BOARD OF DIRECTORS Number: /3 Date: Risk and Capital Management. Basel II Pillar 3 Disclosure Year 2013

Transcription

1 BOARD OF DIRECTORS Number: /3 Date: Risk and Capital Management Basel II Pillar 3 Disclosure Year 2013

2 Contents 1. General information Basic information about the Vojvodjanska banka, member of NBG Group Introduction Pillar Pillar Pillar Overall risk and capital management Risk management strategy... 6 Liquidity risk Policy... 8 Policy for the management of interest rate risk in the banking book... 8 Country Risk Management Policy Risk management framework Risk governance structure Capital management Risk types Monitoring and reporting Capital structure and capital adequacy ratio Capital structure and adequacy ICAAP considerations Credit risk Introduction Capital requirement for credit risk Quantitative information on the credit risk Gross and net credit exposure per exposure classes Credit exposure per geographical areas Credit exposure per sectors Credit exposure according to the remaining time to maturity Distribution of exposures per classification categories and exposure classes, as well as calculated special and needed reserves Large exposures Impaired facilities and past due exposures

3 5.7 Credit risk mitigation Related party and intra-group transactions Equity investments held in banking book Market risk Introduction Foreign exchange risk management Market risk management Capital requirement for market risk Operational risks Introduction Operational risk management Capital requirement for operational risk Other types of risk Introduction Liquidity risk Management of interest rate risk in the banking book Concentration risk Counterparty credit risk Reputational risk Other risks

4 The NBS Basel II guidelines became effective on 31 December 2011 as the common framework for the implementation of Basel II standards for banks incorporated in the Serbia. The Basel II Pillar 3 Disclosure Report has been prepared in accordance with the NBS requirements outlined in the Decision on disclosure of data and information by banks (RS Official Gazette 45/2011). This Basel II Pillar 3 Disclosure Report contains a description of the Bank s risk management and capital adequacy practices and processes. The Disclosures in this Report are in addition to or in some cases, serve to clarify the disclosures set out in the Notes to the Financial Statements for the year ended 31 December 2013, presented in accordance with the Financial Accounting Standards (FAS) and International Financial Reporting Standards (IFRS). 1. General information 1.1. Basic information about the Vojvodjanska banka, member of NBG Group Vojvodjanska banka a.d., Novi Sad (the Bank ) was established on 1 January 1990 by the transformation of Vojvodjanska bank - Associated Bank, Novi Sad. On 30 December 2001, in accordance with its Articles of Incorporation and the Decision of the Bank s General Assembly, the Bank merged with Srpska razvojna banka a.d. Beograd and Uzicka banka a.d., Uzice. In December 2006, in accordance with the terms of the Agreement on the Purchase and Sale of Share Capital, the National Bank of Greece became the major owner of the Bank s share capital, by acquiring an equity interest of 99.43%. The aforementioned acquisition was duly registered with the Central Securities Depository and Clearing House, on 12 December On 25 October 2007, the National Bank of Greece, Athens, conducted the mandatory purchase of the remaining 1,727 shares and became the sole owner of the Bank. On 7 December 2007, Vojvodjanska banka a.d., Novi Sad was excluded from the Belex list on its own request. The Bank is registered in the Republic of Serbia a closed joint stock company to provide a wide range of banking services associated with payment transfers, credit and deposit activities in the country and abroad, and it operates in accordance with the Republic of Serbia s Law on Banks. In accordance with the Decision brought by the Bank s Assembly on 3 January 2008, Vojvodjanska banka a.d., Novi Sad merged with the National Bank of Greece a.d. Beograd, with the date of merger being 31 December The aforementioned status change of merger by absorption of the National Bank of Greece a.d., Beograd was inscribed in the registry maintained by the Serbian Business Registers Agency on 14 February 2008 under the number BD 6190/2008 (removal of the business entity the National Bank of Greece a.d., Beograd as the acquired bank) and the change in equity structure of Vojvodjanska banka a.d., Novi Sad was inscribed (Decision number BD 6210/2008). The National Bank of Greece a.d., Beograd was entirely in the ownership of the National Bank of Greece Athens, Greece. The Bank continued its operations under the name of Vojvodjanska banka a.d., Novi Sad. The Bank s Head Office is located in Novi Sad, 7, Trg slobode. As of 31 December 2013, the Bank operated through its Central Office located in Novi Sad, 54 branches, excluding the inactive braches in Pristina and Podgorica, 55 sub-branch offices (31 December 2012: 60 branches, 57 sub-branches). As of 31 December 2013, the Bank had 1,703 employees (31 December 2012: 1,770 employees). 4

5 The Bank s registration number is Its tax identification number is As of 31 December 2013, the Bank had controlling interest in the following legal entities, which are not consolidated in the accompanying financial statement: Brodogradiliste Apatin d.o.o, Apatin (100% of interest in capital) Imos a.d. Sid (51.55% of interest in capital). 2. Introduction The new Basel II based framework, which has been implemented in Serbia by 31 December 2011, provides a more risk sensitive approach to assessment of risk and the calculation of regulatory capital. The new framework intends to strengthen the risk and capital management practices and processes within financial institutions. Given the NBS s requirements the Bank has accordingly taken steps to comply with these requirements. The NBS s risk and capital management framework, consistent with the Basel II framework, is built on three pillars: Pillar 1: Calculation of the regulatory capital, risk weighted assets, capital requirements and capital adequacy ratio. Pillar 2: The supervisory review process, including the Internal Capital Adequacy Assessment Process. Pillar 3: Rules for the disclosure of risks management and capital adequacy data and information. 2.1 Pillar 1 Basel II Pillar 1 prescribes the basis for the calculation of the regulatory capital adequacy ratio. Pillar 1 defines the regulatory minimum capital requirements for each bank to cover the credit risk, market risk and operational risk. It also defines the methodology for measurement of these risks and the various elements of qualifying capital. The capital adequacy ratio is calculated by dividing the regulatory capital base by the total Risk Weighted Assets (RWAs). The resultant ratio is to be maintained above a predetermined and communicated level by NBS. Under Basel II standards, the minimum capital adequacy ratio for banks incorporated in Serbia is set on 12% compared to the Basel Committee s minimum ratio of 8 per cent. The NBS also requires banks incorporated in Serbia to maintain a capital buffer of 2.5 per cent above the minimum capital adequacy ratio. In the event that the capital adequacy ratio (CAR) is higher for less than 2.5% of prescribed 12% or it would be higher after redistribution of retained profit for less than 2.5% of prescribed 12%, it means that the Bank is restricted to perform redistribution of profit only into elements/items of the Core Capital. Under the NBS s Basel II capital adequacy framework, the RWAs are calculated using more sophisticated and risk sensitive methods than under the previous Basel I regulations. The table below summarizes the Pillar 1 risks and the approaches used by the Bank to calculating the RWAs in accordance with the NBS s Basel II capital adequacy framework. RISK TYPE Credit risk Market Risk Operational Risk APPROACH USED BY THE BANK Standardized Approach Standardized Approach Basic Indicator Approach 5

6 2.2 Pillar 2 Basel II Pillar 2 deals with the Supervisory Review and Evaluation Process (SREP). It also addresses the Internal Capital Adequacy Assessment Process (ICAAP) to be followed by banks to assess the overall capital requirements to cover all relevant risks (including those uncovered under Pillar 1). Under the NBS s rules and Pillar 2 guidelines, each bank is to be individually assessed by the NBS and an individual minimum capital adequacy ratio could be prescribed as higher if the NBS assesses it is necessarily and is in interest of bank. The ICAAP incorporates a review and evaluation of risk management and capital relative to the risks to which the bank is exposed. The Bank has developed an ICAAP process which involves identification and measurement of risks to maintain an appropriate level of internal capital in alignment to the Bank s overall risk profile and business plan. An ICAAP Policy has been developed to address major components of the Bank s risk management, including risk types which are not covered under Pillar 1 and they are liquidity risk, credit fx risk, interest rate risk in the banking book, concentration risk, reputational risk and other risks. In its ICAAP Report 2013 the Bank has, in addition to risks from Pillar 1, calculated internal capital requirements for interest rate risk in the banking book, fx credit risk, risk of possible underestimation of credit risk in the SA and for concentration risk. 2.3 Pillar 3 In the NBS s Basel II framework, the Pillar 3 prescribes how, when, and at what level of data and information should be publicly disclosed about an institution s risk management, governance and capital adequacy practices. The disclosures comprise detailed qualitative and quantitative information. The purpose of the Pillar 3 disclosure requirements is to complement the first two Pillars and the associated supervisory review process. The disclosures are designed to enable stakeholders and market participants to assess an institution s risk appetite and risk exposures and to encourage all banks, via market pressures, to move towards more advanced forms of risk management. In accordance with NBS s regulation, the Bank ordinarily annually and semi annually disclosed data and information about risk and capital management. 3. Overall risk and capital management 3.1 Risk management strategy The Bank perceives strong risk management capacities to be the strong foundation in delivering business results to customers, investors and NBG Group. In accordance with this, the Bank endeavors 6

7 to develop the best international practices of risk management trying to provide the highest level of market discipline. The primary objectives of the Risk strategy of the Bank are to: Manage risks inherent in the Bank s activities in line with the risk appetite of the Bank; Strengthen the Bank s risk management practices to reflect the industry best practices; and Align internal capital requirements with risk materiality. The risk strategy is articulated through the limit structures for individual risks. These limits are based on the Bank s business plans and guided by regulatory requirements and guidance in this regard. By setting the risk appetite, the Bank links its individual risks to its strategy. The risk limits reflects the level of risk that the Bank is prepared to take in order to achieve its objectives. The Bank reviews and realigns risk appetite as per the evolving business plan of the Bank with changing economic and market scenarios. The Bank will also assess its tolerance for specific risk categories and its strategy to manage these risks. The risk appetite outlines the Bank s risk exposures and defines its tolerance levels towards accepting or avoiding these risks. Tolerance levels are contained in the limits defined by the Bank for each risk area. On the basis of the Risk Strategy, the Bank has developed a set of policies referring to individual risks which, inter alia, specify the procedures of identifying, assessing, measuring, monitoring, reporting and controlling risks; the manner of organizing the risk management process in respect of the given risks; as well as roles and responsibilities of the competent organizational units and management bodies with respect to each risk type. The risk mitigation techniques and the manners of ensuring and monitoring risk mitigation efficiency have also been defined in the above-mentioned policies. Credit risk policies The Credit Policy regarding the Corporate Portfolio aims to provide the Bank s personnel with the fundamental guidelines for the control (identification, measurement, approval, monitoring and reporting) of the credit risk related to the Corporate Portfolio. The Credit Policy has been designed to meet the organizational requirements and the regulatory frameworks in the best possible way, as well as to allow the Bank to maintain and enhance its leading position in the market. The Credit Policy has been approved and can be amended or revised by the Board of Directors and it is subject of periodical revision. This Board ratifies all exceptions from the Credit Policy initially approved by the Chief Credit Officer. All exceptions (and the rationale for each exception) should be recorded and have either an expiry date or a review date. Retail Banking Credit Policy and Small Business Banking Credit Policy sets the policies & risk acceptance criteria, which determine the framework for managing and minimizing the credit risks undertaken by the Retail Banking Products and Segments Division. Its main scope is to enhance, guide and regulate the effective and adequate management of retail and small business credit risk, thus achieving a viable balance between risk and reward. Both policies are orientated to serve three basic objectives: 1. Set the framework for the establishment of the basic credit criteria, policies and procedures, 2. Assures compliance with regulatory and NBG Group policy and 3. Establish a common approach for managing Retail Credit risks and Small Business Credit risks. Trading book policy The trading book Policy is related to market risks. Market risks arise from adverse effects on the financial result and equity on the valuation of balance sheet items and off-balance sheet items of the 7

8 Bank arising from movements in market prices. Market risks include currency risk, price risk on debt securities and equity securities and commodity risk. The Bank has no significant exposure to these risks, where there is a constant striving for their reduction to a minimum. Limits setting for market risks aims to risk managing, i.e. minimize risks that can have a negative impact on the operating results of the Bank. In addition to the nominal limit for open positions, limits related to the indicators, the Bank has established VaR limits on open positions in major currencies. In the function of market risk management the Bank has established a number of different limits for transactions agreed on market, where internal limits are stricter than all the limits prescribed by the National Bank of Serbia. The Bank is continuously synchronized its assets and liabilities per currency. Monitoring of currency positions in each currency is done in order to have consistent position with the pre-established limits by currency and the total allowed open position of the Bank. Trading book policy defines the criteria for the allocation of balance sheet items and off-balance sheet items in the trading book and the banking book as well as a methodology for evaluating the trading book and the banking book. Liquidity risk Policy The Liquidity risk Policy defines the basis framework, principles and metrics of liquidity risk management, which the Bank will adhere at any time to successfully satisfy its liquidity needs. The main objective of liquidity management is to reduce the liquidity risk to a minimum by planning the inflow and outflow of funds and the adoption of appropriate measures to prevent and eliminate the causes of insolvency, or the avoidance of negative effects on the financial result and equity due to the inability of the Bank to meet its financial obligations. The Bank strives in each moment to minimize liquidity risk. For the purposes of effective liquidity risk management and monitoring the Bank uses many reports on daily cash flows related to future planned activities including cyclical events that may affect the liquidity. The reports are used by the Treasury Division for daily liquidity management. Except the prescribed reserve requirements, the Bank is establishing its own liquidity reserves with the aim to respond in anytime to unexpected demands and outflows of cash funds. The adequacy of liquidity reserves is monitored on a daily basis. In order to mitigate liquidity risk, the Bank uses a limit system (internal and external), and a set of internal and external indicators. In addition to the cash flows, the Bank also considers its liquidity position through liquidity GAP and conducts stress testing their liquidity position at least once every quarter and the results of stress testing are discussed at meetings of the ALCO Committee. Policy for the management of interest rate risk in the banking book Interest rate risk is the risk of possible adverse effects on the financial result and capital arising from positions in the banking book due to changes in interest rates. Policy for the management of interest rate risk in the banking book, the Bank is complied with the accepted level of risk exposure and targeted risk profile, as well as general and specific risk management principles set out in the Bank s Risk Strategy. 8

9 The Bank assumes exposure to interest rate risk in accordance with the legal provisions and internal rules, where there is a constant striving to reduce this risk to a minimum. Bank tends to maintain ratios between interest sensitive assets and liabilities within the established limits for specified intervals. Interest rate risk management is carried out for all currencies as well as at the level for particular major currencies. The basis for measuring interest rate risk exposure is to analyze mismatches in re-establishing the interest rate differential between interest-bearing assets and liabilities. Such mismatches are monitored monthly by the interest sensitive items of the balance and off-balance sheet distributed at certain time by intervals and upon such terms and on the basis of the next date of re-pricing instrument or the maturity date for instruments with fixed interest rates. The Bank performs stress testing of interest rate GAP through a standardized shock of interest rate exposure to interest rate risk and monitor the effect on the economic value of equity and net interest income (NII). Country Risk Management Policy Country risk is the risk that refers to the country of origin of the bank is exposed, the risk of negative effects on the financial result and equity due to the inability of banks to collect claims from individuals for reasons that are political, economic or social conditions in country of origin. Policy for country risk management set out the key principles that are the basis of all business activities of the Bank, which include exposure to other countries and puts the focus on the Bank's approach to managing country risk arising from transactions with foreign counterparties. The Bank has established limits on individual countries, by groups of countries, in accordance with rating and limits on certain regions of a country where they belong. The basis for determining the limits for exposure to other countries, make the ratings set forth by reputable agencies. The Bank monitors daily the exposure to countries by all the aforementioned categories and maintains a level of exposure so that they are within established limits. Operational Risk Management Policy The Operational Risk Management Policy aim is to ensure that the entire Bank s stakeholders, including the Board of Directors, Executive and Senior Management as well as Staff, manage operational risk within a formalized Framework aligned to business objectives. Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal and compliance risk, but excludes other risks such as strategic or reputational. The main purpose of managing operational risk is to increase the awareness of operational risk, while creating the management structure which includes all organizational parts of the Bank and its employees as well as introducting the operational risk management tools. The Policy gives the management structure for managing operational risk at the Bank level describing the role of every participant. 1. Collection of direct operational losses The Bank emphasizes on the collection of direct operational losses, for which the following definition has been adopted: All direct negative financial impacts on the Bank s financial statements due to the occurrence of an operational risk event. The losses are captured in the ALGO OPVAR application. 9

10 It is the Bank s policy that all risk owners (the management of every organizational part of the Bank) report all incidents resulting in direct losses at the time of occurrence even if they are temporarily booked in transitory and/ or suspense accounts and not yet recognized in the P&L. 2. RCSA The RCSA methodology is conducted at the Bank level and in order to identify operational risks at the process level. The same methodology is used for the introduction of new products, activities, processes and systems, and it also assesses the activities entrusted to the third parties. The RCSA uses also the qualitative approach as well as the assessing of the relevant control environment. 3. KRI (key risk indicators) The purpose of KRIs is to assist in the identification of risk exposures before they crystallize into losses. 4. Action Plans By the term Action Plan we hereby mean all the necessary steps and measures intended to mitigate operational risks, after the acknowledgement of control inefficiencies or risk escalation. 3.2 Risk management framework The Bank has established a comprehensive and reliable system of risk management, integrated in all its business activities, which ensures that the Bank s risk profile is always in line with already established propensity to risks. Risk management system is proportionate to the nature, volume and complexity of the Bank s operations and/or its risk profile. The Bank s risk management system encompasses: Risk management strategy and policies, as well as procedures for risk identification and measurement and assessment and for managing risks Adequate internal organizational structure Effective and efficient process of management of all risk Adequate internal controls system Appropriate information system. The risk management framework of the Bank encapsulates the spirit of the following key principles for Risk Management as articulated by Basel II standards: Management oversight and control Risk culture and ownership Risk recognition and assessment Control activities and segregation of duties Information and communication Monitoring risk management activities and correcting deficiencies. 3.3 Risk governance structure The Bank s Board of Directors has overall responsibility for establishing risk culture and ensuring that an effective risk management framework is in place. The Board of Directors adopts and periodically reviews the Bank s risk management policies and strategies. The Board Risk Management Committee is responsible to control the Risk Management Division in terms of independence, adequacy and 10

11 effectiveness, as well as to ensure development and ongoing effectiveness of the Bank s internal risk management system and its integration into the business decision making process as regards to any type of risk. The Executive Board is responsible for monitoring and implementation of the policies adopted by the Board of Directors. The key element of risk management philosophy is for the Risk Management Department ( RMD ) to provide independent monitoring and control of risks while working closely with the business units which ultimately own the risks. The Risk Governance structure of the Bank is depicted by the following diagram. Board of Directors Strategic level Risk Management Committee Audit Committee Executive Board ALCO Credit Committee Tactical level RISK MANAGEMENT Portfolio and classificaton management Market risk management Credit risk models Operational risk management Basel II CREDIT RISK MANAGEMENT Corporate Credit Risk Retail Credit Initiation Retail policies, procedures and credit portfolio management IT Back office functions Finance Compliance Other specialized units Business Processes HR Marketing Legal Internal Audit Operational level Business units 1st line of defence 2nd line of defence 3rd line of defence The RMD plays a pivotal role in monitoring the risks associated with all the activities of the Bank. The principal responsibilities of the Division are: Determining the Bank s appetite for risk and submitting the same to the RMC and Board of Directors for approval. Developing and reviewing risk management policies in accordance with the risk management guidelines issued by the NBS, NBG Group and international best practices. Reviewing operating policy manuals and ensuring that such policy manuals are in accordance with the risk management policies and appropriately addresses all the key risks embedded in the related processes/ products. Acting as the principal coordinator in Basel II implementation as required by the NBS and facilitating the performance of key Basel II activities. Identifying and recommending risk analysis tools and techniques as required under Basel II, guidelines issued by the NBS and NBG Group. Reviewing the adequacy of the risk limits and providing feed back to the relevant approving authorities. Preparing MIS Reports for review by the RMC and the Board of Directors. 11

12 Developing systems and resources to review the key risk exposures of the Bank and communicating the planned/ executed corrective actions to the Risk Management Committee. Within the Bank, Risk Management broadly takes place at the following levels: Strategic level It encompasses risk management functions performed by the Board of Directors. These include the adoption of risk and capital strategies and policies, ascertaining the Bank s risk definitions, profile and appetite, as well as, the risk reward profile. Tactical level It encompasses risk management functions performed by Executive Board and Directors of Divisions. These include the approval of risk policies and procedure manuals for managing risks and establishing adequate systems and controls to ensure that the overall risk and reward relation remains within acceptable levels. Operational (business line) level It involves management of risks at the point where they are actually created. The relevant activities are performed by individuals who undertake risk on the Bank s behalf. Risk management at this level is implemented by means of appropriate controls incorporated into the relevant operational procedures and guidelines set by the Executive Board. 3.4 Capital management The Bank s policy is to maintain a strong capital base and meet the minimum capital requirements imposed by the regulator (NBS), so as to maintain investor, creditor and market confidence and to sustain future development of the business. The impact of the level of capital on shareholders return is also recognized and the Bank recognizes the need to maintain a balance between the higher returns that might be possible with greater gearing and the advantages and security afforded by a sound capital position. The Bank s capital management policy seeks to maximize return on risk adjusted capital while satisfying all the regulatory requirements. The Bank ensures that the capital adequacy requirements are met and comply with regulatory capital requirements at all times. A prior approval of the NBG Group is obtained by the Bank before submitting a proposal for distribution of profits (i.e. dividend) for shareholders approval. 3.5 Risk types The Bank is exposed to various types of risk. Risks in Pillar 1 Credit risk (Counterparty credit risk; Delivery/Settlement risk for free delivery) Delivery/Settlement risk for unsettled transactions Market risk Operational risk Liquidity risk Residual risk 12

13 Risks in Pillar 2 Credit fx risk Concentration risk Risk of possible underestimation of credit risk in the Standardized Approach Risk of possible underestimation of operational risk in the Basic Indicator Approach Interest rate risk in banking book Strategic risk Business risk Reputational risk External factor risk The details of components of risks and how they are managed are presented in the following sections of this document. 3.6 Monitoring and reporting The Risk Management Division provides independent assurance that all types of risk are being measured and managed in accordance with the policies and guidelines set by the Board of Directors. The Risk Management Division submits a quarterly report about risk management to responsible management bodies of the Bank. Under the market risk management, the Bank has established a number of internal reports, reports submitted to the NBG Group and the National Bank of Serbia. The Bank generates a daily report on the Foreign currency risk, the VaR, the compliance with the limits on open positions and report on the Bank's exposure to other counterparties, balance and revaluation of portfolio securities. Considering liquidity risk the Bank has established a series of reports that are related with daily liquidity risk management activities and that are presented to relevant functions and management bodies of the Bank, NBG Group and the National Bank of Serbia. Comprised are reports on liquidity ratio, narrow liquidity ratio, balance of planned cash inflows and outflows, balance of liquid assets and liabilities to other banks, the balance of the securities portfolio and balance of deposits. Within the Country risk management the Bank has established series of internal reports as they are: a daily report on the Bank's exposure to other countries and usage of limits, the Bank's exposure to country risk by groups of quality rating and exposures presented by region. In addition to the daily, the Bank prepares monthly reports for ALCO Committee concerning market risk, interest rate risk in the banking book, liquidity risk and country risk, which include analysis of movement of relevant internal and external indicators, liquidity GAP's, interest rates GAP's, the results of stress tests and analysis of limit utilization. The Bank is preparing a series of reports and on a monthly or quarterly basis that are included in the reports at NBG Group level. With respect to the credit risk and portfolio and classification management, the Bank prepares reports related to credit risks and delivers them to the National Bank of Serbia, NBG Group, responsible bodies of the Bank and management of the Bank. Reports which the bank delivers to the National Bank of Serbia are the following: reports on classification of balance sheet assets and offbalance sheet items (KA 1-5), large exposures and exposures towards a group of related parties (VI LI, 13

14 VI GPL), report on restructured receivables (IRP), reports on the structure and changes in level of nonperforming loans (NPL 1-3) and reports on capital requirements for credit risk, counterparty risk and settlement/delivery risk based on free delivery per exposure class according to the standardized approach. Stipulated reports are delivered on quarterly basis with the exception of the report on the structure and changes in level of nonperforming loans (NPL 1-3) which is delivered on monthly basis. On monthly basis are also delivered to the National bank of Serbia reports BAN001 Monthly report on loans of clients who have accepted the Bank s offer and have concluded the Annex of the Contract on housing loan indexed in CHF and BAN002 Monthly report on amounts of decrease of the principal of loans approved to individual persons, based on implementing the recommendation related to increase of inestimable elements of variable interest rate. Reports on credit risks are delivered quarterly and annually to responsible management bodies of the Bank and contain data on the quality of the credit portfolio, namely the volume of the portfolio, debtor classification, needed reserve for the estimated losses, structure of the loans per delinquency, largest debtors, large exposure indicators and amounts of credit risk weighted assets with remarks for changes in the last quarter. Also, to responsible management bodies of the Bank the following reports are delivered on monthly basis: Watch list, Branch concentration, Data on corporate portfolio volume, segmentation, total exposure and maximum delinquency, as well as report on blocked corporate clients. With respect to the credit risk and portfolio and classification management to the NBG Group the following reports are delivered: Basel II, ICAAP report for credit risks, Bank s large debtors, large exposures, presentation of data on volume, structure of corporate loans and retail loans per delinquency, client segmentation, type of product and NPL indicators. Internally, to the Finance Division are also delivered reports which are integral components of IFRS reports, US GAAP reports, as well as the report on restructured receivables. The operational risk reporting of the appropriate functions and the Bank s bodies it is conducted on the monthly, quarterly and annual basis. The reports contain the operational risk events details, the actual and potential operational risk events, information about taken measures in managing operational risk, the results of testing of the BCP (business continuity plan) and other. Also, the Bank conducts quarterly reporting towards National bank of Serbia considering calculated capital requirement for operational risk. Reports which the Bank prepares (daily, monthly and quarterly) for National Bank of Serbia are submitted to certain forms in accordance with the timetable set by the Regulator. 14

15 4. Capital structure and capital adequacy ratio 4.1 Capital structure and adequacy The Bank s regulator, the NBS, sets and monitors capital requirements for the Bank. In implementing current capital requirements the NBS requires the Bank to maintain a prescribed ratio of 12% of total regulatory capital to total risk-weighted assets. Banking operations are categorized as either trading book or banking book, and risk-weighted assets are determined according to specified requirements that seek to reflect the varying levels of risk attached to assets and off-balance sheet exposures. The NBS also requires banks incorporated in Serbia to maintain a buffer of 2.5 per cent above the minimum capital adequacy ratio. The Bank's policy is to maintain a strong capital base so as to maintain investor, creditor and market confidence and to sustain the future development of the business. The Bank is required to comply with the provisions of the Decision on Capital Adequacy by Bank (which is based on the Basel II standards) in respect of regulatory capital. The Bank has adopted the standardized approach to credit and market risk and basic indicator approach for operational risk management under the revised framework. The Bank has complied with the capital requirements set by the regulator throughout the year. The capital adequacy ratio of the Bank as at 31 December 2013 was on the level of 16.61%. The Bank further plans to maintain strong capital position. The Bank s regulatory capital is analyzed into two tiers: Core Capital (Tier 1 capital) includes: Paid up shares (excluding preference cumulative shares PCS), Premium on issued shares; Reserves allocated from profit; and Profit of the Bank; reduced for Losses from earlier years; Current year losses; Intangible investments; Acquired own common and preference shares (excluding PCS) pledged with the Bank; and Regulatory value adjustments. Supplementary Capital (Tier 2 capital) includes: Paid up PCS; Premium on issued PCS; Part of positive revaluation reserves; Hybrid instruments; Subordinated debt; reduced for Own PCS; PCS pledged with the Bank; and Claims covered by hybrid instruments and subordinated debts of the Bank. Deduction items from Capital in case of the Bank include: Amount of which is exceeded qualified participation of the Bank in non-financial entities; and Amount of Needed reserves for estimated losses on balance sheet and off-balance items. The Bank s capital structure, capital requirements and risk weighted assets at 31 December 2013 was as follows: 15

16 In RSD thousands No. CAPITAL STRUCTURE I CAPITAL 9,030, CORE CAPITAL 12,176,479 Paid-up shares (excluding CPS) 16,337,430 Premium on the issue shares (excluding CPS) 120 Reserves allocated form profit 122,185 Portion of retained profit from earlier years 259,527 Losses from earlier years 0 Current year losses 0 Intangible investment (395,428) Regulatory value adjustments unrealized losses (9,735) Needed reserve for estimated losses (4,137,620) 2. SUPPLEMENTARY CAPITAL 1,260,101 Portion of revaluation reserves which refers to fixed assets, securities 1,260,101 and other funds 3. DEDUCTION FROM CORE CAPITAL AND SUPPL.CAPITAL (4,405,959) 3.1. It refers: reduction of core capital (3,145,858) 3.2. It refers: reduction of supplementary capital (1,260,101) Amount for which is exceeded qualified participation of bank in entities (268,339) which are not financial sector entities Needed reserve for estimated losses on balance sheet and off balance (4,137,620) sheet items; in accordance with article 427. Paragraph 1 of Decision on capital adequacy by bank 4. TOTAL CORE CAPITAL 9,030, TOTAL SUPPLEMENTARY CAPITAL 0 No. CAPITAL REQUIREMENTS I CAPITAL 9,030, TOTAL CORE CAPITAL 9,030, TOTAL SUPPLEMENTARY CAPITAL 0 II CAPITAL REQUIREMENTS 6,523, Credit risk; counterparty risk; delivery/settlement risk for free delivery 5,744, Delivery/settlement risk for unsettled transactions 0 3. Market risk 17, Price risk in respect of debt securities 17, Price risk in respect of equity Foreign exchange risk Commodities risk 0 4. Operational risk 761, COVERAGE OF CAPITAL REQUIREMENTS 6,523,257 III CAPITAL ADEQUACY RATIO 16.61% No. RISK WEIGHTED ASSETS STRUCTURE Credit 47,873, Delivery/Settlement risk 0 3. Market risk 145, Operational risk 6,342,292 TOTAL RWA 54,360,479 Under the NBS rules the Bank is obliged to maintain capital structure, capital level and capital adequacy ratio in accordance with following regulatory capital requirements and restrictions: 16

17 - Total Capital at least 10 million Euros. - Core Capital at least 50% of Total Capital. - Capital Adequacy Ratio (CAR) minimum 12%. - Total amount of hybrid instruments may be maximum 50% of the Core Capital. - Total amount of hybrid instruments excluding convertible instruments in the case of balance sheet deterioration (except cumulative preference shares) may be maximum 35% of the Core Capital. - Subordinated debt included in Supplementary Capital is restricted to 50% of Core Capital. - Bank with CAR higher for less than 2.5% of prescribed 12% or it would be higher after redistribution of retained profit for less than 2.5% of prescribed 12%, is restricted to perform redistribution of profit only into elements/items of the Core Capital. - The sum of Capital deduction items is subtracted 50% from Core Capital and 50% from Supplementary Capital. If 50% of total amount of deduction items is greater than the disposable amount of Supplementary Capital the difference above the amount of disposable Supplementary Capital is subtracted form the Core Capital. - Bank is allowed to treat a part of Needed Reserves as deductable item from the Total Capital, instead treating same as deductible item from the Core Capital on the following way: until the end of % of that amount; until the end of % of that amount; and until the end of % of that amount. - During the last five years to maturity, a discount factor of 20% per year will be applied to subordinated obligations eligible for inclusion in bank s supplementary capital, so in the last year prior to that date subordinated debt are not included in Supplementary Capital. - Bank is obliged to exclude hybrid instruments with maturity below 12 months from calculation of Supplementary Capital. Capital adequacy ratio of the Bank is equal to the ratio of the Bank s capital and the sum of the credit RWA, capital requirement in relation to market risk multiplied with the reciprocal value of the capital adequacy ratio, and capital requirement in relation to operational risk multiplied with the reciprocal value of the capital adequacy ratio. The table below summarizes the structure of the Bank s capital and risk weighted assets as of 31 December 2013 and 2012, as well as the capital adequacy ratio: 17

18 In thousands RSD Regulatory capital Tier 1 capital 12,176,479 14,295,215 Tier 2 capital 1,260,101 1,256,607 Total Tier 1 and Tier 2 capital 13,436,580 15,551,822 Deductible items: Shoirtfall amount of the special reserves ( 4,137,620) ( 5,655,792) for potential losses Exceeded qualified investments in non-financial entities ( 268,339) ( 304,486) Total capital (1) 9,030,621 9,591,544 Risk weighted assets Balance sheet assets 44,616,871 46,195,012 Off balance sheet items 3,237,450 2,044,978 Non- trading derivatives 18,866 15,374 Operational risk exposure 6,342,292 6,712,825 Foreign currency risk exposure 0 1,125,308 Price risk exposure 145, ,150 Total (2) 54,360,479 56,246,647 Capital adequacy (1/2 x 100) 16.61% 17.05% 4.2 ICAAP considerations The ICAAP incorporates a review and evaluation of risk management and capital relative to the risks to which the Bank is exposed. The Bank has developed its own ICAAP framework which involves identification and measurement of all material risks and calculation of internal capital requirements, to maintain an appropriate level of internal capital in alignment to the Bank s overall risk profile and business plan. An ICAAP document has been developed in order to primarily meet regulatory requirements, and secondary to complement its ongoing improvement of risk (including risk types which are not covered under Pillar 1 including liquidity risk, fx credit risk, interest rate risk in the banking book, concentration risk, strategic risk, business risk, reputational risk and other risks) and capital management approaches. One of the key elements of the Basel II standard adopted by National Bank of Serbia is the requirement for an Internal Capital Adequacy Assessment Process (ICAAP) of the Bank. In accordance with the NBS regulation the Bank is obligated to implement the Internal Capital Adequacy Assessment Process, i.e. determine total internal capital requirements in accordance with its risk profile, as well as determine available internal capital and perform its allocation. 18

19 The Bank implements the Internal Capital Adequacy Assessment Process with the purpose to identify all materially significant risks to which the Bank is exposed in its business activities and in that respect to ensure that the Bank at all times has sufficient capital (or in wider terms available financial resources) to cover all these risks. The Bank and NBG Group have developed adequate capabilities that are utilized for internal assessment of capital adequacy which are primarily related to effective and efficient risk and capital management. These capabilities are continuously enhanced and formalized so as to address regulatory requirements but also reap business benefits and support the strategic aspirations of the Bank and NBG Group. The key objective of ICAAP is to ensure that the Bank has sufficient capital (or in wider terms available financial resources) to cover all materially significant risks to which the Bank is exposed in its business activities. A number of already existing capabilities and activities in the Bank may be, to a greater or lesser extent, considered as components of the ICAAP in its broadest sense. These include: -Overall business strategy and objectives of the Bank -Governance, particularly governance in regard to risk and capital management in the Bank -Business planning and budgeting -Risk Management, including risk identification, measurement, assessment, mitigation, monitoring and control of individual risks -Regulatory capital, available internal capital and the Bank funding management -Performance management -Overall internal control system. Thus, the ICAAP is a process that leverages and integrates into these elements mainly from the point of view of available internal capital adequacy assessment, taking into account regulatory requirements. In particular, the ICAAP can be perceived as related to the further integration of risk management, capital management and performance management across the Bank, and thus serves the further implementation of the strategic direction of the Bank. This integration represents best international practice and aims at addressing challenges across capital, risk and performance management in a way that optimally addresses the fundamental relationship between capital, risk and performance. The ICAAP represents process of assessment of all materially significant risks to which the Bank is exposed or could be exposed in its banking activities. In accordance with NBS regulation rules, the Bank has developed ICAAP which contains next phases: -Identification, mapping and assessment of materially significant risks; -Calculation (assessment) of internal capital requirements for individual risks; -Calculation (assessment) of aggregated capital requirements; - Comparison of regulatory and available internal capital; comparison of regulatory and internal capital requirements for individual risks; comparison of aggregated regulatory and aggregated internal capital requirements. Overall assessment of internal capital adequacy (ICAAP), as one of the base assumptions has the assessment of materiality of risks to which the Bank is exposed to, in order to determine the need for calculation of internal capital requirements for individual risk the Bank has identified as materially significant. For all risks identified on the level of the Bank during the risk identification phases, the Bank performs materiality assessment. In accordance with ICAAP Policy, materiality assessment of each risk is performed by applying the following methodology, i.e. approaches depending on risk nature, 19

20 as well as NBS requirement. For all assessed risks recognized as materially significant, the Bank calculates internal capital requirement applying adopted methodology and stress testing. Short description of methodologies (approaches) for calculating internal capital requirement for individual risks: Credit risk, counterparty risk and Settlement/Delivery risk for free delivery The Bank applies standardized approach (prescribed by the Decision on Capital Adequacy of Banks); Approach of the method of current exposure and Approach prescribed by the Decision on Capital Adequacy of Banks, respectively. Market risk (price) The Bank applies standardized approach (prescribed by the Decision on Capital Adequacy of Banks). Market risk (fx) The Bank applies standardized approach (prescribed by the Decision on Capital Adequacy of Banks). Settlement/Delivery risk for unsettled transactions The Bank applies Approach prescribed by the Decision on Capital Adequacy of Banks. Operational risk The Bank applies Basic indicator Approach (prescribed by the Decision on Capital Adequacy of Banks). Credit FX risk In calculation of internal capital requirement for credit fx risk the Bank applies its own methodology which is based on estimation of part of loan portfolio which is consisted of debtors for which there is a assessment that they have unmatched fx position due to volatility of RSD exchange rate (on annual level) would affect the amount of capital requirement.. Country risk The Bank applies approach of weighting exposure derived from net assets and off balance sheet items towards other countries by applying risk weights which are differed for each group depending on credit rating in which underlined country is classed along with stress testing. Residual risk The Bank applies approach of measuring volatility of market value of collaterals in form of financial property which are accepted regarding standardized approach used for credit risk mitigation along with stress testing. Risk of possible underestimation of credit risk in the SA The Bank applies scenario defining approach taking into the consideration one or more assumptions which can lead to possible underestimation of credit risk in the SA. Risk of possible underestimation of operational risk in the BIA The Bank applies scenario defining approach taking into the consideration one or more assumptions which can lead to possible underestimation of operational risk in the BIA. Liquidity risk The Bank uses its own methodology based on consideration of the ratio of liquidity assets and total liabilities. 20