1 Introduction 3. 2 Capital adequacy Capital adequacy regulations 4

Transcription

1 2016 PILLAR 3

2 2 Contents 1 Introduction 3 2 Capital adequacy Capital adequacy regulations Pillar 1 Minimum capital requirements Pillar 2 - Internal Capital Adequacy Accessment Process (ICAAP) Pillar 3 - Public disclosure of information The Group s capital adequacy targets Adapting to the capital requirements regulations 5 3 Consolidating 6 4 Risk and capital management Group structure Organisation chart Risk and capital management Objective Control and management structure roles and responsibilities Elements of the risk and capital management 11 5 Information per risk group Key risk groups Credit risk Management and control Credit risk models Portfolio information Market risk Management and control Limits, monitoring and reporting Portfolio information Operational risk Management and control Capital requirements Compliance risk Management and control Liquidity risk Management and control Portfolio information Ownership risk Management and control 30 6 Regulatory capital Regulatory capital adequacy Leverage Ratio 33

3 SPAREBANKEN HEDMARK PILAR Introduction This document provides a description of Sparebanken Hedmark s risk and capital management and should satisfy the requirements for the public disclosure of financial information as stipulated in the Part IX of the Capital Requirements Directive. This document is updated annually. If, however, there are significant changes that have an impact on the assessment of the Group s financial standing, then this document will be updated with new information. Periodic information on capital adequacy and the minimum primary capital requirements is available in the Bank s quarterly reports. Beyond the information available in this document, please see About Us on Sparebanken Hedmark s website: Sparebanken Hedmark will merge with the Bank s 100 per cent owned subsidiary Bank 1 Oslo Akershus AS on 1 April Unless otherwise is explicitly stated, this document covers the financial group, including Bank 1 Oslo Akershus AS. A separate Pillar 3 document has been prepared for Bank 1 Oslo Akershus. This is available on:

4 4 CAPITAL ADEQUACY 2 Capital adequacy 2.1 Capital adequacy regulations The rules and regulations are based on a standard for calculating capital adequacy where the purpose is to reinforce the stability of the financial system through: More risk sensetive capital requirements Improved risk management and control Closer supervision Disclosure of more information to the market The regulations are intended to ensure there is Alignment between how the authorities stipulate capital adequacy requirements for financial institutions and the approaches the institutions use to calculate their capital requirements Pillar 1 Minimum capital requirements Pillar 1 concerns the minimum capital requirements for credit risk, operational risk and market risk, for which the minimum capital adequacy requirement has been set at 8 per cent. In addition to this comes a total buffer requirement of 7 per cent as at 31 December Sparebanken Hedmark has not been defined as a nationally systemically important institution. Capital adequacy is defined as the relationship between the institutions total eligible capital and its risk-weighted assets: The capital adequacy regulations are based on three pillars: Pillar 1: Minimum capital requirements Pillar 2: Internal Capital Adequacy Accessment Process (ICAAP) Pillar 3: Public disclosure of information Figure 1: Capital adequacy ratio Common equity Tier 1 capital + Additional Tier 1 capital + Tier 2 capital Credit risk + market risk + operational risk >= Minimum requirement + buffer requirement The capital adequacy regulations contain various approaches for calculating capital requirements. The different approaches are illustrated in the figure below. Figure 2: Approaches for calculating capital requirements Credit risk Market risk Operational risk Standard approach Standard approach Basic approach Foundation IRB Approach *) Internal measurement approach *) Standardised approach Advanced IRB Approach *) AMA approach *) *) The approaches require the approval of the Financial Supervisory Authority of Norway For banks that have permission to use an internal measurement approach (IRB Internal Rating Based Approach) to calculate credit risk, the statutory minimum capital adequacy requirement for credit risk will be based on the banks risk models. This will make the minimum capital adequacy requirement more risk sensitive and means that capital requirements will vary more with the risk inherent in the underlying portfolios than with the standard approach.

5 CAPITAL ADEQUACY Pillar 2 - Internal Capital Adequacy Accessment Process (ICAAP) Pillar 2 stipulates requirements for the banks capital adequacy assessment process (ICAAP), the purpose of which is to ensure a structured and documented assessment process for the Group s risk profile in order to make sure the Group has adequate capital to cover the risk associated with its operations. In addition, banks must have a strategy for maintaining an adequate level of capital. In autumn 2016, the Financial Supervisory Authority of Norway published circular 12/2016 The Financial Supervisory Authority of Norway s practices for assessing risk and capital requirements. The Group has adapted its ICAAP process to comply with the circular. Based on the above-mentioned circular, the Bank calculates its Pillar 2 supplement in a process involving the Parent Bank, important subsidiaries, and the stakes in associated companies/joint ventures. The process is based on an assessment of exposure and management quality and control, where the capital requirements are mainly based on the approach described in the aforementioned circular. The Financial Supervisory Authority of Norway is required to monitor and evaluate banks internal assessments of their capital requirements and associated strategies, as well as their ability to ensure compliance with the authorities capital requirements. The Financial Supervisory Authority of Norway has the authority to implement suitable supervisory measures if they are not satisfied with the results of this process Pillar 3 - Public disclosure of information The purpose of Pillar 3 is to supplement the minimum requirements in Pillar 1 and the supervisory follow-up in Pillar 2. Pillar 3 should contribute to greater market discipline through requirements for the public disclosure of information that makes it possible for the market to evaluate the institution s risk profile and capitalisation, as well as its management and control. The information requirements mean that all institutions must publish information on their organisational structure, risk management system, reporting channels, and how their risk management is built up and organised. In addition, detailed requirements are stipulated for the publication of the level of capital and structure, as well as the risk exposure, and the latter depends on what calculation approaches are used in Pillar 1 The purpose of this document, together with the Bank s annual and quarterly reports, is to fulfil the requirements for the public disclosure of information in accordance with the current regulations. 2.2 The Group s capital adequacy targets The Group s overarching strategic targets are set on the basis that they should underpin a moderate to low risk profile, where the Bank should be among Norway s financially strongest and most profitable banks. The Group s financial strength is expressed through its regulatory capital adequacy. The following must be taken into account when setting the level of capital: Need for freedom of action. Level of ambition in the strategic targets. Commercial framework conditions. Autorities capital adequacy requirements. Desired risk profile. The level of capital set should ensure that the Group has adequate capital to satisfy regulatory requirements in relation to capital adequacy. The Group has the following capital targets: A common equity Tier 1 ratio of at least 16 per cent. Capital adequacy at least on a par with the current minimum requirement, inclusive of the Pillar 2 supplement, currently 16.7 per cent. The Board reviews the capital targets at least once a year in connection with its consideration of the business strategy, overarching risk strategy, and/or capital plan. 2.3 Adapting to the Capital Requirements Regulation As at 31 December 2016, the Parent Bank, Sparebanken Hedmark, and its subsidiary, Bank 1 Oslo Akershus, use the Advanced IRB approach for calculating minimum capital requirement for credit risk in the loans portfolio. The Figure below provides an overview of the approaches the Group uses for calculating capital requirements. Area Parent Bank Bank 1 Oslo Akershus SpareBank 1 Finans Østlandet Credit risk - Central governments Standard approach Standard approach Standard approach - Institutions Standard approach Standard approach Standard approach - Corporates Advanced IRB approach Advanced IRB approach Standard approach - Retail Advanced IRB approach Advanced IRB approach Standard approach - Equity Standard approach IRB - Simple risk-weighted approach N/A - Derivatives Market risk Figure 3: Approaches for calculating capital requirements in the Group Market value approach, and standard approach for CVA risk Standard approach (duration approach) Market value approach, and standard approach for CVA risk Standard approach (duration approach) Operational risk Basic approach Basic approach Basic approach N/A N/A

6 3 Consolidation The Group attaches importance to maintaining adequate capitalisation at all times for all the companies within the Group. No governing bodies have imposed any restrictions on the Board s ability to transfer capital between the Parent Bank and its subsidiaries, and between subsidiaries with the exception of regulatory and other statutory limitations. In addition, there are no provisions in the Articles of Association that impose any such restrictions. For the same reason, the Bank and its subsidiaries do not enter into agreements that impose restrictions on the Board s right to transfer capital as described above. This applies to both funding loan agreements and agreements with suppliers and customers. Moreover, transfer of capital between the companies is regulated by the ordinary regulatory legislation for these companies and the financial group. This does not impose any restrictions on the capital allocation principles stated above. As with investments in subsidiaries, the Group has a strategic interest in supporting the business operations of SpareBank 1 Gruppen AS, SpareBank 1 Banksamarbeidet DA, SpareBank 1 Boligkreditt AS, SpareBank 1 Næringskreditt AS, SpareBank 1 Kredittkort AS, SpareBank 1 Mobilbetaling AS, and other smaller joint ventures in SpareBank 1. In connection with this, the Group ensues that no agreements are entered into or decisions or similar made that involve restricting the owner s ability to transfer capital to these companies should this become necessary to attain satisfactory capital adequacy or financial strength. The Group is not aware of the existence of any such restrictions beyond what follows from the framework legislation. The Group assumes that it will not be practical to transfer capital to the owner s beyond the distribution of ordinary dividends. As far as the Group is aware, there are no private law impediments that restrict dividend distributions from the aforementioned companies. The following table illustrates the difference in the basis for consolidation for consolidation in accordance with the accounting rules and consolidation for capital adequacy purposes.

7 CONSOLIDATING 7 Table 1: Basis for consolidation Wholly consolidated companies Consolidation approach 2016 Business office Number of shares Voting capital Book value Accounting purposes Capital adequacy purposes Sparebanken Hedmark Hamar Fullconsolidation Fullconsolidation Bank 1 Oslo Akershus AS Oslo ,00 % Fullconsolidation Fullconsolidation EiendomsMegler 1 Hedmark Eiendom AS Hamar ,00 % 20 Fullconsolidation Fullconsolidation SpareBank 1 Finans Østlandet AS Hamar ,00 % 808 Fullconsolidation Fullconsolidation SpareBank 1 Regnskapshuset Østlandet AS Hamar ,00 % 81 Fullconsolidation Fullconsolidation Vato AS Hamar ,00 % 9 Fullconsolidation Fullconsolidation Total Proportionally consolidated companies Consolidation approach 2016 Business office Number of shares Voting capital Book value Accounting purposes Capital adequacy purposes KOMM-IN AS Raufoss ,10 % 6 Equity approach Proportional consolidation. Torggt 22 AS Hamar ,00 % 9 Equity approach Proportional consolidation. SpareBank 1 Boligkreditt AS Stavanger ,25 % Equity approach Proportional consolidation. Total Companies in which subordinated capital is deducted Consolidation approach 2016 Business office Number of shares Voting capital Book value Accounting purposes Capital adequacy purposes SpareBank 1 Næringskreditt AS Stavanger ,24 % 176 Equity approach Not consolidated SpareBank 1 Kredittkort AS Trondheim ,87 % 214 Equity approach Not consolidated SpareBank 1 Gruppen AS Tromsø ,00 % 945 Equity approach Not consolidated SpareBank 1 Mobilbetaling AS ,20 % 20 Equity approach Not consolidated Total Companies that are not consolidated and where no subordinated capital has been contributed that has been deducted from subordinated capital in the institution Consolidation approach 2016 Business office Number of shares Voting capital Book value Accounting purposes Capital adequacy purposes SpareBank 1 Banksamarbeidet DA Oslo 19,90 % 21 Equity approach Not consolidated Total 21

8 8 RISK AND CAPITAL MANAGEMENT 4 Risk and capital management 4.1 Group structure The following companies are included in the Sparebanken Hedmark Group: Figure 4: Summary of the Sparebanken Hedmark Group Sparebanken Hedmark Subsidiaries Associated companies Joint ventures Bank 1 Oslo Akershus AS (100,00%) SpareBank 1 Finans Østlandet AS (95,00%) EiendomsMegler 1 Hedmark Eiendom AS (100,00%) SpareBank 1 Regnskapshuset Østlandet AS (100,00%) Vato AS (100,00%) SpareBank 1 Boligkreditt AS (10,04%) SpareBank 1 Næringskreditt AS (5,05%) SpareBank 1 Kredittkort AS (9,28%) SpareBank 1 Mobilbetaling AS (12,60%) KOMM-IN AS (23,70%) SpareBank 1 Gruppen AS (11,00%) SpareBank 1 Banksamarbeidet DA (19,90%) Torggt 22 AS (50,00%) Bank 1 Oslo Akershus AS is a bank in the Oslo and Akershus market area. The Parent Bank Sparebanken Hedmark acquired 100 percent of the shares in Bank 1 Oslo Akershus in The banks will merge with effect from 1 April SpareBank 1 Finans Østlandet AS sells leasing products and secured financing, with all of Eastern Norway as its primary market area. The Parent Bank, some SpareBank 1 banks, and capital goods suppliers are, in addition to the Internet, the company s most important distribution channels. SpareBank 1 Regnskapshuset Østlandet AS is part of SpareBank 1 Regnskapshuset s endeavour to become one of Norway s leading actors in the accounting industry. The SpareBank 1 banks intend, in line with the Alliance s strong traditions, to build up a national accounting operation based on regional ownership and proximity to the market. EiendomsMelger 1 Hedmark Eiendom AS is Hedmark s leading real estate agent and it is represented in the most central locations in the county. Vato AS owns one of the Bank s office buildings. SpareBank 1 Boligkreditt AS is the alliance banks covered bond company for the retail segment. SpareBank 1 Næringskreditt AS is the alliance banks covered bond company for the corporate segment. SpareBank 1 Kredittkort AS is the alliance banks joint credit card company. SpareBank 1 Mobilbetaling AS is the alliance banks joint mobile phone payment company, which operates and develops mcash. SpareBank 1 Gruppen og SpareBank 1 Alliance The purpose of the Alliance is to acquire and deliver competitive financial products and services, taking advantage of economies of scale in the form of lower costs and/or higher quality. The Alliance contributes accordingly to private individuals and corporate customers experiencing local roots, competence and an easier way of having their various requirements met. In addition, the Alliance shall contribute to ensuring the creation of value by the Bank for the benefit of our own region. The SpareBank 1 banks run the Alliance, as well as develop and manage products via SpareBank 1 Utvikling DA and SpareBank 1 Gruppen AS. While SpareBank 1 Gruppen is a product provider primarily within insurance, SpareBank 1 Banksamarbeidet DA is responsible for the cooperation processes in the SpareBank 1 Alliance, where technology, brand names, competence, joint processes/best practices, and purchasing are all key factors. The SpareBank 1 banks work together extensively on development.

9 RISK AND CAPITAL MANAGEMENT 9 Figure 5: SpareBank 1-alliance Owners: SpareBank 1 SR-Bank SpareBank 1 SMN SpareBank 1 Nord-Norge SamSpar Sparebanken Hedmark Bank 1 Oslo Akershus LO/LOforbund SpareBank 1 Gruppen AS SpareBank 1 Banksamarbeidet AS SpareBank 1 Mobilbetaling AS (mcash) SpareBank 1 Kredittkort AS SpareBank 1 Boligkreditt AS SpareBank 1 Forsikring AS Life insurance SpareBank 1 Skadeforsikring AS EiendomsMegler 1 Norge AS SpareBank 1 Kundesenter AS SpareBank 1 Næringskreditt AS SpareBank 1 Markets AS BN Bank ASA ODIN Forvaltning AS Fund management SpareBank 1 Medlemskort AS Management av LOfavør SpareBank 1 Verdipapirservice AS SpareBank 1 ID AS Conecto AS Debt recovery SpareBank 1 Axept AS SpareBank 1 Gruppen Finans AS Factoring - Portfolio 4.2 Organisasjonskart As at 31 December 2016, Sparebanken Hedmark was organised as shown in the organisation chart below. Figure 6: Organisation chart CEO Legal HR Development Org. and HR Communications HR Management Operations Accounting Finance Economics and Finance Operational support Risk mangement Business improvement Purchasing and property Security IT CM Investment centre RM Hedmark Region General Insurance Customer service centre Hedmark Region Key Accounts Hedmark Region Glåmdal Region Østerdal Region Oppland Region Life/pension Insurance Cash Management Company service centre Ringsaker og Oppland Region Sør-Østerdal Region Glåmdal Region Nord-Østerdal Region Private Banking Business support Credit management Credit support Products/channels Market support

10 10 RISK AND CAPITAL MANAGEMENT 4.3 Risk and capital management Objective Risk and capital management in the Group should support the Group s strategic targets, while contributing to financial stability and sound asset management. This should be achieved by: A clear corporate culture characterised by a high awareness of risk management. A good understanding of the risks driving earnings. Striving towards a effecive use of capital within the adopted business strategy. Preventing unexpected events from damaging the Group s financial position to a serious extent. The Group aims for a moderate to low risk profile Control and management structure roles and responsibilities In achiving good, uniform risk management, corporate culture is the foundation that the other elements build on. Corporate culture encompasses the people in the organisation (their individual characteristics and integrity, core values and ethics), management philosophy/style and management principles. It can be difficult to compensate for a poor corporate culture by other control and management measures. The Group has therefore established clearly defined core values and code of conduct, which have been clearly communicated and presented throughout the organisation. The Group emphasises independence in risk management. Responsibility for risk management has, therefore, been divided between different groups in accordance with the Figure below. Figure 7: Responsibilities and roles in the risk management process The Board of Directors Determines the Group s risk profile and ensures that the Group has capital that is reasonable based on the Group s risk and the authorities requirements. CEO, Line units and staff departments Risk Management Internal audit Day-to-day risk management Overarching risk management and follow-up Independent confirmation Instructions, limits and autorisations Formal reporting The Board is responsible for ensuring that the Group has adequate capital based on the adopted risk profile and regulatory requirements. The Board stipulates the overall objectives with respect to the risk profile and return. The Board also stipulates the overall limits, authorisations and guidelines for risk management in the Group, as well as the code of conduct that should contribute to a high ethical standard. The Board s tasks are set out in an annual plan, which is revised annually. This ensures the Board has adequate time to focus on its key duties each year. The Board has established a Risk Committee, an Audit Committee, and a Remuneration Committee. The Risk Committee is a preparatory body for the Board in cases involving the Bank s risk management and internal control, while the Audit Committee prepares cases that involve financial information and internal control associated with this. The committees consist of the same three members of the Board, although the committees do not have the same chair. The Remuneration Committee shall correspondingly assist the Board with matters concerning Sparebanken Hedmark s CEO s terms of employment, as well as matters concerning the general principles and strategy for the remuneration of the senior executive personnel in the Group. The committee consists of three members of the Board. The CEO is responsible for overall risk management. This means that the CEO is responsible for the implementation of efficient risk management systems in the Group and the monitoring of the risk exposure. The CEO is also responsible for delegating authority and reporting to the Board. The business divisions and staff units are responsible for risk management within their area of responsibility. This means that the managers should make sure that proper risk management is established and executed, and that it is performed in accordance with the risk strategies and policies, authorisations, routines and instructions. The Risk Management and Compliance Department is organised independently of the line and staff units and reports directly to the CEO. The department is responsible for further development of the limits for risk management, including risk models and risk management systems. The department is also responsible for independent monitoring and reporting of the risk situation and for ensuring that the Group complies with the applicable laws and regulations. The internal audit is the Board s instrument for ensuring that risk management is targeted, effective, and functioning as

11 RISK AND CAPITAL MANAGEMENT 11 assumed. The internal audit function is outsourced, which guarantees independence, expertise and capacity. The internal audit reports to the Board. The internal audit s reports and recommendations concerning improvements to the Group s risk management are continually reviewed and considered for implementation Elements of the risk and capital management In order to ensure an efficient and appropriate process for risk and capital management, the established framework is based on a number of elements that reflect the way in which the Board and management control the Group: Strategic targets Organisation and corporate culture Risk identification Risk analysis Stress tests Risk strategies Capital management (including return and capital adequacy) Reporting Follow-up Contingency plans Compliance Recovery plans The correlation between the individual elements can be summed up as in the Figure below. Figure 8: Framework for risk and capital management Strategic targets Follow-up Risk identification Return Return on equity Reporting Organisation, management, and corporate culture Risk analysis Capital adequacy Core equity Tier 1 capital Risk-adjusted return Capital management Risk management strategies Stress tests Total capital Liquidity Contingency plans Operation of the Group Capital adequacy Compliance Recovery Strategic targets Risk and capital management in the Group are based on the defined strategic targets as set out in the strategy plan Risk identification Risk identification should be forward looking and an integral part of the strategy and planning process. The process should cover all the significant risks to which the Group is exposed and be carried out at least once a year Risk analysis An analysis of the risks that have been identified should be conducted to understand the characteristics of the risks and causal mechanisms. Significant risks should be quantified, whenever possible, through the expected losses and need for risk-adjusted capital. This will apply primarily to credit risk. The quantification should be based on recognised and reassuring methods and procedures for the measurement of risk. The risk analysis should also ensure that a qualified and structured assessment and documentation of the established control and management measures is made Stress tests and scenario analyses Periodic stress tests and scenario analyses should be carried out to analyse how negative events affect the Group s results, balance sheet and capital adequacy. Such analyses should be conducted for the most critical risk areas, such as the credit, market and liquidity risks, and they should take into account a negative macroeconomic development over a period of at least three years.

12 12 RISK AND CAPITAL MANAGEMENT Risk strategies Based on the risk strategies, the Board must define the desired risk profile by establishing risk-based limits and targets for the various risk areas. The strategies must be revised annually Capital management The Group s capital management must ensure: Effective capital acquisition and use of capital in relation to the Group s strategic targets and adopted business strategy. A satisfactory return on equity. A satisfactory common equity Tier 1 ratio in relation to the chosen risk profile the authorities requirements. Competitive terms and good long-term access to funding in capital markets. Growth opportunities in the Group s defined market areas at any given time are taken advantage of. On the basis of the strategic target, a capital plan is drawn up each year for the following three years to ensure longterm and targeted capital management. The capital plan shall take into account projections of the Group s financial development over the next three years. These projections are based on the expected developments in the period, as well as a situation with a serious economic downturn over a minimum of three years. Based on the projections of the total capital requirements, the management team and Board must make an overall assessment of whether the Group s capital is sufficient and suitable for the Group s current and future risk profiles and strategic targets. The Group s targets for common equity Tier 1 and total capital adequacy ratios must ensure sufficient capital to: Satisfy the authorities requirements. Protect the Group s creditors Follow-up, reporting and monitoring All managers are responsible for the day-to-day risk management in their own areas of responsibility, and they should ensure that the risk exposure is within the limits adopted by the Board or the CEO at all times. The purpose of the Group s risk reporting is to ensure that the different levels of the organisation have access to adequate and reliable risk reporting. The overall monitoring of risk exposure and risk development is performed by the Risk Management Department and followed up through periodic reports to the Board and management team Contingency plans The core business of banks entails the acceptance of risk. Over time this may inflict large unexpected losses on banks, in spite of good risk management systems and processes. Such a situation may entail serious pressure on capital adequacy, funding and operations. The Group must, therefore, have contingency plans for the aforementioned areas Compliance There must be processes that ensure compliance with current Acts and Regulations. This must be achieved by: Clear core values and an ethical standard that is clearly communicated and understood A process that detects, communicates and implements amendments to Acts and Regulations A process that follows up and reports compliance with Acts and Regulations Recovery plans In addition to ordinary contingency plans, there must be a separate recovery plan that specifies concrete, practical measures for managing financial crisis situations. The recovery plan should not predict financial crises; rather it should identify and assess the Group s opportunities to restore its financial strength and viability in situations where the Group is under severe financial pressure.

13 5 Information per risk group 5.1 Key risk groups The Group is exposed to various types of risk. The most important risk groups are: Credit risk: The risk of losses resulting from a customer s or other counterparty s inability or unwillingness to fulfil its obligations. Market risk: The risk of losses due to changes in observable market prices, such as interest rates, share prices or currency rates. Operational risk: The risk of losses resulting from inadequate or failed internal processes or systems, human error or external events. Liquidity risk: The risk of not being able to fulfil obligations or finance assets, including desired growth, without significant extra costs. Ownership risk: The risk that the Group will suffer negative results from stakes in strategically owned companies and/or the need to inject fresh capital into these companies. Ownership is defined as companies in which the Parent Bank Sparebanken Hedmark has a significant stake and influence. Business risk: The risk associated with unexpected income and cost fluctu ations due to factors other than credit risk, market risk, and operational risk. Reputational risk: The risk of a failure in earnings and access to capital due to failing confidence in the market, i.e. customers, counterparties, stock market and authorities. Strategic risk: The risk of losses resulting from unsuccessful strategic initiatives. Compliance risk: The risk that the Group will incur public sanctions/penalties, financial losses or a weakened reputation as a result of a failure to comply with laws and regulations. Risk of irresponsible debt build-up: The risk that the Group s financial strength will be disproportionately reduced due to a high proportion of external funding and excessive debt build-up.

14 14 INFORMATION PER RISK GROUP 5.2 Credit risk Management and control Credit risk in the Group should be managed in accordance with the requirements and recommendations in the: Norwegian capital requirements regulations Financial Supervisory Authority of Norway s methodology for risk-based supervision The Figure below illustrates what management and control of credit risk is based on. Figure 9: Framework for managing credit risk Macroeconomic factors Regulator factors Principles for management and control Bank s strategy plan Code of conduct Corporate social resposibility strategy Overarching risk strategy Policy for risk and capital management Annual market plans Credit strategy Credit policy Credit authorities Portfolio management Process doc. / credit routines Risk classification Reporting The Group s strategy plan The strategy plan describes the market-related targets and defines the Bank s market area. The strategy document represents an important point of departure for other management and plan documents in the area Code of conduct The code of conduct functions as a guide for the Group s activities by defining the ethical requirements we make of ourselves and how we should deal with the surroundings Corporate social responsibility strategy The corporate social responsibility strategy describes the Group s opportunities and challenges in relation to corporate social responsibility and how this issue is managed Overall risk strategy The overall risk strategy is the Board s tool for defining and managing the Group s risk profile. The document is issued by the Board and revised as required, and at least once a year Policy for risk and capital management The policy for risk and capital management is the Group s internal framework for management and control. This policy provides guidelines for the Group s overall attitudes and principles for risk management and should ensure that the Group establishes and maintains an effective and appropriate risk management process. In addition, the document should ensure that the framework satisfies the external requirements and expectations for good risk management. The document is issued by the Board and revised as required, and at least once a year Credit strategy The credit strategy specifies the overall principles for granting credit. The desired credit profile is defined through volume and risk-based targets for portfolio, sub-portfolio and individual customers. This forms the basis for reporting and monitoring the ongoing risk exposure. The document is issued by the Board and revised as required, and at least once a year.

15 INFORMATION PER RISK GROUP Credit policy The credit policy describes the distribution of responsibilities and roles and determines more detailed criteria for the credit operations. The policy describes what is acceptable within the given credit appraisal areas. The purpose is to ensure that the Bank acts in a uniform manner and in accordance with the external regulatory framework (laws and regulations) and established internal risk level. The document is issued by the Board and revised as required, and at least once a year Annual market and activity plans The annual market and activity plans describes activities for the individual year. These plans should help ensure that the market, earnings and risk related targets in accordance with the Bank s strategy plan and risk strategies are achieved. Annual market and activity plans are issued administratively Credit authority regulations The Board delegates credit authority to the CEO and determines the Bank s rules and regulations for granting credit. The credit authorities are personal and should reflect the competence of the individual. Credit authorities are differentiated by volume and risk. The document are revised as required and at least once a year Process documentation/credit routines The documentation regulates various matters related to the ongoing granting of credit and follow-up of commitments, including routines for following up defaulted commitments, evaluations of impairments, etc. The documen tation is prepared by the credit manager in cooperation with the business divisions. The documents are revised on an ongoing basis. Significant changes to the framework must be presented to, and approved by, the CEO Risk pricing The Group strives to achieve the right pricing of credit risk and has established price models based on the risk classification system Validation The purpose of the validation process is to verify the credit risk models and the Group s IRB system to ensure that both the quality of the models and the compliance with and application of the IRB system are good over time. The process and preparation of the necessary reports are carried out by the Risk Management Department. Validation reports are reviewed by the Risk and Balance Sheet Management Committee before the CEO makes decisions relating to matters addressed in the report. The Board is kept informed about the validation work and the decisions that are made Stress testing Periodic stress tests are performed on the credit portfolio, in which the effect of the stress tests on the expected losses and risk-adjusted capital is analysed and assessed Follow-up of credit risk/risk reporting Risk exposure within the credit market is followed up by means of a portfolio management system that contains information that enables an appropriate follow-up of the portfolio s risk profile and its development. Importance is attached to following up the portfolio risk distribution and its development based on movements between the risk classes (migration), expected losses, capital needs, and risk-adjusted return. The Risk Management Department follows up the risk in the credit portfolio and reports quarterly to the Board and the Bank s management team. In addition, the Risk Management Department prepares a monthly risk report to the Bank s management team based on selected risk parameters. The business divisions are responsible for following this up correspondingly within their own divisions Credit risk models Credit models and risk classification systems The Parent Bank Sparebanken Hedmark and Bank 1 Oslo Akershus use common models for calculating credit risk at the portfolio level and in the granting process together with the other banks in the SpareBank 1 Alliance. The models are based on statistical calculations, and are under continuous validation and development. The Parent Bank Sparebanken Hedmark and Bank 1 Oslo Akershus use the model both in internal reporting and in capital adequacy calculations based on the Advanced IRB approach. The models are based primarily on three main components: Figure 10: Risk classification system Probability of default Exposure at default Loss given default Expected loss Risk class Risk-adjusted capital Risk pricing Customers are classified by default classes according their calculated probability of default during the next twelve-month period based on a long-term outcome. Exposure at default specifies the estimated potentially to a customer at the time of default. Loss given default is an estimate that specifies the potential loss that can arise if a customer is to default on its obligations. Expected loss is the aggregate statistical amount to be expected lost during a period of twelve months. Customers are classified by risk classes according to their calculated probability of default. Risk-adjusted capital specifies the amount of capital required to cover potential unexpected losses. Sparebanken Hedmark strives to price risk poperly and have implemented risk-pricing models based on the risk inherent in each individual commitment.

16 16 INFORMATION PER RISK GROUP Probability of Default (PD) Commitments are classified by default classes according to the probability that the customers will default on their commitments during the next twelve-month period. The probability of default is calculated based on a long-term average, which is to represent the probability of default throughout an economic cycle. The probability of default is calculated, for example, on the basis of historical data series. In order to classify customers according to the probability of default, nine default classes (A I) are used. In addition, deafult classes J and K are used for customers with commitments in default or commitments with impairments. Figure 11: Risk classes Risk class Lower limit for probability of default Upper limit for probability of default A - 0,10% B 0,10% 0,25% C 0,25% 0,50% D 0,50% 0,75% E 0,75% 1,25% F 1,25% 2,50% G 2,50% 5,00% H 5,00% 10,00% I 10,00% 99,99% J K Defaults over 90 days Commitments with impairments A commitment is considered to be in default if: A claim has been due for more than 90 days and the amount is greater than NOK 1,000, or When the Bank considers it unlikely that the customer will meet their payment obligations Expected exposure at default (EAD) EAD is an estimate that specifies the exposure to a customer at the time of default. The estimate is based on the overall exposure to the customer, including guarantees and unutilised credit limits Loss Given Default (LGD) LGD is an estimate that specifies the potential loss that can arise if customers default on their obligations. Seven classes are used for classification of the commitments based on the collateral coverage: Figure 12: Collateral classes Collateral class Collateral value (realisation value) 1 More than 120% 2 More than 100% 3 More than 80% 4 More than 60% 5 More than 40% 6 More than 20% 7 Up to 20%

17 INFORMATION PER RISK GROUP Portfolio informastion General information Information about the Bank s credit risk comprises a description of the loan portfolio and doubtful or defaulted commitments, as well as other relevant information related to credit risk. The figure below shows impairments for losses in NOK millions for customer groups where the IRB approach is used. Figure 13: Impairments for losses (balance sheet) where the IRB approach is used Corporate - SME Corporate - specialised lending Retail real estate - SME Retail real estate - non SME 6 13 Retail other - non SME Retail other - SME The figure below shows a comparison between probability of default (PD) and actual default rate (DR) twelve months later. The comparison is based on a scoring model and not regulatory categorisation. This means that, for example, selfemployed people who are scored using the retail market model will not necessarily fall into the mass market category. The differences between PD and the observed default rate (DR) are monitored via monthly reports for the last twelve-month period. The figure shows data for the Parent Bank Sparebanken Hedmark. Please see Bank 1 Oslo Akershus s Pillar 3 document for the corresponding figures for Bank 1 Oslo Akershus. Figure 14: Comparison of probability of default and default rate 5,0% 4,5% 4,0% 3,5% 3,0% 2,5% 2,0% 1,5% PD CM DR CM 1,0% 0,5% 0,0% 1,4% 1,2% 1,0% 0,8% 0,6% 0,4% PD RM residential DR RM residential 0,2% 0,0% % 6% 5% 4% 3% 2% PD RM other DR RM other 1% 0%

18 18 INFORMATION PER RISK GROUP The table below shows the distribution by risk class where the IRB approach is used. All of the portfolios report using the Advanced IRB approach. Table 2: Distribution by risk class for commitments where the IRB approach is used Corporate - SME Risk class Total EAD EAD off-balance CF Average LGD Average risk weighting A % 0 % 0 % B % 19 % 22 % C % 22 % 32 % D % 28 % 47 % E % 24 % 46 % F % 36 % 78 % G % 36 % 93 % H % 41 % 122 % I % 38 % 174 % J % 38 % 15 % K % 0 % 115 % Total % 29 % 68 % Corporate specialised ledning - real estate Risk class Total EAD EAD off-balance CF Average LGD Average risk weighting A % 0 % 0 % B % 13 % 14 % C % 27 % 36 % D % 30 % 58 % E % 27 % 48 % F % 31 % 72 % G % 37 % 98 % H % 31 % 97 % I % 33 % 136 % J % 112 % 0 % K % 0 % Total % 30 % 68 % Corporate other Risk class Total EAD EAD off-balance CF Average LGD Average risk weighting A % 0 % 0 % B % 0 % 0 % C % 36 % 64 % D % 21 % 46 % E % 18 % 42 % F % 42 % 101 % G % 0 % 0 % H % 0 % 0 % I % 0 % 0 % J % 0 % 0 % K % 0 % 0 % Total % 26 % 58 % Corporate specialised lending - object financing Risk class Total EAD EAD off-balance CF Average LGD Average risk weighting A % 0 % 0 % B % 18 % 22 % C % 18 % 24 % D % 26 % 43 % E % 21 % 44 % F % 22 % 67 % G % 23 % 67 % H % 28 % 119 % I % 25 % 130 % J % 29 % 217 % K % 0 % 0 % Total % 21 % 48 %

19 INFORMATION PER RISK GROUP 19 Corporate specialised lending - project financing Risk class Total EAD EAD off-balance CF Average LGD Average risk weighting A % 84 % 27 % B % 0 % 0 % C % 3 % 2 % D % 0 % 0 % E % 19 % 45 % F % 22 % 56 % G % 60 % 217 % H % 0 % 0 % I % 0 % 0 % J % 0 % 0 % K % 0 % 113 % Total % 24 % 52 % Retail - real estate - non SME Risk class Total EAD EAD off-balance CF Average LGD Average risk weighting A % 0 % 0 % B % 16 % 7 % C % 20 % 13 % D % 22 % 21 % E % 24 % 31 % F % 25 % 44 % G % 23 % 65 % H % 22 % 90 % I % 22 % 122 % J % 18 % 28 % K % 29 % 87 % Total % 21 % 23 % Retail - real estate - SME Risk class Total EAD EAD off-balance CF Average LGD Average risk weighting A % 0 % 0 % B % 14 % 6 % C % 17 % 11 % D % 19 % 17 % E % 20 % 26 % F % 21 % 38 % G % 24 % 65 % H % 15 % 63 % I % 22 % 130 % J % 18 % 15 % K % 27 % 144 % Total % 18 % 23 % Retail other - SME Risk class Total EAD EAD off-balance CF Average LGD Average risk weighting A % 0 % 0 % B % 44 % 19 % C % 43 % 28 % D % 48 % 41 % E % 46 % 49 % F % 39 % 51 % G % 47 % 70 % H % 42 % 70 % I % 44 % 104 % J % 59 % 0 % K % 79 % 18 % Total % 46 % 37 % Retail other - non SME Risk class Total EAD EAD off-balance CF Average LGD Average risk weighting A % 0 % 0 % B % 65 % 29 % C % 64 % 41 % D % 63 % 54 % E % 62 % 65 % F % 64 % 82 % G % 65 % 97 % H % 65 % 106 % I % 64 % 155 % J % 57 % 0 % K % 78 % 23 % Total % 64 % 59 %

20 20 INFORMATION PER RISK GROUP The table below shows the Group s total commitments to customers and institutions before and after impairments. Table 3: Commitments Type of commitment Commitment amount as at 31 December 2016 Average commitment amount RM CM Gross commitment, customers Individual impairments Impairments on groups of loans Impairments of guarantees Net commitment, customers Norges Bank Financial institutions Total commitment amount The table below shows the Bank s total loans inside and outside Hedmark. Table 5 shows loans and total commitments by customer group, while table 6 shows the remaining term of loans, guarantees, and unutilised credit limits for customers and financial institutions. Table 4: Commitments by geographic area (based on customer s address) Type of commitment Hedmark Oslo Oppland Akershus Others Abroad Total Gross lending Unutilised credit Guarantees Total Table 5: Commitments by customer group Type of commitment Lending Unutilised credit Guarantees Total Wage earners (RM) Public administration Agrigulture/forestry Wood processing industry Other industries Building and construction Power and water supply Wholesale and retail trade Hotel and restaurant industry Property management Commercial services Transport and communication Other industries CM Total commitments to customers Table 6: Remaining terms of commitments At call Less than 3 months 3 12 months 1 5 years Over 5 years Total Gross loans to customers incl. accrued interest Unutilised credit limits Guarantees Total commitments

21 INFORMATION PER RISK GROUP Impairments and losses on loans and guarantees Individual impairments Individual impairments for losses on individual commitments are made when there is objective evidence that triggers an impairment in value for the Group. Individual impairments represent the difference between the commitment s book value and the present value of the discounted cash flow based on the effective interest rate at the time of the initial calculation of the individual impairment. A impairment entails that a commitment is given the highest default class (K). Individual impairments reduce the book value of the commitments on the balance sheet, and changes in the assessed value during the period are recognised in the income statement as losses on loans and guarantees. The estimation of cash flows is complicated since events in the future are generally associated with uncertainty. Importance is attached to specific orientation and caution in the estimation of value as grounds for the realisation of collateral security. The cash flow is updated at least once a year based on materiality assessments. Group impairments Group impairments comprises of an assessment of a group of loans with approximately the same risk characteristics. Loans where individual impairments have been considered but where objective evidence has not been proven are included. All loans are consequently assessed with the exception of those that have been subject to individual impairments. The model for calculation of group impairments is based on changes in the expected losses as a result of loan portfolio migration, as well as any additions in the event of major changes in the macro conditions. Group impairments reduce the book value of the commitments on the balance sheet, and changes in the assessed value during the period are recognised in the income statement as losses on loans and guarantees. General The Bank monitors the corporate market portfolio to identify credit risk and assess in this context whether individual impairments should be made. Large and particularly doubtful commitments are reviewed on a semi-annual basis. All the identified problem commitments in the corporate market that have been assessed in particular are subject to special intensified follow-up. The summary is maintained monthly. The entire credit portfolio is subject to assessment upon more than 64 days in default as grounds for forwarding to debt collection with the a associated assessment of individual impairments. Loans and other commitments in which there has been a default on the payment terms are classified as in default unless the situation is considered to be of a temporary nature. Classification as in default occurs at day 90 after the default has been established. Guarantees are in default when the guarantee creditor has pledged claim. Table 7 illustrates changes in the impairment of loans and guarantees on the Group s balance sheet and the impairments distributed by customer group. Table 8 illustrates the corresponding data for group impairments. As at 31 December 2016, total impairments (tables 8 and 9) amounted to NOK 418 million. Table 7: Individual impairments Individual impairments Retail market Corporate market Total Individual impairments to cover losses on loans, guarantees, etc., as at 1 January Realised losses in the period on loans, guarantees, etc. previously impaired individually Reversal of impairments from prior years Increase in impairments on commitments previously impaired individually Impairment of commitments not previously impaired individually Change in outgoing balance due to acquisition of B1OA Individual impairments to cover losses on loans and guarantees as at 31 December Table 8: Group impairments Retail Corporate Group impairments market market Total Group impairments to cover losses on loans and guarantees as at 1 January Group impairments to cover losses on loans and guarantees for the period Change in outgoing balance due to acquisition of B1OA Group impairments to cover losses on loans and guarantees as at 31 December