. in course of issue of corporate shares or bonds. At the same time, the Bank acted as an underwriter of the projects, rendering the complete list of services in preparation for issue of securities to their support throughout the term of circulation period and maintenance of their liquidity in the stock market. Based on on-going needs of the clients and specific features of their respective businesses, the Bank developed a diverse system for settlement with contractors in a view to reduce our clients' risks and accelerate payments. In particular, to avoid the risk of non-payment or non-delivery of products by foreign contractors, the Bank offered the clients a number of documentary forms of settlement such as collection of payments, letter of credit or bank guarantee. In order to raise the reliability of the promissory notes as a form of settlement, the interested companies were offered collateral security of promissory notes, and, for a grace period in respect of budget charges (VAT, excise duty), tax promissory notes. At the same time, analyzing the financial performance of the clients, the Bank's specialists developed not only the optimal package of banking products but also the most efficient system for prospect-oriented business management, reorganization and optimization of businesses, cost management, business planning, tax planning, administrative accounting, etc. For companies having ramified network of representative offices, branches, affiliates, holding or versatile companies with

13 13 Development of Corporate Banking Business many contractors (companies of ship building complex, coal, chemical industries) the Bank provided services of cash flow optimization, effective evaluation of current financial performance, in particular, by using specialized software for financial and business performance analysis based on the Western software suite, adapted to Ukrainian businesses, which provides itemized categorization of earnings and costs for the whole group. In addition, for companies with structural divisions, we developed a number of services, which allow complete controlling and analyzing of cash flow on accounts of all their structural divisions, their earnings and costs, cash inflow and outflow, or, in the event of necessity, accumulating the money receipts on accounts of their head offices or distributing them on different accounts with the pre-set ratios. The product line includes Consolidated Statement, Centralized Follow-up System for Payments, Cash Consolidation, etc. For companies providing services to large numbers of individuals, for instance, insurance or broker companies, mass media, operators of mobile communication and those regularly receiving significant amounts of cash money, the experts of the Bank have been offering our specialized Structured Loan Repayment service that enables supervising the receipt of funds from each and every client and tracing their purpose and details. In addition, for companies that, on the contrary, should pay significant amount of cash money to their customers, employees or representatives, the Bank in the reported year also presented a unique offering, specifically cash payments using the channels of Aval Express system thus enabling the payee to receive money at any branch of the Bank irrespective of the place of residence. At the same time, in the last year we continued active implementation of payroll projects for employees of diverse companies and organizations via payment cards issued by the Bank and issue of corporate cards for the corporate employees. So far, these projects have enabled more than 3,000 of our corporate clients to optimize their accounting and management of representative, overhead and other economic expenses and allowed their analyzing and planning. At the same time, employees of these companies were able to receive nearly full range of consumer loans offered by the Bank, such as Products by Installment, Onyx Installment, and loan facilities on card accounts.

14 14 Lending Business For years, the Bank has been operating as one of the largest lenders for the real sector of Ukrainian economy. Only in 2002, the Bank extended to Ukrainian companies in different sectors of economy 9.4 bln. UAH in loans, which nearly 2 times exceeds the amount of loans extended in At the same time, the loan portfolio of the Bank grew by 1.9 bln. UAH and, as of January 1, 2003, approached 4 bln. UAH. The last year has become something of a breakpoint for lending business of the Bank: in 2002 has dramatically expanded lending business and started financing large industrial companies of transport, metallurgy, heavy engineering, fuel and energy complex, etc. on a broad scale. In particular, significant funds were extended to the State Administration of Railway Transport of Ukraine (Ukrzaliznytsya), NAEK Energoatom, Alchevsky Steel & Iron Works, and Khartsyzsky Pipe Plant. This relatively new experience for was so successful based on the results of 2002 that the Bank plans further expansion of lending for the core sectors of economy. At the same time, in the last year we continued escalation of investments in sectors, which have always been traditional for the Bank's lending business, in particular, telecommunication (Ukrtelecom, UMC) and shipbuilding (Black Sea Shipyard, 61 Kommunar Shipyard, etc.). Financing of these and other sectors has provided significant impulse for their development. Thus, specifically owing to the Bank's loan facilities in the reported year, the Black Sea Shipyard completed construction of NICOS I.V. product tanker to order of AVIN company (Greece) and arctic icebreaking tugboat H.Kanter for Orbis Shipping Co. (Estonia). At the same time, 61 Kommunar Shipyard has also completed and delivered to their customers two ships: arctic trawler Scalaberg and supply ship Scandi Buchan, both ordered by DOF Industri (Norway). Except for own resources, the Bank committed funds for intermediate and long term lending of industrial companies in the framework of loan facilities backed by international financial organi-

15 15 Lending Business zations. In particular, for purchase of imported equipment in Germany, the Bank extended a loan for a term from 2 to 5 years in the form of letter of credit for the account of loan facility issued by Bankgesellschaft Berlin (Germany) in the last May. In addition, the Bank invested considerable funds into development of local infrastructure in Ukraine. For instance, Kyiv City State Administration and their subordinated transport and municipal companies received more than 100 mln. UAH in lending resources for financing of development programs in the capital of Ukraine. Mykolayiv Department of the Bank is authorized to serve cash flows in the framework of the passenger transport development program. Significant funds for purchase of city transport were provided by Dnipropetrovsk Department. The Bank maintain the leadership among Ukrainian banks in lending to companies of agroindustrial complex, which continue to be the core borrowers: in the period from January to December, the Bank extended to the agrarians over 2 bln. UAH, of them 1.13 bln. UAH to agricultural producers and 818 mln. UAH to agricultural product processors. At the same time, whereas in previous years the absolute majority of loans was extended to agrarians in a single season for update of circulating assets, last year significant share of loans was extended for updating of fixed assets, in particular, purchase of agricultural machinery and restoration. In a view to expand opportunities for the agrarians to update their fixed assets, the Bank's last year offerings to agricultural producers included a number of special medium term programs, including, among other things, Agricultural Machinery by Installment, Agricultural Machinery Lease, and Agricultural Machinery on Loan. The companies of agroindustrial complex were enabled to purchase agricultural machinery of domestic or western manufacture by

16 16 Lending Business installment (loan or leasing) for three years at minimum interest rates. In addition, in the last autumn EBRD signed with the Bank a direct agreement on extension of 10 mln. USD in short term loans specifically to agricultural producers, which is an unprecedented event for the Ukrainian banking system. In the last year the Bank was very active in working with small businesses, constantly increasing the amount of their lending. Whereas at the end of 2001, the number of microloans was 200 per month totaling over 1 mln. USD, at the end of 2002, this indicator exceeded 400 loans worth 2 mln. USD. In total since the beginning of operations under EBRD and German-Ukrainian Fund Microlending Program, the Bank extended 5,700 loans worth 41.2 mln. USD, and, only in 2002, more than 3,200 loans worth 19 mln. USD. At the same time, the demand for these Bank's loans continues to grow. Taking into account this fact along with the reliability and financial performance of the Bank, EBRD increased the loan facilities for microlending to nearly 9 mln. USD at the end of the last year. 25% - Food industry 18% - Metallurgy and Metal Working 18% - Machine Building 15% - Wood Processing, Cardboard Production, Printing, etc. 13% - Chemical Production 5% - Textile Industry 6% - Others As a consequence, the total EBRD limit for the Bank reached 50 mln. USD including all operating programs, which is the highest parameter among the Ukrainian banks.

17 17 Lending Business Most important loan projects of Bank in 2002: Joint Stock Company Druzhkivsky Machine-Building Plant Corporation Industrial Union of Donbass Joint Stock Company Ukrtelecom State Administration of Railway Transport of Ukraine (Ukrzaliznytsya) State-owned National Nuclear Energy Generation Company Energoatom Joint Venture Ukrainian Mobile Communication (UMC) Joint Stock Company Ukrainian Motor Corporation Limited Liability Company Grain Trading Company Joint Stock Company Chernigivavtodetal Financial Department of Kyiv City State Administration Closed Joint Stock Company Obolon Joint Stock Company Ukrnafta Closed Joint Stock Company Ukravtorus State-owned Company Zorya-Mashproekt Joint Stock Company Alchevsky Steel & Iron Works Joint Stock Company Odesakabel Limited Liability Company Rosan-Agro Lease Company Salivinkivsky Sugar Plant Oil & Gas Extraction Department of GDU Okhtyrkanaftogas of JSC Ukrnafta Joint Venture Ukrtekhnozintez Joint Stock Company Shostka City Dairy

18 18 Provision of Foreign Economic Activities of Ukrainian companies Today, offers corporate clients pursuing foreign economic activities the ultimately complete list of services ranging from purchase of foreign currency funds on interbank currency markets to comprehensive support of foreign economic contracts and foreign partner search. As the interbank market's largest operator, in 2002 acquired over 550 mln. USD and 370 mln. EUR for provision of settlement for the importer clients. At the same time, the total amount of payments under foreign economic contracts was 7.9 bln. USD. The amount of client transfer grew by 35.4%. The fast pace and quality of export and import settlement of our clients were facilitated by our correspondent network, which covers 217 banks all over the world, including, among others, major banks in Europe, USA, CIS and Baltics. In addition, to reduce our clients' risks under foreign economic contracts non-payment, non-delivery or short delivery and to have a grace period in payment if necessary (including, among other things, more than 90 days), the Bank developed a settlement system using such documentary instruments as bank guarantees and letters of credit, which enjoy significant demand among our clients. Last year, taking into account the increased demand for documentary instruments in the clients of the Bank, in a view to expand such settlement methods, the European Bank for Reconstruction and Development increased 's limit from 6 to 15 mln. USD under the International Trade Assistance Program which provides for EBRD's confirmation of documentary credits and bank guarantees issued by. At the same time, EBRD extended the term of such documentary credits and bank guarantees from 180 to 360 days. As a consequence, the total amount of operations since the beginning of Bank's operations under this program (in August 2001) grew to 16.5 mln. USD, including 13.5 mln. USD since the beginning of the last year. The total amount of documentary operations of the Bank was 57.6 mln. USD. In particular, the amount of operations with documentary credits was 47.1 mln. USD (total number of operations was 250). Total amount of guarantees issued by the Bank grew to 10.6 mln. USD (total number of operations was 63). Except for bank guarantees, the Bank was active providing companies pursuing foreign economic activities with loans in foreign currencies for settlement with foreign contractors for the account of own funds and in the framework of the international facilities extended by EBRD, German-Ukrainian Fund, and Bankgesellschaft Berlin (Germany), including, among other things, payment for fixed assets. In particular, under the facility backed by Bankgesellschaft Berlin (Germany), the total amount of operations at the end of the year was 240,900 USD. The total amount of lending resources received during the year from EBRD was as follows: nearly 10 mln. USD

19 19 Provision of Foreign Economic Activities of Ukrainian companies under the program of direct lending on the security of warehouse receipts for agricultural products; 2.7 mln. USD under the MSP-2 (Lending for Small and Medium Businesses) program; and, under the microlending program, at the end of the year, the loans worth over 8.5 mln. USD were extended. In addition, our client offerings included such special form of short term loans for acceleration of settlement in foreign currencies, as technical loans on the security of the funds, which for technical reasons have not arrived on the client accounts by the specified date. In total for the last year, the amount of loans extended by the Bank in foreign currencies grew to 429 mln. USD compared to mln. USD in In addition, the Bank provided services of collateral security for tax promissory notes, issued for the value added tax liability of products delivered to the customs territory of Ukraine whereby enabling the importer companies to receive grace period for payment of import VAT for the term of up to 30 days. Companies with foreign investment were offered collateral security of promissory notes, issued for execution of customs free importation into the territory of Ukraine of property being the contribution of foreign investor into the authorized capital of the company with foreign investment and under joint investment agreements. In the reported year, was also rather active in providing the exporter and importer clients with services of foreign contractor search backed by partnership with DG Bank (Frankfurt am Main), that provides for issue of Aussenhandel und Binnenmarkt with inquiries arriving from the correspondent banks in Austria, Czechia, Belgium, the Netherlands, France, Spain, etc.

20 20 Transactions in Securities In 2002, the Bank's business in the securities market developed successfully. Bank has earned an ultimate reputation of being both Bank for Banks and Bank for Clients. The Bank offered clients the complete list of services in securities, taking into account the specific features of sectors and businesses of every client: portfolio transactions in securities, commission and guarantee operations. In the course of the reported year, the Bank actively worked in the corporate securities market. The total investment in corporate bonds of financially stable companies amounted to nearly 80 mln. UAH some 18 times growth compared to In addition, one of the priority areas of the Bank's operations in the stock market in 2002 was steep growth in operations servicing issue, placement, and circulation of bonded loans for our clients that ensured financing of their projects with considerably less expensive and longer term loan resources. Thus, in 2002, the Bank acted as a project manager for issue of corporate bonds for JSC Monomakh, CJSC Ukrzernoprom, JSC Building Materials, LLC Stroymaterialmarketing, LLC Argo, etc. The Bank offered corporate clients services of placement temporarily unemployed funds in highly liquid corporate bonds in the Bank's portfolio and other securities circulating in the market. In the reported year, the Bank continued transactions in promissory notes. At the same time, our clients shown significant demand for loans and guarantees. Growth in these transactions enabled 66 % increase in the Bank's earnings compared with Professional depositary operations of the Bank as a custodian of securities shown nearly the same intensity. Well-balanced price policies in the market of custodial services and precisely adjusted mechanism for transactions making have

21 21 Transactions in Securities allowed the Bank to expand the client base by more than 1.5 times. In the course of the reported period, the total amount of transactions on client accounts in securities outgrown that of 2001 by 75 %. As of the end of 2002, the Bank's securities portfolio included corporate bonds with total value over 70 mln. UAH. The total amount of commercial transactions of the Bank with corporate bonds in 2002 has exceeded 125 mln. UAH. 19% - Commercial Bank Bonds 81% - Corporate Bonds

22 22 Retail Business Development 2002 proved to be a year of intensive development in our retail business. Upon completion of the national network formation, the Bank has focused effort on increase in the efficiency of operations, gradually expanding the list of offered services with ongoing improvement of the client service quality. First and foremost, in the reported year the Bank started implementation of large-scale project for mass sales of lending products to individuals via the network of branches in all regions of Ukraine, in particular, purchase of products by installment. As of the end of 2002, nearly 700 separated divisions of the Bank (departments, branches and divisions) started offering the citizens of Ukraine consumer loans for diversified programs. Future development assumes that individuals will be able to receive in any of the 1200 branches of the Bank loans under such programs as Onyx Installment, Car by Installment, and also Residence by Installment, whose implementation started in the last summer. Therefore, the Bank's nation-wide network of branches will be implementing an idea of mass lending for private clients directly at the place of their residence or location. However, even today the Bank enjoys an outstanding position by amount of consumer lending for individuals among all Ukrainian banks. At the same time, the loan portfolio for individuals grew nearly 5 times to 320 mln. UAH based on the last year results. This year, using the loans extended by the Bank: nearly 2000 individuals have become owners of new cars more than 600 families moved to new residence 42,000 citizens of Ukraine purchased household products, furniture, computers, travel tours, other products and services

23 23 Retail Business Development maintains partner relations with many largest trade companies, car dealers, and building organizations in financing of sales to individuals of household products and services, residence, and cars by installment. Lending to employees of legal entities being the corporate clients of the Bank served under payroll program gained momentum. This provides comprehensive services for VIP clients, both legal entities and individuals. Aval Loan service has become a fundamentally new service in the area of lending for the population, being something unique in the Ukrainian market: using this service, the Bank card holders are enabled to pay in retail and receive cash money from ATMs as an unsecured loan at the lowest interest rates in the territory of Ukraine and the majority of the countries in the world. In addition, the Bank considerably expanded the list of mobile banking services for payment card holders: starting from May 2002, M-banking users are enabled to use their mobile phones to change their account access passwords, put their card on the stop list in the event of its loss, etc. At the same time, M-banking is now available not only to individuals but also to corporate clients. Along with this, the Bank offered all individuals an opportunity to order payment cards of any class via corporate site of the Bank in the Internet and started implementation of the pilot project providing the card holders with additional services via ATM network (over 486 ATMs all over Ukraine). In prospect, the Bank plans to enable transfer of funds via ATM from card account to deposit and current accounts, receive mini statements, and pay for mobile communication services.

24 24 Retail Business Development Last year, the Bank started implementation of the project for sale of pre-paid mobile communication, IP-telephony, and Internet access services via the regional branch network. In September 2002, the Bank offered clients new prepaid travel card: Visa TravelMoney Cash Passport, that provides its holders with round-the-clock access to own funds in any country. At the same time, the holders are enabled to change their PIN code for access to funds, control balance of funds, receive reports on transactions, up-to-date information on VISA ATM network via the Internet. Continuing to be the leader in money transfer service for individuals in the Western Union system, actively developed Aval Express, our own unique system of express money transfer. In May 2002, the experts of the Bank suggested to use the system for foreign currency transfer in the territory of Ukraine, and in June, for corporate clients transfer for payment of wages to employees, commission fees to dealers and representatives, advertising payments, etc. At the same time, the network of regional branches operating in Aval Express system, grows constantly: since the beginning of the year their number has nearly doubled, reaching 950. In 2002, the Bank has become a winner in the tender for repayment of debts to the depositors of Bank Ukraina. Using our Aval Express system has allowed making these payments in short terms without queues and complaints of the clients. Owing to consistent policies oriented towards improvement of the existing and implementation of the new products, ongoing improvement of the service standards for individuals, private clientele of the Bank in all regions of Ukraine has been expanding constantly. In the period from January 1 to December 31, 2002 the funds on individuals' accounts with the Bank grew by 1 bln. UAH and reached 2.3 bln. UAH, of which more than 1.6 bln. UAH is on deposit accounts (compared to 700 mln. UAH in to the year beginning). At the same time, the number of pension accounts doubled compared with the beginning of the year and, as of January 01, 2003, the total number of accounts for receipt of pensions and other social benefits exceeded 450,000. In 2002, the Bank paid considerable attention to development of payment cards business. At the same time, preference was given to quantitative rather than qualitative parameters. The number of cards issued Bank for individuals reached 900,000, having grown by more than 500,000 since the year beginning. Total number of acquiring outlets

25 25 Retail Business Development reached 3600, growth by more than 600 since the beginning of the year. Considering the significant amount of operations with cards being the issue of cash money, in 2002 the Bank continued to expand the ATM network and improve the quality of our operations. In 2002, our ATM network expanded to 300 ATMs, installed in locations convenient for our clients maintaining, in their overwhelming majority, round-the-clock operations.

26 26 Interbank Business has remained one of the leaders in the interbank market. In the last year, the Bank considerably intensified offerings and services for small and medium banks. Today, our partner banks enjoy the full range of products custom-tailored to specific features of every contractor's business. Our products include management of multi-currency correspondent accounts, payments, documentary operations, trade financing, payment card transactions, etc. However, along with the traditional services, also offers such new for Ukrainian market banking products as settlement service for banks (Bank-to-Bank system), services of satellite communication for on-line money settlement, Aval Express money transfer system, insurance services, consortium lending for clients, margin trade and trade in banking metals, support of the bank regulatory specifications, implementation of expert evaluation of property and legal advise. In particular, for banks whose clients include companies with ramified dealer or branch networks in the territory of Ukraine, year we developed fundamentally new form of services in the last: using the services of branches and divisions with the purpose to accelerate settlement. Our partner banks are provided with more convenience in their operations by our own satellite communication system, which ensures real time connection in every region of Ukraine. In addition, in the last year the Bank has entered the market with unique product that enables the partner banks to considerably reduce risk of illiquidity and change in the interest rates in the market. This products is an interest option, i.e. an obligation of the seller (the bank), to extend an interbank loan whose amount, interest rate, and term are determined at the time of selling the option. In the last year Bank Aval launched another new product: interbank loans secured with assets and loan portfolio of the Bank which is also unprecedented among the Ukrainian banks. As one of the leaders in the retail market of Ukraine and CIS, has been intensively cooperating with other banks in the area of issue and service of payment cards, using a large number of flexible and effective instruments. In addition, the Bank leads the Western Union transfer market and is one of the largest direct agents of the company in Ukraine with 1,169,000 agencies, offers cooperation in the area of express money transfer. At the same time, provides partner banks with custom-tailored terms and individual programs, offering flexible tariff policies and opportunity to receive services in packages based on the needs of specific banks and sector specific features. Based on the results of 2002, the number of correspondent banks grew to 217, the number of multi-currency loro accounts of in Ukraine, Baltics and CIS countries reached 137. The total number of contractor banks, with which established crediting threshold, grew to 132, including banks in the foreign countries and ex-ussr. The number of general agreements made with the partner banks grew to 172 in 2002.

27 27 Information Technology Development Development of the ramified regional network in Ukraine, massive deployment of new banking products and client service technologies at the branch level resulted in a necessity to improve the information technology and software for the business processes of the Bank. Throughout the year, we have upgraded and connected regional divisions to the Robin software suite for higher quality and complete client services, improved existing and implemented radically new banking products, bringing the full range of services to ultimate customers via the regional network of the Bank. In particular, in the reported year we developed and deployed a number of new features of the Robin software suite across the Bank's system, specifically, automatic prolongation of the term of deposit accounts (based on client authorization), transfer of deposits of individuals from one branch to another (on request of the client) and repayment of consumer loans and interests on them directly at the branch nearest to the borrower. In addition, in June 2002 the Bank started implementation of Ukraine's largest project of integrated banking system for retail business based on Bankmaster RS software that will enable considerably acceleration of client services and expansion of the list of services, both in the head office and regional branches across Ukraine. This particular project enabled the clients of the Bank to use the any and all services (replenish the accounts, receive funds from account, receive consumer loans, etc.) at any branch, irrespective of the branch where the account was opened. At the same time, the Bank completed the deployment of corporate land telecommunication network providing connection of all branches to the universal infospace and operation of own IP telephony system. Along with this, in the last year we continued implementation of electronic document circulation system powered by one of the best international software products Documentum and IRBIS software for centralized data processing. Next year, also plans to implement such IRBIS modules as payroll and business costs accounting system.

28 28 Management of Risks, Liquidity Provision Last year, the Bank, as always, strictly and timely complied with the requirements of the Law Ukraine "On banks and banking operations" and the National Bank of Ukraine ("NBU") in relation to obligatory economic specifications, including, among other things, solvency of current and urgent liquidity. At the same time, the internal approaches of the Bank towards limitation of risks were even stricter, than those of the NBU. As a consequence, average weighted values of the indicators normally exceeded the specification, that ensured ultrahigh level of the Bank's financial stability and facilitated development throughout the year. Advanced internal procedures and careful approach towards estimation of loan risks and provision of relevant reserves enabled the Bank to maintain high quality loan portfolio with constant growth. The total amount of reserves generated by the Bank as of January 1, 2002 made 284 mln. UAH, of them 268 mln. UAH secure loan-related risks. In 2002, the management of liquidity at the Bank has entered fundamentally new stage. In a view to achieve the utmost efficiency and flexibility throughout the nationwide network of regional divisions of the Bank, the management of liquidity was concentrated at the head office level. At the same time, such functions as analysis, forecast, and planning of liquidity, modeling of liquidity based on changes in internal and external factors, and development of the relevant recommendations and establishment of the limits for regional divisions was delegated to the Committee for Management of Assets and Liabilities as their exclusive competence. Henceforth, our divisions make provisions their operations in the scope of strictly defined scheduled targets and allocated limits that enables concentration of their effort on quality improvement of the services they rendered to their clients. The transition towards such centralized system enabled optimizing and synchronizing the processes of liquidity management across the Bank's system in its entirety including regional specific features of structural divisions and, specifically, development of regions and ensured their flexibility and efficiency based on current market situation. Main Economic Specifications* January 01, 2003 S1 S2 S3 S4 S5 S6 Minimum value of regulatory capital (minimum value 5,000,000 Euro), in UAH Adequacy Ratio of Regulatory Capital (minimum value 8%) 9,51 % Adequacy Ratio of Fixed Capital (minimum value 4%) 7,30 % Instant Liquidity Ratio (minimum value 20%) 36,52 % Current Liquidity Ratio (minimum value 35%) 46,02 % Prompt Liquidity Ratio (minimum value 20%) 30,29 % * Economic standards were designed in conformity with the Procedural Regulations of Banking Operations in Ukraine, approved by the National Bank of Ukraine Resolution # 368 dated August 28, 2001.

29 29 Staff Development To a considerable extent, successful operations of the Bank in 2002 were made possible by high professional level of our employees. The last year was for the Bank a year of transition towards new technology of staff management, further improvement of the organizational structure and quantitative optimization of our staff. The Bank's Management effort focus on solving the problems of growing the thousand-strong cadre of employees into the utmost professional well-balanced team. For this purpose, there was started implementation of qualitatively new system for selection and evaluation of employees, which takes into account specific features of work at every structural division, improved instruments of motivation, including, among other things, target compensation packages; and relevant conditions for further improvement of the professional level of the employees. For the third year in a series, the Bank has effectively operated a system of continuous education of employees, including, among other things, and management staff at all levels. Very diverse forms of qualification improvement in 2002 covered over 3000 employees, 900 of them took training in base and three regional training centers of the Bank. In total, we developed and implemented 10 training programs. The most topical and important of them are our ongoing programs for consumer lending, qualification improvement, which covered more than 350 branch managers. One of the components of our comprehensive management staff development program is long term cooperation between and the International Institute Management (IIM Kyiv). 22 managers who today are the personnel targeting top managemnt posts in the Bank, have successfully completed training under the 2 year Master of Business Administration program. In spite of rather high professional and educational level of our staff (nearly 80% of employees have higher and incomplete higher education with over 150 studying in higher educational institutions), the Board of the Bank pays significant attention to staff reserves. An impor-

30 30 Staff Development tant step in this direction is on-going implementation of the project. Aval Chance is backed by selection of the best students from high schools for their future employment with the Bank. This Project presentations were held in the nine best Universities and Academies of Ukraine, in particular, in Kyiv State Trade and Economic University, Ukrainian Academy of Banking, Kharkiv National University, Odesa State Economic University and Ternopil Academy of National Economy. More than 500 students all over Ukraine have already applied for prospective enrollment to the Bank's staff.

31 31 Core Operation Performance Balance for 2002 /x 1,000 UAH/ ASSETS Funds and Balance in NBU 517, ,752 Treasury and other securities, 1,523, ,739 refinanced by the National Bank of Ukraine, and securities, issued by the National Bank of Ukraine Funds in other banks 535, ,990 Securities for Sale 54,061 69,381 Loan and Debts of Clients 1,948,051 4,029,699 Investment Securities 2,333 83,389 Long Term Investments into Affiliated Companies and Subsidiaries 15,392 13,867 Fixed Assets and Intangible Assets 288, ,666 Accounted Incomes Receivable 13,852 13,818 Other Assets 195, ,975 Total Assets 5,095, ,276 LIABILITIES Banks Funds 131, ,432 Clients Funds 4,494,532 5,005,724 Other Deposits 58,419 2 Debt Securities, issued by the Bank 0 0 Accounted Costs Payable 26,419 40,466 Other Liabilities 97,848 34,254 Total Liabilities 4,808,732 5,378,878 EQUITY Authorized Capital 210, ,000 Capitalized Dividends 0 0 Shares Redeemed from Shareholders 0 (3,038) Issue Differences 0 0 Reserves 7,521 14,425 Results of revaluation 6,657 6,634 Retained Profits 62,132 81,377 Out of them: revaluation in the event of non-circulating assets withdrawal 5,427 5,450 Total Equity 286, ,398 Total Liabilities 5,095,042 5,978,276

32 32 Core Operation Performance Financial Results Report for 2002 /x 1,000 UAH/ Interest Earnings 594, ,858 Interest Expenses (290,840) (395,661) Net Interest Earnings 303, ,197 Commission Earnings 271, ,123 Commission Expenses (20,236) (26,697) Net Commission Earnings 251, ,426 Dividend Earnings 894 1,982 Net Trade Earnings 26,700 41,247 Profit/loss from Investment Securities (2,176) 1,380 Profit from long-term investment into affiliated companies and subsidiaries, and other investments 0 72 Other Operating Earnings 5,111 4,597 Operating earnings 585, ,901 General administrative expenses (210,135) (303,166) Staff Expense (280,641) (342,717) Operating Profits 94,640 59,018 Costs of Bad and In-Doubt debts (86,314) (51,770) Profit Before Taxes 8,326 7,248 Profit Tax (4,040) (2,926) Profit After Taxes 4,286 4,,322 Unforeseen expenses (12) 45 Net profit/loss of the Bank 4,274 4,367 Net profit per ordinary share 0,0023 0,0013 Adjusted net profits per ordinary share 0,0023

33 33 Core Operation Performance Core operation performance of the Bank for 2002 is presented in the figures below Structure of 's Authorized Capital as of January 01, Shareholders Share in the Authorized Capital, (%) Legal entities out of them: JSC Ukrtelecom 2.11 Ukrainian Mail Company Ukrposhta Other legal entities out of them: IC Еtalon 9.00 Individuals Own shares redeemed % 0.61% 83.86% Share in the Total Amount of the Banking System Operations Description January 01, 2002 January 01, 2003 Net assets 10.7% 9.4% Legal Entities' Funds 16.4% 12% Individuals' Funds 9.7% 12% Loan Portfolio 7.7% 10.4% Development of Regulatory Capital /x 1,000 UAH/ Development of Loan and Investment Portfolio of the Bank /x 1,000 UAH/ January 01, 2002 January 01, 2003 January 01, 2002 January 01, 2003

34 34 Основнi показники дiяльностi Банку Development of Deposits of Legal Entities and Individuals /x 1,000 UAH/ Development of Net Profit /x 1,000 UAH/ January 01, 2002 January 01, 2003 January 01, 2002 January 01, 2003 Development of Bank's Net Assets /x 1,000 UAH/ Development of Liabilities /x 1,000 UAH/ January 01, 2002 January 01, 2003 January 01, 2002 January 01, 2003

35 35 The Bank and the Society Support of social sphere, culture, and arts has always been an ongoing component of 's overall strategy. In 2002, the Board of the Bank continued implementation of target charitable and patronage of art programs initiated in the recent years, in a view to ensure their utmost efficiency and contributed into the new projects for restoration of Ukrainian monuments, cultural values, and building of outstanding persons monuments. As the General Sponsor of Ivan Franko National Academic Drama Theatre, spent significant funds for restoration of the repertoire and tours, Ivan Franko National Academic Drama Theater paid grants to 18 actors being the veterans of the theatre. Significant funds are committed by the Bank for development of education in the framework of the Rural School program, including, among other things, computers, training and methodical literature, sports items etc. In addition, continued implementation of the Fellowship Program for the best students of economic specialties at the major high schools of Ukraine, in particular Kyiv National Economic University, Sumy Academy of Banking, Dnipropetrovsk National University, Academy of Customs Services of Ukraine. In addition, has been rendering financial support for development of sports and physical training of children and youth in Ukraine for years. Since 1998, the Bank has been the sponsor of Kozhany myach (Leather Ball) Club Football Competition which this year gathered over 42,000 children's team and many hundred thousands of schoolboys. After the national tragedy in Sknilov, immediately opened charitable accounts in UAH, USD and EUR for charitable contributions of individuals and legal entities in favor of those suffered and their families and provided the initial contribution of 70,000 UAH. Every regional division of the Bank strives to contribute into development of charity and sponsorship. Regional departments, branches, and divisions implement their own programs, provide assistance to their sponsored facilities. 's Board will provide further care for charity, revival of domestic patronage of arts, support of medicine, education, sports, assistance to those who need it. This is 's vision of moral obligation before the society at large and the public mission of our shareholders, partners, and staff. The Rugal School program