KOMERCIJALNA BANKA A.D., BUDVA

Transcription

1 KOMERCIJALNA BANKA A.D., BUDVA Financial Statements for the year ended and Independent Auditor s Report

2 Contents Page INDEPENDENT AUDITORS' REPORT 1-2 Income statement from January 1 to 3 Statement of other comprehensive income from 1 January to 4 Balance sheet as at 5 Statement of Changes in Equity from January 1 to 6 Cash Flow Statement from January 1 to 7 Notes to the Financial Statements 8-83

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10 1. BANK'S FOUNDATION AND ACTIVITY Komercijalna banka a.d., Budva (hereinafter: the "Bank") has been present in the market of Montenegro since 1992 as a branch, and from 1996 as an affiliate of Komercijalna banka a.d., Beograd. In accordance with the Law on Banks (Official Gazette of Montenegro no. 17/08, 44/10 and 40/11), prescribing that a bank domiciled outside Montenegro may establish an affiliate as a part of the bank having the capacity of a legal entity, on 7 November 2002, Komercijalna banka a.d., Beograd enacted the Decision on the Branch Shutdown and the Affiliate Establishment. On 7 February 2003, the Central Bank of Montenegro issued an operating license number / to Komercijalna banka a.d., Budva. Komercijalna banka a.d., Budva was registered with the Central Registry maintained by the Commercial Court as a shareholding company under the registration number The Bank is included in the Register of Security Issuers maintained by the Securities Commission under the number 372 (Decision number 02/3-29/2-03, as of December ). The sole (100%) owner of Komercijalna banka a.d., Budva is Komercijalna banka a.d., Belgrade. In accordance with the Law on Banks (Official Gazette of Montenegro no. 17/08, 44/10 and 40/11), and the Bank's Articles of Incorporation and Association, the Bank is involved in business of reception of deposits and other assets of private individuals and legal entities and loan and other investment approval form these funds entirely or in part for its own account. In addition to these operations, the Bank is also registered to perform the following activities: - issue guarantees and undertake other commitments; - purchase and collect receivables; - issue, process and record payment instruments; - perform payment transactions abroad; - perform finance lease operations; - trade in its own name for its own account or for the account of a customer with foreign payment instruments; - collect data, prepare analyses and provide information and advice on the company and entrepreneur creditworthiness; - perform depositary operations; - perform custody services over assets and securities; and - perform other ancillary operations and activities related to the Bank's core operations. The Bank's governing bodies are the Shareholder Assembly and the Board of Directors. The Shareholder Assembly is the highest body of the Bank. The Executive Board of Komercijalna banka a.d., Beograd acts on behalf of the Shareholder Assembly. Members of the Board of Directors are elected and appointed by the Bank's Shareholders Assembly. The Bank's Board of Directors has five members, four of which are not the Bank's employees. The Board of Directors has two standing committees: the Audit Board and the Asset and Liability Management Committee. The Chief Executive Officer of the Bank is the Bank's executive manager. The Chief Executive Officer is accountable to the Assembly and to the Board of Directors. The Bank is headquartered in Budva, no number, BC Podkosljun. As of, the Bank is comprised of the Central Office located in Budva, 3 branch offices (Podgorica, Niksic, Kotor, Bar, Bijelo Polje and Herceg Novi) and 10 sub-branches (2 in Budva, 2 in Podgorica, and one in Niksic,Tivat, Kotor, Bar, Bijelo Polje and Herceg Novi). As of the Bank has 138 employees (As of December 31, 2016: 133 employees). 8

11 2. BASIS OF PREPARATION AND PRESENTATION OF THE FINANCIAL STATEMENTS 2.1. Basis of Preparation and Presentation of the Financial Statements The Bank is obligated to maintain its accounting records and prepares its statutory financial statements in conformity with the Law on Accounting of Montenegro (Official Gazette of Montenegro no. 052/16 since August ) which entails implementation of the International Financial Reporting Standards and Decisions of the Central Bank of Montenegro governing financial reporting of banks. The Bank's financial statements have been prepared in accordance with the Decision On the Content, Deadlines and Manner of Preparation and Submittion of Financial Statements of Banks (Official Gazette of Montenegro no.15/12 and 18/13). Upon preparation of these financial statements, the Bank implemented policies in accordance with the regulations of the Central Bank of Montenegro, which depart from the requirements of IFRS and IAS effective as of in respect of recording receivables qualifying for derecognition form the Bank's balance sheet, in respect of format for presentation of the financial statements and the manner ofpresentation and recording loan origination fees. Due to the potentially significant effects of the above described matters on the accuracy and fair presentation of the financial statements, these financial statements cannot be treated as having been prepared in accordance with International Financial Reporting Standards. In the preparation of the accompanying financial statements, the Bank has adhered to the accounting policies described in Note 3, which are in conformity with the accounting, banking and tax regulations prevailing in Montenegro. The official currency in Montenegro and the Bank's functional and presentation currency is Euro (EUR) Use of Estimates Presentation of the financial statements requires the Bank's management to make the best possible estimates and reasonable assumptions that affect the reported amounts of assets and liabilities, as well as disclosures of contingent assets and liabilities as at the financial statements preparation date, and income and expenses arising during the accounting period. These estimations and assumptions are based on historical experience and other information available to us as at the financial statements preparation date that are believed to be reasonable under the circumstances. The estimates and assumptions are the basis of making judgments about the carrying amounts of assets and liabilities that are not readily apparent from other sources. Actual values of assets and liabilities may differ from values estimated in this manner. Estimates and underlying assumptions are reviewed on an ongoing basis. In case that such a review reveals changes in the estimated values of the assets and liabilities, the determined effects thereof are recognized in the financial statements in the period in which a change in the relevant estimate occurred for changes in estimates that affect only the current period, or, in the period in which a change in the relevant estimate occurred as well as the ensuing periods for changes that affect both the current and the future accounting periods. 9

12 2. BASIS OF PREPARATION AND PRESENTATION OF THE FINANCIAL STATEMENTS (continued) 2.3. Going concern principle The financial statements have been prepared in accordance with the going concern concept, which assumes that the Bank will continue to operate over an unlimited period of time in the foreseeable future. In 2017 the Bank incurred profit of EUR 757 thousand (2016: loss of EUR 9,067), which resulted in a capital adequacy ratio of 19.17% (December 31, 2016: 18.33%) IFRS 9 "Financial Instruments" In July 2014, the IASB issued the final text of the standard IFRS 9 Financial Instruments, which will replace the the existing standard IAS 39 starting from January 1, In 2016, the Bank has launched the implementation of IFRS 9 standards, conducted by the Risk Manager, during which the effect of IFRS 9 standards on various processes was analyzed, including accounting inclusion of financial instruments, risk assessment, information system, asset placement, development of new products and more. The bank has hired consultants in order to successfully implement IFRS 9 standards, which included the following phases: Analysis of the business model; Classification and measurement Impairment of financial instruments and fair value calculation Analysis of the business model As a result of business model analysis, it is established that no circumstances exist that would show that the aim of the Bank's business model is other than hold to collect when it comes to loan portfolio. Moreover, the business model for securities portfolio is hold to collect and sell, as it was the case in previous periods. Classification and measurement From the point of classification and measurement the new standards requires that all financial assets other than equity instruments and derivatives, are estimated based on the business model of financial management and the contractual cash flow characteristics of the instrument. The categories of possible estimates in accordance with IAS 39 will be replaced: amortized cost, fair value through the profit and loss (FVPL) and the fair value through other comprehensive income (FVOCI). Equity instruments that are not held for trading may be classified as assets whose value is estimated by the fair value through other comprehensive income, without further reclassifying the gains and losses through profit and loss. With respect to the nature of the Bank's liabilities, the accounting of financial liabilities will be the same as in accordance with the requirements of IAS 39. During the initial evaluation, the Bank expects to: Loans given to clients to still be in valued with the amortized cost method in accordance with IFRS 9 and IAS 39. Financial instruments that are traded and whose value is estimated to the fair value through profit and loss, to continue the evaluation in the same way; Debt instruments classified as available for sale in accordance with the IAS 39 to be mostly measured at fair value through the other comprehensive income and a smaller amount to be measured at amortized cost. 10

13 2. BASIS OF PREPARATION AND PRESENTATION OF THE FINANCIAL STATEMENTS (continued) 2.4. IFRS 9 "Financial Instruments" (Continued) Initially, the financial asset is measured at fair value plus the transaction costs, except in the case of financial assets that are measured at fair value through profit and loss (FVTPL) in which these costs are recognized through profit and loss. A financial asset is measured at amortized cost unless it is designated as FVTPL and meets the following criteria: the objective model of holding a financial asset is the collection of contractual cash flows, and contractual terms of a financial asset lead to cash flows that represent only principal and interest payments. Debt securities are valued as FVOCI only if the following criteria are met and are not indicated as FVTPL: the goal of a business model of holding a financial asset is the collection of contracted cash flows and sales, and contractual terms of a financial asset lead to cash flows that represent only principal and interest payments. Subsequently, gains or losses from FVOCI assets are recognized in other comprehensive income, except for gains/losess from impairment and exchange gains/losses from, until the moment of derecognition or reclasification. In the moment of derecogniton, cummulative gains/losses previously recongized in other comprehensive income are reclassified from equity into profit and loss. Interest is calculated based on effective interest rate method and recognized in profit and loss. Impairment of financial assets In accordance with the IFRS 9, impairment methodology is significantly changed. Standard will replace the incurred loss model in accordance with IAS 39, with the model of expected credit loss (ECL). The Bank will be required to calculate the costs of impairment to expected losses for all receivables and other debt instruments that are not valued at fair value through profit and loss, including irrevocable payables and guarantees issued. Impairments are based on the expected loan losses in accordance with the probability of default over the next 12 months, unless there is a significant deterioration in credit risk from the time of initial recognition, when the level of impairment is based on the probability of default for a lifetime period of an instrument. Impairment costs are based on the present value of cash flows to the expected duration of the financial assets, and represent the difference between: contractual cash flows, and cash flows that the Bank expects to receive, discounted with the effective interest rate of the loan. Compared with IAS 39, impairment costs are higher, and their higher volatility is expected. The total portfolio of loans is classified in stage 1, stage 2 and stage 3: Stage 1 Loans with no significant increase in credit risk since initial recognition. The Bank calculates impairment based on 12-month expected credit losses; 11

14 2. BASIS OF PREPARATION AND PRESENTATION OF THE FINANCIAL STATEMENTS (continued) 2.4. IFRS 9 "Financial Instruments" (continued) Stage 2 Loans with identified significant increase in credit risk since initial recognition. The Bank calculates impairment based on lifetime expected credit losses; Stage 3 Impaired loans. The Bank recognizes lifetime expected credit losses, through multiple probability-weighted scenarios. The Bank calculates impairment on debt securities measured at fair value through other comprehensive income, which are classified in Stage 1. However, expected credit losses will not reduce the carrying amount in the balance sheet for securities still measured at fair value. Instead, the equal amount of impairment will be recognized through other comprehensive income and will have an impact on profit and loss. Stage 1 Impairement expenses for financial instruments with no significant increase in credit risk since initial recognition, based on 12-month expected credit losses, in accordance with IFRS 9. Stage 1 includes exposures to government. Stage 2 All financial instruments with significant increase in credit risk are classified in Stage 2 and impairment expenses are calculated based on lifetime expected credit losses, which represent a new concept comparing to IAS 39. The Bank considers whether significant increase in credit risk is present since the initial recognition og an financial asset. Identification of singnificant increase in credit risk is based in early warning signals, more than 30 days of delay in repayment, etc. Stage 3 As it was the case with IAS 39, financial instruments will be included in Stage 3 in case of objective evidence of impairment and there is no change in volume of loans included in this segment. Multiple scenarios of repayment will be considered and the impairment calculation will be based on this principle. Forward looking information The Bank, in estimating expected credit losses, included information on macroeconomic trends, considering parameters for future 3 years, for which statictical significance was established. First adoption of IFRS 9 By adoption of IFRS 9, level of impairment increased by EUR 391 thousand, of which EUR 191 refers to impairment for exposures to Government of Montenegro, mostly on securities previosly under IAS 39 classified as Available for sale and for which the increase of impairment lead to increase of revaluation reserves. The first addoption effect of IFRS 9 on 1 January 2018 is recognized in accumulated gains from previous years and has effect on capital adequacy, regulatory capital, foreign exchange risk indicator, coverage of NPLs by allowance and other regulatory and internal indicators. 12

15 2. BASIS OF PREPARATION AND PRESENTATION OF THE FINANCIAL STATEMENTS (continued) 2.4. IFRS 9 "Financial Instruments" (continued) Portfolio/Segment Cash and deposit accounts held with depository institutions Loans and receivables due from banks Loans and receivables due from customers Gross exposure as of Amount of impairment in accordance with IAS 39 as of Amount of impairment in accordance with IFRS 9 as of Impact of the implementation of IFRS 9 on the amount of impairment 19, , ,154 4,152 4, corporate loans 36,459 3,183 3, retail loans 27, , Securities available for sale * 19, Other receivables (fees, etc.) Off-balance items 13, TOTAL 132,446 4,552 4, * The specific impairment method of securities according to IFRS 9 provides that gross value of securities to be increased for the impairment loss, for the net value to be equal to fair value. 13

16 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 3.1. Interest, Fee and Commission Income and Expense Interest income and interest expense, including penalty interest and other income and expenses related to interest-bearing assets and liabilities are accounted for on an accrual basis. Fee and commission income and expenses from banking services are determined when due for settlement and/or collection. Origination fees for loans, guarantees and other sureties, as well as fee expenses charged to the Bank based of its borrowings are recognized in accordance with IAS 18 "Revenues" and IAS 39 "Financial Instruments: Recognition and Measurement," loan origination fees are considered to be an integral part of an ongoing involvement with the resultant financial instrument, and are deferred and recognized as an adjustment to the return using effective interest rate method Foreign Exchange Translation Transactions denominated in foreign currencies are translated into EUR at the official exchange rates prevailing on the Interbank Foreign Exchange Market, at each transaction date. Assets and liabilities denominated in foreign currencies are translated into EUR by applying the official middle exchange rates, as determined on the Interbank Foreign Exchange Market that are prevailing at the balance sheet date. Net foreign exchange gains or losses arising upon the translation of transactions, and the assets and liabilities denominated in foreign currencies are credited or charged to the Income statement. Commitments and contingent liabilities denominated in foreign currencies are translated into EUR by applying the official exchange rates prevailing on the Interbank Foreign Exchange Market, at the balance sheet date Taxes and Contributions Income Taxes Current Income Taxes Income taxes are calculated and paid in conformity with the income tax regulations defined under Article 28 of the Montenegrin Corporate Income Tax Law (Official Gazette of Montenegro, no. 65/01, 12/02, 80/04, 40/08, 40/11, 14/12 and 61/13) at the proportional income tax rate of 9% applied to the taxable income. Taxable income is determined based on the profit stated in the Bank's statutory income statement after the adjustments of income and expenses performed in accordance with Montenegro Corporate Income Tax Law (Articles 8 and 9, regarding the adjustment of income and Articles 10 to 20 pertaining to the adjustment of expenses). 100% of the capital gains are included in the tax base in the year in which they are earned. Capital losses may be offset against capital gains earned in the same year. In case there are outstanding capital losses even after the offsetting of capital losses against capital gains earned in the same year, these outstanding losses are available for carryforward during the ensuing 5 years. Montenegro tax regulations do not envisage that any tax losses of the current period be used to recover taxes paid within a specific carryback period. However, any current year losses reported in the annual corporate income tax returns may be carried forward and used to reduce or eliminate taxes to be paid in future accounting periods, but only for duration of no longer than five years. 14

17 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) 3.3. Taxes and Contributions (continued) Income taxes (continued) Deferred Income Taxes Deferred income tax is determined using the balance sheet liability method, for the temporary differences arising between the tax bases of assets and liabilities, and their carrying values in the financial statements. The currently enacted tax rates at the balance sheet date are used to determine the deferred income tax amount. Deferred tax liabilities are recognized for all taxable temporary differences. Deferred tax assets are recognized for the deductible temporary differences, and the tax effects of income tax losses and credits available for carry forward, to the extent that it is probable that future taxable profit will be available against which deferred tax assets may be utilized. Indirect Taxes, Contributions and Other Duties Payable Indirect taxes, contributions and other duties payable include property and other taxes, contributions and charges payable pursuant to various republic and municipal regulations Cash and Cash Equivalents For purposes of the cash flow statement, cash and cash equivalents include cash on hand, balances on the current account held with the Central Bank of Montenegro, including the obligatory reserve, and balances held on the accounts with other banks in the country and abroad Loans Loans originated by the Bank are recorded in the books of account at the moment of the transfer of funds to the loan beneficiary - borrower. Loans originated by the Bank are stated in the balance sheet in the amount originally approved, net of the principal repaid and an allowance for impairment which is based on the management's estimate of the specifically identified risk exposures and which serves to cover any losses inherent in the Bank's loan portfolio. The Bank's management applies the methodology prescribed by the Central Bank of Montenegro for the estimate of impairment of balance sheet assets and possible loss on off-balance sheet items in accordance with IAS 39, which is described in Note Provisions and Impairment of Irrecoverable Receivables The Central Bank of Montenegro Decision on the Minimum Standards for Credit Risk Management in Banks (Official Gazette of Montenegro no. 22/12, 55/12 and 57/13) defines elements of credit risk management, minimum criteria and manner of classification of assets and off-balance sheet items in respect of which the Bank is exposed to credit risk and the manner of determining reserves for potential losses arising from the Bank's credit risk exposure. Within the meaning of the aforesaid Decision, the Bank's risk-weighted assets comprise loans, interest, fees and commissions, lease receivables, deposits held with other banks and advances as well as all other asset items where the Bank is exposed to default risk, and, on the other hand, guarantees issued, other sureties, opened letters of credit, approved and unused loans and other off-balance-sheet items representing the Bank's contingent liabilities. 15

18 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) 3.6. Provisions and Impairment of Irrecoverable Receivables (continued) The Bank is obligated to assess balance sheet assets and off-balance sheet items for impairment at least on a monthly basis, where balance sheet items are assessed for impairment whereas for off- balance sheet items probable losses are estimates. All these items are to be classified in appropriate classification groups in accordance with the effective Decision on the Minimum Standards for Credit Risk Management in Banks (Official Gazette of Montenegro no. 22/12, 55/12 and 57/13). In addition, the Bank is under obligation to determine a methodology for assessment of impairment of balance sheet assets and probable losses per off-balance sheet items in accordance with IAS 39. Pursuant to the Decision on the Minimum Standards for Credit Risk Management in Banks (Official Gazette of Montenegro no. 22/12, 55/12 and 57/13), loans and other assets exposed to risk are classified into the following categories: - A category ("Good Assets") - including assets assessed as collectable in full and as agreed; - B category ("Special Mention") - with B1 and B2 subcategories including items for which there is remote probability of loss, but which, require special attention, as potential risk, if not adequately monitored, could diminish collectability; - C category ("Substandard assets") - with C1 and C2 subcategories for which there is high probability of loss, due to the clearly identified collectability issues; - D category ("Doubtful assets") - including items the collection of which is, given the creditworthiness of borrowers, quality of collaterals, highly unlikely; - E category ("Loss") - including the items which are uncollectable in full, or will be collectable in an insignificant amount. Impairment Allowance The Bank reviews receivables and other investments in order to determine impairment allowance and provisions/reserves for losses on a monthly basis. In determining whether the impairment losses on receivables and investments should be recognized in the income statement, the Bank assesses whether there is information/evidence indicative of the existence of a measurable decrease in the estimated future cash flows on a portfolio level before such losses can be identified at an individual level. Information indicating impairment losses include: irregularity and default in liability settlement, local market and economic conditions which cause delays in payment etc. Management's estimates of impairment of receivables and other investments using the estimated future cash flows are based on actual historical losses incurred on financial assets with similar risk exposure and similar impairment causes. The methodology and assumptions underlying the process of defining the amounts and periods of cash inflows from investments are reviewed on an ongoing basis in order to minimize the difference between the estimated and actual losses. Impairment assessment is performed on an individual level and on a group level. 16

19 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 3.6. Provisions and Impairment of Irrecoverable Receivables (Continued) Group-Level Impairment Assessment Impairment assessment is performed on a group (portfolio) level for individually less significant loans and for those individually significant loans where there is no objective evidence of individual impairment. Group-level assessment for impairment is performed in groups formed according to the internally prescribed methodology based on the system of internal loan rating on a monthly basis. Group impairment percentages are calculated based on risk category migrations into default status per type of borrower or type of product. Individual Assessment Impairment assessment is performed on an individual level for each materially significant loan thereby taking into consideration the borrower's financial position, sustainability of the borrower's business plan, borrower's ability to improve performance in instances of financial difficulties, projected revenues, availability of other types of financial support, value of collaterals that may be foreclosed and expected cash flows. If new information becomes available that significantly alter the creditworthiness of the borrower, collateral value and certainty of liability settlement, ad hoc impairment assessment of such loans is performed. Impairment of loans decreases the value of loans and is recognized under expenses within the income statement. Impairment of interest receivables decreases interest income. The amounts of the expected cash inflows from a loan are estimated based on evidence of the borrower's projected revenues, and in instances these are insufficient, cash flows from collateral foreclosure are estimated. Number of days past-due in collection of receivables from a borrower is determined by considering all the relevant information on the timeline of projected revenue realization and historical information of the borrower's default. For the purpose of protection against credit risk, in addition to regular monitoring of the customer business operations, the Bank also acquires security instruments (collaterals) to secure the collection of receivables and minimize credit risk. Depending on the assessment of the ability to settle contractual liabilities, the level of loan coverage is defined so that in case of the debtor default, the Bank could collect its receivables through collateral foreclosure. The quantity and type of collateral depends on the assessed credit risk. For valuation of property or pledges assigned over movable assets, the Bank hires certified appraisers in order to minimize potential risk of unrealistic valuation. Property, goods, equipment and other movables pledged must be insured by an insurance company acceptable to the Bank and insurance policies must be duly endorsed in favour of the Bank. The Bank monitors the market value of collaterals and if necessary, it can demand additional collateral pursuant to the loan/deposit agreement executed. 17

20 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 3.7. Securities Held to Maturity Held-to-maturity investments are non-derivative financial assets with fixed or payments and fixed maturity that the management has the positive intention and ability to hold to maturity. Securities held to maturity comprise Treasury bills of the Ministry of Finance of the Government of the Republic of Montenegro. All securities are initially recorded at cost. As of the balance sheet date, securities held to maturity are stated at amortized cost Equity Investments in Other Legal Entities and Securities Available For Sale Equity Investments in other legal entities and available-for-sale securities are carried at cost which is believed by the management to approximate the fair value of these instruments. Securities available for sale comprise Treasury bills and bonds of the Republic of Serbia, in which the Bank has invested available funds and which may at any time be sold to the Parent Bank in Belgrade, as a guarantee and secondary source of liquidity in the case the Bank suffers a liquidity crisis. Available-for-sale assets are initially measured at cost and stated at market value if known as of the balance sheet date. Gains and losses incurred upon the change in the market value of these securities are stated as revaluation reserves within equity until such financial assets are sold, collected or disposed of, when revaluation reserves are transferred to income or expenses. The Bank generates its income from interest on securities and interest income is calculated and accrued on a monthly basis Property, Equipment and Intangible Assets Business premises, other fixed assets and intangible assets at 31 December 2017 are stated at cost less accumulated depreciation/amortization and impairment loss, if any. Cost represents the prices billed by suppliers increased by all the costs incurred in bringing the respective asset to the location and condition necessary for its intended use. Depreciation and/or amortization are provided for on a straight-line basis to the cost of assets using the depreciation/amortization rates calculated based on the estimated useful lives of those assets.. Depreciation and/or amortization are calculated using the following prescribed annual rates: Buildings 2.50% Computers 25.00% Furniture and equipment % Motor vehicles 15.50% Software % The calculation of depreciation and/or amortization commences when an asset is placed into use. Property and equipment are tangible assets that are held for use for business purposes, which the expected future economic benefits are for more than one accounting period The recognition of items of property and equipment is carried out if the following conditions are met: - the existence probability of future economic benefit for a period longer than one year and -the possibility of obtaining a reliable measurement of costs Initial measurment of property, plant and equipment is at cost, ie. Purchase price plus acquisition costs and the costs of bringing the asset into use, net of discounts and rebates. 18

21 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 3.9. Property, Equipment and Intangible Assets (continued) Subsequent investment in property and equipment, which affect the improvement of the state of the asset beyond its initial estimated useful life, increase the purchase value of proper and equipment.the cost of replacing a component of the fixed asset is recognized as par of the book value of the fixed asset if it is probable that future economic benefits associate will come from that replaced part to the Bank and the cost of that part can be measured reliably. The carrying amount of the replaced part is written-off. Spare parts are recorded as inventory and recognized as an expense at the time of consumption. Significant spare parts that can be used only for a single item of property or equipment are recognized as a real estate or equipment if they meet the general requirements for the recognition. When parts of property or equipment have different useful lives, they are accounted for as separate items (major components). Investments based on the current maintenance of property and equipment are recognized as an expense in the income statement in the period in which they arise. After initial recognition, property measured at revaluation amount represents their fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. The revaluation is performed at least once in the period of five years or more often in the case of major disturbances on the market, so as to ensure that book value does not significantly differ from the values to which we would derive using the fair value at the end of the reporting period. The effects of revaluation are recognized proportionally over the cost and written-off the value of the individual properties while presenting: - negative effects as a reduction of the previously established Revaluation reserves and / or reduction of an expense of fixed assets in the income statement and; - positive effects like income from increasing the value of fixed assets to the level of previously recognized losses on the same basis for the same property and/or as an increase of Revaluation reserves. Revaluation reserves as a result of the revaluation of individual property is transferred to retained earnings at the latest on the date of disposal of the property. During the period of use of the property, its revaluation reserves are transferred to retained earnings from previous years, the amount corresponding to the difference between the calculated accounting annual depreciation and depreciation that would have been calculated if for that property applied only cost model of the depreciation (cost model is equal to depreciation for tax purposes). Equipment, after initial recognition, is valued at cost less depreciation, and overall total accumulated losses based on impairment. Depreciation is recognized in the income statement in equal annual amounts over the estimated useful life of each item of property and equipment, since that is the best way to reflect the expected consumption of utility of economic value embodied in the asset. Depreciation is calculated at rates that provide compensation for the value of property and equipment over their useful lives in accordance with the act passed by the Chief Executive Officer. 19

22 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) 3.9. Property, Equipment and Intangible Assets (continued) The basis for depreciation is the cost or revalued amounts of property and equipment, net of estimated residual (remaining) value. The method of amortization, the useful life and residual values are estimated at the end of the reporting period, and when it is necessary to perform appropriate correction. The Bank keeps records of property and equipment which provide the calculation of depreciation with the above-mentioned method, and the calculation of depreciation at the prescribed rates on the basis of amortization recognized by the applicable tax regulations. The difference between the amount of depreciation calculated in accordance with the accounting policies set out in this Article and the amount of depreciation, which is recognized by tax regulations is entered in the tax balance in a manner determined by tax regulations. Gains or losses on disposal of property and equipment is determined as the difference between the value realized from their sale and their book amount and are recognized within Other income and expenses in the period Investment property Investment property is property (land, building or part of a building), which the Bank holds for the purpose of earning income from rents or to increase capital or for both, but not for sale in the ordinary course of business or to use for administrative purposes. When one part of the property is used for business purposes and the other for rent, they are segregated into an investment property and property used for business purposes. Initial evaluation of investment property during acquiring (procurement) is carried at cost or purchase price. Cost of investment property is comprised of the purchase price and all expenses that are directly attributable to the acquisition of the asset. Subsequent expenditure which relate to the already recognized investment property are attributed to the carrying amount of the investment property when it is probable that future economic benefits will be greater than originally estimated rate of return and investment property. All other subsequent expenditure is recognized as an expense in the period in which they arise. After initial recognition, investment property is carried at fair value which reflects market conditions at the balance sheet date. Fair value is estimated annually by independent certified appraiser. Changes in fair value are recorded in the income statement as part of Other income. Investment property is reclassified to Other assets when there is a change of its purpose, based on bookkeeping documents proving this change. Investment property is removed from the accounts when it comes to its disposal or when no future economic benefits are expected from its use and disposal. The difference between the book value and the sales value of investment properties which are for sale, are recognized in the income statement in the period in which it was made. 20

23 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Provisions Provisions are recognized when the Bank has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources embodying economic benefits will be required to settle the liability, and a reliable estimate of the amount of the liability can be made Employee Benefits Employee Taxes and Contributions for Social Security Pursuant to the regulations effective in Montenegro, the Bank has an obligation to pay contributions to various state social security funds. These obligations involve the payment of contributions on behalf of an employee, by the employer, in the amounts calculated by applying the specific, legally prescribed rates. The Bank is also legally obligated to withhold contributions from gross salaries to employees, and on their behalf to transfer the withheld portions directly to the appropriate government funds. These contributions payable on behalf of the employee and employer are charged to expenses in the period in which they arise. Retirement Benefits In accordance with the Collective Bargaining Agreement, the Bank is under obligation to pay retirement benefits to an employee upon his/her regular retirement in the amount of 3 average salaries earned by the Bank's employees in the month in which payment is made. Long-term liabilities for provisions for retirement benefits represent the present value of expected future payments to employees determined in an actuarial valuation relying on the following assumptions: annual discount rate of 3 % and salary growth rate of 5 % Fair Value In accordance with IAS 32, "Financial Instruments: Disclosures and Presentation," the fair value of financial assets and liabilities should be disclosed in the Notes to the Financial Statements. For these purposes, the fair value is defined as an amount at which an asset can be exchanged, or a liability settled, between knowledgeable willing parties in an arm's-length transaction. The Bank is obligated to disclose the fair value information of those components of assets and liabilities for which published market information is readily available, and for which their fair value is materially different from their recorded amounts. In Montenegro, sufficient market experience, stability and liquidity do not exist for the purchase and sale of receivables, investments and other financial assets or liabilities, for which published market information is presently not readily available. Fair value cannot readily be determined in the absence of active capital and financial markets, as generally required under the provisions of IFRS/IAS. In the opinion of management, the reported carrying amounts are the most valid and useful reporting values under the present market conditions. To the extent of the identified estimated risk that the carrying value will not be realized, a provision is recognized based on the relevant decision of the Bank's management. 21

24 4. INTEREST INCOME AND EXPENSES a) Interest Income In thousand EUR From loans approved to: - Banks 4 - Government Municipalities Corporate customers 1,562 1,857 - Retail customers 1,868 1,833 3,721 3,866 From securities: - securities available for sale securities held to maturity Impairment allowance of interest receivables (247) (878) 4,334 3,775 b) Interest Expenses In thousand EUR Banks and other financial institutions Montenegro Government 30 9 Corporate customers Retail customers IMPAIRMENT LOSSES AND PROVISION CHARGES a) Impairment Losses In thousand EUR Net impairment losses on: - loans (1,334) 3,360 - guarantess activated (54) - - acquired assets 1,197 3,905 - fixed assets other assets (143) 7,559 b) Provision charges In thousand EUR Net impairment losses per: - off-balance sheet items (21) litigations other assets (note 25) (30)

25 56 1, IMPAIRMENT LOSSES AND PROVISION CHARGES (continued) Movements on Accounts of Impairment Allowances of Irrecoverable Receivables and Provisions In thousand EUR Loans (note15) Interest and guarantees (note 15) Fees Acquired assets (note 22) Assets held for sale Employee benefits andlitigations (note 25) Off-Balance Sheet Items (note 29) Total Balance as of January 1, ,049 1, , ,344 Adjustments during the year, net 3, , ,295 Other Balance as of December 31, ,409 2, ,964-1, ,304 Adjustments during the year, net (1,136) (302) 48 1, (77) (21) (478) Transfer to offbalance sheet / writeoff of receivables (3,557) (1,733) (153) (5,442) Payment (87) (123) (210) Reclassification (3,651) 3, Other (95) - (189) (1) (285) Balance as of 3, ,451 3, , FEE AND COMMISSION INCOME AND EXPENSES a) Fee and Commission Income In thousand EUR Loan fees Fee and commission income from off-balance-sheet operations Fee and commission income from payment transfers Fee and commission income from foreign currency trading Fee and commission income from account maintenance Other fee and commission income b) Fee and Commission Expenses 1,836 1,396 In thousand EUR Fees and commissions payable to the Central Bank Fee and commission expenses arising from deposit insurance premium Other fee and commission expenses

26 7. STAFF COSTS In thousand EUR Net salaries 1,320 1,137 Payroll taxes and contributions 1, Other employee benefits, net Remunerations to the members of the Board of Directors (Note 28) 8 31 Employee transport allowance, net 3 34 Business travel expenses and per diems Employee professional trainings 1 2 Provisions for retirement benefits and jubilee awards (1) (52) Other staff costs (8) 5 2,626 2, GENERAL AND ADMINISTRATIVE COSTS In thousand EUR Rental costs Security services Fuel and electricity Cleaning Taxes payable for business premises Maintenance of vehicles 3 6 Insurance costs Auditing services Court fees 12 7 Other professional fees 1 - Lawyer fees Intellectual services Money transportation costs Telephone bills Communication network costs Office supplies Public utility costs Representation costs 8 10 Marketing and advertising Miscellaneous other cost ,592 1,789 Miscellaneous costs relate to: costs of the current maintenance of fixed assets EUR 222 thousand (2016: EUR 232 thousand), storing of documentation amounting to EUR 29 thousand (2016: EUR 43 thousand), mediation services of an employment agency EUR 29 thousand (2015: EUR 29 thousand), other non-productive services - EUR 19 thousand (2016: EUR 21 thousand), fuel - EUR 11 thousand (2016: EUR 15 thousand), consumable material EUR 9 thousand (2016: EUR 11 thousand), publications - EUR 11 thousand (2016: EUR 4 thousand) and other costs which are not individually material. 24

27 9. DEPRECIATION/AMORTIZATION CHARGE In thousand EUR Depreciation (Note 17) Amortisation (Note 18) OTHER EXPENSES Other expenses for the year ended December in the amount of EUR 50 thousand (December : EUR 226 thousand) mostly relate to costs of direct write-offs in the amount of EUR 26 thousand (December : EUR 78 thousand). 11. OTHER INCOME Other income totalling EUR 144 thousand as of (December 31, 2016: EUR 53 thousand) mostly relate to the collection per off-balance sheet items (broken-period interest), as well as income from lease of investment property. 12. INCOME TAXES Components of Income Taxes In thousand EUR Current income tax - 61 Deferred income tax (253) 5 (253) 66 Numerical Reconciliation between Tax Expense and the Product of Accounting Results Multiplied by the Applicable Tax Rate In thousand EUR Profit / (loss) before tax 504 (9,002) Income tax at the statutory tax rate of 9% 45 (810) Effects of expenses not recognized for tax purposes 1 12 Tax effects of capital gains from the sale of securities - 61 Unrecognized tax credits on behalf of the transfer of losses for the year Use of transferred tax losses (140) - Other (158) (58) Tax effect on the income statements

28 12. INCOME TAXES (continued) a) Deferred Tax Assets In thousand EUR Actuarial gains on retirement benefits - 6 Accrued unpaid earnings 13 - Property Impairment costs - Estimated Value At the lower carrying amount of the current tax value of property and equipment 98 - Total Deferred tax assets as of amount to EUR 219 thousand: EUR 13 thousand relate to accrued unpaid earnings and retirement benefits, EUR 108 thousand relate to impairment of assets which is determined as the difference between the net present value of assets in accordance with International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS) and its estimated recoverable amount and EUR 98 thousand relate to taxable temporary differences between the carrying and the tax value according to which fixed assets and investment property are recognized for tax purposes and the amounts by which these assets are presented in the financial statements of the Bank. Unused tax losses which the Bank has not recognized as a deferred tax asset as at December are shown in the table below: Year of beginning Year of expiry Tax loss Years of using Used amount According to the Law on Profit Tax losses arising from business relations, excluding those resulting in capital gains and losses may be carried forward to offset profit in future periods, but not longer than five years. b) Deferred Tax Liabilities In thousand EUR On higher carrying than tax NPV of property, plant and equipment - 33 Unrealized gains on securities available for sale Gains on revaluation of fixed assets Other tax liabilities 1 - Deferred tax liabilities

29 12. INCOME TAXES (Continued) b) Deferred Tax Liabilities (Continued) Deferred tax liabilities stated as of in the amount of EUR 165 thousand, out of which the amount EUR 25 thousand relates to taxable temporary differences between the tax base of securities available for sale as presented in the income tax return, while EUR 1 thousand refers to the taxable temporary differences between the tax base of actuarial estimates for employee benefits and unused vacation days which are recognized in tax balances and temporary differences arrising from revalorisation in amount of EUR 138 thousand of carrying values included in the Bank's financial statements. 13. CASH AND DEPOSIT ACCOUNTS HELD WITH CENTRAL BANKS December 31, 2017 In thousand EUR December 31, 2016 Cash on hand: - in EUR 3,224 2,510 - in foreign currencies Gyro account 8,759 10,400 Obligatory reserves with the Central Bank of Montenegro 7,485 6,233 19,971 19,614 The Bank's obligatory reserve as of represents the minimum deposits set aside in accordance with the CBM regulations referred to in the Decision on Obligatory Bank Reserves with the Central Bank of Montenegro (Official Gazette of Montenegro no. 73/15, 78/15, 3/16 and 015/17). Pursuant to the aforementioned Decision, the required reserve is to be calculated based on demand deposits and time deposits. Deposit accounts held with depository institutions in Montenegro in the amount of EUR 485 thousand (2016: EUR 6,233 thousand) pertain to the obligatory reserve allocated at the rate of 7.5% applied to the portion of the basis for reserve calculation comprised of deman deposits and time deposits with maturities of up to a year, i.e. up to 365 days and at the rate of 6.5% applied to the portion of the basis for reserve calculation comprised of deposits with agreed maturities of over a year, i.e. over 365 days. The rate of 7.5% is also applied to deposits with maturities of less than 365 days and contracted early withdrawal clauses. Until, The Bank may hold up to 50% of the obligatory reserve in the form of Treasury bills issued by Montenegro, for maintaining daily liquidity. 27