NATIONAL BANK OF THE REPUBLIC OF MACEDONIA

Transcription

1 NATIONAL BANK OF THE REPUBLIC OF MACEDONIA Pursuant to Article 47 paragraph 1 item 6 of the Law on the National Bank of the Republic of Macedonia ("Official Gazette of the Republic of Macedonia" no. 158/2010 and 123/2012), Article 68 paragraph 1 item 1 and Article 69 paragraph 2 of the Banking Law ("Official Gazette of the Republic of Macedonia" no. 67/2007, 90/2009, 67/2010 and 26/2013), the National Bank of the Republic of Macedonia Council adopted the following DECISION on credit risk management ("Official Gazette of the Republic of Macedonia" no. 50/2013) I. GENERAL PROVISIONS 1. This Decision lays down the methodology for credit risk management which includes classification, the method of determining and the amount of impairment and special reserve, the scope and elements of credit risk management and supervisory standards for overdue claims. 2. Certain terms used in this Decision shall have the following meanings: 2.1. Credit risk shall denote the risk of loss to the bank because of the inability of its client to settle their liabilities in the agreed amount and/or as set by the contractual terms Exposure to credit risk (credit exposure) shall include: - balance sheet items based on the following claims: loans and deposits, finance leases, payments made on the basis of given guarantees, letters of credit, backing guarantees and other off-balance sheet items, interests, fees and charges, claims on the Republic of Macedonia and the National Bank of the Republic of Macedonia (hereinafter: National Bank), purchased claims (factoring and forfeiting); investments in securities and other financial instruments held to maturity, investments in securities and other financial instruments available for sale and other balance sheet claims that expose the bank to credit risk; - off-balance sheet items based on: undisbursed irrevocable lines of credit, undisbursed irrevocable credits based on overdrafts, credit cards and other potential credit exposure; unfulfilled assumed irrevocable liabilities for purchase of claims (factoring and forfeiting); issued uncovered guarantees, opened uncovered letters of credit; provided backing guarantees; provided acceptances; issued uncovered performance guarantees and other offbalance sheet items that represent a potential liability for the bank. The following items shall not be a part of the credit exposure:

2 - cash, bank's account balances with the National Bank, intangible assets, land, property and equipment, natural resources, foreclosed assets, means of operations and supplies; - items that expose the bank to market and/or other risks, other than credit risk: investments in securities and other financial instruments held for trading, investments in securities and other financial instruments that are measured at fair value through the income statement; investments in subsidiaries, associated companies and joint venture, and loans and claims measured at fair value through the income statement Client shall be an entity subject to credit exposure Nonperforming claim shall be a credit exposure classified in D or E risk categories and credit exposure under paragraph 2 or paragraph 3 of this subitem. Nonperforming claim shall also be an individual contract on credit exposure classified in C risk category, which on any basis (principal, interest, other noninterest income) has not been collected in a period longer than 90 days from the date of maturity, while the uncollected amount which is due for a period longer than 90 days is greater than: - Denar 1,000, for exposures to natural persons; - Denar 3,000, for exposures to small companies; - Denar 10,000, for exposures to other legal entities. Notwithstanding paragraph 2 of this subitem, the bank may regard as nonperforming claim any agreement on credit exposure classified in C risk category, which, on any basis, has not been collected in more than 90 days from the date of maturity, but the bank shall use this opportunity for all exposures, regardless of the unpaid amount, the type of exposure and the client, and to regulate it in its internal acts. Exposure classified in D or E risk categories may be excluded from the category of nonperforming claims, only if the conditions for its reclassification to a better risk category are met and if the bank has collected the full amount that is overdue by more than 31 days. Exposure classified in C risk category may be excluded from the category of nonperforming claims, only if the bank has collected the full amount that is overdue by more than 31 days Loan portfolio shall include exposures that: - may be a part of a retail loan portfolio, according to the Decision on the methodology for determining the capital adequacy, or - meet the criteria of the Decision on the methodology for determining the capital adequacy for claims covered by a residential property. The loan portfolio may not include nonperforming claims. 2

3 2.6. Rate of expected loss for certain portfolio of loans is the product of the probability of default and the rate of loss given default of exposures from loan portfolio. Probability of default of the exposures from loan portfolio shall represent the probability that the exposures from loan portfolio will be given a nonperforming status for a period of twelve months and shall be measured as a multi-annual average of the annual rates of default. The annual rates of default shall be the ratio between the number of exposures that in the twelve-month period have been given a nonperforming status and the number of exposures in that portfolio at the beginning of that period. The rate of loss given default shall represent the average loss for the bank arising from nonperforming and written-off claims with similar characteristics as the portfolio to which the rate of loss given default refers, for a period of up to three years. Loss shall be any uncollected part of non-performing claims and written-off claims Residential property shall be a family house or an apartment, as well as construction land for building of family houses or apartments supported by construction license. Garage or parking place, basement, balcony, terrace, loggia or yard shall be considered a residential property if they are pledged, along with the family house or the apartment Commercial real estate shall be any property intended for performing certain business or commercial activity, with the exception of plants and related manufacturing facilities and agricultural land. Construction land shall be considered commercial real estate, if intended for building of commercial real estate and if supported by construction license. Garage or parking place or yard shall be considered commercial real estate, if they are pledged, along with the commercial real estate. The equipment in the commercial real estate shall be considered commercial real estate, if it is pledged, along with the commercial real estate, with the exception of office equipment, computers, furniture and other similar equipment Maturity date shall be the last day on which the client was required to pay a certain amount of money, according to the contract signed with the bank. After this period, the claim or part of the claim shall be considered due Refinancing shall include: - consolidation of multiple claims of the bank in one claim that is not a result of deteriorating financial position of the client; - changing of contractual terms which is not a result of changes in the bank's internal acts (e.g. extension of the maturity date, interest rate cuts, etc.) and which is not a result of deteriorating financial position of the client, or - approval of credit exposure for payment of credit exposure (fully or partially) to another bank in the Republic of Macedonia Restructuring of claim/claims shall mean establishing credit exposure by the bank to replace one or multiple existing claims or to change existing credit 3

4 exposure, thus amending the contractual terms as a result of deteriorating financial position of the client, which among other things includes: - extension of maturity date; - interest rate cuts; - reduction of the amount of claim (principal and/or due interest and commission) through write-off; - capitalization of interest; - consolidation of multiple claims in one claim by changing the contractual terms, or - other similar activities Capitalization of interest shall be attribution or conversion of a claim based on interest on/in claim based on principal Lending for the purposes of claim/claims recovery shall be a direct or indirect approval of credit exposure for collection of claim/claims of the bank First-rate foreign bank shall be any foreign bank whose last long-term credit rating at least equals to AA- (according to the rating of "Standard & Poor's" or "Fitch") or Aa3 (according to the rating of "Moody's") Date of expected collection of collateral shall be the date when the bank expects to collect the credit exposure by selling the collateral that secures this exposure Small companies shall be entities which, according to the Decision on the methodology for determining the capital adequacy, are defined as small companies The methodology for determining the capital adequacy shall mean the Decision on the methodology for determining the capital adequacy and the relevant Instructions for implementation of this Decision The methodology for recording and evaluating accounting items and compiling financial statements shall mean the Decision on the methodology for recording and evaluating accounting items and compiling financial statements. The terms not defined in this Decision shall have the meaning specified by the Banking Law. 3. The bank shall classify and determine the impairment and special reserve on individual basis for all credit exposures by applying the provisions of section II of this Decision. Notwithstanding paragraph 1 of this item, the bank may classify credit exposures that can be a part of the loan portfolio and determine impairment and special reserve on a group basis, in accordance with the provisions of section III.1 of this Decision. Exposures of paragraph 1 of this item, for which the bank considers not to have been eligible for allocation of impairment and special reserve on individual 4

5 basis, it shall classify and determine impairment and special reserve on a group basis for a group of similar financial instruments, in accordance with provisions of section III.2 of this Decision. Notwithstanding paragraph 3 of this item, the bank shall not be required to classify and determine impairment and special reserve on a group basis for a group of similar financial instruments, for the following credit exposures where no impairment or special reserve on individual basis has been determined: - investments in equity securities; - claims on the European Central Bank and central governments and central banks of countries whose claims, under the methodology for determining the capital adequacy, have a risk weight of 0%; - claims secured by first-rate collateral instruments; - claims on financial institutions; - off-balance sheet positions based on: unfulfilled assumed irrevocable liabilities for purchase of claims (factoring and forfeiting), issued uncovered guarantees, opened uncovered letters of credit, provided backing guarantees, provided acceptances and issued uncovered performance guarantees; - in the cases of item 9 paragraph 3 of this Decision. 4. General impairment indicators used in the classification and identification of impairment and special reserve shall include: - information on the financial difficulties of the client; - information on breach of contract, including default or late payment of due liabilities; - certainty that the client will go under bankruptcy proceedings; - disappearance of an active market for a particular claim or financial instrument, or - data suggesting that there is a decrease of the estimated future cash flows for group of credit exposures, compared to initial recognition, although the decrease cannot be related to individual credit exposure, including: a) adverse changes in the client's creditworthiness (e.g. increased number of late payments), or b) deterioration of the national or local economic conditions that affect the payment of liabilities by the client (e.g. an increase of the unemployment rate in the geographical area of the client, reduction of the price of property that serves as collateral, reduction of the price of clients' product or service, etc.). II. CLASSIFICATION AND CALCULATION OF IMPAIRMENT AND SPECIAL RESERVE ON INDIVIDUAL BASIS II.1 Classification on individual basis 5. The bank shall classify the client and/or the credit exposure in risk categories referred to in item 7 of this Decision. 5

6 The bank shall make the classification under paragraph 1 of this item once a month. 6. During classification, the bank shall take into account: - the creditworthiness of the client; - the regularity of settlement of liabilities; - the collateral. Creditworthiness of a client shall be assessed according to the following criteria: - client's status and economic characteristics and the quality and expertise of the management and supervisory bodies; - quality of the program/project for which financial support has been requested from the bank or for which the client has been incorporated; - assessment whether the use of funds under the agreed purpose of credit exposure will cause cash flow of the client, in a scope and pace that suit the agreed method of repayment of liabilities; - amount of capital, reserves and client's property power, as well as the ability to realize future cash flows for settlement of liabilities; - client's perspective and activity; - possible effects on client's creditworthiness by persons/entities connected to the client; - political and economic situation of the country of the client - nonresident; - level of client's indebtedness based on loans and other forms of credit exposure of the bank and other banks, liabilities to other legal entities and natural persons, etc., determined on the basis of internal and/or external data sources (e.g. Credit Registry of the National Bank, credit bureaus, etc.); - client's exposure to currency risk and other risks. Client's creditworthiness shall be assessed: - at the time of approval of credit exposure; - at least once every six months or more due to the general impairment indicators referred to in item 4 of this Decision; - in case of restructuring or refinancing. Notwithstanding paragraph 3 of this item, the creditworthiness of the client - a natural person shall be assessed at least at the time of approval of the credit exposure or at the restructuring or refinancing, taking into account the criteria referred to in paragraph 2 of this item that match the characteristics of the natural persons. When determining the regularity in settling liabilities, the bank shall take into account: - the current days of delay and the method of settlement of credit exposure during the preceding period of at least six months; 6

7 - the client's credit history, which includes checking the usual method of settlement of all client's liabilities to the bank and/or other banks during the preceding period of at least six months. When classifying the credit exposure, the bank shall take into account the collateral, only if it is first-rate collateral instrument and in cases of item 11 of this Decision. 7. The Bank shall classify in the following risk categories: 7.1. A risk category shall include credit exposure that meets the following criteria: - claims on the European Central Bank and the central governments and central banks of countries whose claims pursuant to the methodology for determining the capital adequacy have a risk weight of 0% and that meet the criteria of indent 4 of this subitem; - part of credit exposure that is secured by first-rate collateral instruments, as defined in item 12 of this Decision, if the instrument is activated within 60 days of the date of maturity of the exposure; - financial position and cash flows of the client allows its further operation and opportunity to cover the current and future liabilities to the bank; - liabilities based on credit exposure are settled within the maturity period or with a delay of 31 days, or - in the last twelve months, no claim on the client has been restructured. Notwithstanding paragraph 1, indent 4 of this subitem, the bank may classify in A risk category, any credit exposure settled with a delay of more than 31 days, if the total amount not collected for more than 31 days is lower than Denar 500 and the delay is no longer than 60 days B risk category shall include credit exposure that meets the following criteria: - the client shows financial weaknesses, but its cash flows are sufficient for regular settlement of due liabilities; - liabilities based on credit exposure are commonly settled with a delay of 60 days, or 90 days as an exception, if the delay only occasionally ranges from 61 to 90 days, or - in the last six months, the credit exposure has not been restructured C risk category shall include credit exposure that meets the following criteria: - cash inflows of client are unsuitable for regular settlement of liabilities; - there is an inadequate maturity structure between the sources of funding of the program/project for which financial support has been requested from the bank and proceeds generated from the program/project; - the bank does not hold the necessary and updated information to assess the creditworthiness of the client; - the credit exposure is restructured; 7

8 - liabilities based on credit exposure are commonly settled with a delay of up to 120 days, or 180 days as an exception, if the delay only occasionally ranges from 121 to 180 days; - the client - nonfinancial entity has claims based on financial loan on entity enjoying a credit rating equal to or lower than CCC+ (according to the rating of "Standard & Poor's" or "Fitch") or Caa1 (according to the rating of "Moody's") or on entity enjoying a higher credit rating, but its domicile country's credit rating equals to or is lower than CCC+ (according to the rating of "Standard & Poor's" or "Fitch") or Caa1 (according to the rating of "Moody's"), or - the client - nonfinancial entity has claims based on financial loan on entity for which no credit rating has been established, but its domicile country's credit rating equals to or is lower than B- (according to the rating of "Standard & Poor's" or "Fitch") or B3 (according to the rating of "Moody's") or its domicile country's credit rating has not been established yet. Notwithstanding paragraph 1 of this subitem, the bank may not classify credit exposure to the client under paragraph 1, indents 6 and 7 of this subitem in C risk category, if: - the exposure is based on a customs guarantee or bid guarantee; - the financial loan does not exceed Denar 31,000,000 (in case of foreign currency financial loan, the Denar equivalent of the loan shall be taken into consideration), or - the financial loan is equal to or greater than Denar 31,000,000, and the bank's exposure is greater than the amount of financial loan and the bank has calculated impairment or allocated special reserve, at least in the amount exceeding 20% of the amount of financial loan, whereby the credit exposure or the client meets the criteria for classification in another risk category D risk category shall include credit exposure that meets the following criteria: - the client is illiquid; - the collection of credit exposure depends on the use of collateral instruments referred to in item 11 of this Decision; - the liabilities based on credit exposure are commonly settled with a delay of up to 240 days, or 300 days, as an exception, if the delay only occasionally ranges from 241 to 300 days, except for the liabilities under item 11 of this Decision, which are regulated by the exception referred to in item 14 of this Decision; - the client (including governments and central banks) enjoys a credit rating equal to or lower than CCC+ (according to the rating of "Standard & Poor's" or "Fitch") or Caa1 (according to the rating of "Moody's"); - the client's credit rating is higher than the rating referred to in indent 4 of this subitem, but its domicile country's credit rating is equal to or lower than CCC+ (according to the rating of "Standard & Poor's" or "Fitch") or Caa1 (according to the rating of "Moody's"), or - the client has not been given any credit rating, but its domicile country's credit rating is equal to or lower than B- (according to the rating of 8

9 "Standard & Poor's" or "Fitch") or B3 (according to the rating of "Moody's") or its domicile country has not been given any credit rating yet. Notwithstanding paragraph 1 of this subitem, the bank may not classify the credit exposure of paragraph 1, indents 4, 5 and 6 of this subitem in D risk category, in case of off-balance claim based on customs guarantee or bid guarantee E risk category shall include credit exposure that meets the following criteria: - liabilities based on credit exposure are commonly settled with a delay of over 241 days, except for the liabilities referred to in item 11 of this Decision that, based on item 14 of this Decision, may be classified in D risk category; - the client has undergone bankruptcy or liquidation proceedings; - the client denies the existence of credit exposure (in court or out-of-court proceedings), or - the bank expects to collect only an insignificant portion of credit exposure to the client. II.2 Calculating impairment and special reserve on an individual basis 8. Upon classification, the bank shall assess the need and shall make impairment of the claims or allocate special reserve for off-balance sheet items arising from each credit exposure agreement signed with client, by determining the present value of future cash flows that will stem from those claims. The bank shall determine the amount of impairment or special reserve at least on a monthly basis. 9. The amount of impairment of balance sheet items on an individual basis shall be determined as the difference between the carrying amount of balance sheet items and the present value of future expected cash flows based on those claims. The present value of balance sheet items shall be obtained by discounting the expected future cash flows based on those claims using the effective interest rate (as set by the methodology for recording and evaluating accounting items and compiling financial statements) determined on the basis of the contractual terms. The bank shall make full impairment of accrued interest on nonperforming claims. Notwithstanding item 8, paragraph 1 and paragraph 1 of this item, after the classification of credit exposure that consists of interest only (the principal debt has been settled) and/or only of fees and commissions (for ceased off-balance sheet item or settled principal debt), the bank shall not be required to calculate the present value of expected future cash flows, and the amount of impairment shall be determined in accordance with item 15 of this Decision. 10. The amount of special reserve for off-balance sheet items on an individual basis, shall be determined only in case of expected cash flows on the basis of assumed contingent liabilities and is equal to the present value of expected future 9

10 cash flows as a result of bank's payments on the assumed contingent liabilities and collections from the client, discounted by the current market price of risk-free securities issued in the same currency and with the same maturity as the currency and the maturity of the expected payment or collection. Provided that there is no current market price of risk-free securities with the same maturity as the maturity of the expected payment, the present value of the expected payment on the assumed contingent liability of the bank shall be determined on the basis of the current market price of risk-free securities with the closest maturity to the maturity of the expected payment. Notwithstanding paragraph 1 of this item, credit exposure arising from the same contractual relationship and including on-balance sheet and off-balance sheet items (e.g., used and unused overdrafts and loans based on credit cards, used and unused portion of irrevocable lines of credit, fee for off-balance sheet item and the off-balance sheet position itself, etc.), the bank shall apply the same percentage of impairment and special reserve for all parts of the exposure. 11. For credit exposures classified in D and E risk categories that the bank expects to collect through activation of collateral, the bank may take into account the value of collateral when determining the present value of expected future cash flows of such exposures, if : 11.1 The collateral is a collateral instrument referred to in item 12 of this Decision The collateral is a pledge on a residential property or commercial real estate, and the following conditions are met: - the bank makes an assessment of the market value of residential property or commercial real estate at least once a year. The bank shall provide an appraisal of the market value of the property in a shorter period as well, in case of a significant decline of market prices of similar properties or if the claim covered by residential property or commercial real estate exceeds 5% of the bank's own funds. The appraisal of the property's market value shall be carried out as specified by the law, and - the bank holds proper documentation for the pledged property, which consists of: notary act accompanied by documents for the pledge on the property, including the enforceability clause; title deed or other evidence of the competent institution for the established pledge on the property, taking into account the market value of the pledged property relative to the total debt of the client secured by such property; insurance policy for residential property or commercial estate endorsed for the benefit of the bank and other relevant documentation The collateral is a pledge on claims on the Republic of Macedonia (central government and public institutions in the Republic of Macedonia which, according to the methodology for determining the capital adequacy, are treated as central government), where the bank holds proper documentation for pledge in accordance with law, the pledge has been registered in a pledge registry and is given a precedence order of recovery against other pledge takers. 10

11 12. First-rate collateral instruments in terms of this Decision shall include: 12.1 Cash deposit and possessory pledge on gold or other precious metals, with the simultaneous fulfillment of the following conditions: - the maturity of cash deposit is equal to or longer than the maturity date specified in the credit exposure contract; - cash deposit or pledge on gold and other precious metals may be withdrawn by the client only for the settled portion of credit exposure; - there is a written document confirming the purpose of the deposit or the pledge on gold and other precious metals as a collateral for credit exposure; - cash deposit or pledge on gold or other precious metals are defined as collateral in the credit exposure contract; - in case of activation of collateral, the bank shall be the only beneficiary of the cash deposit, the pledged gold or other precious metals pledged; - the collateral is activated in circumstances when the client does not meet its liabilities arising from the credit exposure contract Securities issued by the European Central Bank and the central governments, central banks, multilateral development banks and international organizations whose claims, pursuant to the methodology for determining the capital adequacy, have risk weight of 0% Securities that the National Bank accepts as collateral in the conduct of monetary operations Securities (excluding subordinated and convertible debt instruments) issued by first-rate foreign banks Debt instruments (excluding subordinated and convertible debt instruments) issued by domestic banks Unconditional guarantees payable on first written call and issued by the European Central Bank and the central governments, central banks, multilateral development banks and international organizations, whose claims, according to the methodology for determining the capital adequacy, have risk weight of 0% and entities, established by these institutions, whose activities and liabilities are fully covered with an explicit guarantee issued by these institutions Unconditional guarantees payable on first written call and issued by domestic and first-rate foreign banks Insurance policies for claims issued by the Macedonian Bank for Development Promotion endorsed for the benefit of the bank. When determining the first-rate collateral instruments under paragraph 1 of this item, the central government shall also include public sector entities which, according to the methodology for determining the capital adequacy, are treated as central government. 11

12 13. Collateral which meets the requirements of item 11 of this Decision shall be included in the calculation of the present value of expected future cash flows, in the amount that is equal to the lesser of the value of collateral and the total credit exposure covered by collateral, while the discounting covers the period up to the date of expected recovery of collateral. The value of collateral of paragraph 1 of this section is equal to: - 100% of the fair value of the collateral - for the collateral instruments referred to in item 12 of this Decision; - 70% of the appraisal of the market value of collateral - for residential property; - 50% of the appraisal of the market value of collateral - for commercial real estate; - 100% of the value of the pledged claims - for pledge on claims on the Republic of Macedonia. The date of expected recovery of the collateral, in case of collaterals referred to in item 11 subitem 11.2 of this Decision, may not be shorter than four years from the date of calculation of the impairment. The bank shall document the method of determining the value of collateral and the date of inclusion of the value of collateral in the calculation of the present value of expected future cash flows. 14. The bank shall reclassify credit exposure from item 11 of this Decision classified in D risk category and not collected within one year after the date of inclusion of the value of collateral in the calculation of the present value of expected future cash flows, in E risk category. 15. The bank shall make impairment or allocate special reserve for each exposure, within the following limits: - from 0% to 5% of the credit exposure classified in A risk category; - over 5% to 20% of the credit exposure classified in B risk category; - over 20% to 45% of the credit exposure classified in C risk category; - over 45% to 70% of the credit exposure classified in D risk category; - over 70% to 100% of the credit exposure classified in E risk category. The amount of impairment, or the amount of allocated special reserve for individual credit exposure may not be lower than the lower limit provided for in paragraph 1 of this item for each risk category. If, when determining the present value of the credit exposure classified on an individual basis, the bank identifies a higher amount of impairment, i.e. the higher amount allocated for special reserve than the amount prescribed in paragraph 1 of this item for the risk category of the credit exposure, it shall reclassify the exposure in an appropriate risk category that fits the specified amount of impairment, i.e. the amount of allocated special reserve. 12

13 The Bank shall not make impairment, i.e. shall not allocate special reserve (impairment or special reserve is equal to 0% of the credit exposure) for credit exposures in item 7 subitem 7.1. indents 1 and 2 of this Decision. For nonperforming claims classified in C risk category, the bank shall determine impairment of at least 30% of the amount of claim. Notwithstanding paragraph 1, indent 5 of this section, the bank shall make impairment, or allocate special reserve of at least 85% of credit exposures collateralized by pledge on plants and similar manufacturing facilities, agricultural land and products whose price depends on fluctuations in the price of that product on international markets, if the bank has proper pledge documentation, as follows: - for plants and similar manufacturing facilities and agricultural land: notary act accompanied by documents for the pledge on real estate, including an enforceability clause; title deed or other evidence of the competent institution for the established pledge on real estate, taking into account the market value of the pledged property relative to the total debt of the client secured by such property; insurance policy for the real estate, endorsed for the benefit of the bank, a valid appraisal of the market value of the property, conducted in accordance with law and other relevant documentation; - for products whose price depends on fluctuations in the price of that product on international markets: evidence of registration in pledge registry; the precedence order of recovery against other pledge takers; insurance policy of pledged product endorsed for the benefit of the bank; right to control and physical inspection of collateral, on a regular basis; evidence of regular monitoring of the market value of the pledged product on the international markets and other similar documents. The bank shall make impairment or allocate special reserve in the amount of 100% for credit exposure that meets at least one of the following criteria: - there are strong expectations that the bank will not be able to collect any part of the exposure; - the client settles its liabilities based on the exposure with a delay of more than 365 days and the bank has no collateral for the exposure or holds collateral which is legally doubtful; - the client settles its liabilities based on exposures of paragraph 6 of this item with a delay of more than two years; - the bank holds collateral for the exposure which meets the requirements referred to in item 11 of this Decision, but the bank has not collected the exposure in a period of four years from the date of inclusion of the value of collateral in the calculation of impairment. II.3 Classification of credit exposure and calculation of impairment on an individual basis for investments in securities available for sale 16. In cases where the bank finds that, in accordance with items 4 and 6 of this Decision, investment in securities available for sale is impaired, the bank shall calculate the amount of impairment that is equal to the negative difference between 13

14 fair value and amortized cost determined in accordance with the methodology for recording and evaluating accounting items and compiling financial statements. Based on the impairment of paragraph 1 of this item, the bank shall allocate investments in securities available for sale in the categories of risk, in accordance with item 15 of this Decision. 17. The bank shall not release the impairment for investments in equity securities available for sale. 18. The investments in securities available for sale shall be regulated by the provisions of item 3 paragraphs 3 and 4 of this Decision. III. CLASSIFICATION AND CALCULATION OF IMPAIRMENT AND SPECIAL RESERVE ON A GROUP BASIS III.1 Loan Portfolio 19. The bank shall classify the loan portfolio on a monthly basis by calculating the impairment/special reserve as a basis for allocating exposures of this portfolio in risk categories, in accordance with item 15 of this Decision. 20. The total amount of loan portfolio must not exceed 50% of total credit exposure of the bank. In case of exceeding the limit under paragraph 1 of this item, the bank shall reclassify some of the loan portfolio exposures in exposures which are classified on an individual basis, until reaching the prescribed limit. 21. The bank shall perform segmentation of the loan portfolio in several homogeneous subportfolios by similarity of individual credit exposures (e.g. same collateral, same source of repayment, borrowers geographic location, age, occupation, employer's or the company s business where the person is employed, the same loan product, delay in payment of liabilities to the bank, etc.). For each subportfolio, the bank shall have data on credit exposures that were part of the subportfolio, but were written-off or received the status of nonperforming claims that year, and take them into account when determining the rate of expected loss. 22. For each loan subportfolio, the bank shall calculate the impairment and special reserve using the expected loss rates for that portfolio. 23. When determining the probability of default, the bank shall determine annual default rates for each loan subportfolio for at least the last five years. The bank may assign greater weight to the more recent annual default rates, if identified that they more realistically show the probability of default and expected loss. The probability of default of loan portfolio exposures may not be lower than 0.03%. When determining the rate of loss given default, the bank shall hold historical data on losses arising from nonperforming and written-off claims with similar characteristics that received this status five years ago, at the most. 14

15 If the bank does not hold enough data to determine the rate of loss given default for a certain loan subportfolio, it shall apply the rate of loss given default which may not be lower than 90%. III.2 Group of similar financial instruments 24. The bank shall classify, on a group basis for a group of similar financial instruments, exposures for which no impairment on an individual basis has been calculated, for a group of similar financial instruments, in accordance with item 3 paragraphs 3 and 4 of this Decision. Based on the determined amount of impairment or special reserve, the bank shall classify exposures of paragraph 1 of this item in the risk categories according to the provisions of item 15 of this Decision. The bank shall classify exposures of paragraph 1 of this item in homogeneous subportfolios by similarity (e.g. type of exposure, main activities, geographical location, etc.). Notwithstanding paragraph 1 of this item, the bank shall not be required to classify, on a group basis, exposures of paragraph 1 of this item, if their classification in homogeneous subportfolios is not possible. 25. The bank shall determine the amount of impairment for exposures of item 24 of this Decision in accordance with item 22 of this Decision. If exposures referred to in item 24 of the Decision have credit risk related to a specific subportfolio of loans, when determining the impairment the bank may apply the rate of expected loss of that subportfolio. IV. CREDIT RISK MANAGEMENT 26. Credit risk management is a part of the overall bank's risk management system and meets the requirements for risk management defined by the Banking Law, the Decision on risk management, as well as other regulations adopted pursuant to this law. 27. The bank shall establish an organizational structure that includes: - defined responsibilities and lines of accountability; - cooperation and exchange of information on credit risk management; - clearly defined responsibilities of organizational units of the bank responsible for the lending activity and for taking credit risk and organizational units responsible for credit risk management, and - clearly defined responsibilities of the organizational unit responsible for approving loans or other forms of credit exposure and the back office responsible for lending activities. 28. Credit risk management policy or internal acts for identifying, measuring, controlling or mitigating and monitoring credit risk (rules, procedures, etc.) the bank has to establish and apply, should include: 15

16 - criteria for approving loans and other forms of credit exposure. The bank shall, before granting the loan or other form of credit exposure, identify all factors that may have a significant impact on the risk of exposure, or the client, taking into account the minimum criteria in item 6 of this Decision; - criteria for monitoring the client's creditworthiness; - method for determining and monitoring the regularity of debt settlement; - assessment of credit risk arising from currency risk the client is exposed to and establishment of criteria for granting foreign currency loans or Denar loans with FX clause, having regard to the provisions of item 29 of this Decision; - criteria for monitoring domicile country risk of the client - a foreign entity; - contents and manner of keeping a credit file for bank clients; - method of stress testing, assumptions underlying the testing and method of reporting on the testing results; - procedure for classifying and determining the impairment and special reserve on individual and group basis. If the bank has developed internal risk categories, for the purposes of calculating the impairment and differ from the risk categories defined in item 7 of this Decision, the bank should enable their linking with risk categories provided for by this Decision and ensure their consistent application, for both granting credit exposure and its monitoring; - criteria for establishing loan subportfolios, procedure for determining and revising the rate of expected loss, probability of default and the rate of loss given default and their testing; - criteria for defining, identifying and monitoring higher credit risk exposures and taking action for recovery of these exposures; - defining internal credit exposure limits according to the structure of total credit exposure of the bank (e.g. by client, type of credit products, activity, currency, etc.); - granting authorizations to persons and bodies involved in the loan approval process; - defining permissible exceptions and procedures for their approval; - defining acceptable level and type of source of repayment in respect of credit risk exposure to natural persons. When defining the acceptable level of source of repayment, the bank shall consider relevant indicators for the movement of consumer prices and exposure currency; - defining acceptable collateral (type of real estate and movable property, securities, claims and other rights) which can be taken as collateral for a loan product or currency of exposure, defining the necessary documentation and defining the required level of coverage of credit exposure with acceptable collateral; - procedure and deadlines for taking and selling collateral; - procedure and frequency of monitoring the market value of collateral; - procedure and rules for determining the period of expected recovery of collateral and for determining the percentage of the reduced value (haircut) of the collateral that is included in the calculation of impairment and special reserve; - procedure and rules for writing-off claims; 16

17 - procedure and rules for restructuring and refinancing claim/claims; - method of reporting to supervisory and management bodies and all other persons involved in the credit risk management. 29. The assessment of credit risk arising from currency risk the client is exposed to, should at least refer to the monitoring, analysis and assessment of (mis)match of the currency position of the client and its impact on the client's ability to regularly settle its liabilities to the bank. When granting foreign currency loans and Denar loans with FX clause, the bank shall establish and apply: - specific criteria for granting loans in foreign currency or in Denars with FX clause which also take into account the currency risk the client is exposed to; - quantitative limits on the amount of each loan in foreign currency and/or in Denars with FX clause; - quantitative limits on the share of credit exposure in foreign currency and of credit exposure in Denar with FX clause of clients in the total credit exposure of the bank. Within the regular stress testing, the bank shall determine the impact of exchange rate changes on bank's loan portfolio, at least once a year. If the client s expected foreign currency inflows, foreign currency claims and claims in Denar with FX clause cover at least 80% of its total expected foreign currency outflows, foreign currency liabilities and Denar liabilities with FX clause, the client shall be considered to have matched currency position. It shall also be considered that clients whose price of dominant product depends on movements in the price of that product on international markets also have matched currency position. The bank shall maintain records of clients with matched and mismatched currency position. As an exception, the bank shall not apply the provisions of this item, for clients whose overall credit exposure amounts to Denar 200,000 for natural persons and small companies, or to Denar 600,000 for other legal entities. 30. The bank s reporting system shall provide reports on at least: - the structure of overall credit exposure, by risk category and by activity/area of relevance to the bank's exposure to credit risk (e.g. by sector, credit product, currency, type of collateral, maturity, country, etc.); - total credit exposure of the bank to the connected persons/entities; - higher credit risk exposure, determined in accordance with item 28, indent 10 of this Decision; - migration of credit exposures from one risk category to another within a specified period (so-called transition matrices); - credit exposures approved on the basis of permissible exceptions; - results of stress testing; 17

18 - refinanced claims; - restructured claims; - written-off claims; - the level and movements in the impairment and special reserve at the level of total credit exposure and by specific activities/areas (e.g. sectors, currency, maturity, etc.); - collected nonperforming and written-off credit exposures. The reports referred to in paragraph 1 of this item shall be submitted to the Supervisory Board at least quarterly, with the exception of the report referred to in paragraph 1, indent 6, which shall be submitted within 30 days after the stress test and the report referred to in paragraph 1, indent 4, which is submitted at least on an annual basis. 31. The bank shall maintain credit files for each client. The credit file shall contain all relevant data based on which the bank will be able to determine the identity, creditworthiness, regularity of settlement of liabilities by the client and the quality of collateral. The bank may maintain a credit file for each client in electronic form. 32. The National Bank shall check the classification of the client made by the bank and may require from the bank to change the risk category, the amount of impairment and the amount of special reserve for each credit exposure, each loan subportfolio and each group of similar financial instruments. The bank shall, immediately after receiving notification from the National Bank (letter, report or other similar document), implement the amendments in paragraph 1 of this item. V. SUPERVISORY STANDARDS FOR OVERDUE CLAIMS V.1 Extension of maturity 33. The extension of maturity of a claim two or more times, which is part of refinancing a claim, shall be subject to approval by the Risk Management Board or by the Credit Committee. During any extension of the maturity of paragraph 1 of this item, the bank shall analyze the reasons behind such extension. The provisions of paragraphs 1 and 2 of this item shall not apply to deposits in domestic and foreign banks and to off-balance sheet items. V.2 Restructuring claim/claims 34. When restructuring claim/claims, the bank shall observe the criteria for classification of credit exposure arising from the restructuring, determined by this Decision, taking into account the provisions of this section. 18

19 35. The net effect of the claim/claims restructuring shall not increase the financial position of the bank, except in the case of reducing credit exposure as a result of recovery. Within six months upon restructuring, the bank shall not record income based on the release of impairment/special reserve, which is not a result of recovery of credit exposure. 36. Notwithstanding items 34 and 35 of this Decision, the bank may classify in a better risk category and/or calculate a lower amount of impairment/special reserve, only if the credit exposure arising from the restructuring is secured by a collateral instrument referred to in item 12 of this Decision. 37. The bank may perform capitalization of interest only if it is a part of the claim/claims restructuring, whereby the criteria of this section are met. 38. When restructuring the claim/claims, the bank shall analyze the reasons behind the restructuring. Based on the analysis, Risk Management Board or Credit Committee shall make decision to restructure the claim/claims. V.3 Crediting recovery of claim/claims 39. The bank must not credit any recovery of claim/claims. The following cases shall not be considered crediting of recovery of claim/claims: - approving a loan to a person who has due liabilities to the bank or has a liability to the bank that becomes due within 30 days, and the bank has provided documented evidence that the approved loan will not be used for repayment to the bank; - refinancing or restructuring; - approving a loan to a person to settle any undue liabilities to the bank, while the approval of the loan ensures more favorable conditions for the person; - disbursement of approved unconditionally irrevocable credit lines, overdrafts and loans based on credit cards, while at the time of approval, the person has no due liabilities to the bank. 40. The bank shall take measures to make sure that the credit exposure from item 39, paragraph 2, indent 1 of this Decision will not be used for settlement of liabilities to the bank. V.4 Write-off of claims 41. Bank shall write-off any claim: - on the basis of effective court decision (if a final court judgment is made stating that there is no legal ground for the claim or that the bank is not entitled to the claim; if the bankruptcy proceedings are completed, etc.); - in cases that are provided for by an internal act of the bank (i.e. when the bank undoubtedly identifies inability and/or unwillingness of the client to settle the liability; if the costs of initiating and conducting 19