4, 5, 6 and. Indents 2, 3, 68 of the Banking Law. ("Official Gazette of the Republic. the the. and Article DECISION. Regulatory for.

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1 NATIONAL BANK OF THE REPUBLIC OF MACEDONIA Pursuant to Article 47 paragraph 1 item 6 of the Law on the National Bank of the Republic of Macedonia ("Official Gazette of the Republic of Macedonia no. 158/10 and 123/12) and Article 68 of the Banking Law ("Official Gazette of the Republic of Macedoniaа no. 67/07, 90/09 and 67/10), the National Bank of the Republic of Macedonia Council adopted the following DECISION on amending the Decision on the risk management ("Official Gazette of the Republic of Macedonia" no. 165/12) 1. In the Decision on the risk management ("Official Gazette of the Republic of Macedonia no. 42/11), in item 3 indent 16, the full stop at the end of the indent shall be replaced with semicolon and two new indents 17 and 18 shall be addedd which shall state: "- Regulatory capital for risk coverage is the capital requirements for risk coveragee determined pursuant to the Decision on the methodology for determining the capital adequacy (hereinafter referred to as: the methodology for determining the capital adequacy); - Internal capital for covering individual risk is assessment of the amount of the current and future capital requirements for covering individual risk the bank is or can be exposed in its operating. The sum of all internal capitals for covering individual risks the bank is or can be exposed shall present the total internal capital for risk coverage. 2. In item 5 indent 3, the words: "internal determining and assessment of the required capital adequacy, shall be replaced with the words: "determining the internal capital. 3. In item 6 indent 2, the words: "internal determining and assessment of the required capital adequacy, shall be replaced with the words: "determining the internal capital. state: 4. In item 12, after indent 1, new indent 2 shall be added and it shall - conduct the process of determining the internal capital; Indents 2, 3, 4, 5, 6 and 7 shall become indents 3, 4, 5, 6, 7 and The title of the Section III.3 shall be amended and it shall state: PROCESS OF DETERMINING THE INTERNAL CAPITAL OF THE BANK".

2 6. In item 28, paragraph 1 and 2, the words: "internal determining and assessment of the required capital adequacy, shall be replaced with the words: determining the internal capital. 7. Item 29 shall be amended and it shall state: "The banks shall conduct the process of determining the internal capital at least once a year and at each significant change in the risk profile. The total internal capital for risk coverage shall be at least equal to the regulatory capital for risk coverage, while higher than the regulatory capital if the bank determines that the following is required: - higher level of internal capital for covering individual risks encompassed with the methodology for determining the capital adequacy, compared to the level of capital prescribed in that methodology; - additional internal capital for covering the other material risks which are not encompassed with the methodology for determining the capital adequacy. In instances under paragraph 2 of this item, the bank shall be required to ensure and maintain the level of own funds, i.e. the capital adequacy ratio, determined pursuant to the process of determining the internal capital. The bank shall inform the National Bank on the results of the process of determining the internal capital and submit the Report on the process of determining the internal capital no later than March 15 in the year the Report refers to. Provided that the bank, because of significant change in the risk profile, or upon a request of the National Bank, has conducted a process of determining the internal capital during the year, shall be required to submit the Report on the process of determining the internal capital within 30 days from the completion of the entire process. Pursuant to the Banking Law and the bylaws thereof, the National Bank may request from the bank to make changes in the process of determining the internal capital and/or maintain higher level of own funds than the level prescribed in paragraph 3 of this item, if finds that the process of determining the internal capital and/or total internal capital for risk coverage fails to correspond to the bank risk profile and/or its environment. 8. In item 30 paragraph 1, the words: "internal determining and assessment of the required capital adequacy, shall be replaced with the words: "determining the internal capital. After paragraph 1, new paragraph 2 shall be added, which shall state: "During the establishing and documentation of the process of determining the internal capital, the bank shall adhere to the guidelines provided in Annex 7 of this Decision. 2

3 9. In item 31, after paragraph 1 two new paragraphs 2 and 3 shall be added, which shall state: "The bank which is subordinated entity in the banking group and is not a subject to consolidated supervision, shall not be required to establish a process of determining the internal capital, but it shall provide all required data and information to the bank which is subject to consolidated supervision, for the purpose of determining the total internal capital for covering the risks of the banking group. The bank which is subject to consolidated supervision shall be required to establish a process of determining the internal capital on individual and consolidated basis. 10. In item 32, after paragraph 1, new paragraph 2 shall be added, which shall state: "By derogation of paragraph 1 of this item, the foreign banks' branch offices and savings houses shall not be required to apply the provisions from Section III.3 and Annex 7 of this Decision. 11. In item 34, paragraph 2 shall be deleted. 12. Item 35 shall be deleted. 13. In the Annexes, at list bottom, the following words shall be added: "Annex no. 7 - Basic elements of the process of determining the internal capital. 14. After Annex 6, new Annex 7 shall be added, which shall state: "ANNEX 7 Basic elements of the process of determining the internal capital 1. Basic principles for establishing and implementation of the process of determining the internal capital 1. The establishing of adequate process of determining the internal capital (PIC) shall denote the implementation of the following stages: - identification of the material risks; - measurement or assessment of individual material risks and determining the adequate amount of internal capital for covering individual risk; - determining the total internal capital for risk coverage, and - comparison of the amount of the bank's own funds with the total internal capital for risk coverage and undertaking activities for reaching and/or maintenance of the required amount of own funds. 2. Having in mind the basic stages of PIC, it shall include also the qualitative elements that should support the establishing and the maintenance of efficient risk management system. In that regard, the providing of higher amount of capital for risk coverage shall not be considered as adequate replacement for weak and inefficient risk management system. 3

4 When establishing and implementation of PIC, the bank shall always have in mind the following principles 1 : - principle of responsibility - the establishment and the implementation of PIC shall be the bank responsibility, and it should ensure its documentation and adequate explanations on the scope, the methodologies and the procedures used within that process, - principle of proportionality - PIC must correspond to the nature, the size and the complexness of the bank's financial activities, its risk management system and the approaches it applies to determine the regulatory capital, - principle of risk materiality - PIC must encompass those risks that already have or can have significant influence on the current and the future needs of own funds, - future-oriented principle - PIC should cover the influence of the business cycle, the factors from the environment that can have negative influence on the capital adequacy for risk coverage, the development plan and the bank business policy and their dependence on the macroeconomic factors, as well as the results of the performed stress-tests. 3. PIC should be clear and understandable, thus providing: its single implementation by all persons included in its implementation and assessment of its adequacy by the National Bank. 2. Identification of the material risks 4. The bank should identify all risks it is exposed to in its operating, and then to separate the material from nonmaterial risks. The bank shall separate the material from nonmaterial risks, i.e. identify the material risks, on the basis of internally defined criteria, which it should use on ongoing basis. For PIC needs, the bank does not have to consider all the risks of item 4 paragraph 2 of this Decision material risks, if, according to internally defined criteria, finds, for certain risks, that are not material to its operations. This means that for all the risks that the bank deems nonmaterial, there should be a written document that will contain the reasons for classifying these risks as nonmaterial.. 5. Risks that the bank has identified as material risks and for which it determines an internal capital may be divided into the following four groups: 1) Risks that are covered by the methodology for determining capital adequacy: credit risk, market risk, currency risk, operational risk; 2) Risks that are not fully covered by the methodology for determining capital adequacy: operational risk the bank can be exposed to as a result of the introduction of new products and processes, etc.; 1 The principles for the establishment and application of PIC derived from the basic guidelines and principles contained in the Guidelines on the Application of the Supervisory Review Process under Pillar 2, prepared by the European Banking Authority (CEBS, January 2006). 4

5 3) Risks that are not covered by the methodology for determining capital adequacy at all: liquidity risk, interest rate risk in the banking book, exposure concentration risk of the bank, country risk, strategic risk, reputational risk and other risks; 4) Risks of external environment - arising from macroeconomic, business or regulatory environment in which the bank operates. The distribution of risks in the groups referred to in paragraph 1 of this item does not mean that the bank should have identified material risks in each of these groups. Particular risk group may remain empty if the bank determines that there are no material risks that belong to that group or if a particular risk, due to its characteristics, can be included in any of the other risk groups. 6. In identifying and measuring or assessment of the material risks covered by the PIC, the bank shall comply with the requirements laid down in this Decision or special bylaws adopted on the basis of the Banking Law which refer to the management of individual risk. 3. Measurement or assessment of risks 7. The bank shall be required to define the methodology for measuring or assessment of individual risks, which it uses for determining the internal capital for covering individual risks and document and explain the method or approach for assessment of the measurable risks and the manner of assessment of the immeasurable risks. 8. When measuring the first group of risks from item 5 of this Annex (risks covered by the methodology for determining the capital adequacy, the bank can: 1) use the approach prescribed in the methodology for determining the capital adequacy (regulatory approach), or 2) use internal approach for determining the internal capital for covering the particular risk (internal approach). In instances provided in sub-item 2) of this item, the bank should ensure explanation of the reason for using the chosen approach and the differences in the approach prescribed in the methodology for determining the capital adequacy. Provided that the sum of the internal capitals for risk coverage encompassed with the methodology for capital adequacy is lower than the total amount of the regulatory capital, the amount of the regulatory capital shall be included in the determining of the total internal capital. 9. During the measurement/risk assessment of the other three groups of risks from item 5 of this Annex, the bank should develop its own quantitative or qualitative approaches/methodologies for measurement/assessment of the risks. 10. The bank's internal approach to measure/assess individual risk from item 8, paragraph 1, sub-item 2) and item 9 of this Annex should match the bank's risk profile and characteristics of the risk management process of that particular risk. The bank may determine the internal capital for covering individual risk and by using advanced techniques for measuring risk - economic models that use 5

6 mathematical or statistical methods, if these models more suit to the nature and size of the bank. 11. Regardless of the approach the bank uses to establish internal capital for covering individual risk, the bank should have detailed explanations of the approach and properly document all its elements, such as: assumptions the internal approach derive from, time series used, the confidence interval, the allowed level of subjectivity (ex. using expert opinions), way of linking quantitative with qualitative factors (if used both types of factors), method and frequency of testing of the approach and its results, the conditions under which they can make changes in the approach and its elements, the persons responsible for development and approach change and the like. 12. In establishing internal capital for covering individual risks, the bank should take into consideration also the stress-tests results, conducted on the basis of stress-testing rules defined in this Decision and in the special bylaws adopted on the basis of the Banking Law. Stress-testing is one of the elements that enable the bank to follow the forward-looking principle and should encompass all identified material risks and cover the same time period covered by PIC. In order to encompass the risks from the external environment, of particular importance is the stress-testing to include specific scenarios for the impact of the adverse movements of the macroeconomic factors on the internal capital and the bank's own funds. This type of scenarios should include the relation between macroeconomic factors (GDP, exchange rates, the general level of interest rate, budget deficit, foreign investments, exports, etc.) and the bank risk measures (rate of non-performing loans, OCP, weighted value of the banking book, liquidity ratios, rates of return on assets and equity, etc.). The results of the conducted stress-testing should be properly taken into account in the determining of the internal capital for covering individual risks and the total internal capital. The results of the stress-tests may encourage the bank bodies to take also other activities, related to the qualitative elements of PIC for risk management (review of internal exposure limits, strengthen the internal control system, strengthen the reporting system, changes in pricing policy, etc.). 4. Determining the total internal capital for risk coverage 13. The total internal capital for risk coverage shall be calculated as a sum of the internal capitals for covering individual (material) risks. For the purposes of determining the total internal capital for risk coverage, the National Bank shall not recognize the effects of diversification and the correlation between individual risks. 14. The bank shall present the total internal capital for risk coverage, the way it gets its value, as well as the basic features and elements of the PIC in the Report on the process of determining the internal capital, which is an integral part of this 6

7 Annex. Despite the Report from paragraph 1 of this item, the bank may submit to the National Bank also any other documentation, if it considers that it is important for the proper evaluation of PIC by the National Bank. 5. Comparison of the amount of own funds and total internal capital 15. The Bank should identify and explain all differences between the amount of the regulatory capital and the total internal capital. 16. If the amount of total internal capital is higher than the amount of regulatory capital, the bank should determine the current and future needs of their own funds. If the current amount of own funds is lower, equal or slightly higher than the amount of total internal capital, the bank shall be required to undertake activities to reach and maintain the required level of own funds and to prepare a capital plan which should refer to a period of at least next three years. The capital plan should include activities that the bank will undertake for achieving and/or maintaining the required level of own funds (ex. recapitalization, a change in the policy on the payment of dividends, changes in the assets structure, etc.). 17. The determined total internal capital for risk coverage, the current and future needs for own funds, as well as all other results of the implementation of PIC should be properly included in the development plan and the business policy of the bank. 6. Risk management as part of PIC 18. PIC is an integral component of the risk management system and should enable its improvement and strengthening. From that point, it has to follow the rules and requirements contained in this Decision. 19. The bank should use the results of PIC at least in the following processes: - defining and monitoring the implementation of strategy and risk management policy/policies; - defining and improvement of the organizational setup of the risk management; - defining of the acceptable level of risk; - planning and - making important business decisions (ex. when introducing a new product and/or activity, enter new markets, etc.). 20. Within the competence for approving, monitoring and evaluation of the risk management strategy, the Supervisory Board of the bank shall: - approve the general approach to PIC and monitor its implementation, - take care of adequate change of the established PIC in the event of significant changes in the risk management strategy, risk profile and the type and 7

8 scope of activities of the bank and its external environment, as well as changes to meet the requirements provided in this Decision, - approve and monitor the implementation of capital plans, - ensure that the results of the PIC, primarily the identified current and future needs of their own funds, to be included in the development plan and the bank's business policy. 21. Within the competence for establishing and implementing the risk management strategy and regular evaluation of the risk management system, the bank's Risk Management Committee shall: - establish and monitor PIC and undertake activities for its improvement, - monitor the results of PIC and their impact on the required amount of own funds, - give recommendations to the Supervisory Board to cover the current and future needs of the own funds, - assess the adequacy of the approach used for measuring or evaluating the risks and for determining the total internal capital for risks coverage and give recommendations for its improvement/review, - ensure adequate involvement of PIC and its results in the risk management system. 22. Within the competence for enforcement of PIC, the bank's Management Board shall: - provide conditions for covering all risks to which the bank is or may be exposed, - define the criteria for identifying the material risks, - define the approach that is used for measuring or assessing the risks and for determining the total internal capital for risks coverage, - prepare and implement capital plans, - approve and implement all internal acts relating to the implementation of the PIC, - identify organizational units and/or persons responsible for the implementation of individual components of PIC, especially units/persons responsible for determining the internal capital requirement for covering individual risks and total internal capital, - provide conditions for all employees of the bank who are involved in PIC to understand and to apply it in a unique way, - provide documented process. 23. Information system (reporting system) of the bank should ensure the preparation of reports that will provide adequate and timely reporting about the established PIC to the bank bodies, the National Bank and other interested parties (ex. the external auditor, the parent entity, if the bank is member of the banking group in the Republic of Macedonia or abroad, the supervisory authority responsible for the supervision of the bank's parent entity, etc.). The PIC reports should contain at least the following information and data: 1) description of the approaches used to determine internal capital and 8

9 differences in the approaches prescribed by the methodology for determining capital adequacy; 2) description of stress-testing which bank takes into consideration in PIC and a description of its results; 3) the amount of internal capital for covering individual risk and total internal capital and current and future needs of the own funds; 4) actions taken to achieve/maintain the required level of own funds. The Bank shall determine the organizational units or the persons responsible for the preparation and submission of predefined reports, as well as to define the frequency of the preparation and submission of the reports to the appropriate bodies/entities (external or internal). In addition to taking appropriate measures, the reports should be used to enhance existing PIC, as well as for the development and improvement of existing policies, internal acts, rules and practices of the bank. 24. The Supervisory Board of the bank shall be obliged to include the PIC in the established system of internal control and audit. The Internal Audit Department shall, on a regular basis, review the PIC, its implementation, and the implementation of measures taken on the basis of the results of PIC. Report on the process of determining the internal capital 1. General data Name and address of the bank Period the report refers to Contact person Telephone and Organizational unit Member/members of the Management Board competent for preparation of the Report* Signature/s* *New lines can be added, if needed to Identification of material risks 2.1. List of risks the bank is or can be exposed to Risk Risk Explanation Treatment in PIC definition why the risk Measurable Immeasurable is not (YES/NO) (YES/NO) important Nonmaterial risks 9

10 Material risks (the bank's internal acts which define the way of identifying the material risks shall be stated) 3. Measurement or assessment of the material risks and determining the internal capital for covering individual risk 3.1. Measurement of risks Risk Approach Regulatory approach (RA) Internal approach (IA) Risks covered by the methodology for determining the capital adequacy* Credit risk Operational risk** Currency risk Market risk Risks that are not fully covered by the methodology for determining the capital adequacy*** Risks that are not covered by the methodology for determining the capital adequacy at all*** Risks from the external environment*** * The column that fits the approach used by the bank shall be filled-in, inserting the abbreviation for the approach used: RA or IA in the appropriate column. Example: if the bank uses an internal approach, in the last column it shall enter IA. If the bank uses an internal risk measurement approach, which meets the requirements for using the advanced approaches for measuring credit risk, operational or market risk as defined in the Basel Capital Accord (Basel II), in the last column it shall insert: IPIRB. ** If the bank, for the purposes of the methodology for determining capital adequacy, uses the basic indicator approach, while for the purposes of determining the internal capital for operational risk coverage uses a standardized approach, it shall fill-in the third column and insert: IASA. If the bank uses different approaches for measuring individual risks that are part of the operational risk (ex, risk of inadequacy of information systems, money laundering, legal risk, etc.), it shall add additional rows below the row for operational risk for each risk. *** For all other risks, the bank shall fill-in only the last column. For risks the measurement of which is provided with another bylaw of the National Bank (ex, interest rate risk in the banking book), the bank shall note whether 10

11 it uses the prescribed approach or other internal approach (if the bank uses the prescribed approach, in the third column it shall enter: IARA) Description of the internal approaches for measuring risks Risk Description of the approach This table shall include the risks that the Bank measures by using the internal approach (third column of Table 3.1). For each risk separately, the bank shall enter the following data and information: - whether it is a quantitative or qualitative approach to measurement/assessment of risk, or the approach is a combination of quantitative and qualitative factors, - description of the assumptions approach is based on, - description of the statistical/mathematical parameters that approach is based on (if uses models for measuring the risk), - differences with regulatory approach (for the risks covered by the methodology for determining capital adequacy and for the risks the measurement of which is provided by another bylaw of the National Bank), - the method and frequency of testing the approach and its results and organizational unit or outsourcing entity responsible for performing the testing (if testing is performed by outsourcing, the basic data on that entity experience in using/testing models, the reason the bank has chosen that entity, the period for which the contract was signed to perform testing by outsourcing, etc. shall be stated), - internal act or internal acts that prescribe the risk measurement approach Description of the stress-testing taken into consideration in PIC Risk Amount of internal capital as a result of stress-testing (in 000 denars) Description of the performed stress-testing (assumptions and procedure) This table shall present all the stress-tests conducted by the bank which are taken into consideration in the PIC, whether the bank has determined a higher amount of internal capital for covering individual risk as a result of the stress-testing or not. The last column shall give a description of the assumptions, simulations or scenarios and procedure of the performed stress-testing for each risk. If the stress-test assumes a combination of multiple simulations/scenarios which cover more risks, and the bank can divide the required amount of internal capital by certain risks, then it shall fill-in the rows of all the risks covered by the stress-testing (in the last column it shall insert the same explanation of all the risks involved in stress-testing). If the bank can not divide the required amount of internal capital by certain risks, then it shall fillin the row for the risk with the greatest impact determined by that particular stress-testing. However, in the last column the bank shall state all the other risks that have been included in the stress-testing. 4. Determining the total internal capital for risk coverage in 000 denars Risk Regulatory capital Internal capital Risks covered by the methodology for determining the capital adequacy Credit risk Operational risk* 11

12 Currency risk Market risk Risks that are not fully covered by the methodology for determining the capital adequacy Risks that are not covered by the methodology for determining the capital adequacy at all Risks from the external environment Total internal capital for risk coverage * If the bank uses different approaches for measuring individual risks that are part of the operational risk (ex., risk of inadequacy of information systems, money laundering, legal risk, etc.) and as a result has determined internal capital for each of these risks, it shall add additional rows below the row for operational risk for each risk and cite the internal capital for each risk for which it uses a particular approach. 5. Comparison of the own funds and the total internal capital for risk coverage 5.1. As of December 31, in the preceding year in 000 denars Regulatory capital Total internal capital for risk coverage Difference between the total internal capital and the regulatory capital Own funds 5.2. Capital plan Total internal capital* Current and future needs for own funds Planned capital adequacy ratio Planned core capital rate/risk weighted assets Activities for reaching the required amount of own Current year in 000 denars Current year + 1 Current year

13 funds: issues of shares subordinated instruments hybrid instruments retaining of profit assets reduction... (The bank shall provide a detailed description of the activities that will be taken to achieve and/or maintain the current and future needs of its own funds, including the instances when the bank converts a capital instrument in another.) * Total internal capital for the next two years (current year +1 and +2) shall be the anticipation of the bank on the possible amount of total internal capital taking into consideration the results of the current PIC, the bank's risk profile, the development plan and the bank's business policy. If the bank's capital plan applies to more than three years, the bank shall add the appropriate number of columns (for all additional years). 6. Risk management Organizational structure (bodies, organizational units and persons involved in the establishment and the implementation of PIC, along with their responsibilities and lines of reporting concerning PIC shall be stated) PIC update (cases where PIC is updated, the internal acts that define the update, how does the change in the development plan and the bank's business policy influence on PIC, which body is responsible for initiating changes in PIC shall be stated) Documenting of PIC (all internal acts referring to the implementation of PIC and the bodies/organizational units responsible for drafting and adoption of those acts shall be stated) Reporting system (list of reports that are prepared for the PIC needs, bodies/persons - external and internal, to which those reports are submitted and the frequency of the preparation and submission of the reports) Internal and external audit (description of the latest assessment of PIC by the Internal Audit Department: when it is carried out, the scope and the conclusions and findings) (description of the latest assessment of PIC by the external auditor: when it is carried out, the scope and the conclusions and findings) (measures that have been taken as a result of the findings of internal and/or external audit and who is responsible for taking and monitoring the measures) The bank shall answer in details on all questions encompassed in the table. 15. This Decision shall enter into force on the eighth day of its publication in the "Official Gazette of the Republic of Macedonia", and will take effect from January 1,2013. Banks shall be required to comply with the provisions of this Decision until 13

14 August 1, 2013, and to submit the Report on the process of determining the internal capital for the January 1 - December 31, 2013 period until September 1, D no /XIII-1/2012 December 20, 2012 Skopje Governor and Chairperson of the National Bank of the Republic of Macedonia Council Dimitar Bogov 14