CRNOGORSKA KOMERCIJALNA BANKA AD, PODGORICA. Financial Statements For the Year Ended December 31, 2016 and Independent Auditors Report

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1 CRNOGORSKA KOMERCIJALNA BANKA AD, PODGORICA Financial Statements For the Year Ended and Independent Auditors Report

2 CONTENTS Page Responsibility for the financial statements 1 Independent Auditors Report 2 Financial Statements: Statement of Comprehensive Income 3 Statement of Financial Position 4 Statement of Changes in Equity 5 Statement of Cash Flows 6 Notes to the Financial Statements 7-54

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4 Deloitte d.o.o. Podgorica Bulevar Svetog Petra Cetinjskog bb Podgorica Montenegro Tax Identification Number: Registration Number: /19 Tel: +382 (0) Fax: +382 (0) INDEPENDENT AUDITORS REPORT To the Board of Directors and Owner of Crnogorska komercijalna banka AD, Podgorica We have audited the accompanying financial statements (pages 3 to 54) of Crnogorska komercijalna banka AD, Podgorica (hereinafter: the Bank ) which comprise the statement of financial position as of, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and a summary of significant accounting policies and other explanatory notes. Management's responsibility for the financial statements Management is responsible for the preparation and fair presentation of these separate financial statements in accordance with the International Financial Reporting Standards, as well as for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. Auditors' responsibility Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with Law on Auditing of Montenegro, Law on Accounting of Montenegro and standards on auditing applicable in Montenegro. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the entity's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide solid basis for our audit opinion. Opinion In our opinion, the financial statements present fairly, in all material respects, the financial position of the Bank as of, and its financial performance and its cash flows for the year then ended, in accordance with International Financial Reporting Standards. Deloitte d.o.o. Podgorica March 21, 2017 Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee ( DTTL ), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as "Deloitte Global") does not provide services to clients. Please see to learn more about our global network of member firms For information, contact Deloitte d.o.o. Podgorica. 2

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9 1. GENERAL INFORMATION Crnogorska komercijalna banka AD, Podgorica (hereinafter: the Bank ) was established as an independent bank and registered with the Commercial Court in Podgorica on January 15, OTP Bank Plc. Budapest holds 100 percent equity interest in the Bank s equity. The Bank is registered as a shareholding company. The Bank s registration number in the Central Register of the Commercial Court is /49. The Bank obtained the operating license from the Central Bank based on the Decision number / dated February 18, The Bank is registered with the Securities Exchange Commission and entered into the Register of Security Issuers under number 51 (Decision number 02/3-47/2-01 as of July 12, 2001). Pursuant to the Law on Banks, Founding Decision and Statute, the Bank is engaged in the business of keeping deposits and other assets of private individuals and legal entities and it approves loans and makes other advances from 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: to issue guarantees and undertake other off-balance sheet commitments; to purchase, sell and collect receivables; to issue, process and record payment instruments; to perform payment transactions domestically and abroad; to perform finance lease operations; to trade in its own name for its own account or for the account of a customer with foreign payment instruments and financial derivatives; to prepare analysis and provide information and advice on the company and entrepreneur creditworthiness; depositary operations; safekeeping of assets and securities and other operations as in accordance with the approval of the Central Bank of Montenegro. The Bank is headquartered at Moskovska Street, no number. During 2016, the Bank opened the branch for Private banking. The basic idea is that the clients can perform all their transactions with the Bank in an efficient and simple way, at one place, with their own personal banker. On, the Bank consisted of its Head Office in Podgorica and fifteen branches, ten sub-branch offices and five counters located on the territory of Montenegro. As of, the Bank had 441 employees (December 31, 2015: 436 employees). The members of the Board of Directors of the Bank are as follows: First name and surname Position Mr. Barna Zsolt Mr. Szabolcs Horvath Mr. Nyitrai Győző Mr. Szabolcs Korba, PhD Mr. Attila Kozsik Mr. Miklos Nemeth Mr. Milan Sztepanov President Member Member Member Member Member Member 7

10 1. GENERAL INFORMATION (Continued) The members of the Audit Committee of the Bank are as follows: First name and surname Mr. Attila Kozsik Mr. Fritz Laszlo Mr. Andreas Szalay Position President Member Member Executive directors of the Bank as of 31 December 2016 were: Name and surname Mr. Szabolch Horvath Mrs. Maja Krstić Mr. Nebojsa Nedić Mr. Gabor Jandacsik Mr. Balazs Balog Mr. Milan Sztepanov Key area Chief Executive Officer Executive Director for Finance and Bank Operations Executive Director for Retail Banking Executive Director for Corporate Banking Executive Director for Credit Approval and Risk managment Executive Director for Compliance and Security As of, Head of Compliance Department was Srđan Knežević. As of, Internal Auditor was Irena Mašović. 2. BASIS OF PREPARATION OF THE FINANCIAL STATEMENTS These financial statements are general purpose financial statements prepared in accordance with International Financial Reporting Standards ( IFRS ). The Bank also prepares financial statements according to statutory accounting rules that differ materially from IFRS. (a) Statement on Compliance These financial statements have been prepared in accordance with IFRS adopted by the International Accounting Standards Board (IASB). The preparation of financial statements in conformity with IFRS requires from the Bank s management to use certain critical accounting estimates. It also requires management to exercise its judgment in the process of applying the Bank s accounting policies. The areas involving a higher degree of judgment or complexity, or areas where assumptions and estimates are significant to the financial statements are disclosed in Note 2 (d). The IFRS accounting policies provided below have been consistently applied by the Bank to all periods presented in these financial statements. (b) Basis of Preparation These financial statements have been prepared under the historical cost convention, as modified by the revaluation of available-for-sale financial assets, financial assets and financial liabilities (included derivate financial instruments) held at fair value through profit or loss, under the going concern assumption. (c) Functional and Reporting Currency The financial statements are stated in EUR, which is the Bank s functional currency. Unless otherwise is stated, all financial information is presented in EUR rounded to the nearest thousand. 8

11 2. BASIS OF PREPARATION OF THE FINANCIAL STATEMENTS (Continued) (d) Use of Estimates and Judgments The preparation of financial statements in conformity with IFRS requires management to make judgments, estimates and assumptions that affect the application of policies and reported amounts of assets and liabilities, income and expenses. The estimates and associated assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period or in the period of the revision and future periods if the revision affects both current and future periods. Information about significant areas of estimation uncertainty and critical estimates in applying accounting policies that have the most significant effect on the amount recognized in the financial statements are described in Note 5 to the financial statements. A summary of the principal accounting policies applied in preparing the IFRS financial statements are set out within Note 3 to the financial statements. (e) Standards and Interpretations Issued that Came into Effect in the Current Period In the current year, the Bank applied the following amendments and revisions to IFRS issued by the International Accounting Standards Board ( IASB ) mandatorily effective for the accounting periods beginning on or after January 1, 2016: Amendments to IFRS 11 Joint Arrangements Accounting for Acquisition of an Interest in a Joint Operation (effective for annual periods beginning on or after January 1, 2016). IFRS 14 Regulatory Deferral Accounts (effective for annual periods beginning on or after January 1, 2016) Amendments to IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets Clarification of Acceptable Methods of Depreciation and Amortization (effective for annual periods beginning on or after January 1, 2016). Amendments to IAS 16 Property, Plant and Equipment and IAS 41 Agriculture Agriculture: Bearer Plants (effective for annual periods beginning on or after January 1, 2016). Amendments to IAS 27 Separate Financial Statements - Equity Method in Separate Financial Statements (effective for annual periods beginning on or after January 1, 2016). Amendments to IFRS 10, IFRS 12 and IFRS 28 Investment Entities: Applying the Consolidation Exception. These amendments clarify that the exemption from preparing consolidated financial statements is available to a parent entity that is a subsidiary of an investment entity, even if the investment entity measures all its subsidiaries at fair value in accordance with IFRS 10. Consequential amendments have also been made to IAS 28 to clarify that the exemption from applying the equity method is also applicable to an investor in an associate or joint venture if that investor is a subsidiary of an investment entity that measures all its subsidiaries at fair value. (These amendments shall be applied retrospectively for annual periods beginning on or after January 1, 2016 with early adoption permitted.) 9

12 2. BASIS OF PREPARATION OF THE FINANCIAL STATEMENTS (Continued) (e) Standards and Interpretations Issued that Came into Effect in the Current Period (continued) Amendments to various standards Improvements to IFRSs (cycle ) resulting from the annual improvement project of IFRS (IFRS 5, IFRS 7, IAS 19 and IAS 34) primarily with a view to removing inconsistencies and clarifying wording (amendments are to be applied for annual periods beginning on or after January 1, 2016). Amendments to IAS 1 Presentation of Financial Statements Disclosure Inititative (effective for annual periods beginning on or after January 1, 2016). (f) Standards and Interpretations in Issue not yet Effective At the date of issuance of these financial statements the following standards, revisions and interpretations were in issue but not yet effective for the financial year ended December 31, 2016: IFRS 9 Financial Instruments and subsequent amendments, supplanting the requirements of IAS 39 Financial Instruments: Recognition and Measurement, with regard to classification and measurement of financial assets. This standard eliminates the categories existing under IAS 39 assets held to maturity, assets available for sale and loans and receivables. IFRS 9 shall be effective for annual periods beginning on or after January 1, 2018, with early adoption permitted. In accordance with IFRS 9, financial assets shall be classified in one of the following two categories upon initial recognition: financial assets at amortized cost or financial assets at fair value. A financial asset shall be measured at amortized cost if the following two criteria are met: financial assets relate to the business model whose objective is to collect the contractual cash flows and the contractual terms provide the basis for collection at certain future dates of cash flows that are solely payments of principal and interest on the principal outstanding. All other financial assets shall be measured at fair value. Gains and losses on the fair value measurement of financial assets shall be recognized in the profit and loss statement, except for investments in equity instruments which are not traded, where IFRS 9 allows at initial recognition a subsequently irreversible choice to recognize changes in fair value within other gains and losses in the statement of comprehensive income. An amount recognized in such a manner within the statement of comprehensive income cannot subsequently be recognized in profit and loss. IFRS 15 Revenue from Contracts with Customers, defining the framework for revenue recognition. IFRS 15 supplants IAS 18 Revenue, IAS 11 Construction Contracts, IFRIC 13 Customer Loyalty Programs, IFRIC 15 Agreements for the Construction of Real Estate and IFRIC 18 Transfers of Assets from Customers. IFRS 15 shall be effective for annual periods beginning on or after January 1, 2018, with early adoption permitted. IFRS 16 Leases provides a comprehensive model for identification of lease arrangements and their treatment in the financial statements of both lessors and lessees. As from its effective date, January 1, 2019, this standard shall supplant the following lease standards and interpretations: IAS 17 Leases, IFRIC 4 Determining whether an Arrangement Contains a Lease, SIC 15 Operating Leases Incentives and SIC 27 Evaluating the Substance of Transactions Involving the Legal Form of a Lease. Amendments to IFRS 2 Share-Based Payment - Classification and Measurement of Share-Based Payment Transactions, effective for annual periods beginning on or after January 1, 2018, with early adoption permitted. 10

13 2. BASIS OF PREPARATION OF THE FINANCIAL STATEMENTS (Continued) (f) Standards and Interpretations in Issue not yet Effective (Continued) Amendments to IFRS 10 Consolidated Financial Statements and IAS 28 Investments in Associates and Joint Ventures - Sale or Contribution of Assets between an Investor and its Associate or Joint Venture ought to have been effective for annual periods beginning on or after January 1, 2016; however, in December 2015 IASB deferred the effective date indefinitely, with early adoption permitted. Amendments to IAS 7 Statement of Cash Flows - Disclosure Initiative require and entity to provide disclosures that enable users of financial statements to evaluate changes in liabilities arising from financing activities, including both changes arising from cash flows and non-cash changes. Amendments to IAS 7 shall be effective for annual periods beginning on or after January 1, 2017, with early adoption permitted. Amendments to IAS 12 Income Taxes - Recognition of Deferred Tax Assets for Unrealized Losses, shall be applied retrospectively for annual periods beginning on or after January 1, 2017, with early adoption permitted. IFRS 9 Financial Instruments IFRS 9 issued in November 2009 introduced new requirements for the classification and measurement of financial assets. IFRS 9 was subsequently amended in October 2010 to include requirements for the classification and measurement of financial liabilities and for derecognition, and in November 2013 to include the new requirements for general hedge accounting. Another revised version of IFRS 9 was issued in July 2014 mainly to include a) impairment requirements for financial assets and b) limited amendments to the classification and measurement requirements by introducing a fair value through other comprehensive income (FVTOCI) measurement category for certain simple debt instruments. The Bank believes that IFRS 9 will have an impact on the financial statements of the Bank, however, the Bank is currently unable to estimate the effects of IFRS 9 introduction. The Key requirements of IFRS 9 are: All recognized financial assets that are within the scope of IAS 39 Financial Instruments: Recognition and Measurement are required to be subsequently measured at amortized cost or fair value. Specifically, debt investments that are held within a business model whose objective is to collect the contractual cash flows, and that have contractual cash flows that are solely payments of principal and interest on the principal outstanding are generally measured at amortized cost at the end of subsequent accounting periods. Debt instruments that are held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets, and that have contractual terms that give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding, are generally measured at fair value through other comprehensive income. All other debt investments and equity investments are measured at their fair value at the end of subsequent accounting periods. In addition, under IFRS 9, entities may make an irrevocable election upon initial recognition to measure an equity investment (that is not held for trading) at fair value through other comprehensive income, with only dividend income generally recognized in profit or loss. 11

14 2. BASIS OF PREPARATION OF THE FINANCIAL STATEMENTS (Continued) IFRS 9 Financial Instruments (continued) With regard to the measurement of financial liabilities designated as at fair value through profit or loss, IFRS 9 requires that the amount of change in the fair value of the financial liability that is attributable to changes in the credit risk of that liability is presented in other comprehensive income, unless the recognition of the effects of changes in the liability's credit risk in other comprehensive income would create or enlarge an accounting mismatch in profit or loss. Changes in fair value attributable to a financial liability's credit risk are not subsequently reclassified to profit or loss. Under IAS 39, the entire amount of the change in the fair value of the financial liability designated as fair value through profit or loss is presented in profit or loss. In relation to the impairment of financial assets, IFRS 9 requires an expected credit loss model, as opposed to an incurred credit loss model under IAS 39. The expected credit loss model requires an entity to account for expected credit losses and changes in those expected credit losses at each reporting date to reflect changes in credit risk since initial recognition. In other words, it is no longer necessary for a credit event to have occurred before credit losses are recognized. The new general hedge accounting requirements retain the three types of hedge accounting mechanisms currently available in IAS 39. Under IFRS 9, greater flexibility has been introduced to the types of transactions eligible for hedge accounting, specifically broadening the types of instruments that qualify for hedging instruments and the types of risk components of non-financial items that are eligible for hedge accounting. In addition, the effectiveness test has been overhauled and replaced with the principle of an economic relationship. Retrospective assessment of hedge effectiveness is also no longer required. On the initiative of the OTP Group, the Bank in 2017 initiated the IFRS 9 project, and hired consultants for this purpose. The project provides for the following phases: Testing and training of classification tool Pilot classification on sample products/contracts Grouping of products/contracts (individual or grouped classification) Classification of stock Preparation of Fair Value models IT development In the context of the classification and measurement, the Bank considers the possibility of defining business models and other requirements of IFRS 9 for the classification of financial assets that will be subsequently carried at amortized cost, at fair value through the comprehensive income or at fair value through profit or loss. In the area of impairment, the Bank together with OTP Bank is working on defining the methodology for calculating the expected credit losses and modelling of risk parameters, which include all the parameters necessary for the design of future impacts. IFRS 15 Revenue from Contracts with Customers In May 2014, IFRS 15 was issued which establishes a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. IFRS 15 will supersede the current revenue recognition guidance including IAS 18 Revenue, IAS 11 Construction Contracts and the related Interpretations when it becomes effective. The core principle of IFRS 15 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Specifically, the Standard introduces a 5-step approach to revenue recognition: 12

15 2. BASIS OF PREPARATION OF THE FINANCIAL STATEMENTS (Continued) IFRS 15 Revenue from Contracts with Customers (continued) Step 1: Identify the contract(s) with a customer, Step 2: Identify the performance obligations in the contract, Step 3: Determine the transaction price, Step 4: Allocate the transaction price to the performance obligations in the contract, and Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation. Under IFRS 15, an entity recognizes revenue when (or as) a performance obligation is satisfied, i.e. when control of the goods or services underlying the particular performance obligation is transferred to the customer. Far more prescriptive guidance has been added in IFRS 15 to deal with specific scenarios. Furthermore, extensive disclosures are required by IFRS 15. Management of the Bank is currently considering the impact of the above listed standards and interpretation in the Bank s financial statements as well as their effective dates. The accounting policies and estimates used in preparation of these financial statements are consistent with the those applied upon preparation of the Bank's annual financial statements for 2015, except for newly adopted IFRS, their amendments and interpretations, the application of which had no effect on the Bank's financial position or performance. Preparation of the financial statements in accordance with IFRS requires the Bank s management to make certain key accounting estimates. It also requires management to use their judgement in applying the Bank s accounting policies. 13

16 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 3.1. Income and Expense Recognition Interest income and expense are recognized in the statement of comprehensive income for all instruments measured at amortized cost using the effective interest rate method. The effective interest rate method is a method of calculating the amortized cost of a financial asset or a financial liability and of allocating the interest income or interest expense over the relevant period. The effective interest rate is the rate that discounts estimated future cash payments or receipts over the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying value of the financial asset or financial liability. When calculating the effective interest rate, the Bank estimates cash flows considering all contractual terms of the financial instrument (for example, prepayment options) but does not consider future credit losses. The calculation includes all fees and commissions paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums or discounts. Fees and commissions are generally recognized on an accrual basis once the service is rendered. Loan approval fees are charged as onetime fee, deferred and recognized in income as an adjustment of the effective interest rate on the loan. Fee and commission income, also, includes transfer payments in foreign currency, domestic payments transactions, loan administration, guarantee, letter of credit business and other banking services Foreign Exchange Translation Transactions denominated in foreign currencies are translated into Euros at the official middle exchange rates, at the date of each transaction. Assets and liabilities denominated in foreign currencies are translated into Euros by applying the official middle exchange rates, prevailing at the statement of financial position 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 statement of comprehensive income. Commitments and contingent liabilities denominated in foreign currencies are translated into Euros by applying the official middle exchange rates, at the statement of financial position date Leasing Leases undertaken by the Bank are classified as operating leases. The payments made under operating leases are charged to operating expenses in the statement of comprehensive income on a straight-line basis over the period of the lease Taxes and Contributions Income Taxes Current Income Taxes Income taxes are calculated and paid in conformity with the income tax regulations defined under the Montenegro Corporate Income Tax Law, Article 28 (Official Gazette of Montenegro, no. 65/01, 80/04, 40/08, 86/09, 14/12, 61/13 and 55/16) as per the effective proportional tax rate of 9 percent on taxable income. A taxpaying entity s taxable income is determined based upon the income stated in its statutory statement of comprehensive income following certain adjustments to its income and expenses performed in accordance with the Montenegro Corporate Income Tax Law. 14

17 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 3.4. Taxes and Contributions (continued) Income Taxes (continued) Current Income Taxes (continued) The capital gain is considered as income generated by the sale of land, buildings, property rights and securities. Capital losses may be offset against capital gains realized in the same period. If after such offsetting capital loss is incurred, the taxpayer may carry forward the capital loss to the future periods against capital gains within the ensuing five years. Montenegro tax regulations do not envisage that any tax losses of the current period be used to recover taxes paid within a specific carry back 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 an ensuing period of a maximum of five years. Deferred Income Taxes Deferred income tax is determined using the statement of financial position 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 statement of financial position 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. Taxes, contributions and other duties not related to operating results Taxes, contributions and other duties that are not related to the bank s operating result, include property taxes and other various taxes and contributions paid pursuant to state and municipal regulations Cash and Cash Equivalents For the purposes of the statement of cash flows, cash and cash equivalents comprise balances with less than a three month maturity from the date of acquisition including: cash on hand, non-restricted balances with the Central Bank of Montenegro and other banks Financial Assets The Bank classifies its financial assets in the following categories: loans and receivables; held-to-maturity investments; available-for-sale financial assets and financial assets at fair value through profit or loss. Management determines the classification of its investments at initial recognition. (a) Loans and receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market and that the Bank does not intend to sell immediately or in the near term. They arise when the Bank provides money or services directly to a debtor with no intention of trading the receivable. Loans and receivables comprise loans and receivables to banks and customers. Loans and receivables are initially measured at fair value plus direct transaction costs, and subsequently measured at their amortized cost using the effective interest method. 15

18 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 3.6. Financial Assets (Continued) (b) Held-to-maturity investments Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Bank s management has the positive intention and ability to hold to maturity. Held-to-maturity investments are carried at amortized cost using the effective interest method. Any sale or reclassification of a more than insignificant amount of held-to-maturity investments would result in the reclassification of all held-to-maturity investments as available-for-sale, and prevent the Bank from classifying investment securities as held-to-maturity for the current and the following two financial years. (c) Available-for-sale investments Available-for-sale financial assets are those non-derivative financial assets that are designated as available for sale or are not classified as another category of financial asset. Available-for-sale investments are those intended to be held for an indefinite period of time, which may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices. (d) Investments Carried at Fair Value through Profit or Loss This category comprises two sub-categories: financial assets classified as held for trading, and financial assets designated by the Bank as at fair value through profit or loss upon initial recognition. A financial asset is classified as held for trading if it is acquired principally for the purpose of selling in the near term or if it is part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent actual pattern of short-term profit-taking. The Bank designates certain financial assets upon initial recognition as at fair value through profit or loss (fair value option). Financial assets designated upon initial recognition as at fair value through profit or loss consists of shares of corporate entities. Financial assets, for which the fair value option is applied, are recognized in the statement of financial position as Financial assets designated at fair value through profit or loss. Realized and unrealized fair value changes relating to financial assets designated at fair value through profit or loss are recognized in Net gains/ (losses) on financial instruments designated at fair value through profit or loss. Dividends on financial assets designated at fair value through profit or loss equity instruments are recognized in the statement of comprehensive income when the entity s right to receive payment is established. (e) Initial recognition and subsequent measurement of financial assets Purchases and sales of held-to-maturity and available-for-sale financial assets are recognized on trade-date the date on which the Bank commits to purchase or sell the asset. Loans are recognized when cash is advanced to borrowers. Financial assets are initially recognized at fair value plus transaction costs for all financial assets not carried at fair value through profit or loss. Available-for-sale financial assets are subsequently carried at fair value. Loans, receivables, and held-to-maturity investments are carried at amortized cost using the effective interest method. Gains and losses arising from changes in the fair value of available-for-sale financial assets are recognized directly in equity, until the financial asset is derecognized or impaired at which time the cumulative gain or loss previously recognized in equity should be recognized in profit or loss. However, interest calculated using the effective interest rate method is recognized in the statement of comprehensive income. Dividends on available-for-sale equity instruments are recognized in the statement of comprehensive income when the entity s right to receive payment is established. Foreign exchange gains or losses on available-for-sale assets are recognized in profit or loss. The fair value of quoted investments in active markets is based on current bid prices. If the market for a financial asset is not active (and for unlisted securities), the Bank establishes fair value by using valuation techniques. These include the use of recent arm s length transactions, discounted cash flow analysis and other valuation techniques commonly used by market participants. 16

19 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 3.6. Financial Assets (Continued) (f) Impairment of financial assets i) Assets carried at amortized cost The Bank assesses at each statement of financial position date whether there is objective evidence that a financial asset or group of financial assets has been impaired. A financial asset or a group of financial assets is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a loss event ) and that loss event has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated. Objective evidence that a financial asset or group of assets is impaired includes observable data that comes to the attention of the Bank about the following loss events: Payment delinquency; Restructuring of the contract; Termination of the risk assumption contract; Bankruptcy proceedings, liquidation proceedings debt settlement procedures with local governments; Litigations; Cross default. The Bank first assesses whether objective evidence of impairment exists individually for financial assets that are individually significant, and individually or collectively for financial assets that are not individually significant. If the Bank determines that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, it includes the asset in a group of financial assets with similar credit risk characteristics and collectively assesses them for impairment. Assets that are individually assessed for impairment and for which an impairment loss is or continues to be recognized are not included in a collective assessment of impairment. If there is objective evidence that an impairment loss on loans and receivables carried at amortized cost has been incurred, the amount of the loss is measured as the difference between the asset s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset s contracted effective interest rate. The carrying amount of the asset is reduced through the use of an allowance account and the amount of the loss is recognized in the statement of comprehensive income. If a loan has a variable interest rate, the discount rate for measuring any impairment loss is the current effective interest rate determined under the contract. The calculation of the present value of the estimated future cash flows of a collateralized financial asset reflects the cash flows that may result from executing the collateral less costs for obtaining and selling the collateral, whether or not the execution of collateral is probable. The calculation of the present value of the estimated future cash flows is based on an effective interest rate. For the purposes of a collective evaluation of impairment, financial assets are grouped on the basis of similar credit risk characteristics. Those characteristics are relevant to the estimation of future cash flows for groups of such assets by being indicative of the debtors ability to pay all amounts due according to the contractual terms of the assets being evaluated. 17

20 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 3.6. Financial Assets (Continued) (f) Impairment of financial assets (Continued) i) Assets carried at amortized cost (continued) Future cash flows in a group of financial assets that are collectively evaluated for impairment are estimated on the basis of the contractual cash flows of the assets in the Bank and historical loss experience for assets with credit risk characteristics similar to those in the Bank. Historical loss experience is adjusted on the basis of current observable data to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of conditions in the historical period that do not exist currently. Loan loss provision is calculated at a level of group of financial assets. The loan loss percentage is determined by the assessment of probability of default, based on historical loss experience for the group of financial assets. Estimates of changes in future cash flows for group of assets should reflect and be directly consistent with changes in related observable data from period to period. The methodology and assumptions used for estimating future cash flows are reviewed regularly by the Bank to reduce any differences between loss estimates and actual loss experience. When a loan is uncollectible, it is written off against the related provision for loan impairment. Such loans are written off after all the necessary procedures have been completed and the amount of the loss has been determined. Subsequent recoveries of amounts previously provided for, decrease the amount of provisions for impairment losses and are recognized in the statement of comprehensive income. If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognized, the previously recognized impairment loss is reversed by adjusting the allowance account. (ii) Assets carried at fair value The Bank assesses at each statement of financial position date whether there is objective evidence that a financial asset or a group of financial assets has been impaired. In the case of equity investments classified as available-for-sale, a significant or prolonged decline in the fair value of the security below its cost is considered in determining whether the assets are impaired. If any such evidence exists for available - for - sale financial assets, the cumulative loss measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that financial asset previously recognized in profit or loss is removed from equity and recognized in the statement of comprehensive income. If, in a subsequent period, the fair value of a debt instrument, classified as available-for-sale, increases and the increase can be objectively related to an event occurring after the impairment loss was recognized in profit or loss, the impairment loss is reversed through the statement of comprehensive income. (g) Borrowings Borrowings are recognized initially at fair value (fair value of consideration received), net of transaction costs incurred. Borrowings are subsequently stated at amortized cost; any difference between proceeds net of transaction costs and the redemption value is recognized in the statement of comprehensive income over the maturity period of the borrowings using the effective interest method. 18

21 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 3.7. Intangible Assets Costs associated with maintaining computer software programs are recognized as an expense when they incur. Costs that are directly associated with identifiable and unique software products controlled by the Bank and will probably generate economic benefits exceeding costs beyond one year, are recognized as intangible assets. If the agreed period of using is less than eight years, depreciation is calculated in accordance with the period of use agreed in the contract. If the agreed period of use is longer than eight years, depreciation is calculated using the straight-line method, at a rate of 12,50%, in order to distribute the cost of licenses over their estimated useful lives use. Costs include external software company development costs. Amortization of intangible assets is charged on a straight-line basis over their estimated useful lives, which are as follows: Intangible Assets Useful Life (in Years) License 8 Software 8 There were no changes in estimated useful lives of intangible assets compared to prior year Property, Plant and Equipment All property, plant and equipment are stated at cost less depreciation and impairment losses, if any. The cost includes expenditure that is directly attributable to the acquisition of the items. Depreciation on property, plant and equipment is calculated using the straight-line method to allocate their cost to their residual values over their estimated useful lives, remained the same as in previous years, and are as follows: Major Categories of Property, Plant and Equipment Useful Life (in Years) Buildings 50 Computers and computer equipment 8 Furniture and office equipment 4-10 Motor vehicles 8 ATM machines 8 Other equipment 8 Assets under construction are carried at cost. Depreciation of these assets, on the same basis as for other property, commences when the assets are ready for their intended use. Investments in property, plant and equipment based on current maintenance are recognized as operating expenses in the period in which they arise. There were no changes in estimated useful lives of property, plant and equipment compared to prior year Impairment of Tangible and Intangible Assets At each statement of financial position date, the Bank s management reviews the carrying amounts of the Bank s tangible and intangible assets. If there is any indication that such assets have been impaired, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss. If the recoverable amount of an asset is estimated to be less than its carrying value, the carrying amount of the asset is reduced to its recoverable amount. 19

22 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 3.9. Impairment of Tangible and Intangible Assets (continued) An impairment loss is recognized as an expense of the current period and is recorded under other operating expenses. Where an impairment loss subsequently reverses, the carrying amount of the asset is increased to the revised estimate of its recoverable value. However, this is performed so that the increased carrying amount does not exceed the carrying value that would have been determined had no impairment loss been recognized for the asset in prior years Acquired assets Acquired assets are assets that became the property of the Bank based on collection of receivables that were secured by that property. The Bank records the received assets at the lower than gross carrying amount of receivables or market value of the collateral less costs of sale 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 obligation, and a reliable estimate of the amount of the obligation can be made. Provisions are measured at the present value of the estimated expenditure required to settle the present obligations. Provisions are re-examined at each statement of financial position date and adjusted so as to reflect the best present estimate. If it is no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation, the provision is reversed and credited to the income statement. The Bank does not recognize provisions against contingent liabilities until it has determined the existence of a present obligation which can result in an outflow of resources embodying economic benefits required to settle the obligation, or if a reliable estimate cannot be made of the amount of the obligation, in which case it is so disclosed Employee Benefits Employee Taxes and Contributions for Social Security In accordance with the regulations prevailing 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 the employee, by the employer in an amount calculated by applying the specific, legally prescribed rates. The Bank is also legally obligated to withhold contributions from gross salaries to employees, and on behalf of the employees, to transfer the withheld portions directly to 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 and Other Long Term Employee Benefits In accordance with the Collective Bargaining Agreement, the Bank has an obligation to disburse an employment retirement benefit to a retiree, in an amount equal to six average net salaries effective in the Bank in the month prior to the employee s retirement. The Bank's financial statement as of, include provisions calculated based on the estimated present value of retirement benefits to employees upon vesting in respective right by independent authorized actuary. 20

23 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Transaction with related parties The aim of International accounting standard 24 Related-Party Disclosures", is to ensure that the financial statements of an entity include the disclosure, which will draw attention to possible impact of related parties on the financial position and profit or loss of the entity. The related parties are: companies that directly, or indirectly, through one or more intermediaries, control the reporting company or are under its control, or that control the reporting entity jointly with other entities associated companies in which the Bank has significant influence and which are not a subsidiary or joint venture of the investor; natural persons who have, directly or indirectly, the voting right in the Bank, which gives them significant influence over the Bank, as well as any other entity which is expected to influence, or be influenced by that related person in their dealings with the Bank managers on key positions, or persons that have authority and responsibilities for planning, directing and controlling the activities of the Bank, including directors and key management When observing any related party transaction, the attention should be paid to the essence of the relationship, not merely on the legal form. 21

24 4. FINANCIAL INSTRUMENTS 4.1. Risk Management In its business operations, the Bank is exposed to various risks, the most important of which are: Credit risk Market risk Liquidity risk and Operating risk. The risk management procedures are designed with a view to identify and analyse risks, to define the adequate limits and controls required for risk management, as well as to keep track of the Bank's exposure to each individual risk. The risk management procedures are subject to regular control ensuring the adequate response to the changes in the market, products and services. The Risk Management Department is responsible for monitoring the Bank's exposure to certain risks and the compliance with the risk management procedures, as well as defined limits, which is reported to the Bank's Board of Directors on monthly basis. In addition, the Supervising Committee and the Credit Risk Management Committee are in charge of monitoring the Bank's exposure to certain risks. The Bank tests the sensitivity of the Bank to certain types of risk, on an aggregate level as well, by using several types of stress scenarios. Stress scenarios include assumptions about changes in market and other factors which may have a material impact on the Bank's operations. In addition, the introduction of new services requires market and economic analyses in order to optimize the relation between income and risk Credit Risk The Bank takes on exposure to credit risk, which is the risk that a counterparty will be unable to pay its debts in full when due. Impairment losses identified as of the statement of financial position date are provided for. Significant changes in the economy, or in the health of a particular industry segment that represents a concentration in the Bank s portfolio, could result in losses that are different from those provided for at the statement of financial position date. Management therefore carefully manages its exposure to credit risk Credit Risk Management Exposure to credit risk is a risk of financial loss, which may occur as a consequence of a counterparty being unable to fulfil its obligations towards the Bank. The Bank manages the credit risk it undertakes by placing limits in relation to large loans, single borrowers and related persons. Such risks are monitored on a revolving basis and subject to annual or more frequent reviews. All loans above the prescribed limit have to be approved by the Credit Risk Management Committee. In accordance with the limits prescribed by the Central Bank of Montenegro, the sector concentration is constantly monitored. The exposure to any borrower including banks and brokers is further restricted by sublimits covering statement of financial position and off-balance sheet exposures. Actual exposures against limits are monitored regularly. Exposure to credit risk is managed through regular analysis of the ability of borrowers and potential borrowers to meet interest and capital repayment obligations. 22