His Majesty King Hamad bin Isa Al Khalifa The King of The Kingdom of Bahrain

Transcription

1 ANNUAL REPORT 2013

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3 His Royal Highness Prince Khalifa bin Salman Al Khalifa The Prime Minister of the Kingdom of Bahrain His Majesty King Hamad bin Isa Al Khalifa The King of The Kingdom of Bahrain His Royal Highness Prince Salman bin Hamad Al Khalifa The Crown Prince, Deputy Supreme Commander and First Deputy Prime Minister of the Kingdom of Bahrain

4 Al Fateh Grand Mosque - Bahrain

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6 04 Liquidity Management Centre B.S.C. (c) Kuwait Grand Mosque - Kuwait

7 2013 ANNUAL REPORT 05

8 06 Liquidity Management Centre B.S.C. (c) Corporate Profile Shareholders SHAREHOLDERS COUNTRY SHAREHOLDING (%) Bahrain Islamic Bank Kingdom of Bahrain 25% Dubai Islamic Bank United Arab Emirates 25% Islamic Development Bank Kingdom of Saudi Arabia 25% Kuwait Finance House Investment Co State of Kuwait 25% Bahrain Islamic Bank: Bahrain Islamic Bank (BIsB) was established in 1979 as the first Islamic commercial bank in the Kingdom of Bahrain. The Bank has been maintaining its leading position in the Islamic banking sector through adopting innovative Islamic investment and financing products, supported by superior retail and corporate banking services. The Bank is listed on the Bahrain Stock Exchange. The major shareholders are leading local and regional financial institutions. The Bank operates under supervision and the regulatory framework of the Central Bank of Bahrain. Dubai Islamic Bank: Dubai Islamic Bank is a pioneering institution that has combined the best of traditional Islamic values with the technology and innovation that characterize the best of modern banking. Since its formation in 1975 DIB has established itself as the undisputed leader in its field, setting the standards for others to follow as the trend towards Islamic banking gathers momentum in the Arab world and internationally. Islamic Development Bank: The Islamic Development Bank is a multi-national financial institution established in pursuance of the Declaration of Intent issued by the Conference of Finance Ministers of Muslim Countries held in Jeddah in Dhul Q adah 1393H, corresponding to December The purpose of the Bank is to foster the economic development and social progress of member countries and Muslim communities individually as well as jointly in accordance with the principles of Shari a. Kuwait Finance House Investment Company: Kuwait Finance House Investment Company formally Liquidity Management House is a wholly owned subsidiary of Kuwait Finance House. KFHI was established in December 2007 in the State of Kuwait and commenced its operations in May The company was launched with a paid up capital of Kuwaiti Dinars 100 Million (approx US$ 360 million) with the objective to be market leader in International Debt Capital Market arena. Corporate Profile

9 2013 ANNUAL REPORT 07 LMC Today LMC plays an active role in the primary and secondary Islamic financing market delivering original, adaptable and tradable Islamic Shari a compliant short term and medium term financial instruments to Islamic financial institutions. In addition, it provides Islamic advisory services, including but not limited to the areas of structured finance, project finance and corporate finance. With an authorized capital of US$ 200 million and a paid up capital of US$ 51 million, LMC proudly shares a very close working relationship with each of its shareholders who are renowned in the Islamic Financial Market for their contribution to the industry, namely, Bahrain Islamic Bank B.S.C. (Kingdom of Bahrain), Dubai Islamic Bank P.J.S.C. (United Arab Emirates), Islamic Development Bank (Saudi Arabia) and Kuwait Finance House Investment Company (State of Kuwait) each of whom today hold equal shares in LMC. The Bank has proven to be an innovative arranger of sukuk instruments (Islamic bonds) having issued a number of sukuk with recognised structures that have been reflected in other sukuk issued in the region. LMC has won the award of Euromoney as the best debt house in Bahrain Best Domestic Market Sukuk House in The Bank s focus has not only been on bringing long term financing opportunities but also developing short term Shari a compliant investment opportunities. The Short Term Sukuk Program is the first such repackaged Sukuk product to be offered into the Islamic banking market. The Bank has pioneered the structure of its Short Term Sukuk Program, a tradable low risk liquidity management product which provides investors with opportunity to invest in short term sukuk. Monthly tenors are secured by a diverse portfolio of asset backed corporate and sovereign sukuk instruments arranged and administered by LMC and other recognized arrangers. BUSINESS SERVICES AND PRODUCTS OFFERED 1. Short Term Investment Services LMC conducts extensive Sukuk asset sourcing and repacking as part of the offering, placement and administration of its Short Term Sukuk (STS) Program. 2. Structured Finance Services LMC s structured finance services provide an end-to-end solution tailored to meet the needs of its clients in the international market place. Comprising services offered include the following: Finance Raising: LMC has extensive experience in the structuring, issuance, marketing and post-issuance administration of tradable Islamic capital markets instruments such as Sukuk. The approach centres on structuring attractive transactions in partnership with clients. Its role includes being an arranger, structuring advisor, documentation agent and placement agent. Private Equity Raising: Conducts and coordinates with its client the modelling of transactions, identifying and resolving prospective legal and corporate issues arising from equity offerings, prepares offering documents and presentation materials, articulates all placement related activities, and conducts the offering process. Throughout, Liquidity Management Centre is solely focussed on ensuring the successful completion of the equity raising transaction. Corporate Profile

10 08 Liquidity Management Centre B.S.C. (c) BUSINESS SERVICES AND PRODUCTS OFFERED (continued) 3. Strategic Advisory Services These services revolve around the provision of analysis and advice to clients in relation to their business development activities. The principal objective is to develop and evaluate strategic plans which meet the client s needs. Additionally, LMC actively focuses in ensuring that its clients optimise their capital structures with a view to facilitating access to new and efficient sources of debt and/or equity and other forms of Islamic compliant financing. Portfolio Management: Advise and manage fixed income investments which include Sukuk in various sectors through valuation tools and factors that influence sukuk yields. LMC also manages a proprietary equity investment portfolio to maximize returns through carefully examining markets and companies while adhering to Shari a principles. PRIMARY MARKET ARRANGEMENT TRACK RECORD 1. Bahrain - Eskan Bank - Bahrain Property Musharaka Trust BD 40 Million issued in November Bahrain - Golden Falcon Syndicated Ijara Facility - US $140 million closed in July Bahrain - BFH Asset Company, Syndicated Investment Agency (Wakala) Facility - AED million closed in December Sudan - Sudan Salam Sukuk - Euro 68 Million issued in November UAE - Thani Investments Limited Sukuk - US$100 Million issued in November UAE - Berber Investment Agency Sukuk - US$130 Million issued in September Kuwait - Lagoon City Sukuk - US$200 Million issued in December UAE - Bukhatir Investments Limited Sukuk - US$50 Million issued in May Bahrain - Bahrain Financial Harbour Al Marfa a Al Mali Sukuk - US$134 Million issued in July Kuwait - The Commercial Real Estate Company Ijara Sukuk - US$100 Million issued in May Bahrain - Durrat Khaleej Al Bahrain Sukuk - US$152.5 Million issued in January Bahrain - FIRSAN Sukuk - Euro76 Million issued in October UAE - EMAAR Sukuk - US$65 Million issued in June Bahrain - Bahrain Monetary Agency Ijara Sukuk US$250 Million issued in June SECONDARY MARKET DEVELOPMENT ACTIVITIES LMC plays an active role in the secondary Islamic financing market delivering innovative, adaptable and tradable Islamic Shari a compliant short term, medium term and long term financial instruments to Islamic financial institutions. The Bank has pioneered the structure of its Short Term Sukuk Program, a tradable low risk liquidity management product which actively promotes the secondary market development activities. Backed by its strong operating performance, LMC looks forward to maintaining a reasonable growth phase during the current unfavourable market condition. Having said that, LMC foresees itself equipped to harness further activities and expand its services to include a range of investment banking solutions including debt capital markets, asset management, equity capital markets and private equity in compliance with Islamic Shari a principles. Corporate Profile

11 2013 ANNUAL REPORT 09 Bahrain Property Musharaka Trust BD 40,000,000 Islamic Unit Trust LMC Role-Financial Advisor Golden Falcon US$ 140,000,000 Syndicated Ijara Facility BFH Asset Company AED 367,300,000 Syndicated Investment Agency (Wakala) Facility Republic Of Sudan Euro 68,000,000 Sukuk Al Salam Thani Investments LLC US$ 100,000,000 Musharaka Sukuk Berber Cement Company US$ 130,000,000 Investment Agency Musharaka Sukuk Al Ahlia Gulf Holding Company US$ 200,000,000 Musharaka Sukuk Bukhatir Investment Ltd. US$ 50,000,000 Investment Agency Sukuk Bahrain Financial harbour US$ 134,000,000 Istisna s Ijara Sukuk The Commercial Real Estate Co. US$ 100,000,000 Ijara Sukuk Durrat Khaleej Al Bahrain US$ 152,500,000 Istisna s Ijara Sukuk First Islamic Investment Bank Euro 76,000,000 Investment Agency Sukuk EMAAR Properties US$ 65,000,000 Ijara Sukuk Kingdom of Bahrain US$ 250,000,000 Ijara Sukuk Corporate Profile

12 10 Liquidity Management Centre B.S.C. (c) chairman s message 2013 RESULTS AND PERFORMANCE 1. As widely acknowledged, 2013 remained a relatively challenging year for the financial markets albeit with an improved outlook at times which spurred an increase in liquidity in the markets. Distressed valuations and asset quality deterioration continued to remain the largest factor weighing on profitability for financial institutions. Though flight to quality has been ongoing, 2013 witnessed an improved risk appetite as financial institutions searched for higher returns. Nevertheless, most of the year saw the investment grade, government and quasi government issuers gaining a much larger share compared to other corporate entities. Despite current market volatility, out of Europe and earlier in the Middle East, LMC managed to achieve a net profit of USD 3.58 million for the fiscal year 2013 in comparison to a net profit of USD 3.07 million for the same period in It is worth noting that the Bank continued to be prudent by implementing aggressive steps to enhance its balance sheet. LMC further maintained the amount of provisions in line with the market conditions and requirements. The Bank s gross operating income stood at USD million in 2013 and this was mainly due to: Emad Al Monayea Chairman of the Board In the name of Allah, the Most Compassionate, the Most Merciful, Praise be to Allah who takes all things towards perfection; Prayers and peace be upon Mohammed, His Last Prophet. On behalf of the Board of Directors of Liquidity Management Centre B.S.C. (c) ( LMC or the Bank ) I am pleased to present the Report of the Board of Directors for the year ended 31st December a) The successful Sukuk investment activities, mainly through the Short Term Sukuk Program ( STS Program ) has proven to be, given current market conditions, a relatively superior instrument offering superior risk-adjusted returns; b) The increase in total assets due to booking assets and also due to the capitalization of the portion repaid for the Ijarah facility for the LMC headquarter along with liquidity support received from the shareholders, the Bank s total assets increased from USD million in 2012 to USD million in 2013; c) As mentioned above, lack of demand for corporate issuance resulted in a negative impact on fees income from primary Chairman s Message

13 2013 ANNUAL REPORT 11 issuance however this was offset by fee income from advisory services for prominent restructuring transactions. Moreover, the Bank s revenue stream benefited from its diversified investment policy; d) Barring for the ultra low levels of LIBOR during the year 2013, the returns from the Bank s investments would have been higher. 2. One off expense payments during 2013 resulted in an increase in the operating expenses from USD 4.91 million in 2012 to USD 5.72 million in Other than the one off expense, the operating expenses were kept in check by prudent cost control measures reflecting positively on the Bank s performance. 3. The net profit before unrealized fair value change and impairment provisions witnessed a significant increase from USD 3.16 million to USD 4.85 million reflecting the Bank s efficiency in generating income from the yielding portfolio which was enhanced and supported by booking more quality investments. 4. The bank continued to further book quality assets and take advantage of opportunistic market conditions investment. As such, the investment portfolio of the Bank recorded a significant increase of 28% from USD million in 2012 to USD million in 2013 which positively affected the net profit for the year The shareholders equity showed a positive increase from USD million in 2012 to USD million in 2013 due to stabilized profits and retained earnings over the last two years. This was a result of the efficient performance of the Bank during challenging economic circumstances. 6. After the fruitful results and the growth achieved during the year, the Board of Directors have decided to propose the distribution of dividends in the amount of USD 2.55 million, equivalent to 5% of the Bank s Paid-up Share Capital, in the form of 1 bonus share to 20 existing shares. This is subject to approval of the Shareholders at the AGM. The positive growth in net operating income during 2013 was also a reflection of an opportunistic approach to deals and trades as and when they appeared. Continued support from LMC s shareholders has helped the Bank in maintaining its leading position for secondary market trading. We look forward to 2014 with greater confidence as we pursue further diversification through cautiously exploring and engaging in new business lines. In closing, on behalf of the Board of Directors, I would like to thank the Government of the Kingdom of Bahrain represented by the Central Bank of Bahrain and Ministry of Industry and Commerce for their continued commitment and support to the Islamic Banking sector. My highest appreciation is also due to our shareholders, Islamic Development Bank, Dubai Islamic Bank, Bahrain Islamic Bank and Kuwait Finance House Investment Co. (a wholly owned subsidiary of Kuwait Finance House - Kuwait), whose commitment was and will continue to be crucial to our success. Finally, I would also like to thank the management and the staff of the Bank, for their outstanding dedication and performance Allah the Almighty is the Purveyor of all Success. Emad Al Monayea Chairman of the Board Chairman s Message

14 12 Liquidity Management Centre B.S.C. (c) Biographies of Board of Directors Mr. Emad Y. Al Monayea - Chairman Mr. Emad Yousef Al Monayea is a Board Member and the Chief Executive Officer of Kuwait Finance House Investment Company, Kuwait (KFH Investment), a wholly owned subsidiary of Kuwait Finance House. He is also a Board Member of Global Investment House, Kuwait (Global). Currently he is the Chairman of the Nomination, Remuneration, and Governance Committee of Liquidity Management Centre in Bahrain (the Bank). Mr. Al Monayea is a Kuwaiti national, who holds a B.S. degree from Kuwait University. He has completed the Executive Finance Program of INSEAD, France. He has more than 30 years of professional experience. Mr. Mohamed Ebrahim - Deputy Chairman Mr. Mohamed Ebrahim is the Chief Executive Officer of Bahrain Islamic Bank (BISB). He is a Board Member of Liquidity Management Centre, Enjaz Property Development Company, and Kingdom University Board of Trustee. He has held several senior positions in various banks including Chase Manhattan Bank, Saudi National Commercial Bank (SNCB), Bank of Bahrain and Kuwait (BBK) & CrediMax. Mr. Mohamed Ebrahim is a Bahraini national who holds a Master s degree in Business Administration from the University of Glamorgan, in the United Kingdom, and is a graduate of the Gulf Executive Development Program of the University of Virginia, USA, and the General Management Program from Harvard Business School, USA. He has over 35 years of banking experience. Mr. Abdul Wahab Essa Al Rushood - Director Mr. Al Rushood is the General Manager - Treasury in Kuwait Finance House (Kuwait). He is currently holds board memberships in Kuwait Finance House (KFH), Bahrain; Liquidity Management Center (LMC), Bahrain & Aviation, lease and Finance co (ALFCO). Mr. Al Rushood is a Kuwaiti national who holds a B.Sc. degree in Mathematics from Western Oregon State College, USA. He has over 27 years of professional experience. Biographies of Board of Directors Dr. Adnan Chilwan - Director Dr. Adnan Chilwan is currently Chief Executive Officer of Dubai Islamic Bank (DIB). He also represents DIB in boards of various strategic investments, subsidiaries and associates. He is currently Board Member, Tamweel PJSC; DIB Capital; Deyaar PJSC; Liquidity Management Centre Bahrain and Dar Al Shari a Consultancy. Dr. Chilwan has an extensive career spanning nearly two decades with reputed conventional and Islamic banks in the region such as Dubai Islamic Bank, Dubai Bank, Commercial Bank of Qatar, Mashreq Bank, Abu Dhabi Islamic Bank and HSBC. Dr. Chilwan is an Indian national who holds a PhD and MBA in Marketing. He is a Certified Islamic Banker (CeIB), a Post Graduate in Islamic Banking & Insurance and an Associate Fellow Member in Islamic Finance Professionals Board. He has over 18 years of banking experience in the gulf region.

15 2013 ANNUAL REPORT 13 Mr. Ammar Odah - Director Mr. Ammar Odah is the Division Manager of Treasury Operations at the Islamic Development Bank (IDB) in Jeddah, Saudi Arabia. Mr. Odah is a Syrian national who holds an MBA from King Fahd University of Petroleum & Minerals, Saudi Arabia. He has over 18 years of banking experience in liquidity management, treasury operations, investment strategies, portfolio management, capital markets, and Islamic banking & finance. Mr. Khalid M. Al Doseri - Director Mr. Khalid Mohammed Al Doseri is Chief Financial Officer (CFO) at Bahrain Islamic Bank (BISB). He is currently a Board member of Liquidity Management Centre, Bahrain. He was previously a Board Member and Managing Director of the Islamic Bank of Yemen. Mr. Al Doseri, a Bahraini national, is a Certified Public Accountant (CPA) from Oregon Board of Accountants, an MBA from the University of Glamorgan, and is a graduate of the Executive Management Development Program from the University of Virginia, Darden. He has over 30 years of professional experience. Mr. Mohamed S. Al Sharif - Director Mr. Al Sharif is currently the Chief of Investment Banking in Dubai Islamic Bank (DIB). He holds several Chairmanships and Board memberships on publicly traded companies and financial services firms on behalf of DIB Group. Starting his career with the UAE Central Bank, Al Sharif held many positions in the Financial Control and Banking Supervision departments and later transitioned to Dubai Islamic Bank where he held the position of CFO for 11 years. Mr. Al Sharif is a UAE national who is a Certified Public Accountant (CPA) from Virginia, USA; and a Master s degree in Accounting. He is a registered accounting and banking expert by UAE Courts. Al Sharif is a banking professional with 27 years of experience in Islamic Banking and Central Banking. Mr. Mohammad Saeedullah - Director Mr. Mohammad Saeedullah represents the Islamic Development Bank (IDB), KSA, on the Board of Liquidity Management Centre, Bahrain. He has served on the boards of various companies including International Islamic Financial Market (IIFM), Bahrain. Mr. Saeedullah, a Pakistani national, holds a Master s degree in Applied Mathematics from University of Karachi and MBA from Institute of Business Administration, Karachi. He has more than 32 years of investment and development banking experience. Biographies of Board of Directors

16 14 Liquidity Management Centre B.S.C. (c) CEO s Message Moreover, the bank s operating income stood at USD million in comparison to USD 8.06 million in Net income before fair value changes and impairment provision stood at USD 4.85 million for the year 2013 in comparison to USD 3.16 million for the year During these trying times, the bank booked assets selectively and the total assets increased from USD million in 2012 to USD million in Ahmed Abbas Chief Executive Officer In the name of Allah, the Most Compassionate, the Most Merciful, Praise be to Allah who takes all things towards perfection; Prayers and peace be upon Mohammed, His Last Prophet was characterized by lingering political turmoil in parts of MENA region adversely affecting its investment attractiveness. It was not the brightest year to say the least and a year filled with economic predicament worldwide. This was reflected in a an estimated drop in Sukuk issuances of around 12% to USD120bn in 2013 due partly to market jitters over US bond purchase tapering in comparison to 2012 s record of USD137bn. As the world continues to recover from one of the worst financial crisis, 2013 reaffirmed the continuation of an economic recovery which has impacted bottom lines worldwide. Again, the continuing fear of further asset devaluations remains the main driver of an ongoing risk-averse environment especially in the real estate sector. As a result of the current environment, LMC has taken preventative measures and aggressive steps towards enhancing its financial position with adequate levels of provisioning. However, despite the state of the global economy, LMC was still able to achieve a net profit of USD 3.58 million (return on capital 7.02%) for the fiscal year 2013 which reflected a growth of 16.62% to the USD 3.07 million net profit earned in Issuances during 2013 were lower than The bank s involvement in the primary and secondary markets remained a core business area and given its cautious investment approach the bank was able to realize growth in the net profit margins. Clients remained risk-averse and reluctant to come to capital markets however the Bank continued to secure advisory transaction mandates. Our assessment is that the worldwide economic and financial situation will show some recovery, mostly in this region due to the fact that oil prices have stabilized on average around $95 per barrel, above the average price anticipated by many GCC fiscal budgets for Given our track record and strong team here at LMC, we are well equipped to capitalize on opportunities should they arise in the coming future. In conclusion, 2013 continued to be a challenging year for investors and despite all efforts, the market conditions limited us from achieving higher profit rates. However, we are confident that all necessary preparations have been made for an evolving economic climate. We would like to take the opportunity to thank our team members, clients and more so our shareholders and strategic partners for their continued support. Ahmed Abbas Chief Executive Officer Liquidity Management Centre CEO s Message

17 2013 ANNUAL REPORT 15 Executive Management Ahmed Abbas Chief Executive Officer Amer Sadiq Executive Vice President Structured Finance Hussain Merza First Vice President Financial Controls Executive Management

18 Sheikh Zayed Grand Mosque - United Arab Emirates

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20 18 Liquidity Management Centre B.S.C. (c) Corporate Governance LMC acknowledges the importance of Corporate Governance as an application of the best management practices that are directed towards achievement of corporate values, goals and objective and enhancing shareholders value coupled with high transparency and corporate responsibility. During 2013, the Board conducted a thorough review of the Bank s high level policies for corporate governance, internal control, risk management and compliance with the latest regulations and guidelines of the Central Bank of Bahrain (CBB). THE BOARD OF DIRECTORS The Board is nominated by the shareholders of the Bank in accordance with the provisions of the Article of Association of the Bank and CBB approvals. The Board has eight directors representing the interest of the Bank and it is highly responsible for the Management and its performance and provides directions and applies policies in order to ensure strategic guidance of the Bank. Board s Responsibilities The Board of Directors is delegated with the responsibility to assist the Bank in carrying out its duties and enhance the effectiveness of the Board. It serves in monitoring the Management to ensure that the policies and processes are in the right place to shows that it is operating effectively and taking the responsibility with regard to the financial report, internal control and the process of monitoring compliance with laws and regulations. Each Director is appointed for a three years term renewable at an Annual General Meeting of the shareholders of the Bank, subject to CBB approvals. Board Meetings In accordance with the applicable CBB regulations and the Article of Association of the Bank, the Board of Directors is required to meet at least four times per year. On a regular basis the Board have close contact with Management and are required to act within their given authority for the benefit of the Bank. BOARD COMMITTEES Board of Directors Board of Directors is responsible for the conduct of the general operations of the Bank and exercises all the powers delegated by the Articles of Association of the Bank. The Board has created four sub-committees to assist in carrying out its duties. Executive Committee The Executive Committee is responsible for reviewing investment proposals and implementing the Bank s strategy and policies agreed by the Board of Directors. It also proposes new strategies and policies to the Board of Directors and acts as the principal forum in which members liaise through their representatives with Management. Audit Committee The Audit Committee is responsible for the integrity of the Bank s financial statements and financial reporting process and the Bank s systems of internal accounting and financial controls; reviewing internal control, internal audit and external audit. In addition, the committee is responsible for the compliance of the Bank with legal and regulatory requirements, including the Bank s disclosure controls and procedures. Nomination, Remuneration & Corporate Governance Committee The Nomination Remuneration & Corporate Governance Committee enables the Board to fulfill its responsibilities in setting the appropriate composition and evaluating the performance of the Board, individual directors and senior management. It is also responsible for the remuneration policies. The committee Corporate Governance

21 2013 ANNUAL REPORT 19 BOARD COMMITTEES (continued) also takes a leadership role in shaping corporate governance policies, practices and leads the Board in its annual review of the Board s performance and recommends to the Board of Directors, candidates for each committee for appointment. Risk Management Committee The Risk Management Committee is responsible in identifying, monitoring and approving the risk management policies of the Bank to establish the appropriate approval level of decisions. The committee also provides a forum for big-picture analysis of future risks and critically assesses the Bank s business strategies and plans from a risk perspective. SHARI A SUPERVISORY BOARD The Shari a Supervisory Board is entrusted to ensure the compliance aspects of the Bank s products and instruments. They are also responsible for monitoring and approving the operations, investments and activities carried out by the Bank without violating the principles and provisions of Islamic Shari a. The views of the Shari a advisor shall be binding in the specific area of supervision. team. The Management in LMC is responsible for working in an effective manner combining legal and ethical manners in it aims to increase teamwork, commitment and to achieve a successful decision making process through its staff and business units in the Bank. ORGANIZATIONAL STRUCTURE As LMC cares about updating and maintaining its track record. The Board has defined the organization structure responsibilities and authorities for the Management team and staff where they mainly respond to the changes and needs of the Bank during the year and ensure the proper segregation of responsibilities, accountabilities and duties of the staff at all levels. COMPLIANCE LMC conducts its business with separate compliance functions in handling its works under the regulatory requirements stipulated by the CBB. The Bank complies under many key regulations such as, Shari a Compliance, Legal Compliance, Financial Accounting Standards and the CBB s Regulations and Guidelines. Shari a Board Members 1. Dr. Hussain Hamed Hassan 2. Dr. Abdul Sattar Abu Ghuddah 3. Dr. Ajeel Jassim Al-Nashmy 4. Shaikh Adnan Al Qattan MANAGEMENT LMC boasts significant achievements in a span of eleven years with a sound track record, acknowledged by industry leaders around the world. LMC is led by Mr. Ahmed Abbas, the Chief Executive Officer, and supported by a professional technical and structured finance team and a highly experienced and qualified management Corporate Governance

22 20 Liquidity Management Centre B.S.C. (c) Financial highlights Financial Performance of Liquidity Management Centre B.S.C. (c) for the year ended on 31st December, Balance Sheet Position Total Assets 221, , , , , ,791 Total Liabilities 158, , , , , ,481 Total Equity 62,957 58,774 55,464 55,423 61,976 56,310 Profit & Loss Statement Operating Income 10,569 8,060 7,349 7,740 10,783 12,942 Net profit before unrealized fair value change and impairment provision 4,851 3,155 1, ,318 7,369 Net Profit/(Loss) 3,579 3, (9,570) 3,201 1,042 Cash Flow Statement Operating cash flow (12,419) 24,324 3,147 (6,874) (1,964) 21,643 Investing cash flow (5,739) (2,549) (4,305) (7,561) (1,116) (197) Financing cash flow (5,100) Performance Ratios (%) Return on average assets (%) (3.56) Return on average equity (%) (16.12) Liquidity Ratio (%) Liquid asset Ratio (%)* Capital Adequacy Ratio (%) Capital adequacy (%) * Total of Cash, Short term balances with banks, Short term Murabaha and Mudharaba as a percentage of total assets. 276, ,403 61,976 62, , , ,045 58, ,657 56,310 55,423 55, Total Assets USD millions Total EQUITY USD millions Financial Highlights

23 2013 ANNUAL REPORT 21 3,201 3,069 3,579 1, Net Profit/ (Loss) USD millions (9,570) Capital Adequacy (%) (3.56) (16.12) Return on average assets (%) Return on average equity (%) EXTERNAL FACTORS AFFECTING THE BANK S PERFORMANCE There are many factors that affect the Bank s business and the results of its operations, some of which are beyond the control of the bank. The following is a description of some of the important factors that may cause the actual results of the Bank s operations in the future periods to differ materially from those currently expected or desired. 1. The Bank s future growth rates and success are in-part dependent on continued growth and success of international markets. Although the Bank s dealings are concentrated in areas that are deemed very safe, as is the case with most international operations, the success and profitability of the bank s international business can be subject to numerous risks and uncertainties such as local economic and labour conditions, stage of the business cycle, political instability, a change in tax laws, new monetary policies affecting exchange rates along with other economic structures, overall business sentiment, and newly introduced or amended local and national government regulations. 2. Due to Bank s diversified portfolio, the profit margins realized by the bank can vary somewhat among these products and services, its clientele and its geographic markets. Consequently, the overall profitability of the Bank s operations for any given period is partially dependent on the product, clientele and geographic mix reflected in that period s revenues. 3. A sharp downfall in oil prices can put a strain on local economies where the Bank concludes most of its business. Although oil prices seem to have stabilized, there is no guarantee that a further deterioration in the global economy will manage to keep oil prices stable to comfortably service these economies. 4. A sudden deterioration in liquidity of the global economy and local banking institutions can cause further depreciation in asset prices, deleveraging and de-equitization which can affect the Bank s balance sheet. 5. The Bank s profitability will be highly dependent on the upcoming economic performance and its recovery. Three key prerequisites for sustained economic rebound internally are further enhancement of regulatory environment, a stabilization of real-estate activities and a stable political environment. Fiscal stimulus if conducted by local economies may temporarily boost GDP, but without these prerequisites, sustained economic expansion can be affected. Financial Highlights

24 22 Liquidity Management Centre B.S.C. (c) Shari a Supervisory Board REPORT On the activities of Liquidity Management Centre for the year ended on 31st December, 2013 In the name of Allah, the most compassionate and the most merciful To M/s: The stakeholders of Liquidity Management Centre B.S.C. (Closed) Thanks to all mighty Allah and prayers and peace be upon our last prophet Mohammed and his relatives and comrades. Based on the standard principles and the assigning of Fatwa and Shari a Supervisory Board to supervise the group s activities and investments, the Fatwa and Sharia a Supervisory Board present s the following report: 1. Fatwas and Resolutions: The Board has answered the queries and questions received from the group s management, and accordingly, the Board issued the suitable fatwas and resolutions required, which the group abided to eventually. 2. Structured Finance and Documents Preparation: The Board has approved all the group s structured financing related transactions, and has reviewed and approved the contracts and documents related to it. 3. Approval of amendments to Sukuk & Syndicated Facilities: The Board has reviewed the group s preparations /co- preparations for the amendments to investment sukuk and syndicated facilities and has accordingly approved those transaction documents. 4. Product Development: The Board, in co-operation with the group s management is developing a number of products. 5. Compliance and Legislative Auditing: The Board has legislatively audited some of the group s accomplished transactions within the said year, and has commented on them accordingly. 6. Reviewing of Books and Records: The Board reviewed a set of the group s books, records and documents based on it s own demand, and has received the data and information in terms of enabling the board to perform the duty of supervisory and legislative auditing. 7. Reviewing the Balance Sheet: The Board has reviewed the group s balance sheet, the related statements and detailed notes. Accordingly, the board concluded that this balance sheet, based on the data and information provided by the group s management truly represents the group s assets and income. 8. The Board Overall Conclusion: The Board confirm that the group has abided towards the compliance of shari a and committing on executing the Boards fatwas within all the group s activities, and based on the received transactions, collected data, auditing, commenting and truthful response by the group in terms of abiding to the Board comments, the Board according to it s authorization has concluded that the group s accomplished activities and transactions within the said year are in total compliance with Islamic sharia a terms as well as the Board s fatwas. We all to call Allah the almighty to realize for us the right guidance and the good achievements as he likes and accepts, Peace is upon all of you, as well as God s mercy and blessings. Dr. Shaikh Hussain Hamed Hassan Head of Shari a Supervisory Board Dr. Shaikh Ajeel Al-Nashmy Member Dr. Shaikh Abdul Sattar Abu Ghuddah Member Shaikh Adnan Alqattan Member Shari a Supervisory Board Report

25 2013 ANNUAL REPORT 23 Independent Auditors Report To the Shareholders of Liquidity Management Centre B.S.C. (c) We have audited the accompanying consolidated financial statements of Liquidity Management Center B.S.C. (c) (the Bank ) and its subsidiary (the Group ) which comprise the consolidated statement of financial position as at 31 December 2013, and the related consolidated statements of income, cash flows and changes in owners equity for the year then ended. These consolidated financial statements and the Group s undertaking to operate in accordance with Islamic Shari a Rules and Principles are the responsibility of the Group s Board of Directors. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with Auditing Standards for Islamic Financial Institutions issued by the Accounting and Auditing Organisation for Islamic Financial Institutions ( AAOIFI ). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statements presentation. We believe that our audit provides a reasonable basis for our opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Group as of 31 December 2013 and the results of its operations, cash flows and changes in owners equity for the year then ended in accordance with Financial Accounting Standards issued by AAOIFI. Other Matters As required by the Bahrain Commercial Companies Law and the Central Bank of Bahrain (CBB) Rule Book (Volume 2), we report that: a) the Bank has maintained proper accounting records and the consolidated financial statements are in agreement therewith; and b) the financial information contained in the Report of the Board of Directors is consistent with the consolidated financial statements. We are not aware of any violations of the Bahrain Commercial Companies Law, the Central Bank of Bahrain and Financial Institutions Law, the CBB Rule Book (Volume 2 and applicable provisions of Volume 6) and CBB directives or the terms of the Bank s memorandum and articles of association having occurred during the year ended 31 December 2013 that might have had a material adverse effect on the business of the Bank or on its financial position. Satisfactory explanations and information have been provided to us by management in response to all our requests. The Bank has also complied with the Islamic Shari a Rules and Principles as determined by the Shari a Supervisory Board of the Group. 13 February 2014 Manama, Kingdom of Bahrain Independent Auditors Report

26 Al Masjid Al Nabawi - Saudi Arabia

27 2013 ANNUAL REPORT 25 Financial Statements

28 26 Liquidity Management Centre B.S.C. (c) Consolidated Statement of Financial Position At 31 December Notes US$ 000 US$ 000 ASSETS Cash and bank balances 1,900 2,558 Due from banks and financial institutions 3 16,362 30,500 Mudaraba receivables 4 30,170 41,733 Ijarah receivables Financing receivables 5 8,309 6,750 Investment in sukuks 6 127,111 99,055 Investment in equities and funds 6 14,394 16,170 Investment in real estate 7 19,912 13,641 Investment in real estate held-for-sale Equipment Other assets 8 2,627 1,122 TOTAL ASSETS 221, ,645 LIABILITIES AND OWNERS EQUITY Liabilities Due to short term sukuk investors 9 65,135 75,082 Due to banks and financial institutions 89,650 77,210 Other liabilities 10 3,303 2,579 Total liabilities 158, ,871 Owners Equity Share capital 11 51,000 51,000 Reserves 11 8,688 7,726 Retained earnings 3, Total owners equity 62,957 58,774 TOTAL LIABILITIES AND OWNERS EQUITY 221, ,645 Emad Al Monayea Mohammed Ebrahim Ahmed Abbas Chairman Deputy Chairman Chief Executive Officer The attached notes 1 to 26 form part of these consolidated financial statements. Financial Statements

29 2013 ANNUAL REPORT 27 Consolidated Statement of Income For the year ended 31 December Notes US$ 000 US$ 000 INCOME Income from: Investments in sukuk 12 7,826 5,873 Investments in equities and funds Due from banks and financial institutions Financing receivables Mudaraba receivables Ijarah receivables Gain from sale of investment in real estate held-for-sale Gain on investments at fair value through statement of income Less: Return to Short Term Sukuk - investors (1,097) (1,755) Less: Return to banks (1,225) (922) 7,961 4,641 Investment banking fees 13 1,126 2,009 Ijarah income 1,525 1,496 Foreign exchange losses (43) (86) OPERATING INCOME 10,569 8,060 EXPENSES Staff costs 14 2,934 2,646 Ijarah expense Depreciation General and administrative expenses 15 1, OPERATING EXPENSES 5,718 4,905 NET PROFIT FOR THE YEAR BEFORE UNREALISED FAIR VALUE CHANGE AND IMPAIRMENT PROVISION 4,851 3,155 Unrealised fair value change on investments in funds (456) (1,749) (Impairment provision) / writeback - net 16 (816) 1,663 NET PROFIT FOR THE YEAR 3,579 3,069 Emad Al Monayea Mohammed Ebrahim Ahmed Abbas Chairman Deputy Chairman Chief Executive Officer The attached notes 1 to 26 form part of these consolidated financial statements. Financial Statements

30 28 Liquidity Management Centre B.S.C. (c) Consolidated Statement of Cash Flows For the year ended 31 December Notes US$ 000 US$ 000 OPERATING ACTIVITIES Net profit for the year 3,579 3,069 Adjustments for: Depreciation Amortisation of discount / (premium) on investments (59) (103) Restructuring investments in funds (771) (24) Unrealised fair value loss on investments through statement of income - funds 456 1,749 Net gain from sale of investments at amortised cost 12 (2,093) (1,122) Net gain from sale of investment in real estate held-for-sale (115) (323) Impairment provision / (writeback) - net 816 (1,663) Operating profit before changes in operating assets and liabilities 2,299 2,139 Changes in: Due from banks and financial institutions (3,362) - Mudaraba receivables 11,563 (39,483) Ijarah receivables 953 1,485 Financing receivables (1,559) 810 Other assets (1,505) 546 Due to short term sukuk investors (9,947) (53) Due to banks and financial institutions 12,440 25,681 Other liabilities Purchase of investments at amortised cost (55,881) (65,994) Sale/ redemption proceeds of investments at amortised cost 28,740 99,070 Sale/ redemption proceeds of investment at fair value through equity Sale of investment at fair value through statement of income - net 3, Net cash (used in) from operating activities (12,419) 24,324 INVESTING ACTIVITIES Investment in real estate (6,720) (4,432) Purchase of equipment (107) (169) Sale of investment in real estate held-for-sale 1,088 2,052 Net cash used in investing activities (5,739) (2,549) NET MOVEMENT IN CASH AND CASH EQUIVALENTS (18,158) 21,775 Cash and cash equivalents at 1 January 33,058 11,283 CASH AND CASH EQUIVALENTS AT 31 DECEMBER 14,900 33,058 Cash and cash equivalents at year end comprise of: Cash and balances with banks 1,900 2,558 Due from banks and financial institutions with original maturity of ninety days or less 13,000 30,500 The attached notes 1 to 26 form part of these consolidated financial statements. Financial Statements 14,900 33,058

31 2013 ANNUAL REPORT 29 Consolidated Statement of Changes in Owners Equity For the year ended 31 December 2013 Reserves Investment Total Share Statutory General fair value Total Retained owners capital reserve reserve reserve reserves earnings equity US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 Balance at 1 January ,000 2,533 2,226 2,967 7, ,774 Cumulative changes in fair value Total income recognised directly in equity Net profit for the year ,579 3,579 Total income recognised directly in equity ,579 4,183 Transfer to statutory reserve (358) - Balance at 31 December ,000 2,891 2,226 3,571 8,688 3,269 62,957 Balance at 1 January ,000 2,226 2,226 4,475 8,927 (4,463) 55,464 Cumulative changes in fair value Total income and expenses recognised directly in equity Net profit for the year ,069 3,069 Transfer of unrealised fair value loss to reserve (1,749) (1,749) 1,749 - Total income and expenses recognised during the year (1,508) (1,508) 4,818 3,310 Transfer to statutory reserve (307) - Balance at 31 December ,000 2,533 2,226 2,967 7, ,774 The attached notes 1 to 26 form part of these consolidated financial statements. Financial Statements

32 30 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December INCORPORATION AND ACTIVITIES Liquidity Management Centre B.S.C. (c) (the Bank ) is a closed joint stock entity incorporated in the Kingdom of Bahrain on 31 July 2002 under Commercial Registration number The Bank operates under a wholesale banking license issued by the Central Bank of Bahrain (the CBB ). The Bank s registered office is Building 852, Road 3618, Block 436, Seef District, Kingdom of Bahrain. The principal activities of the Bank and its wholly owned subsidiary (the Group ) include the following: - Facilitating the creation of an Islamic inter-bank money market that will allow Islamic Financial Services Institutions ( IFSI ) to effectively manage their assets and liabilities. - Providing short-term liquid, tradable asset backed treasury instruments (Sukuk) based on Islamic Shari a principles where IFSI can invest their surplus liquidity. - Providing short-term investment opportunities based on Islamic Shari a principles. The Bank is regulated by the CBB and supervised by the Shari a Supervisory Board for compliance with Shari a rules and principles. As of 31 December 2013, the total number of employees employed by the Bank was 23 (2012: 25). The consolidated financial statements were approved for issue by the Board of Directors on 13 February ACCOUNTING POLICIES 2.1 Basis of preparation The consolidated financial statements have been prepared in accordance with Financial Accounting Standards ( FAS ) as issued by the Accounting and Auditing Organisation for Islamic Financial Institutions ( AAOIFI ), the Islamic Shari a rules and principles as determined by the Shari a Supervisory Board of the Group, the Bahrain Commercial Companies Law, the Central Bank of Bahrain and Financial Institutions Law and the CBB regulations (as combined in Volume 2 and applicable provisions of Volume 6 of the CBB rulebook). In accordance with the requirements of AAOIFI, for matters which are not covered by AAOIFI standards, the Group uses relevant International Financial Reporting Standards ( IFRS ) as issued by the International Accounting Standards Board (the IASB ). Statement of Compliance The consolidated financial statements have been prepared on a historical cost basis, except for equity type instruments carried at fair value through equity and equity type instruments carried at fair value through statement of income that have been measured at fair value. The consolidated financial statements have been presented in United States Dollar ( US$ ), being the reporting and functional currency of the Group s operations. All values are rounded to the nearest thousand (US$ 000) unless otherwise indicated. Basis of consolidation The consolidated financial statements comprise the financial statements of the Bank and its subsidiary as at and for the year ended 31 December of each year. The financial statements of the subsidiary are prepared for the same reporting year as the Bank, using consistent accounting policies. All intra-group balances, transactions, income and expenses and profits and losses resulting from intra-group transactions are eliminated in full. Financial Statements

33 2013 ANNUAL REPORT 31 Notes to the Consolidated Financial Statements At 31 December ACCOUNTING POLICIES (continued) Basis of consolidation (continued) The Bank s subsidiary is fully consolidated from the date of acquisition, being the date on which the Group obtained control, and continues to be consolidated until the date that control ceases. Control is achieved where the Group has the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. The consolidated financial statements comprise the financial statements of the Bank and its following subsidiary: Ownership Year of Country of Nature of incorporation business Held directly by the Bank The Short Term Sukuk Centre B.S.C. (c) 100% 100% 2003 Kingdom of Buying, selling and Bahrain investing in sukuks 2.2. Summary of significant accounting policies The accounting policies adopted in the preparation of the consolidated financial statements are consistent with those of the previous year, except for the adoption of the following new standard effective as of 1 January 2013: FAS 26 Investment in real estate Under FAS 26, properties held for rental, or for capital appreciation purposes, or both, are classified as investment in real estate. Investments in real estate are initially recorded at cost, being the fair value of the consideration given and acquisition charges associated with the property. Subsequent to initial recognition, an entity has the option to adopt either the fair value model or the cost model and shall apply that policy consistently to all of its investment in real estate. The Group has opted for the cost model. Investment in real estate remeasured using the cost model, is stated at cost less depreciation and any impairment provisions. Depreciation is the systematic allocation of the cost of an asset over its estimated useful life. Major expenditure incurred by the entity related to additions to and improvements in real estate subsequent to its acquisition shall be added to the carrying amount of investment in real estate in the consolidated statement of financial position, provided that the entity expects that such expenditure will increase the future economic benefits to the entity from the real estate. However, if such economic benefits are not expected to occur, the entity shall recognise this expenditure in the consolidated statement of income in the financial period in which it is incurred. If the entity has made the decision to sell an investment in real estate and expects the sale to occur within twelve months of the end of its reporting period, the investment shall be reclassified in the statement of financial position as investment in real estate held-for-sale. Depreciation on investment in real estate carried at cost is discontinued from the date of such reclassification and the investment shall be carried at the lower of its carrying value and expected fair value less costs to sell (net realisable value). Any adjustment shall be recognised in the consolidated statement of income. However, if the investment in real estate is not sold within twelve months (except for delays in conclusion of a sale transaction in its normal course of business beyond the control of the entity) or the plan to sell has been discontinued, the asset is reclassified to its previous classification. For investment in real estate carried at cost, the asset is remeasured to the lower of its recoverable amount and the carrying amount that would have been recognised if the asset would not have been classified as held-for-sale. The resulting adjustment is recognised in the consolidated statement of income of the period when reclassification is made. Financial Statements

34 32 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December ACCOUNTING POLICIES (continued) 2.2. Summary of significant accounting policies (continued) Accordingly, the Group has reclassified an amount of US$ 17,624 thousand (2012: US$ 13,641 thousand) from Property and equipment to Investment in real estate, and has reclassified an amount of US$ Nil (2012: US$ 973 thousand) from investment in properties to Investment in real estate held-for-sale. The adoption of FAS 26 had an effect on the classification and measurement of the Group s direct investment in real estate rather than investment in shares and other financial instruments providing indirect exposure to investment in real estate. The Group has accounted for such other investments under other standards issued by AAOIFI. As a result of the application of this new standard, the Group revisited the classification of the investment portfolio and changes, if any, were made to these classifications in line with FAS 26. There was no impact on the opening retained earnings. The adoption of the other standards, changes in IFRS or interpretations as issued by the IASB do not have any impact on the Group. In addition, standards issued but not yet effective up to the date of issuance of the Group s consolidated financial statements are not expected to have any significant impact on the Group s financial position or performance. Changes in accounting estimates During the year ended 31 December 2013, the Group has revised the useful life of its real estate investment from 25 to 33 years, which in management s view better represents the remaining useful life of the asset. Changes have been applied prospectively in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. The depreciation charge that would have been included in the consolidated statement of income for the year ended 31 December 2013 had the estimate not been changed amounted to US$ 628 thousand instead of US$ 320 thousand and the net profit for the year would have been US$ 3,271 thousand instead of US$ 3,579 thousand. a. Cash and cash equivalents Cash and cash equivalents as referred to in the consolidated statement of cash flows comprise cash and balances with banks and amounts due from banks and financial institutes with original maturities of 90 days or less. b. Due from banks and financial institutes These comprise international commodity murabaha and wakala contracts, which are trade transaction agreements stated net of deferred profit and provision for impairment. c. Mudaraba receivables Mudaraba receivable is a partnership in which the Group contributes capital. These contracts are stated at the fair value of the consideration given less provision for impairment. d. Financing receivables These represents wakala and murabaha financing to projects and are stated at the fair value of consideration given less provision for impairment. e. Investments These are classified as either equity type instruments carried at fair value through the statement of income or fair value through equity or debt type instruments carried at amortised cost. Financial Statements

35 2013 ANNUAL REPORT 33 Notes to the Consolidated Financial Statements At 31 December ACCOUNTING POLICIES (continued) 2.2. Summary of significant accounting policies (continued) Initial recognition All investments are recognised on the acquisition date and are recognised initially at their fair value plus transaction costs, except for investments carried at fair value through the statement of income. Transaction costs relating to investments carried at fair value through the statement of income are charged to the consolidated statement of income when incurred. Equity type instruments carried at fair value through the statement of income Investments held for trading and designated at fair value through the statement of income are subsequently remeasured at fair value. All related realised and unrealised gains or losses are reported in the consolidated statement of income. Equity type instruments carried at fair value through equity Investments designated at fair through equity are subsequently remeasured at fair value and the resultant fair value gain or loss is directly reported in equity under investment fair value reserve until the investment is sold, realised or deemed to be impaired, at which time the realised gain or loss is reported in the consolidated statement of income. Losses arising from impairment of such investments are recognised in the consolidated statement of income in impairment losses and removed from the investment fair value reserve. Impairment losses recognised in the consolidated statement of income for an equity instrument classified as fair value through equity are not reversed through the consolidated statement of income. Debt type instruments carried at amortised cost These instruments are managed on a contractual yield basis and are not held for trading and have not been designated at fair value through the statement of income. Such investments are carried at amortised cost, less provision for impairment in value. Amortised cost is calculated by taking into account any premium or discount on acquisition. Any gain or loss on such investments is recognised in the consolidated statement of income when the investment is de-recognised or impaired. f. Fair value Fair value is determined for each investment individually in accordance with the valuation policies set out below: (i) (ii) For investments that are traded in organised financial markets, fair value is determined by reference to the quoted market bid prices prevailing on the consolidated statement of financial position date. For unquoted investments, fair value is determined by reference to recent significant buy or sell transactions with third parties that are either completed or are in progress. Where no recent significant transactions have been completed or are in progress, fair value is determined by reference to the current market value of similar investments. For others, the fair value is based on the net present value of estimated future cash flows, or other relevant valuation methods. (iii) For investments that have fixed or determinable cash flows, fair value is based on the net present value of estimated future cash flows determined by the Group using current profit rates for investments with similar terms and risk characteristics. (iv) Investments which cannot be remeasured to fair value using any of the above techniques are carried at cost, less provision for any impairment. Financial Statements

36 34 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December ACCOUNTING POLICIES (continued) 2.2. Summary of significant accounting policies (continued) f. Fair value (continued) In accordance with AAOIFI, such gains or losses are appropriated to investment fair value reserve at each year end. Upon realisation, these gains/ losses are transferred to retained earnings from the investment fair value reserve. g. Offsetting Financial assets and financial liabilities are only offset and the net amount reported in the consolidated statement of financial position when there is a legal or religious enforceable right to set off the recognised amounts and the Group intends to either settle on a net basis, or to realise the asset and settle the liability simultaneously. h. Derecognition of financial instruments Financial assets A financial asset (or, where applicable a part of a financial asset or part of a group of similar financial assets) is derecognised when: (i) (ii) (ii) the right to receive cash flows from the asset have expired; the Group retains the right to receive cash flows from the asset, but has assumed an obligation to pay them in full without material delay to a third party under a pass through arrangement; or the Group has transferred its rights to receive cash flows from the asset and either (a) has transferred substantially all the risks and rewards of the asset, or (b) has neither transferred nor retained substantially all the risks and rewards of the asset, but has transferred control of the asset. Financial liabilities A financial liability is derecognised when the obligation under the liability is discharged, cancelled or expires. i. Provisions Provisions are recognised when the Group has a present obligation (legal or constructive) arising from a past event and it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of obligation. j. Revenue recognition Income from investments, ijarah receivables, due from banks and financial institutions and financing receivables Income is recognised on a time-apportioned basis over the period of the investment. Income that is 90 days or more overdue is suspended until it is received in cash. Dividend income Dividends are recognised when the right to receive payment is established. Ijarah income Ijarah income is accounted for on a straight line basis over the ijarah terms. Financial Statements

37 2013 ANNUAL REPORT 35 Notes to the Consolidated Financial Statements At 31 December ACCOUNTING POLICIES (continued) 2.2. Summary of significant accounting policies (continued) j. Revenue recognition (continued) Income from mudaraba receivables Income on mudaraba receivables is recognised when the right to receive payment is established or on distribution by the mudarib. Investment banking fees These comprise fees for structuring, arranging and underwriting deals. Investment banking fees are recognised when the services are provided and income is earned. This is usually when the Bank has performed all significant acts in relation to a transaction and it is highly probable that the economic benefits from the transaction will flow to the Bank. Significant acts in relation to a transaction are determined based on the terms agreed in the private placement memorandum/contracts for each transaction. k. Return to short term sukuk investors Return to short term sukuk investors is recognised in accordance with the underlying contracts. l. Foreign currencies Transactions in foreign currencies are recorded at the rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are retranslated into US Dollars at the rate of exchange ruling at the reporting date. All differences are taken to the consolidated statement of income at the entity level. Translation gains or losses on non-monetary items are included in equity as part of the fair value adjustment. m. Impairment of financial assets An assessment is made at each statement of financial position date to determine whether there is objective evidence that a specific financial asset or a group of financial assets may be impaired. If such evidence exists, the estimated recoverable amount of that asset is determined and any impairment loss, based on the assessment by the Group of the estimated cash equivalent value, is recognised in the consolidated statement of income. Specific provisions are created to reduce all impaired financial contracts to their realisable cash equivalent value. Financial assets are written off only in circumstances where effectively all possible means of recovery have been exhausted. Impairment is determined as follows: (i) (ii) For assets carried at fair value, impairment is the difference between cost and fair value, less any impairment loss previously recognised in the consolidated statement of income. For assets carried at cost, impairment is the difference between carrying value and the present value of future cash flows discounted at the current market rate of return for a similar financial asset. (iii) For assets carried at amortised cost, impairment is the difference between carrying amount and the present value of future cash flows discounted at the original effective profit rate. For investments at fair value through equity impairment losses recognised in the consolidated statement of income and cannot be reversed through the consolidated statement of income and should be recorded as increases in cumulative changes in fair value through equity. Financial Statements

38 36 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December ACCOUNTING POLICIES (continued) 2.2. Summary of significant accounting policies (continued) n. Estimates and judgments In the process of applying the Group s accounting policies, management has made estimates in determining the amounts recognised in the consolidated financial statements. The most significant use of estimates and judgments are as follows: Going concern The Group s management has made an assessment of the Group s ability to continue as a going concern and is satisfied that the Group has the resources to continue in business for the foreseeable future. Furthermore, management is not aware of any material uncertainties that may cast significant doubt upon the Group s ability to continue as a going concern. Therefore, the consolidated financial statements continue to be prepared on the going concern basis. Impairment The Group assesses at each statement of financial position date whether there is objective evidence that a specific asset or a group of assets may be impaired. An asset or a group of assets is deemed to be impaired if, and only if, there is objective evidence of impairment as a result of one or more events that have occurred after the initial recognition of the asset (an incurred loss event ) and that loss event(s) have an impact on the estimated future cash flows of the asset or the group of the assets that can be reliably estimated. Collective impairment provision Impairment is assessed collectively for losses on Islamic financing facilities that are not individually significant and for individually significant facilities and investments in sukuk where there is not yet objective evidence of individual impairment. Collective impairment is evaluated at each reporting date with each portfolio subject to a separate review. Fair valuation of investments The determination of fair values of unquoted investments requires management to make estimates and assumptions that may affect the reported amount of assets at the date of the consolidated financial statements. The valuation of such investments is based on the fair value criteria explained above. The actual amount that is realised in a future transaction may differ from the current estimate of fair value and may still be outside management estimates, given the inherent uncertainty surrounding valuation of unquoted investments. Liquidity The Group manages its liquidity through consideration of the maturity profile of its assets and liabilities which is set out in the liquidity risk disclosures in note 19 (b). This requires judgment when determining the maturity of assets and liabilities with no specific maturities. In the process of applying the Group s accounting policies, management has made the following judgments, apart from those involving estimations, which affect the amounts recognised in the consolidated financial statements: Classification of investments Management decides on acquisition of a equity type financial asset whether it should be classified as equity-type instruments at fair value through the statement of income or equity-type instruments at fair value through equity. A similar decision is taken by management on acquisition of a debt type financial asset whether it should be classified as debt-type instruments through the statement of income or debt-type instruments at amortised cost. Financial Statements

39 2013 ANNUAL REPORT 37 Notes to the Consolidated Financial Statements At 31 December ACCOUNTING POLICIES (continued) 2.2. Summary of significant accounting policies (continued) o. Zakah In accordance with its Articles of Association, the Group is not required to pay Zakah on behalf of its shareholders. p. Fiduciary assets Assets held in a fiduciary capacity are not treated as assets of the Group. q. Employees end of service benefits Provision is made for leaving indemnity payable under the Bahraini Labour Law applicable to non-bahraini employees accumulated period of service at the statement of financial position date. In addition, provision for indemnity is also made for Bahraini employees in accordance with the above guidelines. Bahraini employees of the Bank are covered by contributions made to the Social Insurance Organization of the Kingdom of Bahrain (SIO) as a percentage of the employees salaries. The Bank s obligations are limited to these contributions, which are expensed when due. r. Shari a Supervisory Board The Group s Shari a Supervisory Board consists of four members appointed by the general assembly. They review the Group s compliance with general Shari a principles and specific fatwas, rulings and guidelines issued. Their review includes examination of evidence relating to the documentation and procedures adopted by the Group to ensure that its activities are conducted in accordance with Islamic Shari a principles. s. Earnings prohibited by Shari a The Group is committed to avoid recognising any income generated from non-islamic sources. Accordingly, all non-islamic income is credited to a charity account where the Group uses these funds for various social welfare activities. t. Dividends Dividends to shareholders are recognised as a liability when they are approved by the shareholders. u. Trade and settlement date accounting All regular way purchases and sales of financial assets are recognised on the trade date, i.e. the date that the Group commits to purchase or sell the asset. 3. DUE FROM BANKS AND FINANCIAL INSTITUTIONS US$ 000 US$ 000 Wakala contracts 8,000 30,500 Commodity murabaha contracts 8,425-16,425 30,500 Less: Deferred profits (63) - 16,362 30,500 Financial Statements

40 38 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December DUE FROM BANKS AND FINANCIAL INSTITUTIONS (continued) The original maturity of wakala and commodity murabaha contracts are as follows: US$ 000 US$ 000 Original maturity of 90 days or less 13,000 30,500 Original maturity of more than 90 days 3,362-16,362 30, MUDARABA RECEIVABLES US$ 000 US$ 000 Banks and financial institutions 30,170 41, FINANCING RECEIVABLES US$ 000 US$ 000 Wakala receivable* 6,750 6,750 Murabaha receivable 1,559-8,309 6,750 * This represents a syndicated financing transaction based on an investment agency (wakala) agreement entered into by the Bank in order to finance a project in the Kingdom of Bahrain. The facility is collaterised against nine plots of land. The facility was restructured during 2012 with the maturity being extended to 3 September 2018 bearing an average profit rate of 6% p.a. As at 31 December 2013, the fair value of the collateral against wakala receivable was US$ million for a total transaction value of US$ 45 million ( 2012: US$ million against a total transaction value of US$ 45 million). Financial Statements

41 2013 ANNUAL REPORT 39 Notes to the Consolidated Financial Statements At 31 December INVESTMENTS Fair value Fair value through the Amortised through statement cost equity of income Total US$ 000 US$ 000 US$ 000 US$ 000 Debt type Quoted investments - Sukuk 133, ,426 Equity type Quoted investments - Equity shares - 4, ,521 Unquoted investments - Funds - 9,705 6,550 16, ,426 14,180 6, ,202 Less: Impairment provision (note 16) (6,315) (6,382) - (12,697) At 31 December ,111 7,798 6, ,505 Fair value Fair value through the Amortised through statement cost equity of income Total US$ 000 US$ 000 US$ 000 US$ 000 Debt type Quoted investments - Sukuk 106, ,481 Equity type Quoted investments - Equity shares - 2, ,850 Unquoted investments - Funds - 8,991 8,523 17, ,481 11,948 9, ,845 Less: Impairment provision (note 16) (7,426) (5,194) - (12,620) At 31 December ,055 6,754 9, ,225 The Group s investments in sukuk held at amortised cost have a fair value of US$ 129 million (31 December 2012: US$ 101 million). Under unquoted investments which are held at fair value through equity are investments amounting to US$ 2 million (31 December 2012: US$ 2 million) which are held at cost less provision for impairment due to the unpredictable nature of their future cash flows and the lack of other suitable methods for arriving at a reliable fair value for these investments. Investments which are impaired as of 31 December 2013 amounted to US$ 17.2 million (2012: US$ 22.5 million). Financial Statements

42 40 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December INVESTMENTS (continued) Investments include an amount of US$ 105 million (2012: US$ 71.3 million) representing the underlying assets of the secured Short Term Sukuk Program (STS Program) of The Short Term Sukuk Centre B.S.C. (c) managed by the Bank. The maturities of these investments range from 1 to 37 years and the effective profit rate on these investments ranged between 1.4 % to 10 % per annum (2012: 0.84 % to 10 % per annum). The Group has been party to a long term financing arrangement with a third party international financial institution for which certain of the Group s investments amounting to US$ 64.6 million (2012: US$ 55 million) have been pledged as collateral as of 31 December INVESTMENT IN REAL ESTATE This mainly represents the Bank s Headquarter s building, the majority of which is leased under an operating ijara: US$ 000 US$ 000 Cost 19,100 14,668 Accumulated depreciation (1,476) (1,027) 17,624 13,641 Addition* 2,288-19,912 13,641 * During the year, the Bank received property of US$ 2,288 thousand as a partial settlment for one of its investments. 8. OTHER ASSETS US$ 000 US$ 000 Accrued profit 1,251 1,015 Prepaid expenses Fee income receivable Others 1, ,928 1,423 Less: Impairment provision (note 16) (301) (301) 2,627 1,122 Financial Statements

43 2013 ANNUAL REPORT 41 Notes to the Consolidated Financial Statements At 31 December DUE TO SHORT TERM SUKUK - INVESTORS Due to short term sukuk investors represents amounts due under the secured Short Term Sukuk Program Sukuk (STS program) owned by the investors in the secured STS Program of The Short Term Sukuk Centre B.S.C. (c) managed by the Bank. The investors are the legal owners of the underlying investments of US$ 105 million (2012: US$ 71.3 million) of the STS program as disclosed in note OTHER LIABILITIES US$ 000 US$ 000 Staff related payables 2,386 1,909 Others ,303 2, OWNERS EQUITY (a) Share capital US$ 000 US$ 000 Authorised: 200,000,000 ordinary shares of US$ 1 each 200, ,000 Issued, subscribed and paid-up: 51,000,000 ordinary shares of US$ 1 each 51,000 51,000 (i) (ii) The Group has only one class of equity shares and the holders of these shares have equal voting rights. Names and nationalities of the major shareholders and the percentage of equity shares held as at 31 December 2013 and 2012 are as follows: Share Country of % of capital incorporation holding US$ 000 KFH Investment Company Kuwait 25% 12,750 Bahrain Islamic Bank Kingdom of Bahrain 25% 12,750 Dubai Islamic Bank United Arab of Emirates 25% 12,750 Islamic Development Bank Kingdom of Saudi Arabia 25% 12,750 Financial Statements

44 42 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December OWNERS EQUITY (continued) (b) Reserves Statutory reserve In accordance with the requirements of the Bahrain Commercial Companies Law, 10% of the net profit is transferred to a statutory reserve. The Bank may resolve to discontinue such annual transfers when the reserve totals 50% of the paid up share capital. The reserve is not distributable but can be utilised for the purpose of a distribution in such circumstances as stipulated in the Bahrain Commercial Companies Law and following the approval of the CBB. US$ 358 thousand (2012: US$ 307 thousand) was transferred during the year. General reserve In accordance with the Bank s articles of association, the Group may transfer any amount, as approved by the directors, out of net profit for the year to the general reserve after transfer to statutory reserve. The general reserve is distributable, subject to the approval of the CBB. Investment fair value reserve Investment fair value reserve represents unrealised gains and losses resulting from re-measurement of investments at fair value through equity. This reserve is distributable upon value realisation, which takes place at the time of actual exit or derecognition of investments. Proposed appropriation US$ 000 US$ 000 Bonus shares 2,550-2,550 - The Bank proposed issuance of bonus shares from the retained earnings at one bonus share for each 20 shares held. This will be submitted for formal approval at the Annual General Meeting subject to regulatory approval. 12. INCOME FROM INVESTMENTS IN SUKUK US$ 000 US$ 000 Income from sukuk 5,733 4,751 Gain on sale of sukuk 2,093 1,122 7,826 5,873 Financial Statements

45 2013 ANNUAL REPORT 43 Notes to the Consolidated Financial Statements At 31 December INVESTMENT BANKING FEES US$ 000 US$ 000 Fees and commission income 973 1,794 Others ,126 2, STAFF COSTS US$ 000 US$ 000 Staff salaries and related benefits 2,538 2,225 Staff indemnity and related provision Others ,934 2, GENERAL AND ADMINISTRATIVE EXPENSES US$ 000 US$ 000 Premises expenses Board committee expenses Legal and professional fees Advertising and marketing expenses Others , Financial Statements

46 44 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December (IMPAIRMENT PROVISION) / WRITEBACK - NET Investments Investments at fair at fair Investments value Investments value at amortised through Other at amortised through Other cost equity receivables Total cost equity receivables Total US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 Specific provision At 1 January 5,528 5, ,023 4,760 5, ,008 Charge for the year Reclassification (1,168) 1, Writeback (147) (147) Write offs (692) - - (692) ,484 6, ,167 5,528 5, ,023 Collective provision At 1 January 1, ,898 4, ,576 Reclassification (67) - - (67) (680) - - (680) Writeback (1,998) - - (1,998) 1, ,831 1, ,898 TOTAL 6,315 6, ,998 7,426 5, , US$ 000 US$ 000 Charge for the year Investments at fair value through equity - (146) Investments at amortised cost (816) (88) Impairment provision on receivables - (248) Write back of provision - 2,145 (816) 1,663 Financial Statements

47 2013 ANNUAL REPORT 45 Notes to the Consolidated Financial Statements At 31 December RELATED PARTY BALANCES AND TRANSACTIONS Parties are considered to be related if one party has the ability to control the other party or exercise significant influence or joint control over the other party in making financial and operating decisions. Related parties comprise major shareholders, directors, shari a supervisory board, external auditors and executive management of the Group and/or entities over which they exercise control and/or significant influence. The related party balances included in these consolidated financial statements are as follows: Board Board members/ key members/ key management Significant management Significant personnel/ shareholders personnel/ shareholders Shari a board / entities in Shari a board / entities in members/ which members/ which external directors are 31 December external directors are 31 December auditors interested 2013 auditors interested 2012 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 Assets Cash and bank balances ,234 1,234 Due from banks and financial institutions - 1,000 1,000-5,000 5,000 Mudaraba receivables - 17,200 17,200-29,700 29,700 Investment in sukuks - 14,700 14,700-15,428 15,428 Other assets Liabilities Due to short term sukuk investors - 65,097 65,097-75,044 75,044 Due to banks and financial institutions - 37,703 37,703-50,472 50,472 Other liabilities ,555-1,555 Financial Statements

48 46 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December RELATED PARTY BALANCES AND TRANSACTIONS (continued) The related party transactions included in these consolidated financial statements are as follows: Board Board members/ key members/ key management Significant management Significant personnel/ shareholders personnel/ shareholders Shari a board / entities in Shari a board / entities in members/ which members/ which external directors are 31 December external directors are 31 December auditors interested 2013 auditors interested 2012 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 Income Income from investments in sukuk - 1,171 1, Income from due from banks and financial institutions Income from Mudaraba receivables Return to Short Term Sukuk investors - 1,096 1,096-1,754 1,754 Return to banks Expenses Staff costs 2,022-2,022 1,947-1,947 General and administrative expenses Key management personnel of the Group comprise of the key members of management having authority and responsibility for planning, directing and controlling the activities of the Bank. The key management personnel compensation is as follows: US$ 000 US$ 000 Salary and other benefits 2,022 1,947 Financial Statements

49 2013 ANNUAL REPORT 47 Notes to the Consolidated Financial Statements At 31 December RISK MANAGEMENT Introduction Risk is inherent in the Group s activities and is managed through a process of ongoing identification, measurement and monitoring, subject to risk limits and other controls. This process of risk management is critical to the Group s continuing profitability and each individual within the Group is accountable for the risk exposures relating to his or her responsibilities. These risks and the processes to mitigate these risks have not significantly altered from the previous year. The Group is exposed to credit, liquidity, market and operational risk. The independent risk control process does not include business risks such as changes in the environment, technology and industry. They are monitored through the Group s strategic planning process. Risk management structure The Board of Directors is ultimately responsible for identifying and controlling risks, however, there are separate independent bodies responsible for managing and monitoring risks. Board of Directors The Board of Directors is responsible for the overall risk management approach and for approving the risk strategies and principles. The Board has delegated the oversight responsibilities of risk management to the Risk Management Committee and senior management (comprising the Chief Executive Officer and Senior Managers). They are responsible to carry out the policies laid down by the Board by ensuring that there are adequate and effective operational procedures, internal controls and systems for measuring, monitoring and controlling risks. Risk Management Committee In line with the Group s expansion and growth plans, the Board established a Risk Management Committee (RMC) to further strengthen the Group s risk management process. The RMC has the overall responsibility for the development of the risk strategy and implementing principles, frameworks, policies and limits. It is responsible for the fundamental risk issues, managing and monitoring relevant risk decisions. All the members of this Committee are from the Board. The RMC meets quarterly with the objective of assisting the Board in carrying out its responsibilities in relation to managing the Group s range of inter-related risks in an integrated manner. The Committee is supported by the Group s risk management function which assists with the establishment of policies on credit, liquidity, market and operational risk, reviews compliance with set risk limits approved by the Board and identifies emerging risk issues. The RMC is responsible for providing oversight and management of all risks in the Group and to ensure that there is an ongoing process to continuously manage the Group s risks proactively. The following are the management committees that support the risk management of the Group: Risk Management Unit The Risk Management Unit (RMU) is responsible for implementing and maintaining risk related procedures to ensure an independent control process. The RMU is a management committee set up to centralise the management of risks and to assist senior management and the risk committees in the controlling, monitoring and reporting of risks. Financial Statements

50 48 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December RISK MANAGEMENT (continued) Risk management structure (continued) Asset/liability Management Committee The Asset/Liability Management Committee (ALCO) is responsible for the Group s asset and liability management, pricing and funding strategies, management of market and liquidity risks, as well as ensuring that investments are made in accordance with the policies approved by the Board of Directors. Credit and Investment Risk Committee The Credit and Investment Risk Committee ( CICOM ) is responsible for the management of credit risk in compliance with Board decisions on acceptable levels of risk and minimum pricing levels. The function of CICOM includes appraisal and approval of credit applications based on limits set by the Board and also monitoring and reviewing nonperforming portfolio and ensuring that adequate loss provisions are held against delinquent accounts in accordance with Group s policies. Internal Audit Risk management processes throughout the Group are audited annually by the Internal Audit function that examines both the adequacy of the procedures and the Group s compliance with the procedures. Furthermore, overseeing the management of operational risk is the responsibility of Internal Audit which regularly reports to the Audit Committee to provide independent assurance that risks have been identified and there are sufficient and effective controls on all aspects of the Group s operations. Internal Audit discusses the results of all assessments with management, and reports its findings and recommendations to the Audit Committee. Risk measurement and reporting systems Monitoring and controlling risks is primarily performed based on limits established by the Group. These limits reflect the business strategy and market environment of the Group as well as the level of risk that the Group is willing to accept, with additional emphasis on selected industries. In addition, the Group monitors and measures the overall risk bearing capacity in relation to the aggregate risk exposure across all risk types and activities. The principal risks associated with the Group s business and the related risk management processes are as follows: (a) Credit risk Credit risk is the risk that any counterparty, to a financial instrument, will fail to fulfill an obligation and cause the other party to incur a financial loss. The Group attempts to control credit risk by monitoring credit exposures, limiting transactions with specific counterparties, and assessing the creditworthiness of counterparties. In addition to monitoring credit limits, the Group manages credit exposures by entering into collateral arrangements with counterparties in appropriate circumstances, and limiting the duration of exposure. According to the terms of the STS program, the Sukukholders bear the credit risk arising from investments on account of default. However, the Bank bears the risk of a rating downgrade of its holding in sukuk assets. Financial Statements

51 2013 ANNUAL REPORT 49 Notes to the Consolidated Financial Statements At 31 December RISK MANAGEMENT (continued) (a) Credit risk (continued) The Group has established a credit quality review process to provide early identification of possible changes in the creditworthiness of counterparties, including regular collateral reviews. Counterparty limits are established by the use of a credit risk classification system, which assigns each counterparty a perceived risk rating. Risk ratings are subject to regular revision. The credit quality review process allows the Group to assess the potential loss as a result of the risks to which it is exposed and take corrective action. Maximum exposure to credit risk The table below shows the gross maximum exposure to credit risk for the components of the consolidated statement of financial position. The figures represent gross exposure net of any provision for impairment, without taking into account any collateral held and other credit mitigants: Gross maximum exposure US$ 000 US$ 000 Bank balances 1,900 2,558 Due from banks and financial institutions 16,362 30,500 Mudaraba receivables 30,170 41,733 Ijarah receivables Financing receivables 8,309 6,750 Investment in sukuks 127,111 99,055 Other assets 2, , ,456 Concentration Risk Concentrations of credit risk arise when a number of counterparties are engaged in similar business activities, or activities in the same geographic region, or have similar economic features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic, political or other conditions. Concentrations of credit risk indicate the relative sensitivity of the Group s performance to developments affecting a particular industry or geographic location. Financial Statements

52 50 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December RISK MANAGEMENT (continued) (a) Credit risk (continued) Concentration Risk (continued) The Group s financial assets with credit risk, before taking into account any collateral held or other credit enhancements, can be analysed by the following geographical regions: Other GCC Bahrain countries Others Total 2013 US$ 000 US$ 000 US$ 000 US$ 000 Bank balances 1, ,900 Due from banks and financial institutions 13,000 3,362-16,362 Mudaraba receivables 30, ,170 Financing receivables 6,750-1,559 8,309 Investment in sukuks 14,791 93,834 18, ,111 Other assets 354 1, ,407 66,143 99,044 21, ,259 Other GCC Bahrain countries Others Total 2012 US$ 000 US$ 000 US$ 000 US$ 000 Bank balances ,008 2,558 Due from banks and financial institutions 14,000 16,500-30,500 Mudaraba receivable 41, ,733 Ijarah receivables Financing receivable 6, ,750 Investment in sukuks 14,696 77,502 6,857 99,055 Other assets ,941 95,589 7, ,456 Financial Statements

53 2013 ANNUAL REPORT 51 Notes to the Consolidated Financial Statements At 31 December RISK MANAGEMENT (continued) (a) Credit risk (continued) The Group s financial assets with credit risk, before taking into account any collateral held or other credit enhancements, can be analysed by the following industry sectors: Banks and financial institutions Government Real Estate Others Total 2013 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 Bank balances 1, ,900 Due from banks and financial institutions 16, ,362 Mudaraba receivables 30, ,170 Financing receivables 1,559-6,750-8,309 Investment in sukuks 52,025 28,159 37,658 9, ,111 Other assets , ,922 28,625 45,052 9, ,259 Banks and financial institutions Government Real Estate Others Total 2012 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 Bank balances 2, ,558 Due from banks and financial institutions 30, ,500 Mudaraba receivables 41, ,733 Ijarah receivables Financing receivables - - 6,750-6,750 Investment in sukuks 42,542 19,621 31,987 4,905 99,055 Other assets ,705 19,902 38,920 5, ,456 As of 31 December 2013, the Group s exposure to banks and non banks which exceed 15% of the Group s consolidated capital base amounted to US$ 21.6 million (2012: US$ 21.5 million) and has been deducted from the eligible capital. Credit quality per class of financial assets The Group s financial assets are either asset backed or asset based. It is the Group s policy to maintain consistent perceived risk ratings across the investment portfolio. This facilitates management focus on the applicable risks and the comparison of investment exposures across all lines of business, geographic regions and products. The rating system is supported by a variety of financial analytics, combined with processed market information to provide the main inputs for the measurement of counterparty risk. All internal risk ratings are tailored to the various categories and are derived in accordance with the Group s rating policy. The attributable risk ratings are assessed and updated regularly. The Group s holdings are perceived to be rated investment grade or better. Financial Statements

54 52 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December RISK MANAGEMENT (continued) (a) Credit risk (continued) Credit quality per class of financial assets (continued) The risk ratings used by the Group are defined as follows: (i) (ii) High investment grade: These counterparties are internally rated between AAA and A-. These are of high credit quality and considered as low risk. Investment grade: These counterparties are rated internally between BBB+ and BBB-. These are of good credit quality and considered higher risk than the high investment grade counterparties. (iii) Unrated: These counterparties are not rated internally. They are higher risk than investment grade but full repayments are expected. (iv) Past due or individually impaired: These counterparties are expected to be total loss. The table below analyses the credit quality by class of financial asset, based on the Group s internal credit rating system: High investment Investment grade grade Unrated Total 2013 US$ 000 US$ 000 US$ 000 US$ 000 Bank balances ,900 Due from banks and financial institutions - 13,000 3,362 16,362 Mudaraba receivables 5,000 12,200 12,970 30,170 Financing receivables - - 8,309 8,309 Investment in sukuks 23,042 27,741 76, ,111 Other assets 55 1, ,407 29,015 54, , ,259 High investment Investment grade grade Unrated Total 2012 US$ 000 US$ 000 US$ 000 US$ 000 Bank balances 1, ,558 Due from banks and financial institutions - 24,000 6,500 30,500 Mudaraba receivables 16,000 13,700 12,033 41,733 Ijarah receivables Financing receivables - - 6,750 6,750 Investment in sukuks 4,501 47,935 46,619 99,055 Other assets ,465 87,646 72, ,456 Financial Statements

55 2013 ANNUAL REPORT 53 Notes to the Consolidated Financial Statements At 31 December RISK MANAGEMENT (continued) (a) Credit risk (continued) Credit quality per class of financial assets (continued) Past due but not impaired financial assets The table below is an aging analysis of past due but not impaired assets per class of financial assets as well as individually impaired financial assets. The amounts presented are gross of impairment provision: Past due but not impaired Individually Less than 31 to 61 to More than impaired Not yet due 30 days 60 days 90 days 91 days assets Total 2013 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 Investment in sukuks ,501 6,800 18,301 Other assets ,501 7,101 18,602 Past due but not impaired Individually Less than 31 to 61 to More than impaired Not yet due 30 days 60 days 90 days 91 days assets Total 2012 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 Investment in sukuks - 3, ,201 13,600 25,101 Other assets , ,201 13,901 25,402 Financial assets whose terms have been renegotiated Financial assets whose terms were renegotiated, or are in the process of renegotiation, during the year amounted to US$ 23.1 million (2012: US$ 46.7 million). Collateral and other credit enhancements The amount and type of collateral depends on an assessment of the credit risk of the counterparty. The types of collateral mainly include charges over real estate properties. Management monitors the market value of collateral during its review of the adequacy of the allowance for impairment losses. (b) Liquidity risk Liquidity risk is defined as the risk that the Group will encounter difficulty in meeting obligations associated with financial liabilities that are to be settled by delivering cash or another financial asset. The Group s approach to managing liquidity is through entering into liquidity support agreements with its shareholders. Furthermore, the Group has obtained additional liquidity lines (note 6). Financial Statements

56 54 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December RISK MANAGEMENT (continued) (b) Liquidity risk (continued) Details of the Group s liquid assets to total assets as of the reporting date were as follows: At 31 December Financial Statements Liquid assets/ Total assets Liquidity Ratio 9% 15% Including sukuk* 51% 47% * The management is of the view that certain sukuk are tradable or liquid and this ratio is calculated after including the tradable sukuk as liquid assets. The table below summarises the maturity profile of the Group s assets and liabilities as of 31 December 2013 based on expected periods to cash conversion from the consolidated statement of financial position date: ( 2013 ) Up to 1 to 3 3 to 6 6 months 1 to 3 Over No fixed 1 month months months to 1 year years 3 years maturity Total US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 Assets Cash and bank balances 1, ,900 Due from banks and financial institutions 3,000 10,000-3, ,362 Mudaraba receivables 25,170 5, ,170 Financing receivables ,922 3,375-8,309 Investment in sukuks - 4, , , ,111 Investment in equities and funds - 3, ,387-2,490 14,394 Investment in real estate ,912-19,912 Equipment Other assets ,627 Total assets 30,676 23, ,281 26, ,165 3, ,045 Liabilities and owners equity Due to short term sukuk investors 40,135 25, ,135 Due to banks 23,571 64,399 1, ,650 Other liabilities , ,303 Owners equity ,957 62,957 Total liabilities and owners equity 63,706 90,040 1, ,988-62, ,045 Liquidity gap (33,030) (66,342) (957) 3,841 24, ,165 (59,911) Cumulative liquidity gap (33,030) (99,372) (100,329) (96,488) (72,254) 59,911 - Commitments - - 2,211 2,652 4, The net funding requirement with respect to the cumulative liquidity gap is managed through money market lines amounting to US$ 100 million as at 31 December 2013, provided by the shareholders.

57 2013 ANNUAL REPORT 55 Notes to the Consolidated Financial Statements At 31 December RISK MANAGEMENT (continued) (b) Liquidity risk (continued) The table below summarises the maturity profile of the Group s assets and liabilities as of 31 December 2012 based on expected periods to cash conversion from the consolidated statement of financial position date: 2012 Up to 1 to 3 3 to 6 6 months 1 to 3 Over No fixed 1 month months months to 1 year years 3 years maturity Total US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 Assets Cash and balances with banks 2, ,558 Due from banks and financial institutions 30, ,500 Mudaraba receivables 39,611-2, ,733 Ijarah receivables Financing receivables ,750 6,750 Investment in sukuks - 1,567-5,568 2,639 71,195 18,086 99,055 Investment in equities and funds - 1, ,000 1,000 11,774 16,170 Investment in real estate ,641 13,641 Investment in real estate held-for-sale Equipment Other assets ,122 Total assets 73,230 3,365 2,776 5,748 4,639 72,195 51, ,645 Liabilities and owners equity Due to short term sukuk investors 70,081 5, ,082 Due to banks and financial institutions 38,018 37,536 1, ,210 Other liabilities , ,579 Owners equity ,774 58,774 Total liabilities and owners equity 108,099 43,155 1, ,380 59, ,645 Liquidity gap (34,869) (39,790) 1,120 5,649 4,639 70,815 (7,564) Cumulative liquidity gap (34,869) (74,659) (73,539) (67,890) (63,251) 7,564 - Commitments - - 2,215 2,215 8,862 2,215 - The net funding requirement with respect to the cumulative liquidity gap is managed through money market lines amounting to US$ 100 million as at 31 December 2012, provided by the shareholders. Financial Statements

58 56 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December RISK MANAGEMENT (continued) (b) Liquidity risk (continued) The table below summarises the maturity profile of the Group s financial liabilities based on contractual undiscounted repayment obligations: On Less than 3 to 12 1 to 5 Over demand 3 months months years 5 years Total 2013 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 Due to Short Term Sukuk - investors - 40,112 25, ,220 Due to banks - 75,654 14, ,745 Financing related commitments Ijara commitments - - 4,421 4,421-8,842 Total undiscounted financial liabilities - 115,766 44,061 4, ,248 On Less than 3 to 12 1 to 5 Over demand 3 months months years 5 years Total 2012 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 Due to Short Term Sukuk - investors - 42,081 33, ,128 Due to banks - 75,726 1, ,655 Investment related commitments Ijara commitments - - 4,985 9,366-14,351 Total undiscounted financial liabilities ,807 39,961 9, ,714 (c) Market risk Market risk is the risk that changes in market prices, such as profit rates, equity prices, foreign exchange rates and commodity prices will affect the Group s income or the value of its holdings of financial instruments. Market risk comprises equity position risk, profit rate risk, currency risk and other price risk. The Group s policy guidelines for market risk have been vetted by the Board of Directors in compliance with the rules and guidelines provided by the CBB. The Group s principal investment activity focuses on the GCC countries, a region whose dynamics the Group comprehends well and where the Group has a better understanding of the inherent risks. Investments are made after rigorous qualitative and quantitative analysis, and where the desired risk-return objectives are met. A healthy diversification across industry sectors is maintained within the investments. Currency risk Currency risk is the risk that the value of a financial instrument will fluctuate due to changes in foreign exchange rates. The Group s major exposure is in GCC currencies, which are primarily pegged to the US Dollars. The Group considers the US Dollar as its functional currency. Financial Statements

59 2013 ANNUAL REPORT 57 Notes to the Consolidated Financial Statements At 31 December RISK MANAGEMENT (continued) (c) Market risk (continued) Currency risk (continued) The Group had the following net exposures denominated in foreign currencies (other than GCC currencies which are pegged to the US Dollars) as of 31 December: US$ 000 US$ 000 Currency Euro Kuwaiti Dinars 2,339 4,411 Pound Sterling 460 1,082 The table below indicates the impact of reasonably possible changes in exchange rates on the Group s net foreign currency exposures. The impact has been calculated using the net foreign currency exposure as at the consolidated statement of financial position date and calculating the impact of the changes in exchange rates: Net Change in income exchange and rates (+/-) equity (+/-) % US$ 000 Euro 10% 2 Kuwaiti Dinars 10% 234 Pound Sterling 10% 46 Profit rate risk Profit rate risk refers to the potential impact on the Group s net profit and equity caused by unexpected changes in rates of return. Profit rate risk is mitigated by adopting the floating-profit rate approach through close monitoring of the secondary market trading of sukuks and prevailing market expectations on profit rates and yields. The Group s policy is to measure and manage its profit rate sensitive positions to ensure that the Group s profit rates are optimised and its long-run earning power sustained. The Group reviews the volatility of its assets and liabilities portfolio using appropriate tools and techniques. The effects on profit solely due to reasonably possible immediate and sustained changes in profit return rate, affecting both floating rate assets and liabilities and fixed rate assets and liabilities are as follows: Effect on net income Change in rate US$ 000 US$ 000-1% (272) (267) The effect of an increase in profit return rates is expected to have an equal and opposite effect on the net profit. Financial Statements

60 58 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December RISK MANAGEMENT (continued) (c) Market risk (continued) Equity price risk Equity price risk is the risk that the fair value of equity decreases as a result of changes in the levels of equity indices and the value of individual stocks. Equity positions are marked to market prices and monitored by RMU and reported to RMC. Risks arising from dealing and investment activities are managed by the establishment of limits that include trading limits, counterparty limits, as well as product and sub-product limits, i.e. permissible acquisition of BBB rated sukuk and above. Equity price risk arises from the change in fair values of equity investments. The Bank has investments of US$ 2.49 million (2012: US$ 2 million) whose fair values are determined through equity indices. The effect on net profit/loss and equity (as a result of a change in the fair value of investments at fair value through the statement of income at 31 December 2013 and 31 December 2012) due to a reasonably possible change in equity indices, with all other variables held constant, is as follows: Market indices Change Effect on Effect on Change Effect on Effect on in equity net owners in equity net owners price profit equity price profit equity % US$ 000 US$ 000 % US$ 000 US$ 000 Dubai International Financial Exchange (20) (9) (344) (20) (19) (277) Kuwait Stock Exchange (20) (145) Bahrain Stock Exchange (20) (160) - The effect of an increase in equity indices is expected to have an equal and opposite effect on the net profit and owners equity. (d) Operational Risk This risk is defined as the risk of loss arising from inadequate or failed internal processes, people and systems and external events. Operational risk also includes shari a non compliance risk but excludes strategic and reputational risks. In managing this risk, a dedicated team has been established within the Bank to undertake the identification, assessment and measurement, establishing a control framework, monitoring and reporting of operational risks. Financial Statements

61 2013 ANNUAL REPORT 59 Notes to the Consolidated Financial Statements At 31 December SEGMENTAL INFORMATION (a) Industry sector The industrial distribution of the Group s assets and liabilities as of 31 December 2013 is as follows: Banks and financial Real institutions Government Estate Others Total US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 Assets Cash and bank balances 1, ,900 Due from banks and financial institutions 16, ,362 Mudaraba receivables 30, ,170 Financing receivables 1,559-6,750-8,309 Investment in sukuks 52,025 28,159 37,658 9, ,111 Investment in equities and funds 1,718-12, ,394 Investment in real estate ,912-19,912 Equipment Other assets ,627 Total assets 104,677 28,624 77,241 10, ,045 Liabilities Due to short term sukuk investors 65, ,135 Due to banks and financial institutions 89, ,650 Other liabilities ,234 3,303 Total liabilities 154, , ,088 Financial Statements

62 60 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December SEGMENTAL INFORMATION (continued) (a) Industry sector (continued) The industrial distribution of the Group s assets and liabilities as of 31 December 2012 is as follows: Banks and financial Real institutions Government Estate Others Total US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 Assets Cash and bank balances 2, ,558 Due from banks and financial institutions 30, ,500 Mudaraba receivables 41, ,733 Ijarah receivables Financing receivables - - 6,750-6,750 Investment in sukuks 42,542 19,621 31,987 4,905 99,055 Investment in equities and funds - 1,228 13,090 1,852 16,170 Investment in real estate ,641-13,641 Investment in real estate held-for-sale Equipment Other assets ,122 Total assets 118,658 21,130 66,640 7, ,645 Liabilities Due to short term sukuk investors 75, ,082 Due to banks and financial institutions 77, ,210 Other liabilities ,529 2,579 Total liabilities 152, , ,871 Financial Statements

63 2013 ANNUAL REPORT 61 Notes to the Consolidated Financial Statements At 31 December SEGMENTAL INFORMATION (continued) (b) Geographic sector The geographical distribution of the Group s assets and liabilities as of 31 December 2013 is as follows: Other GCC Bahrain countries Others Total US$ 000 US$ 000 US$ 000 US$ 000 Assets Cash and bank balances 1, ,900 Due from banks and financial institutions 13,000 3,362-16,362 Mudaraba receivables 30, ,170 Financing receivables 6,750-1,559 8,309 Investment in sukuks 14,791 93,834 18, ,111 Investment in equities and funds 5,261 5,721 3,412 14,394 Investment in real estate 19, ,912 Equipment Other assets 574 1, ,627 Total assets 91, ,765 24, ,045 Liabilities Due to short term sukuk investors 39 65,096-65,135 Due to banks and financial institutions 32,716 12,517 44,417 89,650 Other liabilities 3, ,303 Total liabilities 36,026 77,645 44, ,088 Financial Statements

64 62 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December SEGMENTAL INFORMATION (continued) (b) Geographic sector (continued) The geographical distribution of the Group s assets and liabilities as of 31 December 2012 is as follows: Other GCC Bahrain countries Others Total US$ 000 US$ 000 US$ 000 US$ 000 Assets Cash and bank balances ,008 2,558 Due from banks and financial institutions 14,000 16,500-30,500 Mudaraba receivables 41, ,733 Ijarah receivables Financing receivables 6, ,750 Investment in sukuks 14,696 77,502 6,857 99,055 Investment in equities and funds 10,890 1,229 4,051 16,170 Investment in real estate 13, ,641 Investment in real estate held-for-sale Equipment Other assets ,122 Total assets 103,743 97,928 11, ,645 Liabilities Due to short term sukuk investors 38 75,044-75,082 Due to banks and financial institutions 32,956 25,054 19,200 77,210 Other liabilities 2, ,579 Total liabilities 35, ,130 19, ,871 The Group s revenue and expenses are reviewed at a Group level and therefore no separate operating segment results and other disclosures are provided in these consolidated financial statements. 20. ACCOUNTING CLASSIFICATION OF FINANCIAL INSTRUMENTS Financial instruments Financial assets and financial liabilities carried on the consolidated statement of financial position include cash and bank balances, financing receivables, mudaraba receivables, due from banks and financial institutions, investments, other assets, due to short term sukuk investors, due to banks and financial institutions and other liabilities. Financial Statements

65 2013 ANNUAL REPORT 63 Notes to the Consolidated Financial Statements At 31 December ACCOUNTING CLASSIFICATION OF FINANCIAL INSTRUMENTS (continued) Financial instruments (continued) Set out below is an overview of financial instruments, other than cash and cash equivalents, held by the Group as at 31 December 2013: Fair value Fair value through Amortised through statement cost equity of income US$ 000 US$ 000 US$ 000 Financial assets: Due from banks and financial institutions 3, Mudaraba receivables 30, Financing receivables 8, Investment in sukuks 127, Investment in equities and funds - 7,798 6,596 Other assets* 2, ,415 7,798 6,596 Financial liabilities: Due to short term sukuk investors 65, Due to banks and financial institutions 89, Other liabilities* 1, , * Other assets exclude advances paid. * Other liabilities exclude provision for indemnity. 21. FAIR VALUE OF FINANCIAL INSTRUMENTS Fair value is the amount for which an asset could be exchanged or a liability settled between knowledgeable and willing parties in an arm s length transaction. Consequently, differences can arise between carrying values and fair value estimates. Fair value hierarchy Fair values of quoted securities are derived from quoted market prices in active markets, if available. For unquoted securities, fair value is estimated using appropriate valuation techniques. Such techniques may include using recent arm s length market transactions; reference to the current fair value of another instrument that is substantially the same; discounted cash flow analysis or other valuation models. Financial Statements

66 64 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December FAIR VALUE OF FINANCIAL INSTRUMENTS (continued) Fair value hierarchy (continued) The Group uses the following hierarchy for determining and disclosing the fair value of financial instruments by valuation technique: Level 1: quoted (unadjusted) prices in active markets for identical assets or liabilities; Level 2: other techniques for which all inputs which have a significant effect on the recorded fair value are observable, either directly or indirectly; and Level 3: techniques which use inputs which have a significant effect on the recorded fair value that are not based on observable market data. The following table shows an analysis of financial instruments recorded at fair value by level of the fair value hierarchy at 31 December: 2013 Level 1 Level 2 Level 3 Total US$ 000 US$ 000 US$ 000 US$ 000 Investments carried at fair value through statement of income Equities and funds 47 6,550-6, ,550-6,597 Investments carried at fair value through equity Equities and funds 2,444 2,609-5,053 2,444 2,609-5,053 2,491 9,159-11,650 Under unquoted investments which are held at fair value through equity are investments amounting to US$ 2 million (31 December 2012: US$ 2 million) which are held at cost less provision for impairment due to the unpredictable nature of their future cash flows and the lack of other suitable methods for arriving at a reliable fair value for these investments (note 6). The fair values of the Group s other financial instruments are not significantly different from their carrying values as at 31 December 2013 and Financial Statements

67 2013 ANNUAL REPORT 65 Notes to the Consolidated Financial Statements At 31 December CAPITAL ADEQUACY The primary objective of the Group s capital management is to ensure that the Group complies with externally imposed capital requirements and that the Group maintains strong credit ratings and healthy capital ratios in order to support its business and to maximise shareholders value. The Group manages its capital structure and makes adjustments to it in light of changes in economic conditions and the risk characteristics of its activities. In order to maintain or adjust the capital structure, the Group may adjust the amount of dividend payment to shareholders, return capital to shareholders or issue capital securities. No changes were made in the objectives, policies and processes from the previous years. The classification of the Group s capital in accordance to the regulatory requirements is as follows: US$ 000 US$ 000 Tier 1 Capital 60,319 56,914 Tier 2 Capital 2, Total Deductions 3,105 4,681 Total Eligible Capital 59,545 52,460 To assess its capital adequacy requirements in accordance to the CBB requirements, the Group adopts the standardised approach for its Credit Risk, the Basic Indicator Approach for its Operational Risk and the Standardised Measurement Approach for its Market Risk US$ 000 US$ 000 Total credit risk weighted assets 173, ,011 Total market risk weighted assets 8,490 10,275 Total operational risk weighted assets 16,303 15,058 Regulatory Risk Weighted Assets 198, ,344 Capital Adequacy Ratio 30.07% 33.13% 23. EARNINGS AND EXPENSES PROHIBITED BY SHARI A During the year no earnings were realised by the Group from transactions which were not permitted by Shari a. Financial Statements

68 66 Liquidity Management Centre B.S.C. (c) Notes to the Consolidated Financial Statements At 31 December COMMITMENTS Financing and Investment related commitments Financing and Investment related commitments represent contractual commitments to fund certain financing arrangements and investment deals. These commitments may expire without being drawn upon and do not necessarily represent future cash flows. As of 31 December 2013, the Group has US$ 441 thousand (2012: Nil) of financing related commitment and US$ Nil (2012: US$ 580 thousand) of investment related commitment. Ijarah commitments The Group has entered into an ijara agreement with financial institutions for the Group s Headquarter s building. There are no restrictions placed upon the Group. The future ijara rentals are due as follows: US$ 000 US$ 000 Within one year 4,421 4,421 After one year but not more than five years 4,421 8,841 Total 8,842 13, SOCIAL RESPONSIBILITY The Group discharges its social responsibilities through donations to charitable causes and organisations. 26. COMPARATIVES Certain prior year amounts have been reclassified to conform to the presentation in the current year. Such reclassifications do not affect previously reported net profit or owners equity. Financial Statements

69 2013 ANNUAL REPORT 67 PUBLIC DISCLOSURE Basel II, Pillar III Disclosures For the year ended 31 December 2013 (Unaudited) 1. BACKGROUND CAPITAL ADEQUACY RISK MANAGEMENT Group wide Risk Management Objectives Strategies, Processess and Internal Controls Structure and Organisation of Risk Management Function Risk Measurement and Reporting System Credit Risk Market Risk Operational Risk Equity Positions in the Banking Book Liquidity Risk Profit Rate Risk Corporate Governance and Transparency 86

70 68 Liquidity Management Centre B.S.C. (c) For the year ended 31 December 2013 (Unaudited) 1. Background The Public Disclosures under this section have been prepared in accordance with the Central Bank of Bahrain ( CBB ) requirements outlined in its Public Disclosure Module ( PD ), Section PD-1: Annual Disclosure requirements, CBB Rule Book, Volume II for Islamic Banks. Rules concerning the disclosures under this section are applicable to Liquidity Management Centre B.S.C. (c) (the Bank ) being a locally incorporated Bank with a Wholesale Islamic Investment Banking license, and its subsidiary together known as (the Group ). The Board of Directors seeks to optimize the Bank s performance by enabling the various Group business units to realize the Group s business strategy and meet agreed business performance targets by operating within the agreed capital and risk parameters and the Group risk policy framework. 2. Capital Adequacy The primary objectives of the Group s capital management are to ensure that the Group complies with externally imposed capital requirements and that it maintains healthy capital ratios in order to support its business and to maximize shareholders value. The Group manages its capital structure and makes adjustments to it in light of changes in economic conditions and the risk characteristics of its activities. In order to maintain or adjust the capital structure, the Group may adjust the amount of dividend payment to shareholders, return capital to shareholders or issue capital securities. The Group s capital adequacy policy is to maintain a strong capital base to support the development and growth of the business. Current and future capital requirements are determined on the basis of growth expectations of the business and future sources and uses of funds. To assess its capital adequacy requirements in accordance with CBB regulations, the Group adopts the Standardized Approach for its Credit Risk, Basic Indicator Approach for its Operational Risk and Standardized Measurement Approach for its Market Risk. Table 1. Capital Structure (PD , ,1.3.15) The following table summarizes the eligible capital after deductions for Capital Adequacy Ratio (CAR) calculation: Tier 1 Tier 2 USD 000 USD 000 Components of capital Issued and fully paid ordinary shares 51,000 General reserves 2,226 Legal / statutory reserves 2,891 Retained profit brought forward 2,953 Unrealized gains arising from fair valuing equities- (45% only) 1,249 Tier 1 Capital before PCD deductions 60,319 Unrealized gains arising from fair valuing equities - (45% only) 500 Collective impairment provision 1,831 Tier 2 Capital before PCD deductions 2,331 Total available capital 62,650 Deductions Excess amount over maximum permitted large exposure limit (1,553) (1,553) TOTAL ELIGIBLE CAPITAL 59,545

71 2013 ANNUAL REPORT 69 For the year ended 31 December 2013 (Unaudited) 2. Capital Adequacy (continued) Table 2. Capital requirements by type of Islamic financing contracts (PD ) The following table summarises the amount of exposures subject to standardized approach of credit risk and related capital requirements by type of Islamic financing contracts; Risk Capital weighted requirements 12% USD 000 USD 000 Type of Islamic Financing Contracts Due from banks and Financial Institutions 5, Mudaraba receivables 8,394 1,007 Financing receivable 8, Investment in Sukuk 88,402 10, ,067 13,327 Table 3. Capital requirements for Market Risk (PD ) The following table summarises the amount of exposures subject to standardized approach of market risk and related capital requirements; USD 000 Market Risk - Standardised Approach Foreign exchange risk 679 Multiplier 12.5 TOTAL MARKET RISK EXPOSURES 8,488 The minimum capital requirement for the above Market risk exposure at 12% is USD 1,019 thousand. Table 4. Capital Requirements for Operational Risk (PD ) & (PD (a & b)) The following table summarises the amount of exposures subject to basic indicator approach of operational risk and related capital requirements; USD 000 Indicators of operational risk Average Gross income 8,695 Multiplier ,688 Eligible Portion for the purpose of the calculation 15% TOTAL OPERATIONAL RISK EXPOSURE 16,303 The minimum capital requirement for the above Operational risk exposure at 12% is USD 1,956 thousand.

72 70 Liquidity Management Centre B.S.C. (c) For the year ended 31 December 2013 (Unaudited) 2. Capital Adequacy (continued) Table 5. Capital Adequacy Ratios (PD ) The following table summarises the Capital Adequacy Ratios as of 31 December 2013 for Total and Tier 1 capital at the top consolidated level in the Group: Total capital ratio Tier 1 capital ratio 30.07% 29.67% 3. Risk Management 3.1 Bank-wide Risk Management Objectives Risk management is an integral part of the Group s decision-making process. The management committee and executive committees guide and assist with overall management of the Group s balance sheet risks. The Group manages exposures by setting limits/strategies approved by the Board of Directors. The risk management philosophy of the Bank is to identify, capture, monitor and manage the various dimensions of risk with the objective of protecting asset values and income streams such that the interest of the Bank s shareholders are safeguarded, while maximizing the returns intended to optimize the Bank s shareholder return while maintaining risk exposure within self-imposed parameters. In addition to satisfying the minimum regulatory capital requirements of CBB, the Bank seeks to constantly identify and quantify, to the extent possible, the various risks that are inherent in the normal course of its business and maintain appropriate internal capital levels and consequently has developed an ICAAP framework. The objective of the Bank s ICAAP is to ensure that adequate capital is retained at all times to support the risks the Bank undertakes in the course of its business. 3.2 Strategies, Processes & Internal Controls Credit Risk Credit risk is the risk that one party to a financial contract will fail to discharge an obligation and cause the other party to incur a financial loss. The Group controls credit risk by monitoring credit exposures, and continually assessing the creditworthiness of counterparties Market Risk The Bank proactively measures and monitors the market risk in its portfolio using appropriate measurement techniques. The Bank carries out stress testing to assess the impact of adverse market conditions on its market risk sensitive portfolio Operational Risk The Bank has established a self assessment process necessary for identifying and measuring its operational risks. In addition to that, the Bank has conducted a Risk and Control Self Assessment ( RCSA ) exercise, which has undertaken the Bank s business lines and their critical activities. The Bank has established a clear segregation of duties, through documentation and implementation of policies and procedures. This ensures objectivity, security and avoids conflicts of interest. Maker checker concept and dual eye principles are applied across the Bank, where possible.

73 2013 ANNUAL REPORT 71 For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.2 Strategies, Processes & Internal Controls (continued) Equity Risk in the Banking Book Equity price risk is the risk that the fair values of equities decrease as a result of changes in the levels of equity indices and the value of individual stocks. The equity price risk exposure arises from the Group s investment portfolio. The Group manages and monitors its equity risk using investment limits Profit Rate Risk Profit rate risk arises from the possibility that changes in profit rates will affect future profitability or the fair values of financial instruments. The Group measures the profit rate risk by carrying out re-pricing gap analysis. This is further supported by limits put in place by the Bank Displaced Commercial Risk Displaced commercial risk ( DCR ) refers to the market pressure to pay returns that exceeds the rate that has been earned on the assets financed by the liabilities, when the return on assets is under performing as compared with competitor s rates. The Group does not take deposit from investors or open profit sharing investment accounts and therefore displaced commercial risk is not currently applicable for the Group Review of Internal Control Process and Procedures The Group will aim to control the risks it is exposed to by strengthening its internal controls, continuing its efforts to identify, assess, measure and monitor its risks, evolving in its risk management sophistication and promoting a strong control culture within the Group. Each business unit head is responsible for ensuring that the internal controls relevant to its operations are complied with on a day to day basis. Current and updated policies and procedures are in place and adhered to. The Risk Committee reviews and evaluates the effectiveness of the Group s procedures and internal control systems for assessing risks or exposures through reviewing policy and procedures of each department. It assists the Board in fulfilling its oversight duties by reviewing the financial information provided to shareholders and others. Also, the risk assessment, that is performed by external professional firm, is get reviewed and approved by Audit Committee. All the above strategies used have been effective throughout the reporting period. 3.3 Structure & Organization of Risk Management Function Risk Management Structure includes all levels of authorities, organizational structure, people and systems required for the smooth functioning of risk management processes in the Bank. The responsibilities associated with each level of risk management structure and authorities include the following: a. The Board retains ultimate responsibility and authority for all risk matters, including:

74 72 Liquidity Management Centre B.S.C. (c) For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.3 Structure & Organization of Risk Management Function (continued) b. Delegating authority to Executive Committee, Investment and Credit Committee, the Chief Executive Officer and further delegation to the management to approve and review. Board of directors Risk Management and Compliance Committee Chief executive Officer Risk Department Credit Risk Market Risk Operational Risk 3.4 Risk Measurement and Reporting System Based on risk appetite of the Bank has put in place various limits. These limits have been approved by the Board of Directors. Any limit breaches are reported to the respective senior management committees and the Board by the Credit and Risk Management Department ( CRMD ). The limits are reviewed and revised at least on annual basis or when is deemed required. The Bank has developed a risk reporting process that generates various types of reports which has enhanced the monitoring process of the Bank. 3.5 Credit Risk Introduction Credit risk is the risk of financial loss if a customer or counterparty fails to meet an obligation under a contract. It arises principally from lending and investment activities. The Group controls credit risk by monitoring credit exposures, and continually assessing the creditworthiness of counterparties. Financing contracts are mostly secured by collateral in form of mortgage financed or other tangible and intangible securities Past Due and Impaired Islamic Financing The Group defines non-performing facilities as the facilities that are overdue for period of 90 days or more. These exposures are placed on a non-accrual status with income only being recognized to the extent that it is actually received. It is the Group s policy that when an exposure is overdue for a period of 90 days or more, the whole financing facility extended is considered as past due, not only the overdue installments/payments External Credit Assessment Institutions The Bank relies on external ratings for rated counterparties and issuances. The Bank uses Standard & Poor s, Fitch, Moody s and Capital Intelligence ratings for such counterparties. These ratings are used for risk assessment and calculation of risk weighted equivalents Concentration Risk Concentration risk is the credit risk stemming from not having a well diversified credit portfolio, i.e. being overexposed to a single customer, industry sector or geographic region. As per CBB s single obligor regulations, banks incorporated in Bahrain are required to obtain the CBB s prior approval for any planned exposure to a single counterparty, or group of connected counterparties, exceeding 15% of the regulatory capital base.

75 2013 ANNUAL REPORT 73 For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.5 Credit Risk (continued) In order to avoid excessive concentrations of risk, the Group s policies and procedures include specific guidelines to focus on maintaining a diversified portfolio. Identified concentrations of credit risks are controlled and managed accordingly Credit Risk Mitigation Credit risk mitigation refers to the use of a number of techniques, like collaterals to mitigate the credit risks that the Bank is exposed to. Credit risk mitigants reduce/transfer the credit risk by allowing the Bank to protect itself and reduce its loss in case of non-performance by counterparty. Generally, the Bank participates in syndicated credit facilities/ extends credit facilities only where supported by adequate tangible collateral security and/or audited financials. Facilities may be considered without adequate tangible collateral security, when audited financials reveal satisfactory financial position/repayment ability and the facilities are properly structured and supported by assignments, guarantees, etc. as appropriate. The majority of the Bank s portfolio is backed by real estate properties and collateral is for the entire sukukholders and its not specific to the bank General Policy Guidelines of Collateral Management Acceptable Collaterals: The Bank has developed guidelines for acceptable collaterals. Assets offered by obligor must meet the following criteria to quantify as acceptable collateral: a. Assets must be maintaining their value, at the level prevalent at inception, until maturity date of the facility granted (over collateralization). b. Such assets should be convertible into cash, if necessary. c. There should be a reasonable market for the assets (marketability). d. The Bank should be able to enforce its rights over the asset if necessary (enforceability). Ownership: Prior to valuation or further follow up on the offered collateral, Credit Administration ensures satisfactory evidence of the borrower s ownership of the assets through though due diligence. Valuation: All assets offered as collateral are valued by reputable external appraisers (real estate related collateral). a. Valuation of Shares: shares are valued at the quotes available from stock exchanges. b. Valuation of Funds: funds are valued based on NAV received from fund manager Custody/ Collateral Management The assets, or title to the asset, are maintained in the Bank s custody or with custodian approved by the Bank. The Credit Administration Department obtains confirmations of the assets held with each custodian Counterparty Credit Risk The Bank has adopted the Standardized Approach to allocate capital for counterparty credit risk. The Bank has put in place an internal counterparty limit structure which is based on internal/external ratings for different types of counterparties and in line with CBB guidelines.

76 74 Liquidity Management Centre B.S.C. (c) For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.5 Credit Risk (continued) Table 6. Credit Risk Exposure (PD (a)) The following table summarises the amount of gross funded and unfunded credit exposures and average gross funded and unfunded exposures as of 31 December The average gross funded and unfunded exposure is calculated on month end balances. Gross credit exposure USD 000 Average gross exposure USD 000 Funded Cash and balances with banks 1,900 3,666 Due from banks and financial institution 16,362 13,012 Mudaraba receivables 30,170 22,711 Ijarah receivables Financing receivable 8,309 7,250 Investment in sukuks 127, ,766 Investment in equities and funds 14,394 15,424 Investment in real estate 19,912 15,065 Investment in real estate held-for-sale Equipment Other assets 2,627 1, , ,127 Unfunded Ijarah commitment 8,842 11,789 Investment commitment ,283 12,364 Table 7. Credit Risk Geographic Breakdown (PD (b)) The following table summarises the geographic distribution of exposures, broken down into significant areas by major types of credit exposure as of 31 December 2013: Geographic area Bahrain GCC Others Total USD 000 USD 000 USD 000 USD 000 Cash and balances with banks 1, ,900 Due from banks and financial institution 13,000 3,362-16,362 Mudaraba receivables 30, ,170 Financing receivable 6,750-1,559 8,309 Investment in sukuks 14,791 93,834 18, ,111 Investment in equities and funds 5,261 5,721 3,412 14,394 Investment in real estate 19, ,912 Equipment Other assets 574 1, ,627 Total assets 91, ,765 24, ,045 * Geographical distribution of exposures into significant areas by major type of credit exposure is based on counterparty/obligor country of incorporation.

77 2013 ANNUAL REPORT 75 For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.5 Credit Risk (continued) Table 8. Credit Risk Industry Sector Breakdown (PD (c)) The following table summarises the distribution of exposures by industry, broken down into major types of credit exposure as of 31 December Banks and financial institutions Government Real Estate Others Total US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 Funded Cash and balances with banks 1, ,900 Due from banks and financial institution 16, ,362 Mudaraba receivables 30, ,170 Financing receivable 1,559-6,750-8,309 Investment in sukuks 52,025 28,159 37,658 9, ,111 Investment in equities and funds 1,718-12, ,394 Investment in real estate ,912-19,912 Equipment Other assets , ,677 28,624 77,241 10, ,045 Unfunded Ijarah commitment 8, ,842 Investment commitment Total 9, ,283 Table 9. Credit Risk Intra-group transactions (PD (d)) The balances and transactions with the related parties are disclosed in the annual audited cosolidated financial statements. All related partries transactions have been made on an arms length basis. The intra-group balances and transactions as of 31 December 2013 are as follows: USD 000 Investment in the Short Term Sukuk Centre Program 26,221 Agency fee receivable from the Short Term Sukuk Centre 5,807 Payable to the Short Term Sukuk Centre (2,000) Income from investment in the Short Term Sukuk Centre 266 Agency fee income 5,807

78 76 Liquidity Management Centre B.S.C. (c) For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.5 Credit Risk (continued) Table 10. Credit Risk Concentration of Risk (PD (f)) The following table summarises exposures with individual counterparties in excess of 10% of the avavliable capital as of 31 December 2013: Percentage % USD 000 Counterparty # 1 * 29% 18,054 Counterparty # 2 * 22% 13,505 Counterparty # 3 19% 11,592 Counterparty # 4 * 17% 10,617 Counterparty # 5 16% 10,000 Counterparty # 6 12% 7,226 Counterparty # 7 11% 7,000 Counterparty # 8 11% 6,852 Total 84,846 * These exposure are in excess of the 15% individual obligor limit. However, they did not result in deductions for capital adequacy purposes as the exposures were either exempted in line with the rules outlined in the CBB rulebook or an expemtion was granted by the CBB.

79 2013 ANNUAL REPORT 77 For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.5 Credit Risk (continued) Table 11. Credit Risk Residual Contractual Maturity Breakdown (PD (g)) The following table summarises the residual contractual maturity broken down by major types of credit exposure as of 31 December 2013: Credit Exposures Up to No One fixed Month month month month years Years Years maturity Total USD 000 USD 000 USD 000 USD 000 USD 000 USD 000 USD 000 USD 000 USD 000 Cash and balances with banks 1, ,900 Due from banks and financial institution 3,000 10,000-3, ,362 Mudaraba receivables 25,170 5, ,170 Financing receivable ,922-3,375-8,309 Investment in sukuks - 4, ,509 77,978 30, ,111 Investment in equities and funds - 3, , ,490 14,394 Investment in real estate , ,912 Investment in real estate held-for-sale Equipment Other assets ,627 Total 30,676 23, ,281 26,222 97,890 34,275 3, ,045 Table 12. Credit Risk Impaired Loans, Past Due Loans and Allowances ( by industry and geographic sector) (PD (h&i)) The following table summarises the impaired financing contracts and provision allowances disclosed by major industry and geographic sector as of 31 December 2013: Past Due no Aging of Impaired Impaired Past Due but not Impaired Specific and General Allowances Islamic Islamic Balance at Balance at financing financing 3 months 1 year to Over the beginning Charge Re- the end of contracts contracts to 1 year 3 years 3 years of the year for the year classification Write-off year USD 000 USD 000 US$ 000 US$ 000 US$ 000 USD 000 USD 000 USD 000 USD 000 USD 000 Banks and financial institutions (GCC countries)* 6, , ,312 Real Estate (GCC countries) - 11,501 11, ,800 11,501 11, , ,312 * The specific allowance represents the specific impairment provision held against the impaired facility above. Subsequent, to the year end the counterparty has made a repayment in accordance with the restructured terms.

80 78 Liquidity Management Centre B.S.C. (c) For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.5 Credit Risk (continued) The following table summarizes the movement in specific and collective impairment provision allowances during the year ended 31 December 2013: Specific and General Allowances Balance at Balance at the beginning Charge the end of of the year for the year Reclassification Write-off year USD 000 USD 000 USD 000 USD 000 USD 000 Banks and financial institutions (GCC countries) 5, (1,168) (692) 4,484 General allowances** (not specific to a geographic area) 1,898 - (67) - 1,831 7, (1,235) (692) 6,315 ** General allowances represent collective impairment provisions against exposures which, although not specifically identified, have a greater risk of default than when originally granted. Table 13. Credit Risk Restructured Islamic financing contracts (PD (j)) The following table summarises the restructured islamic contracts as of 31 December 2013: USD 000 Restructed islamic contracts 14,800 There is no significant impact of the restructured islamic contracts on the provisions as well as present and future earnings. Subsequent to the year end, as formally communicated by one of the obligors of the resturcted contracts above, that the outstanding balance will be repaid during the year Market Risk Market risk is the risk that arises from fluctuations in market risk factors that include, profit rates, currency exchange rate and equity prices and will have a negative impact on the Group profit and/or will decrease the value of its portfolios. Profit Rate Risk Profit rate risk arises from a) Mismatch of maturities of assets and liabilities b) Basis Value Risk c) Profit rate curve risk. The Group measures profit rate risk through the following methodologies: a. Gap analysis: where the assets and liabilities are classified into time bands based on the maturity in case of fixed rate instruments or re-pricing dates for floating rate instruments.

81 2013 ANNUAL REPORT 79 For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.6 Market Risk (continued) b. Economic value of equity-duration gap: this measures the loss in value of the portfolio due to change in profit rates. The Group manages such risk by ensuring that minimum maturity mismatch is achieved between its assets and liabilities and through fixed rates on its assets and liabilities. Financial controls department monitors profit rate risk regularly and submits monthly report to the Asset Liability Committee. Currency risk Currency risk represents fluctuations in exposures held by the group in currencies other than the US dollar. The Group may engage, in normal course of business, in transactions denominated in currencies other than its functional currency. Equity Price Risk The Group has guidelines in place to manage equity price risk. Examples of these guidelines include: a. Equity investment is managed at the preacquisition stage by understanding its performance through different scenarios. b. Specific deal structure to maximise investment rate of return. c. Portfolio approach through geographical and industrial diversification Market Risk Strategy The Group s Board is responsible for approving and reviewing (at least annually), the risk strategy and significant amendments to the risk policies. The Group s senior management is responsible for implementing the risk strategy approved by the Board, and continually enhancing the policies and procedures for identifying, measuring, monitoring and controlling risks. In line with the Group s risk management objectives and risk tolerance levels, the specific strategies for market risk management include: 1. The Group shall manage its market risk exposure by evaluating each new product/ activity with respect to the market risk introduced by it; 2. The Group shall proactively measure and continually monitor the market risk in its portfolio; 3. The Group shall at all time hold sufficient capital in line with the regulatory capital requirements; 4. The Group shall establish a limit structure to monitor and control the market risk in its portfolio, these limits shall include position limits and maturity limits; 5. The Group shall mainly match the amount of floating rate assets with floating rate liabilities; and 6. The Group shall clearly identify the foreign currencies in which it wishes to deal in and actively manage its market risk in all foreign currencies in which it has significant exposure Limits Monitoring The Treasury Department and Risk & Compliance Department monitor the risk limits for each transaction, ensure that the exposures are well within set parameters and report periodically to top management.

82 80 Liquidity Management Centre B.S.C. (c) For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.6 Market Risk (continued) Breach of Limits Adherence to internal and regulatory limits is checked before incurring any exposure and approvals from the respective approving authority is obtained. In case limits are breached, it will be brought to the appropriate authority, as per Discretionary Authority Limit, for their action. The limits are revised at least annually or when deemed required. Table 14. Market Risk Capital Requirements (PD (b)) The following table summarises the capital requirement by the relevant category of market risk: Risk weighted assets USD 000 Capital requirement USD 000 Foreign exchange risk - maximum value 9,113 1,094 Foreign exchange risk - minimum value 8, Operational Risk Introduction Operational risk is the risk of loss arising from inadequate information systems, technology failures, breaches in internal controls, fraud, unforeseen catastrophes, or other operational problems that may result in unexpected losses or damage the Group s reputation Sources of Operational risk The different sources of operational risks faced by the Group can be classified broadly into the following categories. People Risk which arises due to staffing inadequacy, unattractive remuneration structure, lack in staff development policies, lack in procedures for appointment, unhealthy professional working relationship and unethical environment. Processes Risk which arises due to inadequate general controls, inadequate application controls, improper business and market practices and procedures, inappropriate/inadequate monitoring and reporting. Systems (Technology) Risk which arise due to integrity of information - lacking in timelines of information, omission and duplication of data; hardware failures due to power surge, obsolescence, low quality programmes, software failure due to unauthorized or incorrect modifications to software programs, computer virus, programming bug etc Operational Risk Management Strategy As a strategy the Group has identified the sources of operational risks in coordination with each business unit. The Group has carried out Risk and Control Self-Assessments ( RCSA ) to identify the operational risks it is exposed to. The Group on a continuous basis: a. assesses the effectiveness of controls associated with identified risks. b. regularly monitors operational risk profiles and material exposures to losses. c. identifies stress events and scenarios to which it is vulnerable and assess their potential impact, and the probability of aggregated losses from a single event leading to other risks.

83 2013 ANNUAL REPORT 81 For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.7 Operational Risk (continued) Operational Risk Monitoring and Reporting The Group follows internal monitoring and reporting process which ensures a consistent approach for providing pertinent information to Senior Management for the quick detection and correction of deficiencies in the policies, processes and procedures for managing operational risk through ongoing, periodic reviews. The objective of the reporting process is to ensure relevant information is provided to senior management and the Board to enable the proactive management of operational risk. The process ensures a consistent approach for providing information that enables appropriate decision making and action taking Operational Risk Mitigation and Control The Group, in consultation with Risk and Compliance Department will determine all material operational risks and decide the appropriate procedures to be used to control and/or mitigate the risks. For those risks that cannot be controlled, the Group in conjunction with Risk and Compliance Department will decide whether to accept the risks, reduce the level of business activity involved, transfer the risk outside the Group or withdraw from the associated activity completely. Risk and Compliance Department facilitates the Group in codeveloping the mitigation plans Business Continuity Plan ( BCP ) The Group has developed a comprehensive business continuity plan detailing the steps to be taken in the event of extreme conditions to resume the Group s operations with minimum delay and disturbance. Elements of contingency plans and disaster recovery processes include operating systems, physical space, telecommunications and resources. Risk and Compliance Department ensures that the BCP is kept up to date and will be tested once a year in a simulated environment to ensure that it can be implemented in emergency situations and that the management and staff understand how it is to be executed. Results of this testing conducted by Risk and Compliance Department is evaluated by the Credit Manager and presented to the Executive Committee/Board for evaluation. The plan is reviewed periodically to assess and incorporate changes in the business and market conditions. 3.8 Equity Positions in the Banking Book Equity price risk is the risk that the fair values of equities decrease as the result of changes in the levels of equity indices and the value of individual stocks. The equity price risk exposure arises from the Group s investment portfolio. The equity position that the Group is holding is for capital gain purposes. The accounting policies, including valuation methodologies and their related key assumptions, are disclosed in the annual audited consolidated financial statements. Table 15. Equity Position Risk in Banking Book (PD (b) (c) & (f)) The following table summarises the gross and average equity exposure as of 31 December 2013: * Average Risk Gross gross Publicly weighted Capital exposure exposure traded assets Requirement USD 000 USD 000 USD 000 USD 000 USD 000 Equity investments 14,394 15,427 1,718 24,093 2,891 * Average balances are computed based on month end balances.

84 82 Liquidity Management Centre B.S.C. (c) For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.8 Equity Positions in the Banking Book (continued) Table 16. Equity Gains or losses in Banking Book (PD (d) and (e)) USD 000 Total unrealized gains recognized in the balance sheet but not through P&L 3,571 Unrealized gains included in Tier One Capital 1,249 Unrealized gain included in Tier Two Capital 500 Realized gain arising from sales / liquidation Liquidity Risk Introduction The liquidity risk is the risk that the Group will be unable to meet its obligations as they come due because of an inability to obtain adequate funding or to liquidate assets Sources of Liquidity Risk The sources of liquidity risk can broadly be categorized in the following: a. Funding Risk is the risk of not being able to fund net outflows due to unanticipated withdrawal of credit lines; b. Call Risk is the risk of crystallization of a contingent liability; and c. Event Risk is the risk of rating downgrades or other negative public news leading to a loss of market confidence in the Group Group s Funding Strategy The Board reviews the funding strategy on an annual basis and amends the existing strategy, as deemed required. For this purpose, the Group advises the Treasurer of their projected liquidity requirements and contributions at the start of each year as part of annual budgeting process. The funding strategy highlights any anticipated liquidity shortfalls, the funding requirements to finance these shortfalls and their impact on the balance sheet. The strategy also includes a liquidity contingency plan that deals with stressed scenarios and outlines an action plan that can be taken in the event of a loss of market liquidity Liquidity Risk Strategy The Group monitors the liquidity position by comparing maturing assets and liabilities in different time buckets of up to 1 month, 1-3 months, 3-6 months, 6 months to 1 year, 1-3 years, 3-5 years, 5-10 years years and no fixed maturity. The Group carries out stress testing periodically using the worst case scenarios to assess the effects of changes in market conditions on the liquidity of the Bank. The Group has established a contingency liquidity plan to meet urgent liquidity requirements in stressed conditions that addresses how funding liquidity would be managed if either their specific financial conditions were to decline or broader conditions created a liquidity problem. The plan is reviewed and updated regularly. The Treasury Department, in conjunction with Risk and Compliance Department periodically reviews/updates (at least annually) the liquidity risk strategy before presenting to the Executive Committee and the Board for approval.

85 2013 ANNUAL REPORT 83 For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.9 Liquidity Risk (continued) Liquidity Risk Strategy (continued) The Group uses a combination of different limits to ensure that liquidity is managed and controlled in an optimal manner. The Group has set the following limits for monitoring liquidity risks: a. Liquidity Gap limits; and b. Liquidity Ratio limits Contingency Funding Plan The Group has developed a contingency funding plan which details procedures to be followed by the Group, in the event of a liquidity crisis or a situation where the Group faces stressed liquidity conditions. The contingency funding plan is an extension of day to day liquidity management and involves maintenance of an adequate amount of liquid assets and management of access to funding resources. The Asset Liability Committee members discuss and monitor the situation over regular time-intervals to ensure sufficient liquidity in the Group. The group s funding guidelines include: The mobilization and placements of short-term funds, Mudaraba and Murabaha transactions will be the responsibility of the Treasury; All funding objectives would be aligned to the strategic objectives of the Group; The composition, characteristics and diversification of the Group s funding structure will be monitored by Credit and Investment Committee and executed by the Treasury; Treasury will maintain the counterparty relationships to obtain the necessary lines of funding; Credit and Investment Committee will monitor the concentration of funding sources across products and counterparties and effect measures to mitigate undue concentrations; and Treasury will implement the deals within the approved guidelines, including the approved products and the counterparties. Table 17. Equity Position in Banking Book Liquidity Ratios (PD ) The following table summarises the liquidity ratios: 31 December 31 December 31 December 31 December 31 December Short term assets / Short term liabilities 38% 55% 63% 49% 54% Commodities murabaha / Total assets 3.78% - 3% - - Liquid assets / Total assets 7% 15% 6% 5% 9% Liquid assets / Total assets * 49% 47% 51% 38% 33% Due to short term sukuk - investors/ Total assets 29% 35% 41% 40% 41% * The management evidenced that certain sukuk are tradable or liquid and the ratio is calculated after including the tradable sukuk as liquid assets.

86 84 Liquidity Management Centre B.S.C. (c) For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.10 Profit Rate Risk Introduction Profit rate risk is the potential impact of the mismatch between the rate of return on assets and the expected rate of funding due to the sources of finance Sources of Profit Rate Risk The different profit rate risks faced by the Group can be classified broadly into the following categories. a. Re-pricing risk which arises from timing differences in the maturity (for fixed rate) and re-pricing (for floating rate) of assets, liabilities and off balance sheet positions. As profit rates vary, these re-pricing mismatches expose the Group s profit and underlying economic value to unanticipated fluctuations. b. Yield curve risk which arises when unanticipated shifts of the yield curve have adverse effects on the Group s profit and/or underlying economic value. c. Basis risk which arises from imperfect correlation in the adjustment in the rate earned on products priced and the rate paid on different instruments with otherwise similar re-pricing characteristics. When profit rates change, these differences can give rise to unexpected changes in the cash flows and earnings spread between assets, liabilities, and off balance sheet instruments of similar maturities or re-pricing frequencies. d. Displaced Commercial Risk refers to the market pressure to pay returns that exceeds the rate that has been earned on the assets financed by the liabilities, when the return on assets is under performing as compared with competitors rates Profit Rate Risk Strategy The fair value of financial assets may be affected by current market forces including profit rates. The Group recognizes income on certain of its financial assets on a time-apportioned basis. As a strategy the Group: a. has identified the profit rate sensitive products and activities it wishes to engage in; b. has established a limit structure to monitor and control the profit rate risk of the Group; c. measures profit rate risk through establishing maturity/re-pricing schedule that distributes profit rate sensitive assets, liabilities and off-balance sheet items in pre-defined time bands according to their maturity; and d. makes efforts to match the amount of floating rate assets with floating rate liabilities in the banking book Profit Rate Risk Measurement Tools The Group uses the following tools for profit rate risk measurement in the banking book: a. Re-pricing gap analysis which measures the arithmetic difference between the profit-sensitive assets and liabilities of the banking book in absolute terms; and b Basis Point Value ( BPV ) analysis which is the sensitivity measure for all profit rate priced products and positions. The BPV is the change in net present value of a position arising from a 1 basis point shift in the yield curve. This quantifies the sensitivity of the position or portfolio to changes in profit rates.

87 2013 ANNUAL REPORT 85 For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) Profit Rate Risk Monitoring and Reporting The Financial Controls Department monitors these limits regularly. The Chairman of Credit and Investment Committee reviews the results of gap limits and exceptions, if any, and recommends corrective action to be taken according to authority parameters approved by the Executive Committee. Table 18. Profit Rate Risk in Banking Book (PD (b)) Analysis of the Group s sensitivity to an increase or decrease in a 200 bps parallel market profit rates on the Group s net profit and equity: Effect on Changes in Effect on Effect on Net incone basis points value of value of & (+/-) Asset Liability Equity USD 000 USD 000 USD ,639 3, Table 19. Quantitative Indicators of Financial Performance and Position (PD (b)) The following table summarises the basic quantitative indicators of financial performance for the past 5 years: 31 December 31 December 31 December 31 December 31 December Return on average equity 6% 5% 1% -16% 5% Return on average assets 1.65% 1.54% 0.15% -4.00% 1.11% Cost to Income Ratio* 62% 62% 95% 238% 74% * Cost includes operating costs plus provisions and unrealized losses on FVTPL.

88 86 Liquidity Management Centre B.S.C. (c) For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.11 Corporate Governance and Transparency Board Members Profile The Board of Directors consist of eight members as of 31 December No Board member has more than one Directorship of a Retail Bank and a Wholesale Bank. Table 20. Corporate Governance and Transparency Board Members Profile (PD (b)) The following table summarises the information about the profession, business title, experience in years, start date and the qualifications of the current Board members; Name of Board Member Directorships held Profession Representative of Business Title Ex/non Ex Indep/ non Indep Experience in years Start date Qualification Emad Al Monayea - Kuwait Finance House Investment Co. K.S.C.C.-Kuwait - Global Investment House-Kuwait - Sharjah Islamic Bank - UAE Banker KFH Investment Company Chairman of the Board of Directors Non-Independent / Non-Executive 30 April March 2015 Bachelor s Degree from Kuwait University and has completed the Executive Finance Program of INSEAD, France. Mohammed Ebrahim - Enjaz Property Development - Arabian C Real Estate Co. Banker Bahrain Islamic Bank B.S.C Deputy Chairman of Board of Directors Non-Independent / Non-Executive 36 April March 2015 Master Degree in Business Administration from University of Glamorgan in United Kingdom, a graduate of the Gulf Executive Development Program from the University of Virginia in the USA, and General Management Program from Harvard Business School-USA. Khalid Al Dossari NONE Banker Bahrain Islamic Bank B.S.C Board Member Non-Independent / Non-Executive 31 April March 2015 Certified Public Accountants, CPA, from Oregon Board of Accountancy and Executive Management Development Program from University of Virginia Darden. Abdul Wahab Al Rushood - Kuwait Finance House, Bahrain - Development Enterprises Company - Kuwait Banker KFH Investment Company Board Member Non-Independent / Non-Executive 27 April March 2015 Bachelor s Degree in Mathematics from Western Oregon State College and University of Tamps, USA. Adnan Chilwan -Tamweel PJSC -DIB Capital -Deyaar PJSC -Dar Al Sharia Banker Dubai Islamic Bank P.J.S.C Board Member Non-Independent / Non-Executive 19 April March 2015 PhD and MBA in Marketing, and is also a Certified Islamic Banker. Mohammad Saeedullah NONE Banker Islamic Develop-ment Bank Board Member Non-Independent / Non-Executive 33 April March 2015 Master degrees in Applied Mathematics and Business Administration from University of Karachi. Mohammed Al Sharif - Bank of Khartoum Sudan - Dubai Islamic Bank Pakistan - Modern Real Estate Investment Company Egypt - Al Bustan Centre - Jordan Dubai Islamic Bank Banker Dubai Islamic Bank P.J.S.C Board Member Non-Independent / Non-Executive 27 April March 2015 Bsc in accounting and economics from UAE,Master in accounting catholic university of America Washington USA,CPA. Ammar Odah NONE Banker Islamic Development Bank Board Member Non-Independent / Non-Executive 18 April March 2015 MBA from King Fahad University

89 2013 ANNUAL REPORT 87 For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.11 Corporate Governance and Transparency (continued) Board Members Profile (continued) The Group should held a minimum of of four Board meetings during each year. During the year ended 31 December 2013 five Board meetings were held in line with the policy. The following table summarises the information about Board of Directors meeting dates and attendance of directors at each meeting; Table 21. Corporate Governance and Transparency Board of Directors meetings (PD (t and u)) Date Location of Names of Directors Names of Directors Meeting Present Not Present 7 th Feb 2013 LMC Headquarter 1) Emad Al Monayea None 2) Mohammed Ebrahim 3) Khalid Al Dossari 4) Abdul Wahab Al Rashood 5) Mohammed Saeedulla 6) Dr. Adnan Chilwan 7) Mohammed Al Sharif 24 th Apr 2013 LMC Headquarter 1) Emad Al Monayea None 2) Mohammed Ebrahim 3) Khalid Al Dossari 4) Abdul Wahab Al Rashood 5) Mohammed Saeedulla 6) Dr. Adnan Chilwan 7) Mohammed Al Sharif 22 nd Aug 2013 LMC Headquarter 1) Emad Al Monayea Mohammed Ebrahim 2) Khalid Al Dossari 3) Abdul Wahab Al Rashood 4) Mohammed Saeedulla 5) Dr. Adnan Chilwan 6) Mohammed Al Sharif 7) Ammar Odah 24 th Oct 2013 LMC Headquarter 1) Emad Al Monayea None 2) Mohammed Ebrahim 3) Khalid Al Dossari 4) Abdul Wahab Al Rashood 5) Mohammed Saeedulla 6)Dr. Adnan Chilwan 7) Mohammed Al Sharif 8) Ammar Odah 22 nd Dec 2013 LMC Headquarter 1) Emad Al Monayea None 2) Mohammed Ebrahim 3) Khalid Al Dossari 4) Abdul Wahab Al Rashood 5) Mohammed Saeedulla 6) Dr. Adnan Chilwan 7) Mohammed Al Sharif 8) Ammar Odah

90 88 Liquidity Management Centre B.S.C. (c) For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.11 Corporate governance and transparency (continued) Changes in Board Structure Except for the changes below, there were no changes in the Board and Management Committees structure. Moreover, during the year a request letter was sent to the CBB to replace the Member of the Board on 3rd March 2013 for which approval was obtained on 25 April Table 22. Corporate Governance and Transparency Board and Management changes (PD (g)) The following table summarises the information about the profession, business title, experience in years, board terms and the qualifications of the changes in the Board and Management structure; Name of Board Member Profession Representative of Business Title Ex/non Ex Indep/ non Indep Experience in years Board Terms Structural type of change Ammar Odah Banker Islamic Development Bank Board Member Non-Independent / Non-Executive 18 April March 2015 Appointed during the year Abdul Wahab Al Rashood Banker KFH Investment Company Board Member Non-Independent / Non-Executive 27 April March 2015 He was replaced by Ammar Odah in the Executive Committee Mohammad Saeedullah Banker Islamic Development Bank Board Member Non-Independent / Non-Executive 33 April March 2015 He was replaced by Ammar Odah in the Audit Committee Board Committees Table 23. Corporate Governance and Transparency Board Committees Profile (PD (b)) The following table summarises the information about Board Committees, their members and objectives; Board Committee Members Objective Board of Directors Executive Committee Audit Committee Chairman Emad Al Monayea Members Mohammed Ebrahim Abdul Wahab Al Rushood Khalid Al Dossari Adnan Chilwan Mohammed Al Sharif Mohammed Saeedullah Ammar Odah Chairman Mohammed Ebrahim Members Abdul Wahab Al Rushood Mohammed Al Sharif Mohammed Saeedullah Ahmed Abbas (non-voting member) Chairman Khalid Al Dossari Members Adnan Chilwan Ammar Odah The Board of Directors is responsible for overseeing the management and business affairs of the Group and making all major policy decisions of the Group. The ultimate responsibility of approval of financial statements lies with the Directors. The Executive Committee of the Board Considers specific matters delegated to it by the full Board and make recommendations thereon to the Board or decisions based on authorities specifically delegated by the Board. Responsibilities and authorities of the committee are reviewed annually by the Board of Directors. Assists the Board in discharging its oversight responsibilities relating to the integrity of the Group s financial statements and financial reporting process and the Group s systems of internal accounting and financial controls, the annual independent audit of the Group s financial statements and all matters related to external and internal auditors, compliance by the Group with legal and regulatory requirements and compliance with the Group s code of conduct.

91 2013 ANNUAL REPORT 89 For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.11 Corporate governance and transparency (continued) Board Committees (continued) Table 23. Corporate Governance and Transparency Board Committees Profile (PD (b)) (continued) Board Committee Members Objective Nomination and Remuneration Committee Chairman Emad Al Monayea Members Mohammed Ebrahim Ammar Odah Responsible for identifying individuals to become Board members, developing procedure for remuneration policy for the Board senior management; ensure that compensation offered is competitive, in line with the market and consistent with the responsibilities assigned; leads the Board in its annual review of the Board performance, and recommend to the Board the remuneration policy and special compensation plans. Risk and Compliance Committee Shari a Supervisory Board Chairman Adnan Chilwan Members Khalid Al Dossari Ammar Odah Chairman Dr. Hussain Hassan Members Dr. A. Sattar Abu Guddah Dr. Ajeel Al Nashmi Shaikh Adnan Al Qattan Assist the Board in discharging its oversight responsibilities related to establishment of an effective Risk Management and Compliance Framework. The Shari a Supervisory Board is an independent body of specialised jurists in Shari a compliant banking. The Shari a Supervisory Board is entrusted with the duty of directing, reviewing and supervising the activities of the Group in order to ensure that the Bank is in compliance with Shari a rules and AAOIFI. The Fatwas and rulings of the Shari a Supervisory Board is binding on the Group. Basic Organization Structure Shari a Supervisory Board Shari a Compliance Unit Audit Committee Internal Audit Function BOARD OF DIRECTORS Chief Executive Officer Risk Management & Compliance Committee Executive Committee Nomination, Remuneration & Corporate Governance Committee Credit & Investment Committee Legal Affairs Department Support Service Division Investment Division Structured Finance Division Risk Division There are no restrictions on the transfer of funds or regulatory capital within the group and all investments are made fully complying with the Central Bank of Bahrain approval instructions.

92 90 Liquidity Management Centre B.S.C. (c) For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.11 Corporate governance and transparency (continued) Board Committees (continued) Table 24. Corporate Governance and Transparency Audit Committee meetings in 2013 (PD (b)) 7 th Feb 2013 Date Names of Directors Present Names of Directors Not Present 1) Khalid Al Dossari 2) Dr. Adnan Chilwan 3) Mohammed Saeedulla None 24 th Apr st Jul th Oct nd Dec ) Khalid Al Dossari 2) Dr. Adnan Chilwan 3) Mohammed Saeedulla 1) Khalid Al Dossari 2) Dr. Adnan Chilwan 3) Mohammed Saeedulla 1) Khalid Al Dossari 2) Dr. Adnan Chilwan 3) Mohammed Saeedulla 1) Khalid Al Dossari 2) Dr. Adnan Chilwan 3) Ammar Odah None None None None Table 25. Corporate Governance and Transparency Executive Committee meetings in 2013 (PD (b)) 2 nd Dec 2013 Date Names of Directors Present Names of Directors Not Present 1) Mohammed Ebrahim 2) Abdul Wahab Al Rushood 3) Mohammed Al Sharif 4) Mohammed Saeedulla 5) Ahmed Abbas (Non - voting member) None 22 nd Dec ) Mohammed Ebrahim 2) Abdul Wahab Al Rushood 3) Mohammed Al Sharif 4) Mohammed Saeedulla 5) Ahmed Abbas (Non - voting member) None

93 2013 ANNUAL REPORT 91 For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.11 Corporate governance and transparency (continued) Board Committees (continued) Table 26. Corporate Governance and Transparency Risk & Compliance Committee meetings in 2013 (PD (b)) 24 th Apr 2013 Date Names of Directors Present Names of Directors Not Present 1) Khalid Al Dossari 2) Dr. Adnan Chilwan None 21 st Aug ) Khalid Al Dossari 2) Dr. Adnan Chilwan None 24 th Oct nd Dec ) Khalid Al Dossari 2) Dr. Adnan Chilwan 3) Ammar Odah 1) Khalid Al Dossari 2) Dr. Adnan Chilwan 3) Ammar Odah None None Table 27. Corporate Governance and Transparency Nomination, Remuneration & Corporate Governance Committee meetings in 2013 (PD (b)) 7 th Feb 2013 Date Names of Directors Present Names of Directors Not Present 1) Emad Al Monayea 2) Abdul Wahab Al Rushood 3) Mohammed Ebrahim None 7 th Mar ) Emad Al Monayea 2) Abdul Wahab Al Rushood 3) Mohammed Ebrahim None 21 st Mar ) Emad Al Monayea 2) Abdul Wahab Al Rushoo 3) Mohammed Ebrahim None 22 nd Dec ) Emad Al Monayea 2) Ammar Odah 3) Mohammed Ebrahim None

94 92 Liquidity Management Centre B.S.C. (c) For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.11 Corporate governance and transparency (continued) Executive Members Profile Table 28. Corporate Governance and Transparency Executive Members Profile (PD (b)) The following table summarises the information about the profession, business title, experience in years and the qualifications of each Executive member; Name of Executive Member Designation Profession Business Title Experience in Year Ahmed Abbas CEO Banker Chief Executive Officer Qualification 27 Years Bachelor s Degree in Business and Finance from University of Bahrain Amer Sadiq EVP - Structured Finance Banker Executive Vice President 17 Years Bachelor s Degree in Accounting from University of Denver, Colorado, USA Hussain Merza FVP - Financial Controls Banker First Vice President 12 Years ACCA, Bachelor s Degree in Accounting from University of Bahrain, CIPA The following table summarises the information about Management Committees, their members and objectives. Table 29. Corporate Governance and Transparency Management Committees Profile (PD (b)) Management Committee Members Objective Management Committee Chairman Ahmed Abbas Members Amer Sadiq Hussain Merza Leena Sharif Nadia Jabur The Bank has established key management committees to oversee particular aspects of the business. Credit & Investment Committee (C&IC) Chairman Ahmed Abbas Members Amer Sadiq Hussain Merza Leena Sharif Nadia Jabur The Credit & Investment Committee is established to oversee an efficient and comprehensive due diligence transition of an investment transaction from the point of origination to the point of closing, including all internal and external approval requirements and financial and legal due diligence. The CICOM also ensures that management s handling of credit risk complies with Board decisions about acceptable levels of risk and minimum pricing levels. The functions of the committee with regard to credit activities include appraisal and approval of credit applications based on limits set by the Board. The Committee also monitors and reviews non-performing portfolio and ensures that adequate loss provisions are held against delinquent accounts in accordance with the guidelines issued by the Central Bank of Bahrain and the Board and provides monthly reporting to the Board.The responsibilities of the ALCO is being carried out by the CICOM.

95 2013 ANNUAL REPORT 93 For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.11 Corporate governance and transparency (continued) Code of Business Conduct and Ethics for Members of the Board of Directors The new Board was given a proper induction and background regarding their rules and responsibilities as a Board member and as a member of the Board s various committees. The Board members have approved the following code of business conduct and ethics: Purpose code of business conduct and ethics: The primary objectives of the following Code of Business Conduct and Ethics ( the Code ) are to enable each Director to focus on areas of ethical risks, to help him/her to recognize and deal with ethical issues, to provide mechanisms for reporting unethical conduct, and to foster a culture of honesty and accountability within the Group. Conflict of interest Directors shall disclose to the Board any potential conflict of interest in their activities with other organisations. All Board members and members of executive management must declare to the Board in writing, on an annual basis, all of their other interests in other institutions, whether as a shareholder of five percent (5%) or more of the voting capital of the company, a manager or other form of significant participation. Any decision to enter into transactions, under which Board members or any member of executive management may have a conflict of interest that is material, shall be formally and unanimously approved by the Board. Board s Responsibility The Board of Directors are responsible for the establishment and oversight of the Group s business strategy and priorities, for setting its high-level policies, for overall management, and is accountable to shareholders for the financial and operational performance of the Group. It is responsible for the raising and allocation of capital, monitoring of Executive Management and its conduct of the Group s operations, for making critical business decisions and for building long-term shareholder value. The Board ensures that the Group manages risk effectively through approving and monitoring the Group s risk appetite and identifying and guarding against the longer term strategic threats to the business.

96 94 Liquidity Management Centre B.S.C. (c) For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.11 Corporate governance and transparency (continued) Code of Business Conduct and Ethics for Members of the Board of Directors (continued) The Board is also responsible for: Setting and reassessing periodically the Group s corporate goals, plans and objectives; Establishing policies and procedures to further the achievement of the Group s corporate goals, plans and objectives; Establishing and regularly reviewing the management structure, Board of Directors committee charters and responsibilities and monitoring the effectiveness of the Board and Board of Directors Sub- Committees including its ability to plan and execute strategies; Approving strategic investments, alliances, partnerships and material transactions outside the normal course of business/operation or in excess of the limits of approval authority delegated to Executive Management; Putting in place adequate policies and processes for approving budgets and reviewing performance against those budgets and against key performance indicators; Ensuring compliance with all relevant requirements of Shari a and Islamic Accounting Standards issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI); Ensuring that an adequate, effective, comprehensive and transparent corporate governance and Risk Management framework is in place; Ensuring that the Group establishes and maintains an approved employee Code of Conduct and is in compliance therewith; ensuring ethical behavior and compliance with laws and regulations, auditing and accounting standards and the Group s own corporate governance policy; Ensuring that the Group s operations are supported by an appropriate control environment i.e. Internal Audit, Compliance, Risk Management and Financial Control and reporting functions are well resourced and structured; Creating specialized Board Committees when such committees are needed, and deciding on the appropriate dates and venues for meetings; Approving the writing off of credit facilities and investments outside the normal course of business/operation, in accordance with the Group s policies and procedures; Ensuring the preparation of an annual report and financial statements which accurately disclose the Group s financial position, on a regular and consistent basis, and for reviewing and approving for dissemination its periodic financial statements and annual reports; Convening Shareholder meeting and preparing the agendas for such meetings as well as approving the minutes of Board of Directors meetings; Responsible for all matters related to the employment of the Bank s Chief Executive Officer; Appointing the Board corporate secretary Ensuring the equal treatment of all shareholders;and Performing any and all functions required of the Board of Directors under applicable laws and regulations. Responsible for other activities such as approving Director s and management liability insurance, overseeing litigation and all other dispute resolutions, issuing power of attorneys and signing of share certificates.

97 2013 ANNUAL REPORT 95 For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.11 Corporate governance and transparency (continued) Code of Business Conduct and Ethics for Members of the Board of Directors (continued) Board s Responsibility for Disclosure The Board shall oversee the process of disclosure and communications with internal and external stakeholders. The Board shall ensure that disclosures made by the Group are fair, transparent, comprehensive and timely and reflect the character of the Group and the nature, complexity and risks inherent in the Group s business activities and that they are in compliance with the disclosure requirements set out by the CBB. New product information, Group s new announcement and information related to stakeholders are made available in timely manner through various channels of communication which may include publications, website, direct mailers, electronic mail and local media. The Board arranges induction sessions to new Directors to educate them about their responsibilities, the business of the Bank, the regulators s rules and regulations and introducing them to management as well. Further, appointment letters are issued by the Board to all new Directors which clearly state the rights, duties and expectations from new Directors. New Directors are given copies of the Directors Handbook as well for further information on the responsibilities of the Board and its committee. Directors are approved by the CBB and appointed in the Shareholders General Meeting in accordance with the Bank s Memorandum & Articles and Commercial Companies Law. In addition, the Consolidated Financial Statement of at least past 3 years are available on the Bank s website. Compliance with the HC Module The HC Module is issued as a Directive (as amended from time to time) in accordance with Article 38 of the CBB and Financial Institutions Law In common with other rulebook Modules, this Module contains a mixture of rules and guidance. All contents that are categorised as a rule must be complied with by those to whom the content is addressed. Other parts of the HC Module are guidance; nonetheless every Islamic bank licensee to whom HC Module applies, is expected to comply with recommendations made as guidance in HC Module or explain its noncompliance in the Annual Report and to the CBB. The Group is in compliance with the HC Module except for, the Group does not yet have any independent director. However, the Group is equally owned by four well established financial institutions. All directors are nominated by the shareholders and assessed by the Board of Directors before obtaining CBB s approval. The Group has currently eight dependent directors who represent equally the Group s four institutional shareholders.in attempt to be in compliance with the CBB s rules, the Group has nominated four candidates for the position of Independent Director and the Board of Directors are in the process of narrowing this down to one potential candidate subject to CBB approval.

98 96 Liquidity Management Centre B.S.C. (c) For the year ended 31 December 2013 (Unaudited) 3. Risk Management (continued) 3.11 Corporate governance and transparency (continued) Assessment of Board Performance Evaluation of Board Performance The Board shall through the Nomination and Remuneration Committee conduct an annual review of the Board s performance. This review shall include an overview of the talent base of the Board as a whole as well as an individual assessment of each Director s qualification under corporate governance rules and all other applicable laws, rules and regulations regarding directors; consideration of any changes in a Director s responsibilities that may have occurred since the Director was first elected to the Board and such other factors as may be determined by the Committee to be appropriate for review. Remuneration of Board Members is approved in the AGM after being discussed at the Board level. For all Group staff there is a performance bonus. Performance bonus is based on staff performance and recommendation of respective departmental heads. The Nomination and Remuneration Committee empowered by the Board approves all fixed and performance bonus for all staff and Management. Shari a Board Members remuniration is approved by the Board of Directors. Chairman and CEO Performance The Board of Directors shall review the performance of the Chairman and the CEO in order to ensure they are providing the best leadership for the Group.

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100 Liquidity Management Centre B.S.C. (c) 9th Floor, LMC Building - P.O. Box Seef District, Kingdom of Bahrain Tel : (973) Fax : (973)