SC Citadele banka Public financial report for the 2 nd quarter of 2012

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2 Citadele Bank Declared in 2012 to be Best-Governed State-Owned Company in Baltic States During the first half of 2012, the Citadele Bank continued on its successful development by attracting new clients and increasing deposit volumes. Because of these positive operations, the Bank was able to repay all of the state s term deposits early in 2012 and ahead of schedule. It is also pleasing to note that the bank concluded the first half of the year with better profit indicators than during the first half of last year. The bank s operations have received praise from the people of Latvia and internationally. In the first half of 2012, Citadele received the highest rating in a study conducted by the Baltic Institute Of Corporate Governance, Management of State-Owned Companies in the Baltic States. Citadele was declared to be the best company of that type in the three countries. The latest ranking of corporate reputation produced by SIA Nords Porter Novelli and Lietišėā Diena, in turn, shows that Citadele experienced one of the most rapid increases in reputation among all Latvian companies, as well as the greatest improvement in reputation among all of the country s banks. The professionalism of the Citadele team is also seen in the fact that the NASDAQ OMX Rīga stock exchange awarded the title of Broker of the Year 2011 to Citadele securities broker Kaspars KurmiĦš. Developments were also experienced by the Bank s subsidiaries. Citadele Asset Management received several commendations of a high level of international importance. Citadele Life, in turn, increased its market share substantially during this period to take a leading position in Latvia s life insurance market in terms of new premium volumes. Citadele Increased Profits The Citadele Bank and its subsidiaries continued to undergo stable development during the first half of 2012, and the group was profitable. Citadele Bank concluded the first half of the year with profits before provisions and taxes of LVL 9.6 million (LVL 11.4 million for the Group), which was a much better indicator than during the same period last year. After provisions and taxes, the Bank s profit for the first half of 2012 was LVL 2.5 million (LVL 4.6 million for the Group). Moreover, a significant element of the net impairment charges relates to certain historical inherited items. As such, the overall trend in terms of asset quality can be described as neutral. Thanks to a review of the strategy of Citadele and its subsidiaries, net interest revenues increased by 25% during the first half of 2012 in comparison to the same period last year from LVL 9.4 million to LVL 11.8 million (up by 27%, from LVL 12 million to LVL 15.2 million for the Group). The Bank s capital adequacy ratio on June 30 of this year was 12.2% (10.2% for the Group), and its liquidity ratio was 61%. According to data from May 31, 2012, Citadele is Latvia s 4th largest bank in terms of deposits (a 10.3% market share). It is the 7th largest bank in terms of assets (a 7.4% market share), and the 6th largest bank in terms of issued loans (a 5.7% market share). Citadele Repaid State s Term Deposits, Paid Additional Compensation for Aid In February 2012, ahead of schedule, the Citadele Bank repaid the final tranche of the Latvian state s term deposit to the Finance Ministry EUR million. Of this sum, EUR 46.6 million represented the basic sum, while EUR 340,000 represented interest. The Bank has thus repaid all of the state s term deposit of EUR million. Between the Bank s launch of operations in August 2010 and March 2012, Citadele paid EUR 14.7 million in interest to the state. The financing was repaid in tranches during the course of 18 months, and the final repayment was made 10 months ahead of schedule. 2

3 Successful 2011 results and commitments agreed with the European Commission allowed Citadele Bank, on July 18, 2012, to transfer LVL 3.5 million to the National Treasury as additional compensation for the aid which was received by the state. Accordingly, the 2011 full year results have been restated as per the requirements of International Financial Reporting Standards. Citadele is One of Market Leaders in Terms of Scope of Services The Citadele Bank was active in the corporate lending market during the first half of 2012, signing loan and guarantee agreements worth LVL 62 million during those months. During the first half of the year, Citadele provided the most lending to agricultural companies (20% of all loans). Citadele also increased its mortgage lending to a level of LVL 10 million during the first half of In the Retail segment, Citadele gained more than 11,000 new clients, and more than 100 come from the Corporate segment. The Private capital management segment attracted more than 1,200 new clients nearly 50% more than during the same period in Citadele is seen as a trustworthy partner in Latvia and Estonia, as well. More than 3,600 new clients were found in those two countries during the first six months of the year. According to the SKDS market and public opinion research centre, Citadele was evaluated as the third most often utilised bank over the previous six months both in February and May. The May study showed that according to consumers, they had increased faith in the convenience and advantageousness of Citadele services. Citadele Asset Management Receives Major International Praise During the first half of 2012, the Citadele subsidiary Citadele Asset Management received several major international awards. Thus, for instance, the international investment fund information and research company Lipper declared the subsidiary s USD Eastern European Obligation Fund to have delivered the best consistently strong risk-adjusted performance over the course of the past three years in the Bond Emerging Markets Europe category. During those three years, investors in the fund earned more than 20% annualised return. The international financial research company Morningstar, in turn, gave the Citadele USD Eastern European Obligation Fund the highest possible rating of five stars, which put the subsidiary ahead of 90% of its competitors. The Citadele Russian Stock Fund got a high rating of four stars, which was higher than that of 70% of other companies in the area. The praise relates to the high and stable profits of funds managed by Citadele Asset Management. Since the fund was launched, investors in the USD Eastern European Obligation Fund have received an average of 6.9% return per year, while investors in the Russian Stock Fund received an average of 7.6% return per year. Also, World Finance, which is one of the world s leading financial journals, declared Citadele Asset Management to be the best investment management company in the Baltic States in Citadele Life Increases Development Tempo During the first half year of 2012, the Citadele company Citadele Life signed 44% of all new unit-linked life insurance premiums in Latvia. Thanks to these good results, Citadele Life increased its market share of life insurance with savings in terms of signed premiums during the past year from by 9.7% on December 31, 2011 to 11.1% on June 30,

4 Citadele Bank Launches New Social Responsibility Programme Citadele Bank has launched an unprecedentedly large support programme for Latvia s paralympians so as to facilitate the development of paralympic sports in Latvia, attract increasing numbers of differently abled people to sports, and change public attitudes toward people with special needs and their abilities. The bank involved staff and clients, as well as the public at large in the You Are. You Can movement. The aim was to support Latvia s paralympic team at the 2012 Paralympic Games in London, as well as to enhance courage and daring in society at large. Citadele thanks its clients, partners and employees for a successful first half of We will continue to develop the Bank so that it is the best financial partner for our clients, the best workplace for our staff, and the company which ensures the highest value for its shareholders. The report has been approved by the Management Board of the Bank on 28 August

5 Balance sheets as at 30 June 2012 and 31 December 2011 LVL 000 s Restated Restated Group Group Bank Bank Cash and demand deposits with central banks 253, , , ,659 Demand deposits with credit institutions 74, ,259 59, ,016 Financial assets held for trading 7,706 3,678 2,399 3,542 Financial assets designated at fair value through profit and loss 25,908 6, Available-for-sale financial assets 231, , , ,289 Loans and receivables to customers: Loans to credit institutions 41,720 24,162 15,388 4,063 Loans to companies and private individuals 719, , , ,773 Held-to-maturity investments 159, , , ,442 Change in the fair value of the portfolio hedged against interest rate risk Prepayments and accrued income 2,100 1, Fixed assets 30,424 33,532 2,058 2,449 Investment property 1,727 1, Intangible assets 1,160 1, Investments in subsidiaries ,195 44,195 Income tax assets 28,995 29,142 28,311 28,777 Other assets 21,582 19,696 19,835 17,336 Total assets 1,600,101 1,560,297 1,355,515 1,357,075 Due to central banks Demand liabilities to credit institutions 8,847 39,249 20,167 46,955 Financial liabilities held for trading 2, ,841 1,810 Financial liabilities designated at fair value through profit and loss 5,828 4, Financial liabilities measured at amortised cost: Loans from credit institutions 1,306 8,212 21,925 24,804 Deposits from customers 1,406,960 1,317,971 1,144,116 1,099,258 Issued debt securities - 20,925-20,997 Subordinated liabilities 51,926 51,948 51,926 51,948 Other financial liabilities 23,087 23,301 17,594 17,782 Amounts payable under repurchase agreements Change in the fair value of the portfolio hedged against interest rate risk Accrued expenses and deferred income 5,553 6,670 4,374 5,364 Provisions Income tax liabilities Other liabilities 9,504 9,066 6,613 6,884 Total liabilities 1,515,630 1,482,753 1,270,560 1,275,823 Shareholders equity 84,471 77,544 84,955 81,252 Total liabilities and shareholders equity 1,600,101 1,560,297 1,355,515 1,357,075 Memorandum items Contingent liabilities 31,337 21,370 27,974 18,307 Financial commitments 113, , , ,868 * Auditor: SIA PricewaterhouseCoopers 5

6 Statements of income for 6 months period ended 30 June 2012 and 2011 LVL 000 s Group Group Bank Bank Interest income 28,622 30,268 24,009 26,519 Interest expense (13,378) (18,276) (12,220) (17,110) Dividends received - 3-1,503 Commission and fee income 14,180 12,675 10,970 9,470 Commission and fee expense (3,732) (3,485) (3,287) (2,833) Net gain/ (loss) on financial assets and financial liabilities measured at amortised cost Net gain/ (loss) on available for sale financial assets and financial liabilities Net gain/ (loss) on held for trading financial assets and financial liabilities (61) (769) 3 (529) Net gain/ (loss) on financial assets or financial liabilities designated at fair value though profit and loss Fair value change in the hedge accounting Gain/ (loss) from foreign exchange trading and revaluation of open positions 4,465 3,375 3,859 2,771 Net financial profit 30,762 24,420 23,571 19,836 Net gain/ (loss) on disposal of property, plant and equipment, investment property and intangible assets 267 (96) - Other income 2,931 3,411 1,768 2,343 Other expense 80 (583) 366 (515) Administrative expense (20,423) (19,729) (15,457) (15,228) Amortisation and depreciation charge (2,221) (2,832) (623) (1,058) Profit before impairment charges and tax 11,396 4,591 9,625 5,378 Impairment charge and reversals, net (6,565) (4,330) (6,516) (4,799) Corporate income tax (237) 25 (655) (397) Profit for the reporting period 4, , Statements of Comprehensive Income: LVL 000 s Group Group Bank Bank Net change in fair value revaluation reserve of securities and other reserves 2, , Other comprehensive income for the period 2, , Total comprehensive income for the period 6,927 1,112 3, * Auditor: SIA PricewaterhouseCoopers 6

7 Performance ratios of the group and the bank Group Group Bank Bank Return on equity (ROE) (%)* 11.34% 0.69% 5.91% 0.43% Return on assets (ROA) (%)* 0.58% 0.04% 0.36% 0.03% * Average value is calculated as the arithmetic mean of the balance sheet assets or residual capital and reserves at the beginning of the reporting period and at the end of the reporting period. Ratings assigned by rating agencies Long-term rating Short-term rating Financial strength rating Rating s outlook Latest rating revision date Moody's Investors Service B2 Not Prime E+ Negative Detailed information about ratings can be found on the web site of the rating agency: Investments in securities by issuer s country Group Government bonds Other securities Government bonds Other securities Latvia 185,975 4, ,231 6,417 Lithuania 38, , United States 4,509 28,583 2,728 25,406 Germany , ,868 Russia ,231-13,542 Netherlands - 13,020-7,706 United Kingdom - 28,453-1,119 Other countries* 24,969 58,658 14,768 45,254 Total securities, net 255, , , ,354 Bank Government bonds Other securities Government bonds Other securities Latvia 183,447 1, ,666 4,632 United States 4,509 18,443 2,728 16,395 United Kingdom - 27, Germany - 13,889-3,511 Other countries* 20,418 45,062 11,863 38,554 Total securities, net 208, , ,257 63,474 * Each country s issuers total exposure is less than 10% from the eligible capital used for capital adequacy calculation purposes. As at the period end the Bank and the Group has not recognized any impairment allowance for held-to-maturity investments (2011: nil). Market value of the total Bank s and Group s held-to-maturity securities as at 30 June 2012 is LVL 148,140 thousand (2011: LVL 122,002 thousand) and LVL 159,535 thousand (2011: LVL 129,484 thousand), respectively. During the reporting period the Bank and the Group has recognized provisions of LVL 2,324 thousand for available for sale securities (2011: nil); total recognized impairment allowance for available for sale securities as at the period end is LVL 5,916 thousand (2011: LVL 3,432 thousand). 7

8 Consolidation group No. Name of company Registration number Registration address Country of domicile 1 AS Citadele banka" LV Latvia, Riga LV-1010, Republikas laukums 2A LV BNK MAS 2 IPAS Citadele Asset Management" LV Latvia, Riga LV-1010, Republikas laukums 2A LV IPS MS 3 AB Citadele bankas" LT Lithuania, Vilnius LT-03107, K. Kalinausko 13 LT BNK MS 4 SIA Citadele Express Kredīts" LV Latvia, Riga LV-1010, Republikas laukums 2A LV CFI MS 5 AS Citadele atklātais pensiju fonds" LV Latvia, Riga LV-1010, Republikas laukums 2A LV PFO MS 6 AAS Citadele Life" LV Latvia, Riga LV-1010, Republikas laukums 2A LV APS MMS 7 OU Citadele Leasing & Factoring" EE Estonia, Tallinn 10119, Roosikrantsi 2 EE LIZ MS 8 ZAO Parex Asset Management" RU Russia, Moscow , Donskaja 4-2 RU IBS MMS 9 OOO Citadele Asset Management Ukraina UA Ukraine, Kiev 03150, Gorkovo 172 UA IBS MMS 10 SIA E & P Baltic Properties" LV Latvia, Riga LV-1010, Republikas laukums 2A LV IPS MMS 11 UAB Citadele faktoringas ir lizingas" LT Lithuania, Vilnius LT03107, K.Kalinausko 13 LT LIZ MMS 12 UAB Citadele investiciju valdymas" LT Lithuania, Vilnius LT01109, Gyneju 16 LT IBS MMS 13 AP Anlage & Privatbank AG CH Switzerland, Limmatquai 4, 8001, Zurich CH BNK MS 14 Calenia Investments Limited CY-HE Cyprus, Nicosia 1075, 58 Arch. Makarios 3 Avenue, Iris Tower, 6th floor, office 602 Company type* % of total paid-in share capital % of total voting rights CY PLS MS 15 SIA Citadele līzings un faktorings" LV Latvia, Riga LV-1010, Republikas laukums 2A LV LIZ MS 16 SIA Rīgas pirmā garāža" LV Latvia, Riga LV-1010, Republikas laukums 2A LV PLS MS 17 SIA RPG interjers" LV Latvia, Riga LV-1010, Republikas laukums 1 LV PLS MMS 18 SIA PR Speciālie projekti" LV Latvia, Riga LV-1010, Republikas laukums 2A LV PLS MMS 19 OOO Citadele Investments Ukraina" UA Ukraine, Kiev 03150, Gorkovo 172 UA IBS MMS 20 OAO Parex Ukrainian Equity Fund" UA Ukraine, Kiev 03150, Gorkovo 172 UA IBS MMS 21 SIA Hortus Commercial" LV Latvia, Riga LV-1010, Republikas laukums 2A LV PLS MS 22 SIA Hortus Land" LV Latvia, Riga LV-1010, Republikas laukums 2A LV PLS MS 23 SIA Hortus TC" LV Latvia, Riga LV-1010, Republikas laukums 2A LV PLS MS 24 SIA Hortus Residental" LV Latvia, Riga LV-1010, Republikas laukums 2A LV PLS MS *BNK bank, IBS investment brokerage company, IPS investment management company, PFO pension fund, CFI other financial institution, LIZ leasing company, PLS company providing various support services, APS insurance company. ** MS subsidiary company, MMS subsidiary of the subsidiary company, MAS parent company. Basis for inclusion in the group** 8

9 Information about Citadele bank s branches As at 30 June 2012 the Bank was operating a total of 22 branches (including 3 foreign branches), 24 mid-size client service centres and 3 representative offices. Issued share capital as at 30 June 2012 Shareholders Nominal value (LVL) Number of shares Paid-in share capital (LVL) Voting rights VAS Privatizācijas Aăentūra" 1 77,249,999 77,249,999 77,249,999 EBRD 1 25,750,001 25,750,001 25,750,001 Paid-in share capital (%) 75% minus 1 share 25% plus 1 share Total 103,000, ,000, ,000, % Management of the bank as at 30 June 2012 Supervisory Council of the Bank Name Klāvs Vasks Juris Vaskāns Laurence Philip Adams Geoffrey Dunn Position Chairman of the Supervisory Council Deputy chairman of the Supervisory Council Member of the Supervisory Council Member of the Supervisory Council Management Board of the Bank Name Guntis BeĜavskis Valters Ābele Kaspars Cikmačs Philip Nigel Allard Position Chairman of the Management Board, p.p. Member of the Management Board, p.p. Member of the Management Board Member of the Management Board Supervisory Council and Management Board of Citadele bank have agreed on rescheduling of assignments for the management team of the Group with the aim to improve the efficiency of its subsidiaries. Thus from May 2012 Juris Jākobsons serves on Supervisory Councils of a number of subsidiaries and oversees their operations, while the duties of the Chairman of the Management Board of Citadele Bank, on May 1, were taken over by Guntis BeĜavskis. As of May this year Juris Jākobsons assumed responsibilities of the Chairman of the Supervisory Council at AB Citadele bankas in Lithuania and a member of the Supervisory Council at AP Anlage & Privatbank AG in Switzerland. Juris Jākobsons is continuing to serve on Supervisory Councils of AAS Citadele Life and AS Citadele atklātais pensiju fonds and is the Chairman of the Supervisory Council of Citadele Asset Management IPAS. On 14 June 2012 Ăirts Freibergs, the member of the Supervisory Council of the Bank, resigned. 9

10 Capital adequacy ratio as at 30 June 2012 and 31 December 2011 LVL 000 s Restated Restated Group Group Bank Bank Tier 1 capital 103, , , ,000 Tier 1 capital deductions (27,064) (29,291) (22,788) (24,017) Total tier 1 capital after deductions 75,936 73,709 80,212 78,983 Tier 2 capital 32,748 40,216 32,748 40,216 Tier 2 capital deductions (1,500) (4,111) (1,500) (1,500) Total tier 2 capital after deductions 31,248 36,105 31,248 38,716 Applicable tier 3 capital Equity to be utilised in the capital adequacy ratio 107, , , ,699 Credit risk and counterparty credit risk capital charges 71,118 69,724 65,217 62,376 Settlement risk capital charge Position, foreign currency open position and commodities risk capital charge 2,316 3, ,064 Operational risk capital charges 10,624 10,624 8,364 8,364 Other and transition period capital charges Total capital charges 84,058 83,695 74,538 72,804 Surplus regulatory equity over total capital charges 23,126 26,119 36,922 44,895 Capital adequacy ratio 10.2% 10.5% 12.0% 12.9% * Auditor: SIA PricewaterhouseCoopers Restatement According to the initial Commitments to the European Commission the bank shall pay a fee to the state of Latvia for the use of State support, hereinafter referred to as the asset relief fee when Citadele banka's capital adequacy ratio on solo basis is not lower than 12% and capital adequacy ratio at group level is not lower than 8%. In late 2011, management started discussions with the EC to change the terms of the commitments to raise the minimum capital adequacy ratios required as a precondition for the asset relief fee to become payable, which would have resulted in no fees being payable for At the time of finalising the 2011 financial statements, management believed that an agreement was reached and no asset relief fee was payable for However, in June 2012, the EC confirmed that the LVL 3.54 million fee is payable in respect of 2011 at the original terms. All affected balances and amounts in these financial statements have been restated accordingly. 10

11 Risk management Risk management principles are set out in Group s Risk and Capital Management Policy. The Group adheres to the following key risk management principles: The Group aims to ensure low risk exposure, diversified asset portfolio, limited risks in financial markets and low level of operational risk; The Group aims to ensure an acceptable risk level in all operations. Risks are always assessed in relation to the expected return. Risk exposures that are not acceptable for the Group are avoided, limited or hedged; The Group does not assume high or uncontrollable risks irrespective of the return they provide. Risks should be diversified and those risks that are quantifiable should be limited or hedged; The Group pursues prudent risk management policy, that is aligned with the Group business and ensures effective total risk mitigation; Risk management is based on awareness of each and every Group s employee about the nature of transactions he/she carries out and related risks; Risk limit system and strict controls are essential risk management elements. Control of risk level and compliance with limits is ensured by structured risk limit systems for all material risks. Risk management is an essential element of the Group s management process. Risk management within the Group is controlled by independent units - Risk and Compliance Sector. The Group is exposed to the following main risks: credit risk, market risk, interest rate risk, liquidity risk, currency risk and operational risk. The Group has approved risk management policies for each of these risks, which are briefly summarised below. Credit risk Credit risk is the risk that the Group will incur a loss from debtor s non-performance or default. The group is exposed to credit risk in its lending, investing and trading activities, as well as in respect to the guarantees issued to third parties and other off-balance sheet commitments to third parties. Credit risk management is based on adequate risk assessment and decision-making. For material risks, risk analysis is conducted by independent units of Risk and Compliance Sector. The analysis of credit risk comprises evaluation of customer s creditworthiness and collateral and its liquidity. The analysis of creditworthiness of a legal entity includes analysis of the industry, the company, and its current and forecasted financial position. The analysis of creditworthiness of an individual includes the analysis of the customer s credit history, income and debt-toincome ratio analysis, as well as the analysis of social and demographic factors. In the event of material risks, lending decision is made by the Credit Committee, and further reviewed by the Bank s Management Board. After the loan is issued, customer s financial position is monitored on a regular basis in order to timely identify potential credit losses. To limit its credit risk, the Group has set the following concentration limits: individual counterparty limit, limit for group of mutually related customers, limit for large risk exposures, limit for the Group s related parties, an industry limit, limit by customer type, loan product, and collateral type. The Group reviews its loan portfolio on a regular basis to assess its quality and concentrations, as well as to evaluate the portfolio trends. Credit risk identification, monitoring and reporting is the responsibility of Risk and Compliance Sector. Market risk Market risk is the risk that the Group will incur a loss as a result of the mark-to-market revaluation of balance sheet and off-balance sheet items caused by changes in market values of financial instruments due to changes in foreign exchange rates, interest rates and other factors. Position risk of financial instruments is assessed and limits are set by the Financial Market and Counterparty Committee (FMCC). The decisions of FMCC are approved by the Bank s Management Board. Market risk is managed by the Group s business units and subsidiaries which can accept market risk in line with the set limits and investment restrictions of the respective portfolio. Market risk is measured, monitored and risk levels are reported by Risk and Compliance Sector. To manage market risk, the Group sets individual limits to issuers and financial instruments, as well as products exposed to market risk. To assess position risk the Group uses sensitivity analysis and scenario analysis, which 11

12 identifies and quantifies negative impact of adverse events on portfolio of the Group taking into consideration regional, sector and credit rating profile. Interest rate risk Interest rate risk is related to the negative impact of interest rate changes on the Group s income and economic value. Interest rate risk management in the Group is carried out in accordance with the Group s Interest rate Risk Management Policy. Interest rate risk is assessed and decisions are made by Assets and Liabilities Management Committee (ALCO). The decisions of ALCO are approved by the Bank s Management Board. ALCO sets the acceptable interest rate risk level and the Group s internal limit system, monitors the compliance with the approved limits and use of the instruments for the management of interest rate risk. Interest rate risk measurement, management and reporting are responsibilities of Treasury Sector. Interest rate risk management in the Group is coordinated by the Risk and Compliance Sector. The Group manages interest rate risk by using the gap analysis of the risk sensitive assets and liabilities, duration analysis and sensitivity analysis of assets and liabilities as well as stress testing of interest rate risk. The Group sets limits for impact of interest rate shock on economic value, net interest income and revaluation reserve. Based on the market analysis and the Group s financing structure, ALCO sets customer deposit interest rates. Liquidity risk Liquidity risk is the risk that the Group will be unable to meet its legal payment obligations. The purpose of liquidity risk management is to ensure the availability of liquid assets sufficient to meet potential obligations. The Group manages its liquidity risk in accordance with the Group s Liquidity Risk Management Policy. Liquidity risk is assessed and decisions are made by ALCO. The decisions of ALCO are approved by the Bank s Management Board. ALCO sets the acceptable liquidity risk level, the Group s internal limit system and defines instruments for the management of liquidity risk, as well as monitors the compliance with the set limits. Daily liquidity management, as well as control is ensured by the Treasury department. Liquidity risk management and reporting in the Group is coordinated by the Risk and Compliance Sector. The Bank evaluates liquidity risk by using scenario analysis. For this purpose several scenarios of Bank s operations under a variety of conditions are developed: gentle crisis (base case scenario), bank's crisis, general market crisis and a combined scenario. The Bank evaluates its liquidity position for each of the scenarios for a variety of periods (ranging from 1 week to 3 months). System of liquidity risk limits and early warning indicators has been implemented in the Bank. Bank also estimates costs it could suffer under conditions of prolonged liquidity crisis. In addition to scenarios analysis, the Bank also prepares yearly cash flows, which incorporate assumptions about the most likely flows of funds. For general assessment of asset and liability gaps the Bank regularly prepares and analyses liquidity term structure. In the reporting period the Bank was in compliance with liquidity ratio requirements and met mandatory reserve requirements in the Bank of Latvia. Currency risk Currency risk is a risk of loss arising from fluctuations in currency exchange rates. Currency risk management in the Group is carried out in accordance with the Group s Currency Risk Management Policy. Currency risk is assessed and decisions on limits set are made by the Financial Market and Counterparty Committee (FMCC). The decisions of FMCC are approved by the Bank s Management Board. FMCC defines the acceptable currency risk level and the Group s internal limit system, as well as monitors compliance with these limits. Day-to-day currency risk management is the responsibility of Treasury Sector, while risk monitoring and reporting is the responsibility of Risk and Compliance Sector. The Group has set a limit for open currency positions in each currency at 10% of its equity, and the limit for the total open currency position at 20% of its equity. The limits are in compliance with the requirements of Latvian legislation. In assessing its currency risk the Group also makes use of several widely applied methodologies: value at risk, expected shortfall and scenario analysis. 12

13 Operational risk The Group defines operational risk as the risk of losses resulting from processes that are deficient or non-compliant with requirements of external and internal regulations, losses resulting from actions of employees and system malfunctioning, as well as losses resulting from actions of third parties or from other external conditions, including legal risk (risk of penalty fees, sanctions applied by external institutions, losses resulting from litigation and other similar events), but excluding strategic risk and reputation risk. The Group further divides operational risk into the following categories: personnel risk, process risk, IT and systems risk, external risk. The Group does not accept operational risks with potential impact exceeding 10% of the Group s net annual revenues, as well as unmanageable risks or risks with unquantifiable impact, irrespective of the financial gains this could bring (i.e., the Group does not perform business activities incurring such operational risks). The Group applies following approaches for operational risk management: Self-assessment of operational risk the business-owners of the products and processes perform identification and evaluation of potential operational risk events, assessment of the existing control systems and the analysis of the required risk mitigation measures using self-assessment questionnaires and brainstorming sessions with the experts of the respective process; Defining operational risk indicators use of statistical, financial and other indicators that reflect the level of various operational risk types and its changes within the Group; Defining the limits of the acceptable losses; Operational risk measurement by recording and analysing operational risk events, the extent of the respective damage incurred, causes and other related information (data base of operational risk losses and incidents); Four-eye-principle and segregation of duties; Business continuity planning; Risk assessment within product development; Insurance; Investments in appropriate data processing and information protection technologies. 13