PROCREDIT BANK AD - SKOPJE. Financial Statements prepared in accordance with International Financial Reporting Standards

Transcription

1 PROCREDIT BANK AD - SKOPJE Financial Statements prepared in accordance with International Financial Reporting Standards For the year ended 31 December 2007

2 Financial statements for the year ended 31 December 2007 Content Page Independent auditor s report 1-2 Income statement 3 Balance sheet 4 Statement of changes in equity 5 Cash flow statement 6-7 Notes to the financial statements 8-58

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5 Financial statements for the year ended 31 December 2007 Income statement Notes Year ended 31 December Interest and similar income 5 1,043, ,158 Interest expense and similar charges 5 (307,584) (202,578) Net interest income 736, ,580 Fee and commission income 6 102,001 75,967 Fee and commission expense 6 (20,971) (17,836) Net fee and commission income 81,030 58,131 Foreign exchange differences (net) 29,997 25,947 Other operating expenses 7 (690,272) (517,652) Other operating income 9,008 5,593 Impairment losses 9 (22,440) (32,204) Profit before income tax 143,408 86,395 Income tax expenses 10 (20,971) - Net profit for the year 122,437 86,395 The notes on pages 8 58 are an integral part of these financial statements 3

6 Financial statements for the year ended 31 December 2007 Balance sheet Notes At 31 December ASSETS Cash and balances with the Central Bank , ,023 Treasury bills , ,811 Loans and advances to banks 13 1,052, ,225 Loans and advances to customers 14 6,334,028 4,396,200 Investment securities: - Available for sale , ,083 Property and equipment , ,845 Intangible assets 17 42,532 30,881 Deferred income tax asset 25-4,037 Other assets 18 39,814 20,179 Total assets 9,577,663 6,712,284 LIABILITIES Deposits from banks and other financial institutions , ,085 Customer and other deposits 20 6,009,441 4,182,788 Debt securities ,369 - Borrowings 22 1,531,906 1,227,271 Subordinated debt , ,139 Other liabilities 24 32,793 21,447 Current income tax liabilities 4,433 - Deferred income tax liabilities 25 4,826 - Total liabilities 8,731,672 5,988,730 SHAREHOLDERS EQUITY Share capital , ,712 Statutory reserve 21,252 8,293 Retained earnings 211, ,549 Total equity 845, ,554 Total equity and liabilities 9,577,663 6,712,284 The notes on pages 8 58 are an integral part of these financial statements 4

7 Financial statements for the year ended 31 December 2007 Statement of changes in equity Share capital Statutory reserve Accumulated earnings Total equity Balance at 1 January ,712-23, ,159 Profit for the year ,395 86,395 Total recognized income for ,395 86,395 Transfer to statutory reserve - 8,293 (8,293) - Balance at 31 December ,712 8, , ,554 Balance at 1 January ,712 8, , ,554 Profit for the year , ,437 Total recognized income for , ,437 Transfer to statutory reserve - 12,959 (12,959) - Balance at 31 December ,712 21, , ,991 The Bank s share capital consists of 2 million ordinary shares. All shares have a par value of 5 EUR. Note 29 contains in depth information over this issue. The notes on pages 8 58 are an integral part of these financial statements 5

8 Financial statements for the year ended 31 December 2007 Cash flow statement Note Year ended 31 December Cash flow statement from operating activities Profit before tax 143,408 86,395 Adjustments for: Depreciation of property and equipment and amortisation of intangible assets 7 73,700 48,375 Written off property and equipment Impairment losses 9 22,440 32,204 Interest income 5 (1,043,669) (749,158) Interest expense 5 307, ,578 Interest receipts 1,025, ,969 Interest paid (293,458) (202,578) Cash flows from operating profits before changes in operating assets and liabilities 236, ,686 (Increase)/ Decrease in operating assets Restricted accounts 8,983 (5,215) Balances with NBRM (50,513) (164,083) Loans and advances to customers (1,942,337) (1,567,167) Income tax paid (7,675) - Other assets (19,636) (1,498) Increase/(Decrease) in operating liabilities Deposits from banks and other financial institutions 129, ,360 Amounts owed to other depositors 1,826,106 1,416,144 Other liabilities 11,346 (621) Net cash from operating activities 192,331 95,606 Cash flows from investing activities Acquisition of property and equipment (199,936) (107,624) Investment securities acquired (75,191) (332,083) Net cash used in investing activities (275,127) (439,707) The notes on pages 8 58 are an integral part of these financial statements 6

9 Financial statements for the year ended 31 December 2007 Cash flows from financing activities Proceeds from borrowings 490, ,845 Repayments of borrowings (36,721) (36,704) Proceeds from debt securities 298,956 - Net cash from financing activities 752, ,141 Net increase in cash and cash equivalents 669,762 (71,960) Cash and cash equivalents at beginning of year 1,414,116 1,486,076 Cash and cash equivalents at end of year 30 2,083,878 1,414,116 The notes on pages 8 58 are an integral part of these financial statements 7

10 1 General Information ProCredit Bank A.D., Skopje (further the Bank ) is licensed to perform all banking activities in accordance with the law. The Bank has been registered as a Stock Company domiciled in Republic of Macedonia. The bank is a subsidiary of the ProCredit Holding AG, which controls 87.5% of the voting shares of the Bank. ProCredit Holding AG is the ultimate parent of the Bank. The address of its registered office is as follows: Bul Jane Sandanski 109a 1000 Skopje Republic of Macedonia Employees As of 31 December 2007 ProCredit Bank A.D. - Skopje employed 737 persons (2006: 537 persons). Management The names of the Management of the Bank serving during the financial year and to the date of this report are as follows: General Manager Deputy General Manager Borislav Kostadinov Jovanka Joleska Popovska 8

11 2 Accounting policies The principal accounting policies adopted in the preparation of these financial statements are set out below: A Basis of presentation The financial statements of ProCredit Bank A.D. - Skopje have been prepared in accordance with International Financial Reporting Standards (IFRS) and are stated in Macedonian Denars (MKD). The Bank s parent Company is ProCredit Holding AG that has 87.5% ownership over ProCredit Bank AD Skopje. These financial statements have been prepared under the historical cost convention as modified by the revaluation of available for-sale financial assets and financial assets held for trading. The preparation of financial statements in conformity with IFRS requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although these estimates are based on management s best knowledge of current events and actions, actual results ultimately may differ from those estimates. Those areas where assumption and estimates are significant to the financial statement are disclosed in Note 4. (a) Adoption of New or Revised Standards and Interpretations Certain new IFRSs became effective for the Bank from 1 January Listed below are those new or amended standards or interpretations which are or in the future could be relevant to the Bank s operations and the nature of their impact on the Bank s accounting policies. All changes in accounting policies were applied retrospectively with adjustments made to the retained earnings at 1 January 2006, unless otherwise described below. IFRS 7, Financial Instruments: Disclosures and a complementary Amendment to IAS 1 Presentation of Financial Statements Capital Disclosures (effective from 1 January 2007). The IFRS introduced new disclosures to improve the information about financial instruments, including about quantitative aspects of risk exposures and the methods of risk management. The new quantitative disclosures provide information about the extent of exposure to risk, based on information provided internally to the entity s key management personnel. Qualitative and quantitative disclosures cover exposure to credit risk, liquidity risk and market risk including sensitivity analysis to market risk. IFRS 7 replaced IAS 30, Disclosures in the Financial Statements of Banks and Similar Financial Institutions, and some of the requirements in IAS 32, Financial Instruments: Disclosure and Presentation. The Amendment to IAS 1 introduced disclosures about the level of an entity s capital and how it manages capital. The new disclosures are made in these financial statements. 9

12 DRAFT Other new standards or interpretations. The Bank has adopted the following other new standards or interpretations which became effective from 1 January 2007: IFRIC 7, Applying the Restatement Approach under IAS 29 (effective for periods beginning on or after 1 March 2006); IFRIC 8, Scope of IFRS 2 (effective for periods beginning on or after 1 May 2006); IFRIC 9, Reassessment of Embedded Derivatives (effective for annual periods beginning on or after 1 June 2006); IFRIC 10, Interim Financial Reporting and Impairment (effective for annual periods beginning on or after 1 November 2006). The new IFRIC interpretations 7 to 10 did not significantly affect the Bank s financial statements. (b) New Accounting Pronouncements Certain new standards and interpretations have been published that are mandatory for the Bank s accounting periods beginning on or after 1 January 2008 or later periods and which the Bank has not early adopted: IFRS 8, Operating Segments (effective for annual periods beginning on or after 1 January 2009). The Standard applies to entities whose debt or equity instruments are traded in a public market or that file, or are in the process of filing, their financial statements with a regulatory organisation for the purpose of issuing any class of instruments in a public market. IFRS 8 requires an entity to report financial and descriptive information about its operating segments and specifies how an entity should report such information. Management does not expect IFRS 8 to affect the Bank s financial statements. IAS 23, Borrowing Costs (revised March 2007; effective for annual periods beginning on or after 1 January 2009). The revised IAS 23 was issued in March The main change to IAS 23 is the removal of the option of immediately recognizing as an expense borrowing costs that relate to assets that take a substantial period of time to get ready for use or sale. An entity is, therefore, required to capitalize such borrowing costs as part of the cost of the asset. The revised Standard applies prospectively to borrowing costs relating to qualifying assets for which the commencement date for capitalization is on or after 1 January Puttable financial instruments and obligations arising on liquidation IAS 32 and IAS 1 Amendment (effective from 1 January 2009). The amendment requires classification as equity of some financial instruments that meet the definition of a financial liability. The Bank does not expect the amendment to affect its financial statements. 10

13 IAS 1, Presentation of Financial Statements (revised September 2007; effective for annual periods beginning on or after 1 January 2009). The main change in IAS 1 is the replacement of the income statement by a statement of comprehensive income which will also include all non-owner changes in equity, such as the revaluation of available-for-sale financial assets. Alternatively, entities will be allowed to present two statements: a separate income statement and a statement of comprehensive income. The revised IAS 1 also introduces a requirement to present a statement of financial position (balance sheet) at the beginning of the earliest comparative period whenever the entity restates comparatives due to reclassifications, changes in accounting policies, or corrections of errors. The Bank expects the revised IAS 1 to affect the presentation of its financial statements but to have no impact on the recognition or measurement of specific transactions and balances. IAS 27, Consolidated and Separate Financial Statements (revised January 2008; effective for annual periods beginning on or after 1 July 2009). The revised IAS 27 will require an entity to attribute total comprehensive income to the owners of the parent and to the non-controlling interests (previously minority interests ) even if this results in the non-controlling interests having a deficit balance (the current standard requires the excess losses to be allocated to the owners of the parent in most cases). The revised standard specifies that changes in a parent s ownership interest in a subsidiary that do not result in the loss of control must be accounted for as equity transactions. It also specifies how an entity should measure any gain or loss arising on the loss of control of a subsidiary. At the date when control is lost, any investment retained in the former subsidiary will have to be measured at its fair value. The Bank is currently assessing the impact of the amended standard on its financial statements. IFRS 3, Business Combinations (revised January 2008; effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after 1 July 2009). The revised IFRS 3 will allow entities to choose to measure non-controlling interests using the existing IFRS 3 method (proportionate share of the acquiree s identifiable net assets) or on the same basis as US GAAP (at fair value). The revised IFRS 3 is more detailed in providing guidance on the application of the purchase method to business combinations. The requirement to measure at fair value every asset and liability at each step in a step acquisition for the purposes of calculating a portion of goodwill has been removed. Instead, goodwill will be measured as the difference at acquisition date between the fair value of any investment in the business held before the acquisition, the consideration transferred and the net assets acquired. Acquisition-related costs will be accounted for separately from the business combination and therefore recognised as expenses rather than included in goodwill. An acquirer will have to recognise at the acquisition date a liability for any contingent purchase consideration. Changes in the value of that liability after the acquisition date will be recognised in accordance with other applicable IFRSs, as appropriate, rather than by adjusting goodwill. The revised IFRS 3 brings into its scope business combinations involving only mutual entities and business combinations achieved by contract alone. The Bank is currently assessing the impact of the amended standard on its financial statements. 11

14 IFRIC 11, IFRS 2 Group and Treasury Share Transactions (effective for annual periods beginning on or after 1 March 2007); IFRIC 12, Service Concession Arrangements (effective for annual periods beginning on or after 1 January 2008); IFRIC 13, Customer Loyalty Programmes (effective for annual periods beginning on or after 1 July 2008); IFRIC 14, IAS 19 The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction (effective for annual periods beginning on or after 1 January 2008). The new standards and interpretations are not expected to significantly affect the Bank s financial statements. B Foreign currencies Functional and presentation currency Items included in the financial statements are measured using the currency of the primary economic environment in which the Bank operates. The Bank financial statements are presented in MKD, which is the Bank functional and presentation currency. Transactions and balances Assets and liabilities denominated in foreign currency are translated into MKD at exchange rates ruling at the balance sheet date. Transactions denominated in foreign currency are translated into MKD at the exchange rates valid at the date of the transactions. Gains and losses resulting from the settlement of such transactions and from the translation of monetary assets and liabilities denominated in foreign currencies are recognized in the income statement. Exchange rate: 31 December December 2006 MKD MKD USD EUR

15 C Interest income and expense Interest income and expense for all interest-bearing financial instruments, are recognised within interest income and interest expense in the income statement using the effective interest method. The effective interest method is a method of calculating the amortised cost of a financial asset or a financial liability and of allocating the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, the Bank estimates cash flows considering all contractual terms of the financial instrument (for example, prepayment options) but does not consider future credit losses. The calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums or discounts. Once a financial asset or a group of similar financial assets has been written down as a result of an impairment loss, interest income is recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss. D Fee and commission income Fees and commissions are generally recognized on an accrual basis when the service has been provided. Loan disbursement fee that are likely to be drawn down are deferred and recognized as an adjustment to the effective interest rate on the loan. E Financial assets The Bank classifies its financial assets in following categories: loans and receivables, available-for-sale financial assets and financial assets held for trading. The Management determines the classification of its financial assets at initial recognition. All financial assets except investment securities and treasury bills are classified as loans and receivables. Loans and receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They arise when the Bank provides money to a debtor with no intention of trading the receivable. Loans are recognized when cash is advanced to the borrowers and are carried at amortized cost using the effective interest method. Available-for-sale Available-for-sale investments are those intended to be held for an indefinite period of time, which may be sold in response to needs for liquidity. Available-for-sale financial assets are subsequently re-measured at fair value based on quoted market. Unrealized gains and losses arising from changes in the fair value of securities classified as available-for sale are recognised in equity. 13

16 All regular way purchases of available-for-sale investments are recognised at trade date, which is the date that the Bank commits to purchase the asset. Interest calculated using the effective interest method and foreign currency gains and losses on available-for-sale debt investments are recognised in the income statement. Held for trading A financial asset is classified as held for trading if it is acquired principally for the purpose of selling or repurchasing it in the near term and for which there is evidence of a recent actual pattern of short-term profit-taking. Interest earned on trading assets calculated using the effective interest method is presented in the income statement as interest income. All other elements of the changes in the fair value and gains or losses on derecognition are recorded in profit or loss as gains less losses from trading assets in the period in which they arise. The only trading assets held by the Bank are Treasury bills. F Offsetting financial instruments Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right to set off the recognized amounts and when there is an intention to settle on a net basis, or realize the asset and settle the liability simultaneously. G (a) Impairment of financial assets Assets carried at amortised cost The Bank assesses at each balance sheet date whether there is objective evidence that a financial asset or group of financial assets is impaired. A financial asset or a group of financial assets is impaired and impairment losses are incurred only if there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a loss event ) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated. The criteria that the Bank uses to determine that there is objective evidence of an impairment loss include: Delinquency in contractual payments of principal or interest; Cash flow difficulties experienced by the borrower (for example, equity ratio, net income percentage of sales); Breach of loan covenants or conditions; Initiation of bankruptcy proceedings; Deterioration of the borrower s competitive position; Deterioration in the value of collateral; Legal and other difficulties in enforcing the bank s rights to repossess collateral. 14

17 The estimated period between a loss occurring and its identification is determined by local management for each identified portfolio. In general, the period used is one month. The Bank first assesses whether objective evidence of impairment exists individually for financial assets that are individually significant, and individually or collectively for financial assets that are not individually significant. If the Bank determines that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, it includes the asset in a group of financial assets with similar credit risk characteristics and collectively assesses them for impairment. Assets that are individually assessed for impairment and for which an impairment loss is or continues to be recognised are not included in a collective assessment of impairment. The amount of the loss is measured as the difference between the asset s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset s original effective interest rate. The carrying amount of the asset is reduced through the use of an allowance account and the amount of the loss is recognised in the income statement. If a loan or held-to-maturity investment has a variable interest rate, the discount rate for measuring any impairment loss is the current effective interest rate determined under the contract. The calculation of the present value of the estimated future cash flows of a collateralised financial asset reflects the cash flows that may result from foreclosure less costs for obtaining and selling the collateral, whether or not foreclosure is probable. For the purposes of a collective evaluation of impairment, financial assets are grouped on the basis of similar credit risk characteristics (i.e. on the basis of the Bank s grading process that considers asset type, industry, geographical location, collateral type, past-due status and other relevant factors). Those characteristics are relevant to the estimation of future cash flows for groups of such assets by being indicative of the debtors ability to pay all amounts due according to the contractual terms of the assets being evaluated. Future cash flows in a group of financial assets that are collectively evaluated for impairment are estimated on the basis of the contractual cash flows of the assets in the Bank and historical loss experience for assets with credit risk characteristics similar to those in the Bank. Historical loss experience is adjusted on the basis of current observable data to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of conditions in the historical period that do not currently exist. Estimates of changes in future cash flows for groups of assets should reflect and be directionally consistent with changes in related observable data from period to period (for example, changes in unemployment rates, property prices, payment status, or other factors indicative of changes in the probability of losses in the Bank and their magnitude). The methodology and assumptions used for estimating future cash flows are reviewed regularly by the Bank to reduce any differences between loss estimates and actual loss experience. 15

18 When a loan is uncollectible, it is written off against the related provision for loan impairment. Such loans are written off after all the necessary procedures have been completed and the amount of the loss has been determined. If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised (such as an improvement in the debtor s credit rating), the previously recognised impairment loss is reversed by adjusting the allowance account. The amount of the reversal is recognised in the income statement in impairment charge for credit losses. (b) Assets classified as available for sale The Bank assesses at each balance sheet date whether there is objective evidence that a financial asset or a group of financial assets is impaired. In the case of equity investments classified as available for sale, a significant or prolonged decline in the fair value of the security below its cost is considered in determining whether the assets are impaired. If any such evidence exists for available-for-sale financial assets, the cumulative loss measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that financial asset previously recognised in profit or loss is removed from equity and recognised in the income statement. Impairment losses recognised in the income statement on equity instruments are not reversed through the income statement. If, in a subsequent period, the fair value of a debt instrument classified as available for sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised in profit or loss, the impairment loss is reversed through the income statement. (c) Renegotiated loans Loans that are either subject to collective impairment assessment or individually significant and whose terms have been renegotiated are no longer considered to be past due but are treated as new loans. In subsequent years, the asset is considered to be past due and disclosed only if renegotiated. H Property and equipment All property and equipment is stated at historical cost less accumulated depreciation. Historical cost includes expenditures that are directly attributable to the acquisition of the items. Subsequent cost are included in the assets carrying amount or are recognized as separate asset, only when it is probable that future economic benefits associated with the item will flow to the Bank and the cost of the item can be measured reliably. The assets residual value and useful lives are reviewed and adjusted as appropriate at each balance sheet date. Assets that are subject to amortization are reviewed for the impairment whenever events that occur indicate that the carrying amount may not be recoverable and assets carrying amount is written down immediately to its recoverable amount. Gains and losses on disposals are determined by comparing proceeds with carrying amount. These are included in other operating expenses in the income statement. 16

19 Depreciation of other assets is calculated using the straight-line method to allocate their cost to their residual values over their estimated useful lives, as follows: Buildings Leasehold improvements Computers Furniture and equipment 40 years 7-10 years 4 years 4-10 years I Intangible assets Intangible assets consist of computer software and licences. The initial cost of acquiring the intangible asset is recognised as an asset and amortised on a straight-line basis over the estimated useful life, not exceeding a period of 5 years. J Leases The leases entered into by the Bank are primarily operating leases regarding the rent of the Branches and Head office. The total payments are charged to the income statement on a straight line basis over the period of the lease. K Cash and cash equivalents For the purposes of the cash flow statement, cash and cash equivalents comprise balances with less than three months maturity from the date of acquisition, including: cash and non-restricted balances with central banks, treasury bills (eligible for refinancing with central banks) and loans and advances to banks. L Provisions Provisions are recognised when the Bank has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate of the amount of the obligation can be made. M Fiduciary activities The Bank acts as trustees that result in placing of assets in State bills on behalf of individuals and Companies. These assets and income arising thereon are excluded from those financial statements, as they are not the Bank assets. N Employee benefits The Bank, in the normal course of business, makes payments on behalf of its employees for pensions, health care, employment and personnel tax that are calculated on the basis of gross salaries and wages, food allowances and travel expenses according to the legislation. The Bank makes these contributions to the Government s health and retirement funds, at the statutory rates in force during the year, based on gross salary payments. The Bank pays contributions to public pension insurance fund on a mandatory basis. Once the contributions have been paid, the Bank has no further payment obligations. The regular contributions constitute costs for the year in which they are due and as such are included in staff costs. The cost of these payments is charged to the income statement in the same period as the related salary cost. 17

20 The Bank does not operate any other pension scheme or post retirement benefits plan and consequently, has no obligation in respect of pensions to the employees. In addition, the Bank is does not operate shared based compensation plan in exchange to the employee services provided. O Deferred income tax Income tax on the profit or loss comprises current and deferred tax. Current tax is the expected tax payable on the taxable income for the year, using tax rates enacted or substantially enacted at the balance sheet date and any adjustment to tax payable in respect of previous years. The applicable tax rate for the reviewed period in accordance with the Corporate Income Tax Law tax was 12%. Starting from the year 2008 and according to amendments to the Corporate Income Tax Law the corporate income tax rate will be reduced to 10%. Based on the applicable income tax law the Bank has tax holidays for a period of 3 years from the year the Bank started to be profitable. Deferred income tax is provided, using the balance sheet liability method, for all temporary differences arising between the tax bases of assets and liabilities and their carrying values for financial reporting purposes. Deferred tax is measured at the tax rates that are expected to be applied to the temporary differences when they reverse, based on the laws that have been enacted or substantively enacted by the reporting date. Deferred tax assets are recognized to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilized. P Borrowings Deposits, debt securities issued, subordinated liabilities and other borrowings are the Bank s sources of debt funding. Interest-bearing borrowings are initially measured at fair value net of transaction costs. Subsequent to the initial recognition, interest-bearing borrowings are stated at amortized cost. If debt is settled before maturity, any difference between the amount repaid and the carrying amount is recognized in the income statement for the period. 18

21 Q Dividends and share capital Share capital consists of ordinary shares. Share issue costs Incremental costs directly attributable to the issue of new shares are shown in equity as a deduction, net of tax, from the proceeds. Dividends Dividends on ordinary shares if any are recognized in equity in the period in which they are approved by the Bank s shareholders. R Financial guarantee contracts Financial guarantee contracts are contracts that require the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payments when due. Such financial guarantees are given to banks, financial institutions and other bodies on behalf of customers to secure loans, overdrafts and other banking facilities. Financial guarantees are initially recognized in the financial statements at fair value on the date the guarantee was given. Subsequent to initial recognition, the bank s liabilities under such guarantees are measured at the higher of the initial measurement, less amortization calculated to recognize in the income statement the fee income earned on a straight line basis over the life of the guarantee and the best estimate of the expenditure required to settle any financial obligation arising at the balance sheet date. 19

22 3 Financial risk management The Bank s activities expose it to a variety of financial risks and those activities involve the analysis, evaluation, acceptance and management of some degree of risk or combination of risks. Taking risk is core to the financial business, and the operational risks are an inevitable consequence of being in business. The Bank s aim is therefore to achieve an appropriate balance between risk and return and minimize potential adverse effects on the Bank s financial performance. The Bank s risk management policies are designed to identify and analyze these risks, to set appropriate risk limits and controls, and to monitor the risks and adherence to limits by means of reliable and up-to-date information systems. The Bank regularly reviews its risk management policies and systems to reflect changes in markets, products and emerging best practice. Risk management is carried out by a risk department in the Bank (functioning within the broader risk management division) as well as by the specialized risk management committees (Credit Risk Committee, Assets and Liabilities Management Committee, Operational Risk Committee, Steering Committee, Emergency Response Team) under policies approved by the Board of Directors or the Risk Management Committee. The Board provides written principles for overall risk management, as well as written policies covering specific areas, such as, credit risk, foreign exchange risk, interest rate risk and liquidity risk. In addition, internal audit is responsible for the independent review of risk management and the control environment. The most important types of risk are credit risk, liquidity risk, market risk and other operational risk. Market risk includes currency risk, interest rate and other price risk. 3.1 Credit risk The Bank takes on exposure to credit risk, which is the risk that counterparty will cause a financial loss for the Bank by failing to discharge an obligation. Credit risk is the most important risk for the Bank s business; management therefore carefully manages its exposure to credit risk. Credit exposures arise principally in lending activities that lead to loans and advances, and investment activities that bring debt securities and other bills into the Bank s asset portfolio. There is also credit risk in off-balance sheet financial instruments. The credit risk management starts in branches when the loan application is first received and processed, then continues in the credit and risk department as well as within the credit risk committee. The Bank s exposure to credit risk is reported to the Board of Directors and Risk Management Committee on regular monthly basis. 20

23 3.1.1 Credit risk measurement (a) Loans and advances In measuring credit risk of loan and advances to customers and to banks at a counterparty level, the Bank reflects three components (i) the probability of default by the client or counterparty on its contractual obligations; (ii) current exposures to the counterparty and its likely future development, from which the Bank derive the exposure at default ; and (iii) the likely recovery ratio on the defaulted obligations (the loss given default ). These credit risk measurements, which reflect expected loss (the expected loss model ) and are required by the Basel Committee on Banking Regulations and the Supervisory Practices (the Basel Committee), are embedded in the Bank s daily operational management. The operational measurements can be contrasted with impairment allowances required under IAS 39, which are based on losses that have been incurred at the balance sheet date (the incurred loss model ) rather than expected losses (Note 3.1.3). (i) The Bank assesses the probability of default of individual counterparties using internal rating tools. The migration analysis has been developed internally and is based on the historical data of all network banks. Clients of the Bank are segmented into four rating classes. The Bank s rating scale, which is shown below, reflects the range of default probabilities defined for each rating class. This means that, in principle, exposures migrate between classes as the assessment of their probability of default changes. The rating tools are kept under review and upgraded on annual basis. The Bank regularly validates the performance of the rating and their predictive power with regard to default events. Bank s internal ratings scale Bank s rating A B C D+E Description of the grade Investment grade Standard monitoring Special monitoring Sub-standard 21

24 Criterion for classification of Financial Assets or Contingent liabilities into groups A, B, C, D and E are as follows: Financial Assets or Contingent liabilities are classified into Group A if they are towards: National Bank of the Republic of Macedonia and the Republic of Macedonia debtors which is not likely to default and who repays its obligations within the maturity, or with a delay of 15 days; exposures secured by pledging collateral graded as first class collateral. Financial Assets or Contingent liabilities are classified into Group B if they are towards debtors: whose cash flows are assessed as adequate to duly fulfil its due obligations, regardless its present financial position is assessed as weak, without signs of further deterioration in the future; who settle their liabilities with delay of up to 30 days, occasionally with delay between 31 and 90 days. Financial Assets or Contingent liabilities are classified into Group C if they are towards debtors: for which it is assessed, that cash flows will not be sufficient for regular repayment of matured liabilities, that settle their liabilities with delay of up to 90 days, occasionally with delay between 91 to 180 days, that are clearly undercapitalized, that do not have sufficient long term capital resources for financing long term investments, from whom bank does not receive currently satisfactory information or adequate documentation concerning repayment of liabilities. Financial Assets or Contingent liabilities are classified into Group D and E if they are towards debtors: for which exists a strong likelihood of loss of part of financial asset or of payment for Contingent liabilities, that settle their liabilities with delay of more than 90 to 180 days, occasionally with delay between 181 to 360 days, which are insolvent, for which a motion for commencement of process of liquidation or declaration of bankruptcy began and was filed at the provisional court, that are in the process of reform or in the process of liquidation, that declared bankruptcy, from whom no repayment is expected, with questionable legal grounds. (ii) Exposure at default is based on the amounts the Bank expects to be owed at the time of default. For example, for a loan this is the face value. For a commitment, the Bank includes any amount already drawn plus the further amount that may have been drawn by the time of default, should it occur. 22

25 (iii) Loss given default or loss severity represents the Bank s expectation of the extent of loss on a claim should default occur. It is expressed as percentage loss per unit of exposure. (b) Debt securities and other bills For debt securities and other bills, risk department for managing of the credit risk exposures uses ratings depending on of the issuer: Central bank of the Republic of Macedonia and Republic of Macedonia. The investments in those securities and bills are viewed as a way to gain a better credit quality mapping and maintain a readily available source to meet the funding requirement at the same time. Given the fact that the exposure is towards the country the Bank does not expect any counterpart to fail to meet its obligations. The maximum exposure to credit risk is represented by the carrying amount of each financial asset in the balance sheet and is limited and monitored from the Assets and Liabilities Management Committee Risk limit control and mitigation policies The Bank manages, limits and controls concentrations of credit risk wherever they are identified in particular, to individual counterparties and groups. The Banks concentration of credit risk to industries, loan segments and countries is regularly reviewed as well. The Bank structures the levels of credit risk it undertakes by placing limits on the amount of risk accepted in relation to one borrower, or group of borrowers, and limits the amount of aggregate exposure to the top 10 loan clients. Such risks are monitored on monthly basis. Limits on the level of credit risk are approved by the Managing Board, Board of Directors or Risk Management Committee depending on the size of the exposure. Exposure to credit risk is also managed through regular analysis of the ability of borrowers and potential borrowers to meet interest and capital repayment obligations and by changing these lending limits where appropriate. Some other specific control and mitigation measures are outlined below. (a) Collateral The Bank employs a range of policies and practices to mitigate credit risk. The most traditional of these is the taking of security for funds advances, which is common practice. The Bank implements guidelines on the acceptability of specific classes of collateral or credit risk mitigation. Object of collateral can be real estate and other nonmovable property, vehicles, goods on stock, foreign currency, guarantor, and all other valuable collateral items, not prohibited by the legislation. Loans to corporate entities and individuals are generally secured; over drafts and credit cards issued to individuals are secured by bills of exchange at the full amount of principal, interest and other charges. In addition, in order to minimize the credit loss the Bank will seek additional collateral from the counterparty as soon as impairment indicators are noticed for the relevant individual loans and advances. 23

26 Debt securities, treasury and other eligible bills are generally unsecured. (b) Credit-related contingencies The primary purpose of these instruments is to ensure that funds are available to a customer as required. Guarantees and standby letters of credit carry the same credit risk as loans and are secured with same collateral as loans Impairment and provisioning policies The internal rating systems described in Note focus more on credit-quality mapping from the inception of the lending and investment activities. In contrast, impairment provisions are recognized for financial reporting purposes only for losses that have been incurred at the balance sheet date based on objective evidence of impairment. The impairment provision shown in the balance sheet at year-end is derived from each of the four internal rating grades. The table below shows the percentage of the Bank s balance sheet items relating to loans and advances and the associated impairment provision for each of the Bank s internal rating categories: Bank s rating Loans and Impairment Loans and Impairment advances (%) provision (%) advances (%) provision (%) 1.Investment grade 99.2% 1.1% 98.7% 1.3% 2.Standard monitoring 0.4% 30.0% 0.7% 25.0% 3.Special monitoring 0.3% 58.7% 0.4% 75.0% 4.Sub-standard 0.1% 89.9% 0.2% 75.0% 100% 1.5% 100% 2.3% The internal rating tool assists management to determine whether objective evidence of impairment exists under IAS 39, based on the following criteria set out by the Bank:. Delinquency in contractual payments of principal or interest; Cash flow difficulties experienced by the borrower (e.g. equity ratio, net income percentage of sales); Breach of loan covenants or conditions; Initiation of bankruptcy proceedings; Deterioration of the borrower s competitive position; Deterioration in the value of collateral; Legal and other difficulties in enforcing the bank s rights to repossess collateral. 24

27 The Bank s policy requires the review of individual financial assets that are above materiality thresholds at least semi-annually or more regularly when individual circumstances require. Impairment allowances on individually assessed accounts are determined by an evaluation of the incurred loss at balance-sheet date on a case-bycase basis, and are applied to all individually significant accounts. The assessment normally encompasses collateral held (including re-confirmation of its enforceability) and the anticipated receipts for that individual account. Collectively assessed impairment allowances are provided for: (i) assets that are individually below materiality thresholds; and (ii) losses that have been incurred but have not yet been identified, by using the available historical experience, experienced judgment and statistical techniques Maximum exposure to credit risk before collateral held or other credit enhancements Maximum exposure Credit risk exposures relating to on-balance sheet assets are as follows: Treasury bills and other eligible bills 558, ,811 Loans and advances to banks 1,052, ,225 Loans and advances to customers: Loans to individuals: Overdrafts 5, Credit cards 21,013 12,717 Term loans 862, ,774 Loans to corporate entities: Small and medium size enterprises (SMEs) 2,847,369 2,047,321 Other business loans 2,598,365 1,869,440 Investment securities Debt securities 407, ,083 Other assets 39,814 20,179 Credit risk exposures relating to on-balance sheet items 8,392,180 5,888,498 Credit risk exposures relating to off-balance sheet items are as follows: Guarantees 298, ,650 Letters of credit 11,754 29,755 Limits on cheques and cards 242, ,137 Credit risk exposures relating to off-balance sheet items 553, ,542 At 31 December 8,945,373 6,256,040 The above table represents a worse case scenario of credit risk exposure to the Bank at 31 December 2007 and 2006, without taking account of any collateral held or other credit enhancements attached. For on-balance-sheet assets, the exposures set out above are based on net carrying amounts as reported in the balance sheet. As shown above, 82.57% of the total maximum exposure is derived from loans and advances to banks and customers (2006: 84.84%); 4.55% represents investments in debt securities (2006: 5.31%). 25

28 Management is confident in its ability to continue to control and sustain minimal exposure of credit risk to the Bank resulting from both its loan and advances portfolio and debt securities based on the following: 99.56% of the loans and advances portfolio is categorized in the top two grades of the internal rating system (2006: 99.39%); 98.35% of the loans and advances portfolio are considered to be neither past due nor impaired (2006: 97.93%); The Bank has stringent selection process upon granting loans and advances; and 100% of the investments in debt securities and other bills are in securities issued by the Republic of Macedonia and Central bank Loans and advances Loans and advances are summarized as follows: 31 December December 2006 Loans and Loans and advances advances to to banks customers Loans and advances to customers Loans and advances to banks Neither past due nor impaired 6,335,174 1,052,124 4,405, ,225 Past due but not impaired 73,026-69,580 - Impaired 33,539-23,592 - Gross 6,441,739 1,052,124 4,498, ,225 Less: allowance for impairment (107,711) - (102,588) - Net 6,334,028 1,052,124 4,396, ,225 The total impairment provision for loans and advances is MKD 107,711,000 (2006: MKD 102,588,000). Further information of the impairment allowance for loans and advances to banks and to customers is provided in Note 14. During the year ended 31 December 2007, the Bank s total loans and advances increased by 43.19%. 26

29 (a) Loans and advances neither past due nor impaired The credit quality of the portfolio of loans and advances that were neither past due nor impaired can be assessed by reference to the internal rating system adopted by the Bank. 31 December 2007 Total Loans and advances to customers Loans and advances to banks SMEs Grades: 1.Investment grade 5,621 20, ,332 2,611,507 2,836,049 6,335,174 1,052,124 Total 5,621 20, ,332 2,611,507 2,836,049 6,335,174 1,052, December 2006 Loans and advances to customers Individual (retail customers) Corporate entities Overdrafts Credit cards Term loans Other business loans Loans and advances to customers Individual (retail customers) Corporate entities Overdrafts Credit cards Term loans Other business loans Total Loans and advances to customers Loans and advances to banks SMEs Grades: 1.Investment grade 1,557 12, ,393 1,879,566 2,047,647 4,405, ,225 Total 1,557 12, ,393 1,879,566 2,047,647 4,405, ,225 (b) Loans and advances past due but not impaired Gross amount of loans and advances by class to customers that were not yet due and pas due were as follows: (i) Loans and advances to customers 31 December 2007 Individual (retail customers) Overdrafts Credit cards Term loans Total Past due up to 30 days ,065 7,280 Past due days ,681 1,732 Past due days ,183 1,219 Total ,929 10,231 Fair value of collateral - - 9,501 9, December 2007 SMEs Corporate entities Other business loans Total Past due up to 30 days 23,261 21,419 44,680 Past due days 5,536 5,097 10,633 Past due days 3,895 3,587 7,482 Total 32,692 30,103 62,795 Fair value of collateral 31,242 28,575 59,817 27