Report on risk management for 2012 concerning capital adequacy. GER-nr,

Report on risk management for 2012 concerning capital adequacy GER-nr, 80050410

TABLE OF CONTENTS 1. Objectives and risk policies Risk management in general 3 Credit risk 4 Market risk 7 Liquidity risk 7 Operational risk 8 Base capital risk 8 2. Capital base 9 3. Solvency requirement and adequate capital base 10 including a description of the bank s internal procedures and solvency requirement model 4. Counterparty risk 14 5. Market risk 15 6. Exposure in shares, etc. outside the trading book 16 7. Exposure in interest risk in positions outside the trading book 17 8. Credit risk 18 2/19

OPJEKTIVES AND RISK POLICIES Risk management in general The BANK of Greenland operates with a balanced risk profile. The bank s Board of Directors keeps a watchful eye on the bank s risks and follows up on its findings. The Board of Directors has predetermined general frameworks and principles for the various areas of risk. The bank is in a continual process of developing its tools for identification and management of risk. The risk management function is engaged at The Board of Management. The day-to-day management of risk is performed in the bank s Credit-/ Foreign Dept. Checking of this work is the responsibility of the Auditing Dept. The BANK of Greenland employs the standard method for credit and market risk as well as the base indicator method for operational risk. The most important risks associated with the operations of The BANK of Greenland and which impact the bank s growth, earnings and financial alternatives are the following: Credit risk: the risk that the bank, either partially or entirely, will suffer financial loss as the result of its customers inability to meet their commitments. Market risk: the risk that the value of the bank s assets and liabilities are influenced by market conditions. Examples are economic fluctuations, developments on stock markets and changes in foreign currency prices and interest rates. Liquidity risk: the risk of loss ensuing from the bank s inability to meet its commitments to depositors. Operational risk: the risk that the bank, either partially or entirely, will suffer financial loss as the result of inadequate or inappropriate internal procedures, human error, IT systems, etc. Risk on capital base: the risk that the bank cannot comply with the statutory minimum requirements for solvency, and cannot comply with individual solvency requirements. 3/19

OPJEKTIVES AND RISK POLICIES Credit risk The BANK of Greenland s objective for credit risk is to limit its losses on loans, advances, credits and guarantees. However, limitation of loss takes into account the fact that issuing credit is the bank s most important source of earnings; therefore, there is an on-going evaluation of earnings and risk. The BANK of Greenland s credit risk management is based on established policies and business procedures that have been set up by the bank s Board of Directors with a view to issuing loans to customers with the solidity and earnings to ensure good quality of credits in relation to the margin paid. Credits, loans, advances and guarantees are made at several levels within the bank depending on the size and risk of the exposure. The bank keeps a constant eye on all loans, advances and guarantees above a pre-determined maximum in order to ensure that any signs of the customer s failing ability to repay can be identified as early as possible so that the bank can then, in dialogue with the customer, avoid loss. Concentration risk The bank s concentration risk for loans, advances and guarantees is part of its credit risk management. The bank wishes to find an appropriate spread of loans and guarantees for commercial as well as retail customers. Furthermore, the bank seeks a balanced distribution of its loans and guarantees for the various lines of business among its corporate customers. The bank finds this distribution appropriate in light of the potential spread of business opportunities in the bank s market area. Exposures with a customer or a group of associated customers may not, after deduction of particularly secured claims, exceed 25% of the bank s base capital in accordance with the Danish Financial Enterprise Act 145. The Danish Financial Supervisory Authority receives quarterly reports of these figures. Concerning the sum of major exposures, the bank s policy is that the sum of major exposures in publicly run firms may not exceed 75 % and other exposures may not exceed 75 %, of the base capital. 4/19

OPJEKTIVES AND RISK POLICIES Credit exposures amounting to 10% or more of the capital base: Ultimo 2012 Ultimo 2011 Ultimo 2010 Major exposures number 7 8 8 Larger than 20% of capital base 0 0 0 15-20% of capital base 2 3 3 10-15% of capital base 5 5 5 Percentage of capital base 93.5 110.2 115.6 At the end of 2012, the distribution is 30 % on exposures in publicly run businesses and 63.5 % on other exposures. The BANK of Greenland wishes to maintain an appropriate distribution of its customers among various lines of business. Sector DKr 1,000 Public authorities 395,222 Farming, hunting and forestry and fishing 137,364 Industry and mining 17,161 Energy supply 39,758 Construction companies 368,357 Trade 383,400 Transportation, restaurant and hotel companies: Transportation 83,533 Restaurant and hotel companies 142,451 Total transportation, restaurant and hotel companies 225,984 Information and comminication 17,645 Finance and insurance companies 74,071 Real estate, total 521,530 Other commercial enterprises 67,319 Total commercial enterprises 1,844,589 Retail customers 1,758,344 Total 3,998,155 The distribution of loans, advances and guarantees amongst various lines of business must be seen in light of Greenland special geography where The BANK of Greenland has its main market. 5/19

OPJEKTIVES AND RISK POLICIES Value adjustment of loans The BANK of Greenland closely follows all its loans, advances and guarantees above a previously defined maximum on an individual basis. Other loans, advances and guarantees are monitored on a collective basis. However, when individual factors indicate an increased risk, these loans, advances and guarantees will also be evaluated individually. Loans and advances are written down individually or collectively. Individual write-downs are made when there is an objective indication that the ability to repay has deteriorated, thus resulting in a reduction in the expected future repayment. Individual write-downs are made and evaluated centrally in the bank s Credit Dept. Exposures with an objection indication of value deterioration amounted to DKr 112.5 m at the end of 2012. DKr 50.1 m of this amount has already been written down. Collective write-downs on credit risk groups for which no individual write-downs have yet been made, are calculated on the basis of a model developed by the Danish Association of Local Credit Institutions. The BANK of Greenland s historic loss has been included in this model. These write-downs amount to DKr 14.5 m. When an individual exposure has been written-down, the bank s funding practice is limited. A loan or advance is depreciated when its collateral has been realised and there is no longer a possibility of securing repayment. Partial depreciation is made when the exposure is wound up over a lengthy period. Interest is no longer calculated on loans when there is no longer any expectation of it being repaid. Collateral The majority of The BANK of Greenland s loans and advances have been secured by means of liens in real estate (private housing, office buildings, and other commercial property), in movable property (vehicles, operating equipment and the like), in fishing rights, in securities (shares, bonds and unit trusts), in cash deposited in banks, guarantees from other credit institutions or public authorities and by means of exposures in companies and sureties from the companies owners. Collateral is assessed prudently based on the principles behind a forced sale. When being assessed for a forced sale, any particular difficulties predicated on geography are taken into account. 6/19

OPJEKTIVES AND RISK POLICIES Market risk The bank s objective is to minimize the loss that can arise as a result of unpredictable developments on financial markets. Policy: The market risk at The BANK of Greenland is managed by means of fixed limits on a range of risks. Positions in shares and foreign currency are fixed by means of limits related to the bank s capital base. The bank s portfolio of shares at the end of 2012 amounted to DKr 101,789 m of which DKr 91,625 m was sector shares. Positions in interest claims must be restricted to a given interest risk of no more than 3 %. At the end of 2012 the interest risk amount to 1.2 %. The bank has outsourced the management of its portfolio of bonds to an external firm. This firm is subject to the risk framework on a half time frame. The BANK of Greenland has a limited position in foreign currency. Its risk on foreign currency at the end of 2012, measured by currency indicator 1, amounted to DKr 54,687 m, equivalent to 7.1 % of the core capital. Calculation and monitoring is done daily, and the Boards of Directors and Management receive reports regularly based on predetermined guidelines. Liquidity risk The BANK of Greenland s objective is to ensure sufficient and stable liquid contingency with a constant adequacy rate of 125 % of the limits stipulated in the statutes requirements. The BANK of Greenland operates with a minimum limit of 75 %. At the end of 2012, the bank s liquidity adequacy was 198.0 % of statutory requirements. Policy: The BANK of Greenland s liquidity contingency is managed by maintaining sufficient quantities of liquid funds, ultra-liquid securities, as well as its ability to close market positions and take advantage of lines and committed lines. The BANK of Greenland has a strong capital base and excesses of deposits. Despite these strengths, The BANK of Greenland has ensured its access to committed credit facilities with another credit institution. In 2010, The BANK of Greenland issued Danish government secured bonds for a total of DKr 400 m out of a potential DKr 1 billion. DKr 300 million worth of these bonds 7/19

OPJEKTIVES AND RISK POLICIES was held in the bank s own holdings until the second quarter of 2011, when the bank decided to redeem all DKr 300 m ahead of time. This decision was based on the bank s extremely strong liquidity and capital structure. In February 2012, the bank has redeemed the last DKr 100 m and has thus prematurely redeemed all of its Government guaranteed bonds. Calculation and monitoring are done daily, and the Boards of Directors and Management receive reports regularly based on predetermined guidelines. Operational risk The BANK of Greenland s objective is to ensure that operational risk is kept as low as possible in relation to the expense involved. Policy: The bank has established a set of policies and a contingency plan for physical disasters and IT breakdown. The bank s IT operations are run by Bankernes EDB Central (BEC) in Denmark. The bank follows the instructions and recommendations issued by BEC carefully. The bank does not develop its own IT systems. Internal procedures are based on written business procedures and work descriptions; checks are also made across the organization. The bank is constantly on the look-out for ways to outsource operations that have no significance for the bank s competitiveness. By the end of 2012, the bank had outsourced the following: Internal auditing Clearing Current accounts Foreign transfers Customers orders of securities Risk on base capital The BANK of Greenland has a strong capital base and a solvency ratio of 20.2%, at the end of 2012. At the end of 2011 the solvency ratio was 20.0%. Statements are calculated monthly, and the Boards of Directors and Management receive reports regularly according to a previously determined set of guidelines. 8/19

CAPITAL BASE Statement of the capital base at the end of 2012 in DKr 1,000. Core capital Share capital 180,000 Profit brought forward 650,287 Core capital after primary deduction 830,287 Other deductions 0 Half of the sum of capital shares, etc. > 10% 0 Core capital including hybrid capital after deductions 830,287 Supplementary capital 0 Reserves for write-ups 18,467 Base capital before deduction 848,754 Deductions in the core capital Half of the sum of capital shares, etc. > 10% 0 Capital base less deductions 848,754 Impact of shareholders equity from dividend comes to DKr 67,518 m. 9/19

SOLVENCY REQUIREMENT AND ADEQUATE CAPITAL BASE In accordance with current legislation, the Boards of Directors and Management determine individual solvency requirements. The setting of the solvency requirement is an ongoing discussion by the Boards of Directors and Management. These discussions are based on a memo containing proposals for the size of the solvency requirements, including proposals for choosing stress variables, stress levels, expected growth as well as other relevant risks factors. This memo is written by the chief accountant. At least once a year, the Board of Directors has extensive discussions about the method for calculating the bank s individual solvency requirements. These discussions include which risk areas and stress levels should be taken into account when calculating the solvency requirements. The BANK of Greenland has implemented a model for calculating the solvency requirements based on a template designed by Lokale Pengeinstitutter and the Danish Financial Supervisory Authority s Guidelines on adequate base capital and individual solvency needs for credit institutions. The management is of the opinion that, by using this model, the bank arrives at solvency requirements that are adequate for covering the bank s risks. In this model, capital is set aside for four areas of risk: credit risk, market risk, operational risk and other risks. The first part of the model contains a number of stress tests. These tests stress the individual accounting items by applying various variables. Variables that are stress-tested when determining solvency requirements: Capital for covering credit risk Write-downs on loans, etc. 4.27% (group 3-credit institutions) calculation of loans, advances and guarantees before writedowns and depreciation for loss on bad debt. Capital for coverage of market risk Share price fall Interest rise 30% but only 25% on shares, etc in sector companies. 1.35% in the trading book and 1,% outside the trading book. At the same time short-term interest rates ( less than one year) have changed by 0.7 percentage points in one direction and longterm interest rates (longer than one year) have changed by 0.7 percentage points in the opposite direction. Foreign currency risk 2.5% currency indicator 1 (Euro) 12% currency indicator 1 (other) Risk on derivates 8% of positive market value 10/19

SOLVENCY REQUIREMENT AND ADEQUATE CAPITAL BASE Capital for covering other risks General decrease in net interest payable 12% General decrease in net charges 17% payable Price drop on the bank s property 18% The management decides which risks The BANK of Greenland should be able to withstand, and thus which variables should be stress tested. To begin with, the stress tests are an attempt to subject The BANK of Greenland s accounts to a number of negative events in order to see how the bank would react in a given scenario. The result of the stress tests becomes part of the solvency requirement model in that it demonstrates that The BANK of Greenland must, as a minimum, hold capital that can cover the loss that would occur if the scenario in question were to happen. The aggregate effect of the stress tests on the solvency requirement is calculated by comparing the impact on the profit and loss account with the weighted items. The result is a measure of how much capital the bank would need to survive the resulting scenario. Apart from the areas of risk that are included in the stress test, there are a large number of areas of risk that The BANK of Greenland has found relevant to include in an evaluation of the solvency requirement. Other areas of risk that will be evaluated when determining the solvency requirement. Other capital for the coverage of credit risks Growth in loans and advances 100 largest exposures Customers with financial difficulties Geographical concentration Commercial concentration Concentration of collateral Undrawn credit facilities Private segmentation Mega-projects (Raw materials) Further capital for covering market risk Capital for operational risk Further capital for coverage of other risks 11/19

SOLVENCY REQUIREMENT AND ADEQUATE CAPITAL BASE Strategic risks Reputation risks Risks relating to the bank s size Property risks Raising of capital Liquidity risks Winding up risks Extreme risks associated with legislation and compliance Other recruitment, method risk The impact these areas have on the solvency requirement ratio is either calculated directly via supplementary calculations or determined when the management estimates their impact on the calculation of the solvency requirement. In the opinion of The BANK of Greenland, the risk factors included in the model are adequate for all the areas of risk required by current legislation. This legislation specifies which areas the bank s management is required to take into account when determining the solvency requirement as well as which risks the management finds The BANK of Greenland has undertaken. Furthermore, the Boards of Management and Directors must evaluate if the base capital is adequate to support coming activities. At The BANK of Greenland, this evaluation is part of the general determination of the solvency requirement. Therefore, at least once a year, the management evaluates how expectations for growth impact the calculation of solvency requirements. In concrete terms, this means that the management, in the model, has to estimate the future percentage of growth, the average solvency weighting of this growth and the margin of earnings after tax. Liquidity surplus at the end of 2012 Capital base after deduction 781,236 Adequate capital 351,731 Liquidity surplus in DKr 1,000 429,505 Solvency ratio 20.2% Solvency requirement 9.1% Liquidity surplus in percentage points 11.1% From 2013, the method of calculation for individual solvency requirements will change to the 8+ model. This calculation starts as an 8.0% base upon which supplements will be added, such as customers with financial problems. 12/19

SOLVENCY REQUIREMENT AND ADEQUATE CAPITAL BASE The BANK of Greenland's Calculated Capital and Solvency Requirements; Old and New Model DKr 1,000 Probability Model Credit Reserve Model (8+) Capital Requirement Solvency Requirement Capital Requirement Solvency Requirement Credit Risk 287,443 7.43 % Market Risk 40,897 1.06 % Operational Risk 48,022 1.24 % Other -24,631-0.64 % Ordinary Risk 309,665 8.00 % Special Credit Risk 49,656 1.29 % Operational risk 5,000 0.13 % Other 17,927 0.46 % Capital & Solvency Req. 351,731 9.09 % 382,248 9.88 % The new solvency rules are not yet valid in Greenland. However, the bank intends to follow them, and will calculate the solvency requirement both by using the Probability Model and the Credit Reserve Model, until the solvency rules are implemented in Greenland. 13/19

COUNTERPARTY RISK Counterparty risk - derivatives The BANK of Greenland employs the mark-to-market approach for counterparty risk in order to calculate the size and weighting of risk on derivatives. The mark-to-market approach is described below, and it follows the description found in appendix 16 of the Capital Adequacy Directive. The mark-to-market approach includes the market value of contracts with a positive market value and the principal of all the contracts in the capital adequacy directive. The market value of these contracts is included with weightings for these contracts maturity and with weightings for the contracts counterparties. Since The BANK of Greenland employs only derivatives for hedging open items on fixed interest loans, the positive market value of the derivatives has no impact on the determination of adequate capital base. When granting credit and when monitoring exposures, the bank takes a calculated exposure value into account in order to ensure that this value does not exceed the counterparty s granted credit maximum. The value of the bank s aggregate counterparty risk calculated according to the mark-to-market approach at the end of 2012 was DKr 17,148,000. 14/19

MARKET RISK Market risk Calculation of solvency risks within the area of market risk. Risk relating to the trading book in DKr 1,000 Weighted amounts: Ultimo 2012 Ultimo 2011 Instruments of debt 203,996 132,182 Shares, etc. 30,676 24,372 Collective investment trusts 36,648 33,100 Foreign currency positions 54,687 28,333 Total items with market risk 326,007 217,987 15/19

EXPOSURES IN SHARES, ETC. OUTSIDE THE TRADING BOOK Exposures in shares, etc. outside the trading book In concert with other credit institutions, The BANK of Greenland has acquired a number of shares in financial-sector companies. These companies exist to support the business of credit institutions within the areas of payment transfers, IT, pension, unit trusts, etc. The BANK of Greenland does not intend to sell these shares because participation in these sector companies is deemed necessary in order to run a local credit institution. These shares are therefore seen as being outside the trading book. In several of the sector companies, the shares are redistributed in such a way that the credit institutions share of ownership always reflects the individual institutions volume of business with the sector company. This redistribution is usually based on the sector company s equity. Based on the above, The BANK of Greenland adjusts the booked value of these shares every quarter, every half-year or every year, depending on the frequency of new information from the individual sector company. This ongoing adjustment is entered into the books in accordance with the rules governing the profit and loss account. In other sector companies, the shares are not redistributed, but are typically assessed at their price at the time of the most recent sale. Alternatively, their value is calculated on the basis of a recognized assessment method. Regulation of the booked value of these shares is also done via the profit and loss account. The bank s aggregate position in sector shares is DKr 91,625,000. Apart from the shares in sector companies, The BANK of Greenland owns unlisted shares in a few Greenlandic companies with whom the bank has entered into cooperative agreements. These shares are assessed at cost with a deduction of any write-downs. As with shares in the sector companies, the bank has no plans to sell these shares. The bank s aggregate position in these shares is DKr 1,947,000 16/19

EXPOSURE IN INTEREST RISK IN POSITIONS OUTSIDE THE TRADING BOOK Exposures in interest risk in positions outside the trading book. The bank s interest risk for exposures in positions outside the trading book consists of fixed interest assets, loans and claims on credit institutions and fixed-interest deposits. Deposits and debt to credit institutions. At the end of 2012, The BANK of Greenland has an interest risk on exposures in positions outside the trading book amounting + DKr 548,000. Interest risks are calculated daily. 17/19

CREDIT RISK Credit risk The accounting definitions of defaulted claims and impaired claims as well as a description of the approaches employed to determine value adjustments and write-downs can be found in the executive order on financial reports for credit institutions and stock broker companies, etc. 51-54. Weighted items containing credit, counterparty, dilution and delivery risk amount to a total of DKr 3,084,046,000 after write-downs. Impaired claims and write-downs by sector at the end of 2012 Impaired claims, individually Individual writedowns/provisions Loss for the year DKr 1,000 assessed for loss Public authorities 0 0 0 Farming, hunting and forestry and fishing 14,871 7,047 1,202 Industry and mining 0 0 0 Energy supply 0 0 0 Construction companies 11,909 4,691 1,384 Trade 12,672 4,941 8,685 Transportation, restaurant and hotel companies 9,336 1,655 0 Information and comminication 0 0 0 Finance and insurance companies 0 0 0 Real estate 5,523 1,566 0 Other commercial enterprises 10,658 3,512 0 Total commercial enterprises 64,969 23,412 11,271 Retail customers 47,576 26,678 4,934 Total 112,545 50,090 16,205 The collective write-downs, in total amounting to DKr 14,528,000, have not been included in the above statement of write-downs / provisions for loss. The accounting definitions of impaired claims can be found in the executive order on financial reports for credit institutions and stock broker companies, etc. 52, clause 3. 18/19

CREDIT RISK Movements of impaired claims resulting from value adjustments and write-downs at the end of 2012. 1.000 kr. Individual write-downs/provisions for loss Collective write-downs/provisions for loss Loans and advances Gurantee debtors Loans and advances Gurantee debtors Accumulated write-downs/provisions for loss at the start of the period on loans, advances and guarantee debtors 50,957 1,077 8,026 0 Movements during the year Write-downs/provisions for loss during the year 21,928 738 6.636 0 Reversal of write-downs/provisions made in prior accounting years where there is no longer objective indication of impairment or of a reduction of the impairment, 7,950 973 0 0 Other movements 154 0-134 0 Irreversibly lost (depreciated) previously individually written-down/provided for 15,841 0 0 0 Accumulated write-downs/provisions on loans and guarantee debtors at the end of the year 49,248 842 14,528 0 The sum of loans and guarantee debtors where individual write-downs/provisions (calculated before write-downs/provisions) have been made 102,940 9,605 3,005,779 879,831 19/19