Annual report 2008 Akciju sabiedrība Latvijas tirdzniecības banka 1
Content REPORT OF THE COUNCIL AND THE BOARD 3-4 MEMBERS OF THE COUNCIL AND THE BOARD 5 STATEMENT OF MANAGEMENT S RESPONSIBILITY 6 FINANCIAL STATEMENTS: INCOME STATEMENT 7 BALANCE SHEET 8 CASH FLOW STATEMENT 9 STATEMENT OF CHANGES IN SHAREHOLDERS EQUITY 10 NOTES TO THE FINANCIAL STATEMENTS 11-63 AUDITORS REPORT 64 Akciju sabiedrība Latvijas tirdzniecības banka Address: Grēcinieku iela 22 Riga, LV - 1050 Registration number: 4000 304 3232 2
Report of the council and the board The year 2008 has brought along global economic changes and significant recession of the Latvian economy at the end of the year. The crisis has produced a grave effect on the financial sector all over the world. However, owing to the conservative and sound business strategy pursued by the akciju sabiedrība LATVIJAS TIRDZNIECĪBAS BANKA (joint stock company) (hereinafter also the Bank ) consistently for years and its rigorous risk management policy, the financial performance of the Bank has remained at high level also in 2008. The Bank has fulfilled the tasks set by the shareholder, improved its services and operational processes and, therefore, the management of the Bank is delighted to present the results of the Bank s operations for 2008 to the shareholders, customers, and business partners. One of the strategic goals of the Bank is to ensure the balance between risks assumed and profits to minimise the potential negative effect the risks could produce on the Bank s financial position and performance. In formulating the short-term business continuity plans for 2008, the Bank s management considered a high probability of the crisis situation in the economy, and the strict cost saving policy was implemented in the second half of the year. The prudent business and planning policy has proved to be reasonable and enabled the Bank to keep relatively high profitability. The Bank has also maintained its usual high liquidity level. The Bank s profit after tax for the year 2008 amounts to LVL 8,152 thousand, which is a 5% increase from 2007. Return on equity (ROE) was 21.9%, while return on assets (ROA) was 1.4%. The Bank s assets as at the year end reached LVL 327,286 thousand, which represents a 40% decline year-on-year. Meanwhile, the average amount of assets has remained at the prior year level. Due to the global financial crisis, the business volume of our customers tumbled at the year end, which has lead also to a decrease of the customers account balances. In planning its business, the Bank has always taken in consideration the individual specifics of its customers businesses in the investment area and the related significant fluctuations of customer deposits. Being conscious of its responsibility for safeguarding the funds of its customers, the Bank has been choosing only highly liquid and safe assets. The critical drop of interest rates on financial markets to the minimal level ever possible has affected also the Bank s net interest margin. All these factors have impacted also on the Bank s efficiency. Key financial results and performance indicators for 2006 2008 (): 2008 2007 2006 Total assets 327,286 580,794 275,404 Shareholders equity 40,812 32,660 24,899 Profit before tax 9,561 9,130 7,245 Net profit after tax 8,152 7,760 6,163 Net operating income 11,589 11,008 8,786 Return on equity (%) 21.9 26.7 29.0 Return on assets (%) 1.4 1.9 2.3 Capital adequacy: 48% 16% 21% The activities of the akciju sabiedrība LATVIJAS TIRDZNIECĪBAS BANKA are closely linked with the development of MDM Bank (Open Joint Stock Company) (hereinafter also MDM Bank ), which is the sole shareholder of the Bank. 3
Report of the council and the board MDM Bank celebrated its 15 th anniversary at the end of 2008. As a result of dynamic development, MDM Bank has evolved into one of the largest banks in the Russian Federation in terms of equity and assets. MDM Bank is a universal and advanced credit institution focusing on the supply of banking services to corporate customers, investment services and financial services, as well as a wide range of banking services to individual customers. Its customer base includes a large number of major Russian enterprises. Three international rating agencies have granted MDM Bank highest credit ratings among privately owned Russian banks: Standard and Poor s (BB; negative), Fitch (BB, AA- rus, stable), and Moody s Investor Service (Ba1 NP/D+; stable), and it is the only financial institution in Russia that has been given a public corporate governance rating by Standard and Poor s. In December 2008, the shareholders of MDM Bank and URSA Bank, Open Joint Stock Company (hereinafter also URSA Bank ) announced their intention to combine their equity stakes into a holding company to create one of the leading private commercial banks in Russia. Two strong and highly reputable banks will merge as a result of the rigorous strategic analysis. This decision will provide both of these banks with an even stronger foundation from which to implement their long-term plans. MDM Bank and URSA Bank complement each other in terms of both business structure and geographical distribution, as the new combined institution will have an extensive and well-diversified liabilities base and more than 500 points of sale all over the territory of the Russian Federation. In the upcoming period, the Bank will continue operating within the scope of the parent bank s strategy, providing high-quality financial services to major groups of corporate customers, including business partners of MDM Bank and now also URSA Bank, as well as other customers operating in the Russian Federation and international financial and consumer markets. Global economic changes which have affected all markets and market players are a factor forcing entities to look for new ways and development mechanisms. Supported by the parent bank, the akciju sabiedrība LATVIJAS TIRDZNIECĪBAS BANKA intends to establish its regional presence in the European Union. In 2009, the Bank will be specifically focusing on the efficient management of capital and assets and risks on the whole, as well as the improvement of its operational processes. The profoundly respectful and trustworthy cooperation of the Bank s shareholders, business partners, customers, and employees that is the key factor behind the Bank s success, and for that reason observing their interests is one of the operational guidelines of the Bank. The management of the Bank would like to express their sincere gratitude to all the Bank s customers and partners for their understanding and successful cooperation in the reporting year and their deep appreciation to the Bank s staff for their professional and high-quality work. Chairman of the Council Vadim Sorokin Chairman of the Board Armands Šteinbergs 16 February 2009 4
Members of the council and the board As at the date of signing these financial statements, the Members of the Council of the Bank were as follows: Name Position Date of appointment Vadim Sorokin Chairman of the Council 16/12/2008 Tatiana Pupkova Deputy Chairman of the Council 16/12/2008 Konstantin Leonov Member of the Council 15/11/2007 During 2008, the following Members of the Council resigned: Name Position Date of Date of appointment resignation Nikita Monakhov Member of the Council 23/03/2005 05/09/2008 Andrey Ilin Chairman of the Council 23/03/2005 16/12/2008 Oleg Mashtalyar Deputy Chairman of the Council 05/09/2008 16/12/2008 On 5 September 2008, Nikita Monakhov resigned as Member of the Council. On 5 September 2008, the extraordinary shareholders meeting of the Bank appointed Oleg Mashtalyar as Member of the Council. The changes in the Bank s Council were registered with the Enterprise Registry of Latvia. On 16 December 2008, Andrey Ilin and Oleg Mashtalyar resigned as Members of the Council. On 16 December 2008, the extraordinary shareholders meeting of the Bank appointed Vadim Sorokin and Tatiana Pupkova as Members of the Council. The changes in the Bank s Council were registered with the Enterprise Registry of Latvia. As at the date of signing these financial statements, the Members of the Board of the Bank were as follows: Name Position Date of appointment Armands Šteinbergs Chairman of the Board 25/09/2000 Inna Harčenko Member of the Board, Proctor 23/12/2005 Valda Knauere Member of the Board 06/11/2000 On 26 January 2009, Inna Harčenko was re-appointed as Member of the Board, which was registered with the Enterprise Registry of Latvia. 5
Statement of management s responsibility The management of the akciju sabiedrība Latvijas tirdzniecības banka (hereinafter also referred to as the Bank) are responsible for the preparation of the financial statements of the Bank. The financial statements have been prepared in accordance with International Financial Reporting Standards as adopted in the European Union and comply with legislative requirements of the Republic of Latvia. The financial statements on pages 7 to 61 are prepared based on source documents and present fairly the financial position of the Bank as at 31 December 2008 and the results of its operations, changes in shareholders equity and cash flows for the year ended 31 December 2008. The aforementioned financial statements are prepared on a going concern basis, consistently applying accounting policies in conformity with International Financial Reporting Standards as adopted in the European Union. Prudent and reasonable judgments and estimates have been made by the management in the preparation of the financial statements. The management of the akciju sabiedrība Latvijas tirdzniecības banka are responsible for the maintenance of a proper accounting system, safeguarding of the Bank s assets, and prevention and detection of fraud and other irregularities. They are also responsible for operating the Bank in compliance with the Law on Credit Institutions, regulations of the Financial and Capital Market Commission and the Bank of Latvia, and other laws of the Republic of Latvia applicable to credit institutions. For the Bank s management, Chairman of the Board Armands Šteinbergs Member of the Board, Proctor Inna Harčenko 16 February 2009 6
Income statement Notes 2008 2007 Interest revenue 5 12,500 15,884 Interest expense 6 (5,298) (9,282) Net interest revenue 7,202 6,602 Commission and fee revenue 7 702 922 Commission and fee expense 8 (112) (147) Net commission and fee revenue 590 775 Net (loss) / gain on financial assets and liabilities held for trading 9 (25) 19 Net foreign exchange gain 10 3,816 3,606 Other income 6 6 Net operating income 11,589 11,008 Administrative expense 11 (1,763) (1,587) Depreciation and amortisation 21,22 (94) (113) Other expense 12 (172) (177) Net impairment loss on financial assets 13 1 (1) Profit before income tax 9,561 9,130 Corporate income tax 14 (1,409) (1,370) Profit for the reporting year 8,152 7,760 Profit attributable to equity holders of the parent 8,152 7,760 The accompanying notes on pages 11 to 61 form an integral part of these financial statements. 7
Balance sheet Notes 31/12/2008 31/12/2007 ASSETS Cash and demand deposits with central banks 15 26,666 32,999 Due on demand from credit institutions 16 237,914 539,991 Financial assets held for trading 17-25 Loans and receivables: 62,084 7,347 Term deposits due from credit institutions 18 61,907 7,275 Loans to customers 19 177 72 Available-for-sale financial assets: 20 9 9 Shares and other non-fixed income securities 9 9 Intangible assets 21 50 72 Property, plant and equipment 22 188 215 Prepaid expense and accrued income 23 68 56 Tax assets: 24 133 - Current tax assets 124 - Deferred tax assets 14 9 - Other assets 25 174 80 Total assets 327,286 580,794 LIABILITIES Due on demand to credit institutions 26 38 100 Financial liabilities carried at amortised cost: 285,988 547,405 Balances due to credit institutions 27-582 Deposits from customers 28 285,988 546,823 Deferred income and accrued expense 29 244 266 Provisions 30 144 76 Tax liabilities: 31 2 203 Current tax liabilities 2 193 Deferred tax liabilities 14-10 Other liabilities 32 58 84 Total liabilities 286,474 548,134 SHAREHOLDERS EQUITY Paid-in share capital 33 8,200 8,200 Share premium 4,470 4,470 Reserve capital and other reserves 1 1 Revaluation reserves 1 1 Retained earnings 19,988 12,228 Profit for the reporting year 8,152 7,760 Total equity attributable to equity holders of the parent 40,812 32,660 Total shareholders equity 40,812 32,660 Total liabilities and shareholders equity 327,286 580,794 The accompanying notes on pages 11 to 61 form an integral part of these financial statements. 8
Cash flow statement Notes 2008 2007 OPERATING ACTIVITIES Profit before tax 9,561 9,130 Depreciation and amortisation 94 113 Change in impairment allowances (1) 1 Net increase/ (decrease) in provisions for liabilities 68 (52) Unrealised foreign exchange (gain)/ loss (157) 21 Unrealised (gain)/ loss on financial assets and liabilities held for trading 25 (19) Net cash flow from operating activities before changes in assets and liabilities 9,590 9,194 (Increase) in balances due from credit institutions - (1) (Increase)/ decrease in loans to customers (105) 8 (Increase) in prepaid expense and accrued income (11) (5) Decrease in other assets 40 178 (Decrease)/ increase in deposits from other customers (260,835) 299,375 (Decrease)/ increase in deferred income and accrued expense (22) 106 (Decrease) in other liabilities (13) (230) Net cash flow from operating activities before tax (251,356) 308,625 Corporate income tax paid (1,733) (1,468) Net cash flow from operating activities (253,089) 307,157 INVESTING ACTIVITIES Acquisition of property, plant and equipment and intangible assets (45) (105) Net cash flow from investing activities (45) (105) Net cash flow (253,134) 307,052 Cash and cash equivalents at the beginning of the year 579,572 272,520 Cash and cash equivalents at the end of the year 34 326,438 579,572 OPERATIONAL CASH FLOWS FROM INTEREST Interest paid (6,377) (9,143) Interest received 13,362 15,365 There were no dividends paid or received during the years 2008 and 2007. The accompanying notes on pages 11 to 61 form an integral part of these financial statements. 9
Statement of changes in shareholders equity Paid-in Share Reserves Revalua- Retained Total share premium tion earnings capital reserves As at 31 December 2006 8,200 4,470 1-12,228 24,899 Profit for the reporting year - - - - 7,760 7,760 Revaluation of available-for-sale financial assets - - - 1-1 As at 31 December 2007 8,200 4,470 1 1 19,988 32,660 Profit for the reporting year - - - - 8,152 8,152 As at 31 December 2008 8,200 4,470 1 1 28,140 40,812 Reserve capital comprises the remaining portion of the statutory reserves made in the previous years from the year end profit. As at 31 December 2008 and 2007 there was no legislative requirement for creation such a reserve. Revaluation reserves comprises changes in fair value of available-for-sale equity instruments. The accompanying notes on pages 11 to 61 form an integral part of these financial statements. 10
Notes to the financial statements 1. GENERAL INFORMATION Information on the Bank The Bank was established in the Republic of Latvia on 6 December 1991 as a closed joint stock company. The Bank operates under a banking license issued by the Financial and Capital Market Commission according to which the Bank is allowed to conduct all financial services without any restrictions. The principal activities of the Bank involve local and international money transfers, trade financing, trust operations, granting loans to private individuals and corporate customers, foreign exchange transactions on behalf of customers and safeguarding services (individual depositories). Legislation regulating the Bank s operations The Bank s operations are governed by the Law of the Republic of Latvia on Credit Institutions, the Commercial Law, other laws of the Republic of Latvia, and regulations issued by the Financial and Capital Market Commission. The above regulations govern capital adequacy, minimum equity, liquidity, foreign exchange positions, exposure restrictions with respect to one counterparty, a group of related customers, and related parties of the Bank, as well as other applicable requirements. Authorisation of financial statements According to the requirements of the legislation of the Republic of Latvia, on 16 February 2009, the Board of the Bank examined the Bank s financial statements for the year ended 31 December 2008 and submitted them to the Council and the auditor of the Bank for reviewing. The Council reviews the financial statements submitted by the Board and prepares a written report hereon. The financial statements are confirmed by the shareholders meeting convened by the Board after both the auditors and the Council s reports have been received. 2. ACCOUNTING POLICIES (1) Statement of compliance The financial statements of the Bank have been prepared in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union (EU) and as issued by International Accounting Standard Board (IASB) and Interpretations issued by the International Financial Reporting Interpretations Committee (IFRICs), and regulations of the Financial and Capital Market Commission s Regulations on the preparation of annual reports and annual consolidated accounts for banks, investment brokerage firms and investment management companies in force as at the balance sheet date. (2) Basis of preparation The accounting system of the Bank is organised in accordance with the legislation of the Republic of Latvia, including requirements applicable to credit institutions operating in Latvia. The financial year of the Bank coincides with the calendar year. The financial statements have been prepared on a historical cost basis for assets and liabilities except for derivatives carried at fair value, financial assets and liabilities designated at fair value through profit or loss, and available-for-sale assets whose fair value can be reliably estimated. Other financial assets and liabilities and non-financial assets and liabilities are carried at amortised cost using the effective interest rate method. The financial statements have been prepared using accounting principles consistent with those used in the prior year. The accompanying financial statements are reported in thousands of lats (), which is the functional and presentation currency of the Bank. Figures in brackets contained in the comments to the notes to the financial statements represent figures as at 31 December 2007, unless otherwise stated. 11
2. ACCOUNTING POLICIES (CONT D) (3) Use of significant accounting estimates and judgments The preparation of financial statements in conformity with IFRSs requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the 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 of making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates. The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognised 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. The significant areas of estimation and assumptions relate to depreciation and amortisation rates of tangible fixed assets and intangible fixed assets, determining the allowance for credit losses and the fair value of financial assets and liabilities. (4) Foreign currency Transactions denominated in foreign currencies are recorded in lats at the exchange rate set by the Bank of Latvia on the transaction date. Currency exchange differences arising from foreign currency transactions are charged to the income statement on the transaction date. All monetary assets and liabilities, including off-balance-sheet assets and liabilities denominated in foreign currencies are translated into lats in accordance with the exchange rate set by the Bank of Latvia on the last date of the reporting period. Currency exchange differences arising due to changes in exchange rates are charged to the income statement as incurred, except for differences arising from revaluation of available-for-sale equity instruments which are recognised in the shareholders equity. Non-monetary assets and liabilities denominated in foreign currencies that are measured at fair value or cost are translated at the exchange rate at the date when the fair value or cost is determined. Foreign exchange rates for the key currencies at the end of the reporting period were the following (LVL vs. one unit of foreign currency): Reporting date USD EUR RUB 31 December 2008 0.495000 0.702804 0.017100 31 December 2007 0.484000 0.702804 0.019700 (5) Revenue and expense recognition All revenue and expense categories, including interest revenue and expense, are recognised on an accrual basis. Revenue is recognised only to the extent that an inflow of economic benefits to the Bank is possible and such revenue is reasonably estimable. Impairment loss is recognised if the receipt of revenue becomes doubtful. Interest revenue and expense are recognised in the income statement using the effective interest rate method. Payments made by the Bank to the deposit guarantee fund are disclosed under other interest expense. Commission and fee revenue and expense on non-recurring services are recognised on the transaction date on an accrual basis. Commission and fee revenue and expense on services provided or received in a certain period of time are accrued and charged to the income statement over the period of the respective agreement. 12
2. ACCOUNTING POLICIES (CONT D) (6) Financial instruments Initial recognition Financial instruments are recognised when the Bank becomes a party to the contractual provisions of the instrument. All regular way purchases and sales of financial assets are recognised in the balance sheet on the settlement date representing the date when the financial asset is delivered. In the period between the dates of transaction and settlement, the Bank accounts for the changes in the fair value of the received or transferred asset based on the same principles as used for any other acquired asset of the respective category. Financial liabilities are recognised, where the substance of the contractual arrangement results in the Bank having an obligation either to deliver cash or another financial asset to the holder, or to satisfy the obligation other than by the exchange of own shares for a fixed amount of cash or another financial asset. Derecognition Financial assets are derecognised when the rights to receive cash flows from the financial asset have expired or where the Bank has transferred substantially all the risks and rewards of ownership. Financial liabilities are derecognised when the obligation is discharged, or cancelled or expires. Classification Upon initial recognition, all financial instruments are classified into one of the following categories: Financial assets and liabilities designated at fair value through profit or loss are: Held-for-trading financial instruments; and Financial assets and liabilities designated at fair value through profit or loss upon initial recognition. A financial instrument is classified as held for trading if it is acquired or incurred principally for the purposes of selling or repurchasing in the near term or 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. Derivatives are also categorised as held for trading unless they are designated as hedging instruments for hedge accounting purposes. The financial instrument may be designated at fair value through profit or loss when: Doing so significantly reduces measurement inconsistencies that would arise if the related derivatives were treated as held for trading and the underlying financial instruments were carried at amortised cost; Certain assets are managed and evaluated on a fair value basis in accordance with a documented risk management or investment strategy and reported to key management personnel on that basis; Financial instruments containing one or more embedded derivatives that significantly modify the cash flow are designated at fair value through profit or loss. Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturity with respect to which the Bank has the positive intention and ability to hold them to maturity. Held-to-maturity investments include certain debt securities. 13
2. ACCOUNTING POLICIES (CONT D) Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market, other than: Those that the Bank intends to sell immediately or in the short-term; Those that the Bank upon initial recognition designates as at fair value through profit or loss or as available-for-sale; Those for which the holder may not recover substantially all of its initial investments, other than because of credit deterioration. Loans and receivables include term deposits due from credit institutions, loans and receivables from customers, and other financial assets which meet these classification criteria. Available-for-sale financial assets are financial assets classified at inception as available-for-sale or assets other than classified as held-for-trading, held-tomaturity, or loans and receivables. Available-for-sale assets include short-term investments and certain debt and equity securities. Generally, this category is assigned by the Bank to financial assets that are held for an indeterminate period of time and may be sold based on liquidity or interest rate needs, or as a result of changes in exchange rates and share prices. Financial liabilities carried at amortised cost represent financial liabilities of the Bank other than financial liabilities designated at fair value through profit or loss. This category includes term balances due to credit institutions, customer deposits, and other financial liabilities corresponding to such a classification. Measurement Financial instruments are measured initially at fair value plus any directly attributable transaction costs except for financial instruments at fair value through profit or loss. Subsequent to initial recognition, all financial assets and liabilities designated at fair value through profit or loss and all available-for-sale financial assets are measured at fair value except those equity instruments for which no reliable fair value measurement is possible. In this case, such instruments are carried at cost less transaction expenses and impairment loss. All financial liabilities other than financial liabilities designated at fair value through profit or loss are measured at amortised cost using the effective interest rate method. Profit or loss arising from changes to the fair value of financial assets and liabilities designated at fair value through profit or loss are recognised in the income statement. Differences arising from changes to the fair value of availablefor-sale financial instruments are recognised through equity. 14
2. ACCOUNTING POLICIES (CONT D) (7) Impairment losses Financial assets carried at amortised cost The Bank assesses at each balance sheet date whether there is any objective evidence that a financial asset or a group of financial assets is impaired. A financial asset or a group of financial assets is impaired and impairment losses are incurred if there is objective evidence of impairment as a result of one or more loss events that occurred after the initial recognition and that event has an impact on the estimated future cash flows that can be reliably estimated. The criteria that the Bank uses to determine that there is objective evidence of an impairment loss include: Delinquency in contractual payments of principal and/or interest; Cash flow difficulties experienced by the borrower; Breach of the loan covenant or conditions; Initiation of bankruptcy proceedings; Deterioration of the borrower s competitive position; Deterioration in the value of collateral; and Downgrading below investment grade level. The Bank first assesses whether objective evidence of impairment exists individually for financial assets that are individually significant, and individually or collectively for those that are not individually significant. If no objective evidence of impairment is determined for individual assets, whether significant or not, the impairment is tested collectively for groups of assets with similar credit characteristics, excluding assets for which an impairment loss is or continues to be recognised on an individual basis. For the purposes of the collective evaluation of impairment, financial assets are grouped on the basis of the similar credit risk characteristics considering assets type, any asset concentrations, industry, geographical location, collateral type, external agencies ratings, past-due status and other relevant factors. Those characteristics are relevant to the estimation of future cash flows for groups of such assets being indicative of the debtor s ability to pay all amounts due according to the contractual terms of the assets being evaluated. 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 effect of current conditions and to remove the effect of conditions in the historical period that do not currently exist. Estimates of the changes in future cash flows for groups of assets should reflect and be directionally consistent with changes in related observable data from period to period such as changes in unemployment rates, property prices, payment status, or other factors indicative of changes in the probability of loses and their magnitude. The methodology and assumptions used for estimating future cash flows are reviewed regularly to reduce any differences between loss estimates and actual loss experience. The amount of the loss is measured as a difference between the asset s carrying amount and its recoverable amount. The carrying amount of the asset is reduced through the use of the allowance account and the amount of the loss is recognised in the income statement. When an asset is uncollectible, it is written off against the related allowances. Recovered amounts are disclosed in the income statement as a reduction in the allowance for bad debts. 15
2. ACCOUNTING POLICIES (CONT D) Available-for-sale financial assets The Bank assesses at each balance sheet date whether there is any objective evidence that a financial asset or a group of financial assets is impaired. In the case of equity investments classified as available-for-sale, objective evidence would include a significant or prolonged decline in the fair value of the investment below its cost. The Bank esteems more than 20% decline below cost as significant and a decline for more than one yearly accounting period as prolonged. If any such evidence exists, the cumulative loss measured as the difference between the acquisition cost and the current fair value, less any impairment loss previously recognised in profit or loss is reclassified from equity and recognised in the income statement. Impairment losses recognised in the income statement on equity instruments are not reversed through the income statement. If, in a subsequent period, the fair value of a debt instrument increases and the increase can be objectively related to the event occurring after the impairment loss was recognised in profit or loss, the impairment loss is reversed through the income statement. Other assets The book value of other Bank s assets other than a deferred tax asset is reviewed for impairment on each balance sheet date. If impairment indications exist, the recoverable amount of the asset is calculated. An impairment loss is recognised whenever the carrying amount of an asset exceeds its recoverable amount. All impairment losses are recognised in the income statement. (8) Calculation of the recoverable amount The recoverable amount of financial assets carried at amortised cost and at cost is calculated as the present value of future cash flows including amounts that may be recovered from guarantees and loan securities, discounted at the original effective interest rate. The recoverable amount of financial assets and liabilities designated at fair value through profit or loss, and available-for-sale assets is their fair value. The recoverable amount of other assets is the larger of the fair value less cost to sell and the value in use. In assessing the value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. The recoverable amount is determined for an individual asset, unless the asset does not generate cash inflows that are largely independent of those from other assets or groups of assets. If this is the case, the recoverable amount is determined for the cash-generating unit to which the asset belongs. A cash-generating unit is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. If applicable, it s determination is a subject for Management judgement by considering various factors including how the Bank monitors its everyday operations (such as by product lines, businesses, individual locations, districts or regional areas) or how the Management makes decisions about continuing or disposing of the Bank s assets and operations. 16
2. ACCOUNTING POLICIES (CONT D) (9) Property, plant and equipment Property, plant and equipment are stated at acquisition cost including direct costs, net of accumulated depreciation. Depreciation is calculated on a straightline basis. Annual depreciation rates are determined based on the useful life of the respective category of property, plant and equipment. In 2008, the Bank revised the depreciation rates as follows: Old rate New rate Furniture and equipment 10 33% 10 50% Computers and equipment 20 25% 25% OEM software 20% 25% The new depreciation rates took effect on 8 September 2008 and apply only to those assets which have been acquired after the effectiveness of such new rates. Assets acquired prior to that date will be depreciated according to the old rates until the assets are derecognised. In 2008, the Bank did not acquire any assets to which the new depreciation rates would be applied. Leasehold improvements are capitalised and depreciated over the remaining lease period on a straight-line basis. Leasehold improvements are not depreciated as long as the respective assets are not completed. An item of property, plant and equipment is derecognised upon disposal or when the asset is no longer in use and no future economic benefits are expected to arise from the continued use of the asset. Any gain or loss arising on derecognition of the asset calculated as the difference between the net disposal proceeds and the carrying amount of the item upon disposal is included in the income statement. Depreciation methods, useful lives, and residual values are reviewed annually. (10) Intangible assets Intangible assets are identifiable non-monetary assets without physical substance (licences and software that are separately identifiable from electronic devices, etc.) held for rendering of services or other purposes if it is expected that an economic benefit attributable to these assets will flow to the Bank. Intangible assets are stated at cost less accumulated amortisation and are amortised by equal charges to the income statement over the useful life of the asset. The useful life of each intangible asset is estimated on an individual basis, considering the contractual conditions, and/or based on the estimated period over which the asset is expected to generate economic benefits. When the useful life of the asset is not provided in the respective ageement or if the asset has an indefinite useful life, the Bank regards that the asset has the useful life of 5 (five) years, which is equal to the annual amortisation rate of 20%. The amortisation rates as per class of intangible assets are as follows: Software other than OEM 20% Mastercard licence 10% Other licences 20% Licences acquired by the Bank for a period up to one year are expensed as acquired. 17
2. ACCOUNTING POLICIES (CONT D) (11) Leased assets and lease payments Leases where the Bank assumes substantially all the risks and rewards of ownership are classified as finance leases. Upon initial recognition, the leased asset is measured at the lower of fair value and the present value of the minimum lease payments. Subsequent to initial recognition, the asset is accounted for in accordance with the accounting policy applicable to that asset. Other leases are operating leases and leased assets, except for investment properties, are not recognised on the Bank s balance sheet. Minimum lease payments under finance leases are apportioned between the finance charges and the reduction of the outstanding liability. Finance charges are allocated to each period during the lease period so as to produce a constant periodic rate of interest on the remaining balance of the liability. Payments under operating leases are recognised in profit or loss on a straight-line basis over the term of the lease. Lease incentives received are recognised as an integral part of the total lease expense, over the term of the lease. (12) Trust operations The trust operations policy of the Bank sets forth the general guidelines on organisation and execution of trust operations, their control and monitoring. The Bank s policy for trust operations is reviewed annually. The Bank provides trust services only to customers of the Bank. Trust operations are accounted for separately from the Bank s own accounting system thus ensuring separate accounting in a separate trust balance sheet for assets of each customer, by customer and by type of assets under management. The Bank accepts no risk for its trust operations; all risk is retained by its customers. The Bank earns fee revenue for administration of trust operations. (13) Corporate income tax Corporate income tax comprises current and deferred tax. In accordance with Latvian tax regulations, corporate income tax is applied at the rate of 15% on taxable income generated by the Bank during the taxation period. Deferred tax arising from temporary differences in the timing of the recognition of items in the tax returns and these financial statements is assessed using the balance sheet liability method. The amount of deferred tax recognised is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities using tax rates enacted or substantively enacted by the balance sheet date. The principal temporary differences arise from differing rates and methods used for accounting and tax depreciation on property, plant and equipment, accruals and collective impairment loss. Deferred tax assets are only recognised to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilised. (14) Provisions Provisions are recognised when the Bank has a present obligation (legal or constructive) as a result of a past event, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation. If the effect is material, provisions are determined by discounting the expected future cash flows at pre-tax rate that reflects current market assessments of the time value of money and, where appropriate, the risks specific to the liability. The provision for employee holiday pay is calculated for each Bank employee based on the total number of vacation days earned but not taken, multiplied by the average daily remuneration expense for the preceding six months, to which the relevant social security expense is added. 18
2. ACCOUNTING POLICIES (CONT D) (15) Cash and cash equivalents Cash and cash equivalents include cash on hand, balances due on demand and with the remaining maturities of up to three months from the Bank of Latvia and other credit institutions, less amounts due on demand and with the remaining maturities of up to three months to the Bank of Latvia and other credit institutions. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amount of cash and which are subject to an insignificant risk of changes in value. (16) Adoption of new and/or changed IFRSs and IFRIC interpretations Standards issued and adopted by the Bank The Bank has adopted the following new and amended IFRS and IFRIC interpretations during the year: - Amendments to IAS 39 Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures Reclassification of Financial Assets; - IFRIC 11 IFRS 2 Group and Treasury Share Transactions. - IFRIC 12 Service Concession Arrangements. - IFRIC 13 Customer Loyalty Programmes. - IFRIC 14 IAS 19 The Limit on a Defined Benefit Asset, Minimum Funding Re quirements and their Interaction. - IFRIC 16 Hedges of a Net Investment in a Foreign Operation. The principal effects of these changes are as follows: Amendments to IAS 39 and IFRS 7 Reclassification of Financial Assets Through these amendments the IASB implemented additional options for reclassification of certain financial instruments categorised as held-for-trading or available-for-sale under specified circumstances. Related disclosures were added to IFRS 7. The Bank did not reclassify financial instruments based on these amendments. IFRIC 11 IFRS 2 Group and Treasury Share Transactions The interpretation provides guidance on classification of transactions as equity-settled or as cash-settled and also gives guidance on how to account for share-based payment arrangements that involve two or more entities within the same group in the individual financial statements of each group entity. The Bank has not issued instruments caught by this interpretation. IFRIC 12 Service Concession Arrangements. This interpretation applies to service concession operators and explains how to account for the obligations undertaken and rights received in service concession arrangements. No party of the Bank is an operator and, therefore, this interpretation has no impact on the Bank. IFRIC 13 Customer Loyalty Programmes. This interpretation requires customer loyalty award credits to be accounted for as a separate component of the sales transaction in which they are granted and therefore part of the fair value of the consideration received is allocated to the award credit and deferred over the period that the award credit is fulfilled. The Bank does not maintain customer loyalty programmes, therefore, this interpretation will have no impact on the financial position or performance of the Bank. 19
2. ACCOUNTING POLICIES (CONT D) IFRIC 14 IAS 19 The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction. This interpretation specifies the conditions for recognising a net asset for a defined benefit pension plan. The Bank does not have defined benefit plans, therefore, the interpretation has no impact on the financial position or performance of the Bank. IFRIC 16 Hedges of a Net Investment in a Foreign Operation The interpretation provides guidance on the accounting for a hedge of a net investment in a foreign operation. IFRIC 16 will not have an impact on the financial statements because the Bank does not have investments in foreign operations. Standards issued but not yet effective The Bank has not applied the following IFRSs and IFRIC Interpretations that have been issued but are not yet effective: - Amendment to IAS 1 Presentation of Financial Statements. - Amendments to IFRS 1 First-time Adoption of International Financial Reporting Standards and IAS 27 Consolidated and Separate Financial Statements. - Amendments to IFRS 3 Business Combinations and IAS 27 Consolidated and Separate Financial Statements. - Amendment to IFRS 2 Share-based Payment. - IFRS 8 Operating Segments. - Amendment to IAS 23 Borrowing Costs. - Amendments to IAS 32 Financial Instruments: Presentation and IAS 1 Presentation of Financial Statements Puttable Financial Instruments and Obligations Arising on Liquidation. - IFRIC 15 Agreement for the Construction of Real Estate. - IFRIC 17 Distributions of Non-cash Assets to Owners. The principal effects of these changes are as follows: Amendment to IAS 1 Presentation of Financial Statements (effective for financial years beginning on or after 1 January 2009). This amendment introduces a number of changes, including introduction of a new terminology, revised presentation of equity transactions and introduction of a new statement of comprehensive income as well as amended requirements related to the presentation of the financial statements when they are restated retrospectively. The Bank is still evaluating whether it will present all items of recognised income and expense in one single statement or in two linked statements. Amendments to IFRS 1 First-time Adoption of International Financial Reporting Standards and IAS 27 Consolidated and Separate Financial Statements (effective for financial years beginning on or after 1 January 2009 once adopted by the EU). The amendment to IFRS 1 allows an entity to determine the cost of investments in subsidiaries, jointly controlled entities or associates in its opening IFRS financial statements in accordance with IAS 27 or using a deemed cost. The amendment to IAS 27 requires all dividends from a subsidiary, jointly controlled entity or associate to be recognised in the income statement in the separate financial statements. Given the intentions of the Bank as of 31 December 2008, the new requirements will not affect the financial statements of the Bank. Though the new requirement could affect the financial statements of the Bank, if the Bank makes decisions on new subsidiaries and prepares consolidated financial statements. 20
2. ACCOUNTING POLICIES (CONT D) Besides, a new version of IFRS 1 was issued in November 2008. It retains the substance of the previous version, but within a changed structure and replaces the previous version of IFRS 1 (effective for financial years beginning on or after 1 July 2009 once adopted by the EU). Amendments to IFRS 3 Business Combinations and IAS 27 Consolidated and Separate Financial Statements (effective for financial years beginning on or after 1 July 2009 once adopted by the EU). Revised IFRS 3 (IFRS 3R) introduces a number of changes in the accounting for business combinations that will impact the amount of goodwill recognised, the reported results in the period that an acquisition occurs, and future reported results. IAS 27R requires that a change in the ownership interest of a subsidiary (without loss of control) is accounted for as an equity transaction. Therefore, such transactions will no longer give rise to goodwill, nor will it give rise to a gain or loss. Furthermore, the amended standard changes the accounting for losses incurred by the subsidiary as well as the loss of control of a subsidiary. Other consequential amendments were made to IAS 7 Statement of Cash Flows, IAS 12 Income Taxes, IAS 21 The Effects of Changes in Foreign Exchange Rates, IAS 28 Investment in Associates and IAS 31 Interests in Joint Ventures. The Bank will adopt revised requirements on a first-time adoption basis, if the Bank makes decisions on new subsidiaries and prepares consolidated financial statements. Otherwise there will not be any impact on the financial statements of the Bank. Other amendments to IFRSs and IFRIC Interpretations that have been issued but are not yet effective are not relevant to the Bank. Improvements to IFRSs In May 2008 IASB issued its first omnibus of amendments to its standards, primarily with a view to removing inconsistencies and clarifying wording. There are separate transitional provisions for each standard; most of the changes are effective for financial years beginning on or after 1 January 2009. The Bank anticipates that these amendments to standards will have no material effect on the financial statements, whether relevant. IFRS 7 Financial Instruments: Disclosures. Removal of the reference to total interest revenue as a component of finance costs. IAS 1 Presentation of Financial Statements. Assets and liabilities classified as held for trading in accordance with IAS 39 are not automatically classified as current in the balance sheet. IAS 8 Accounting Policies, Change in Accounting Estimates and Errors. Clarification that only implementation guidance that is an integral part of an IFRS is mandatory when selecting accounting policies. IAS 10 Events after the Reporting Period. Clarification that dividends declared after the end of the reporting period are not obligations. IAS 16 Property, Plant and Equipment. Items of property, plant and equipment held for rental that are routinely sold in the ordinary course of business after rental, are transferred to inventory when rental ceases and they are held for sale. Also, replaced the term net selling price with fair value less costs to sell. IAS 18 Revenue. Replacement of the term direct costs with transaction costs as defined in IAS 39. IAS 19 Employee Benefits. Revised the definition of past service costs, return on plan assets and short term and other long-term employee benefits. Amendments to plans that result in a reduction in benefits related to future services are accounted for as curtailment. IAS 20 Accounting for Government Grants and Disclosures of Government Assistance. Loans granted in the future with no or low interest rates will not be exempt from the requirement to impute interest. The difference between the amount received and the discounted amount is accounted for as government grant. Also, revised various terms used to be consistent with other IFRS. 21
2. ACCOUNTING POLICIES (CONT D) IAS 23 Borrowing Costs. The definition of borrowing costs is revised to consolidate the two types of items that are considered components of borrowing costs into one the interest expense calculated using the effective interest rate method calculated in accordance with IAS 39. IAS 27 Consolidated and Separate Financial Statements. When a parent entity accounts for a subsidiary at fair value in accordance with IAS 39 in its separate financial statements, this treatment continues when the subsidiary is subsequently classified as held for sale. IAS 28 Investment in Associates. If an associate is accounted for at fair value in accordance with IAS 39, only the requirement of IAS 28 to disclose the nature and extent of any significant restrictions on the ability of the associate to transfer funds to the entity in the form of cash or repayment of loans applies. In addition, an investment in an associate is a single asset for the purpose of conducting the impairment test. Therefore, any impairment is not separately allocated to the goodwill included in the investment balance. IAS 29 Financial Reporting in Hyperinflationary Economies. Revised the reference to the exception to measure assets and liabilities at historical cost, such that it notes property, plant and equipment as being an example, rather than implying that it is a definitive list. Also, revised various terms used to be consistent with other IFRS. IAS 31 Interest in Joint ventures: If a joint venture is accounted for at fair value, in accordance with IAS 39, only the requirements of IAS 31 to disclose the commitments of the venturer and the joint venture, as well as summary financial information about the assets, liabilities, income and expense will apply. IAS 34 Interim Financial Reporting. Earnings per share is disclosed in interim financial reports if an entity is within the scope of IAS 33. IAS 36 Impairment of Assets. When discounted cash flows are used to estimate fair value less cost to sell additional disclosure is required about the discount rate, consistent with disclosures required when the discounted cash flows are used to estimate value in use. IAS 38 Intangible Assets. Expenditure on advertising and promotional activities is recognised as an expense when the entity either has the right to access the goods or has received the service. The reference to there being rarely, if ever, persuasive evidence to support an amortisation method of intangible assets other than a straight-line method has been removed. IAS 39 Financial Instruments: Recognition and Measurement. Changes in circumstances relating to derivatives are not reclassifications and therefore may be either removed from, or included in, the fair value through profit or loss classification after initial recognition. Removed the reference in IAS 39 to a segment when determining whether an instrument qualifies as a hedge. Require the use of the revised effective interest rate when remeasuring a debt instrument on the cessation of fair value hedge accounting. IAS 40 Investment Property. Revision of the scope such that property under construction or development for future use as an investment property is classified as investment property. If fair value cannot be reliably determined, the investment under construction will be measured at cost until such time as fair value can be determined or construction is complete. Also, revised of the conditions for a voluntary change in accounting policy to be consistent with IAS 8 and clarified that the carrying amount of investment property held under lease is the valuation obtained increased by any recognised liability. IAS 41 Agriculture. Removed the reference to the use of a pre-tax discount rate to determine fair value. Removed the prohibition to take into account cash flows resulting from any additional transformations when estimating fair value. Also, replaced the term point-of-sale costs with costs to sell. (17) Comparative information Comparative figures for the year 2007 have been adjusted to comform with changes in presentation in the current year. 22
3. FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES A number of the Bank s accounting policies and disclosures require the determination of fair value of financial assets and liabilities. The methods described below have been used for the determination of fair values. When applicable, further information about the assumptions made in determining fair values is disclosed in the respective notes. (1) Deposits with other credit institutions The fair value of demand deposits, overnight deposits and floating rate deposits is their carrying amount. The estimated fair value of fixed interest bearing deposits is based on discounted cash flows using prevailing money-market interest rates for debts with a similar credit risk and remaining maturity. (2) Loans to customers The estimated fair value of loans represents the expected discounted amount of estimated future cash flows. The interest rates used to discount estimated cash flows are based on the prevailing money-market interest rates curve plus an adequate credit spread. (3) Shares and other non-fixed income securities The fair value of shares and other non-fixed income securities is determined by reference to their quoted bid price at the reporting date, if available. For a non-material amount of non-listed shares, where disposal is limited, the assumption has been made that the reliable estimate of fair value is not possible. The fair value of S.W.I.F.T shares was determined based on the transfer amount approved for the respective year by the shareholders meeting, that represents the price for new share allocation and participants quit price. (4) Derivative financial instruments The fair value of currency swaps is estimated by discounting the contractual cash flows to be received and to be paid in appropriate foreign currencies for the remaining maturity, and translating the difference of the discounted cash flows into lats, applying exchange rate set by Bank of Latvia. EURIBOR or LIBOR interest rates are used as the benchmark for risk-free interest rate for discounting purposes. (5) Balances due to other credit institutions and customers The estimated fair value of deposits with no stated maturities, which include also non-interest-bearing deposits, is the amount repayable on demand. The estimated fair value of overnight deposits is their carrying amount. The estimated fair value of fixed interest-bearing deposits not quoted in the active market is based on discounted cash flows using interest rates for new debts with a similar remaining maturity. 4. RISK AND CAPITAL MANAGEMENT The Bank s activities expose it to a variety of financial and non-financial risks. The Bank s strategic aim is to achieve an appropriate balance between risks assumed by the Bank and returns and minimise the potential adverse effect on the Bank s financial performance and operations. The risk management system is integrated in the framework of the Bank s internal control based on the effective bank supervision requirements laid down by the Financial and Capital Market Commission and the Basel Committee on Banking Supervision to provide for a risk control function and operational compliance control function independent from business units. Risk measurement, assessment and control functions are separated from the business unit (risk acceptance) functions. 23
4. RISK AND CAPITAL MANAGEMENT (CONT D) The Bank identifies all inherent significant risks and develops, documents and implements appropriate policies for risk management, including measurement, assessment, control, mitigation, and risk reporting and disclosures. Policies are reviewed at least on an annual basis in line with changes in the Bank s operations and external factors impacting the Bank s activities. With respect to new products and services, the Bank assesses the potential inherent risks and approves risk management procedures prior to marketing these new products or services in order to timely and adequately identify risks and determine the permissible exposure limits. The most important types of risk are credit risk, including counterparty risk for credit institutions, concentration risk, liquidity risk, interest rate risk, foreign exchange risk, and operational risk. Market risks other that foreign exchange risks and interest rate risk, i.e. equity price risks are not significant for the Bank. The independent risk control process does not include business risks such as changes in the environment, technology and industry. The impact of these risks has been taken into account during strategic planning. As of 1 January 2008, the Bank has implemented the EU Directive 2006/48/EC relating to the taking up and pursuit of the business of credit institutions, and the EU Directive 2006/49/EC on the capital adequacy of investment firms and credit institutions relating to the improvement of the internal control system and risk management, and the requirements of Compliance and the compliance function in banks developed by the Basel Committee on Banking Supervision (Basel II). (1) Credit risk Credit risk represents the Bank s exposure to potential loss in case a borrower (debtor) or a business partner fails or refuses to fulfil his contractual liabilities towards the Bank. The Bank is exposed to credit risk which is a significant inherent risk for the Bank. Therefore, credit risk management is performed with particular care. The Bank is mainly exposed to two types of credit risks: counterparty risk when a business partner credit institution - fails or refuses to settle its contractual liabilities towards the Bank, and credit risk arising from the borrower s (debtor s) failure to meet his contractual liabilities towards the Bank. Sources of credit risk Credit risk of the Bank arises principally from deposits with credit institutions as well from lending activities and transactions with derivative financial instruments. There is also credit risk inherent in off-balance-sheet financial instruments such as letters of credit, guarantees and payment card overdraft commitments. There is a delivery risk in relation to foreign exchange transactions. For the Bank mostly as a payment bank, exposure to credit risk may interfere with liquidity management activities as the Bank should maintain sufficient funds on accounts with several principal correspondents to provide necessary customers payments in relevant currencies, which sometimes causes also significant concentrations with particular counterparties. Management and control of credit exposures The Bank ensures ongoing monitoring of concentrations of credit risk whenever they are identified, in particular, to individual counterparties or groups of counterparties, and to industries and countries. The Bank structures the levels of credit risk it undertakes by placing limits on the amount of risk accepted in relation to one counterparty, or a group of counterparties, and to geographical and industry segments, and products. Such limits are monitored on a revolving basis and subject to an annual or more frequent review, when considered necessary. 24
4. RISK AND CAPITAL MANAGEMENT (CONT D) The credit risk monitoring system applied by the Bank comprises regular analysis and assessment of the borrower s/ counterparty s credit standing as well as monitoring of the credit ratings granted by the external credit rating agencies, compliance with the contractual terms and conditions, fulfilment of the obligations, collateral control, as well as ongoing limit control. The Bank uses different credit risk management techniques for credit institutions and non-banks, but such techniques are applied consistently to all financial instruments used, both balance-sheet and off-balance sheet items, associated with a particular counterparty or a group of related counterparties, as well as delivery risk in relation to foreign exchange transactions. Limits on exposures to credit institutions and products are considered by the Assets and Liabilities Management Committee and approved by the Management Board. Limits on exposures to non-banks are considered by the Credit Committee and approved by the Management Board or the Supervisory Council depending on the authorisation scope. The Bank performs regular control of the credit risk exposure for counterparties from which the Bank has receivables exceeding 5% of total balances due from credit institutions. In cases when a transaction should be performed with a member of a group of counterparties, assessment is made also of the total credit risk exposure for the group. For the purposes of limiting credit risk, the Bank sets total limits for account balances and transactions with counterparties from non- OECD countries. Exposures to related groups of counterparties and counterparties related to the Bank are also subject to regulatory requirements. According to regulations, any credit risk exposure to a non-related counterparty may not exceed 25% of the Bank s equity. In addition, the regulations lay down that some exposures, such as balances due from credit institutions with the remaining maturities up to one year, are not considered to be credit risk exposures covered by the above regulatory requirements. According to the regulations, the credit risk exposure to a party or a group of related parties, which is a parent or subsidiary of the Bank, or one or several subsidiaries of that parent, may not exceed 20% of the Bank s equity. The total credit risk exposures to other parties related to Bank may not exceed 15% of the Bank s equity. The Bank has a permission issued by the Financial and Capital Market Commission stating that the Bank is not restricted regarding the demand balances due from its parent company MDM Bank in any currency. Credit risk mitigation policies The Bank employs a range of credit risk mitigation methods. The most traditional method is taking security for funds disbursements, which is the common practice. The Bank implements guidelines on the criteria for specific classes of collateral taken. The Bank requires collateral mainly in the form of term deposits for exposures with customers such as loans, letters of credits and guarantees issued, payment card overdraft commitments and derivatives transactions. 25
4. RISK AND CAPITAL MANAGEMENT (CONT D) The amount of collateral required may vary depending on the type of exposure but usually it is set at least to cover the principal amount of the outstanding debt. The Bank provides overdrafts on payment cards up to 75% of the respective security deposits. The Bank s exposures to credit institutions are usually unsecured. Quantitative disclosures Further quantitative disclosures in respect of credit risk are presented in Note 39. (2) Foreign exchange risk Foreign exchange risk represents potential loss from revaluation of balance sheet and off-balance-sheet items denominated in foreign currencies due to movements in foreign exchange rates. Foreign exchange risk management process The foreign exchange risk management policy determines and regulates the tasks to be performed by the Bank s management and structural units and their responsibilities in managing foreign exchange risk, and foreign exchange risk control regulations and mitigation measures relevant for the Bank s transactions in foreign currencies, as well as measurement, reporting and disclosure procedures. Limits on the foreign exchange open position in a single currency and the total open position in foreign currencies are set both on open currency positions to be maintained during the business day and open positions at the end of the day which are monitored and controlled. The Law on Credit Institutions states that the open position in each separate currency may not exceed 10% of the Bank s equity and the total open position in all foreign currencies may not exceed 20% of the Bank s equity. The Bank was compliant with these requirements during financial years 2007 and 2008 and after year end of 31 December 2008. Quantitative disclosures Further quantitative disclosures in respect of foreign exchange risk are presented in Note 40. (3) Liquidity risk Liquidity risk represents the Bank s exposure to significant loss in the event that the Bank does not have a sufficient amount of liquid assets to meet legally substantiated claims or overcome unplanned changes in the Bank s assets and/or market conditions on a timely basis. Liquidity risk management process The Bank s liquidity management policy sets the key principles and processes of liquidity risk management, tasks of management and structural units and their responsibilities in liquidity management and maintenance, methods and conditions, asset and liability management procedure, measures for preventing and managing liquidity crisis, and reporting and disclosure procedure. Liquidity risk management is performed by the Bank on the basis of the asset and liability management method ensuring a balanced asset and liability term structure. If necessary, current liquidity may be managed using other methods such as attracting interbank resources, entering into REPO transactions and FX SWAPs. The following techniques are used to manage liquidity: Day-to-day monitoring of customers cash flows, debt maturity profile and Bank s commitments in principal currencies; 26
4. RISK AND CAPITAL MANAGEMENT (CONT D) Maintaining sufficient liquid funds such as balances on correspondent accounts and short-term inter-bank deposits to ensure that financial liabilities can be met; Monitoring liquidity ratios against internal and regulatory requirements; Monitoring the term structure of assets and liabilities, which includes the impact of off-balance-sheet liabilities such as letters of credits, guarantees, and unused loan commitments; Planning the sources of liquidity such as borrowings for unforeseen liquidity needs. Quantitative disclosures Further quantitative disclosures in respect of liquidity risk are presented in Note 41. (4) Interest rate risk Interest rate risk represents the Bank s exposure in the event that changes in interest rates have an adverse impact on the Bank s revenue and expenses and result in a decrease of the Bank s equity. Interest rate risk represents the risk that there may be changes in future cash flows connected with financial instruments (cash flow interest rate risk) or fair value of financial instruments (fair value interest rate risk) resulting from changes in interest rates on the market. The period when the interest rate of a financial instrument is constant determines how it is exposed to interest rate risk. Sources of interest rate risk The Bank mainly is exposed to cash flow interest rate risk which represents the effect of changes in interest rates on the Bank s net interest margin and the amount of net interest revenue due to the inadequate term structure of interest rate sensitive assets and liabilities. Interest rate risk management process The interest rate risk management policy states risk management principles, tasks and responsibilities of the Bank s management and structural units in interest rate risk management, interest rate risk measurement, setting of limits, and control processes, stress testing, as well as reporting and disclosure procedures. The Bank assesses the impact produced by changes in interest rates on the entire Bank s business, as well as transactions belonging to the Bank s trading and non-trading portfolios, and interest rate risk in each currency for which assets or liabilities exceed 5% of the total balance, and all currencies in total. Interest rate risk control and mitigation are performed through: Ensuring interest rate sensitive assets and liabilities are maintained up to an interest rate risk level acceptable to the Bank; Constant monitoring of changes in interest rates on the financial instrument and money markets; interest rate hedges, if necessary, as well as restricting option contracts for Bank s products related to interest rates; controlling customer contracts involving interest rate risk (such as option contracts). Quantitative disclosures Further quantitative disclosures in respect of interest rate risk are presented in Note 42. 27
4. RISK AND CAPITAL MANAGEMENT (CONT D) (5) Operational risk Operational risk represents the Bank s exposure to loss or failure to receive profits as a result of inappropriate, unsuccessful or incomplete internal processes, human and system actions (errors or interruptions) or external circumstances. The operational risk includes IT risk and legal risk, and risks related to external factors such as fraud, unauthorised access to the Bank s information resources, natural catastrophes, damage of tangible assets. The Bank has developed and implemented an information system Risk event database. It is used for registering any risk events as events of operational risk or another risk, and the amount of loss. Operational risk management process The operational risk management policy details the tasks to be performed by the Bank s management and structural units and their responsibilities in operational risk management, the basic principles of the operational risk management system, operational risk management processes, reporting and disclosures. Operational risk management related to the Bank s information systems is regulated by the Bank s information system management policy and information system security management policy. Operational risk monitoring and control are performed as a set of systematic measures and include: Systematic assessment of the operational risk management system, including efficiency assessment; Compliance reviews of the operational risk control procedures; Analysis of risk assessment results and assessment by line of business, business process and the entire Bank, including analysis of the parameters forming results; Assessment of stress testing results and incorporating them in the risk management system; Regular testing of contingency plans; Assessment of the Bank s operations and external environment in order to determine the potential impact on the Bank and its business process exposure to operational risk; Compliance assessment of the operational risk management system for the volume, types and complexity of the Bank s operations; Monitoring, using the information on risk events in the risk event database; Reporting of various levels on operational risk management, including overall review of operational risk management, operational risk events, etc. to management and managers for decision making; Granting documented (in appropriate regulating documents) authorities in line with the segregation of duties principle; Development of new products including control of the development process in order to determine the acceptable level of operational risk and make a decision on risk management. 28
4. RISK AND CAPITAL MANAGEMENT (CONT D) (6) Capital management The strategic objective of the Bank s capital management is to maintain the adequate capital base that would promote attaining the strategic business goals set by the Bank, that is: Comply with the regulatory requirements; Be sufficient and optimal to support and further development of the Bank s business in terms of both volume and structure; Ensure that the Bank s capital, which, based on the internal calculations, is required to cover risks, both existing and potential, inherent in the current and future business of the Bank, is sufficient to cover significant inherent risks in terms of amount, components and proportion. The Law on Credit Institutions and the regulations developed by the Financial and Capital Market Commission to apply the provisions of this Law require that Latvian banks should maintain a capital adequacy ratio of 8%. In 2008, the Bank calculated the statutory capital requirements according to the Regulations of the Financial and Capital Market Commission on the Calculation of Minimum Capital Requirements that are based on the provisions of Directive 2006/48/EC of the European Parliament and of the Council of 14 June 2006 relating to the taking up and pursuit of the business of credit institutions (recast) and Directive 2006/49/EC of the European Parliament and of the Council of 14 June 2006 on the capital adequacy of investment firms and credit institutions (recast). The minimum capital requirement for credit risk is calculated according to the standardised approach. Operational risk employs the basic indicator approach to calculate the capital requirement. The table below summarises the regulatory capital, capital requirements, and capital adequacy ratios of the Bank as at 31 December 2008. 31/12/2008 Tier 1 capital Paid-in share capital 8,200 Share premium 4,470 Reserve capital 1 Retained earnings 19,988 Profit for the reporting year 8,152 Less: intangible assets (50) Total Tier 1 capital 40,761 Equity 40,761 Summary of calculations Capital requirement for credit risk in the banking book: (5,256) Due from central governments and central banks (408) Due from credit institutions (4,798) Due from and off-balance-sheet liabilities to companies (2) Other balance sheet and off-balance-sheet items (48) Total capital requirements for market risks, including: (217) Capital requirement for currency risk (217) Capital requirement for operational risk (1,294) Total capital requirement (6,767) Surplus of available equity over capital requirement 33,994 Capital adequacy ratio 48,19% 29
4. RISK AND CAPITAL MANAGEMENT (CONT D) A detailed capital adequacy calculation is provided in Note 43. The capital management policy of the Bank lays down the key principles of capital management, components and definition of the capital, tasks of the Bank s management and structural units and their responsibilities, capital calculation, capital management process and control, reporting and disclosure procedures, as well as emergency actions. According to the policy, the Bank s capital should be always larger and the methods employed for capital assessment should be more prudent than it is prescribed by laws. The Bank manages its capital by setting the target range for the capital adequacy ratio, which is treated as a measure of whether the strategic objectives set in capital management have been attained. The goal of capital management control is to maintain the adequate capital to cover significant risks and keep the reserve on an ongoing basis as well as to comply with the capital adequacy targets set by the Bank. The Bank performs control of the capital management process as a set of systematic measures, defining the relevant control procedures. In 2008, the Bank adopted a Pillar I plus approach to determine the capital required to cover all identified significant risks, i.e. the adequate capital amount to cover the risks is determined as the regulatory minimum capital requirements plus additional capital to cover other significant risks. In 2008, the Bank successfully maintained the adequate capital to cover all significant risks as identified, complying with the increased (at least 10%) capital adequacy ratio. 30
5. INTEREST REVENUE 2008 2007 Balances due from credit institutions measured at amortised cost 12,492 15,879 Loans to non-banking customers 8 5 12,500 15,884 6. INTEREST EXPENSE 2008 2007 Interest expense on financial liabilities measured at amortised cost 4,288 8,607 Deposits from non-banking customers 4,202 8,515 Balances due to credit institutions 86 92 Other interest expense 1,010 675 5,298 9,282 7. COMMISSION AND FEE REVENUE 2008 2007 Money transfers 533 708 Payment cards 60 76 Trust account servicing 55 74 Current account servicing 42 44 Documentary operations 7 6 Other commission and fee revenue 5 14 702 922 8. COMMISSION AND FEE EXPENSE 2008 2007 Money transfers 91 124 Payment cards 20 21 Documentary operations 1 2 112 147 9. NET GAIN ON FINANCIAL ASSETS AND LIABILITIES HELD FOR TRADING 2008 2007 Gain / (loss) on changes to the fair value of derivative financial instruments (25) 19 31
10. NET FOREIGN EXCHANGE GAIN 2008 2007 Net gain on currency exchange transactions 3,737 3,558 Net gain on translation of balances denominated in foreign currencies 79 48 3,816 3,606 11. ADMINISTRATIVE EXPENSE 2008 2007 Remuneration to the Board and Council members 377 401 Remuneration to staff 713 618 Statutory social insurance contributions 206 166 Lease of the building 79 85 Security 72 57 Professional services 71 49 Telecommunications 66 54 Taxes 46 - Transportation 40 36 Repairs and maintenance of premises 36 35 Business trips 5 14 Advertising and marketing 3 5 Representation expense 2 4 Other expense 47 63 1,763 1,587 The average number of the Bank s employees in 2008 was 64 (2007: 62). For the Bank as a lessee, the breakdown of the future minimum lease payments by periods until the maturity of operating leases effective as at 31 December 2008 was as follows: Up to 1 year From 1 to 5 years Total Lease of premises 81 300 381 Lease of transport vehicles 17 14 31 98 314 412 12. OTHER EXPENSE 2008 2007 Information and communications 84 102 Maintenance of the Bank s systems 29 21 Payment card servicing 25 24 Membership fees 14 12 Other expense 20 18 172 177 32
13. NET IMPAIRMENT LOSS ON FINANCIAL ASSETS Other assets As at 31 December 2006 3 Increase in the allowance for impairment 1 As at 31 December 2007 4 Reversal of the allowance for impairment (1) Write-off of the allowance for impairment (1) As at 31 December 2008 2 14. CORPORATE INCOME TAX The components of income tax expense for the years ended 31 December 2008 and 2007 were as follows: 2008 2007 Corporate income tax for the year 1,428 1,361 Deferred tax (19) 9 Total tax expense 1,409 1,370 The table below discloses the difference between the actual and theoretical income taxes using the base rate of 15% (2007: 15%): 2008 2007 Profit before tax 9,561 9,130 Corporate income tax at the statutory rate of 15% 1,434 1,370 Tax effects of expenses not deductible in determining taxable profit 8 - Tax effects of tax rebates (33) - Total tax expense for the year 1,409 1,370 The following table presents deferred tax included in the balance sheet and changes recorded in the income statement for the years ended 31 December 2008 and 2007: 31/12/2008 31/12/2007 Deferred tax liability at the beginning of the year 10 1 Increase/ (decrease) of deferred tax liability during the year (19) 9 Deferred tax (asset)/ liability at the end of the year (9) 10 The temporary differences that increase/ (decrease) the deferred tax liabilities as at 31 December 2008 and 2007 are presented in the following balance sheet captions: 31/12/2008 31/12/2007 Accelerated depreciation of property, plant and equipment 17 18 Provisions (26) (8) Deferred tax (asset)/ liability at the end of the year (9) 10 The Bank s management believes that there is reasonable certainty that future taxable profit will be sufficient to fully recover the recognised deferred tax asset in the taxation period following the reporting year. 33
15. CASH AND DEMAND DEPOSITS WITH CENTRAL BANKS 31/12/2008 31/12/2007 Cash 546 401 Demand deposits with the Bank of Latvia 26,120 32,598 26,666 32,999 Demand deposits with the Bank of Latvia represent cash on the correspondent account used for clearing purposes and to comply with the obligatory reserve requirement. The Bank receives interest revenue on these balances within the limits set in the obligatory reserve requirement. In accordance with the Bank of Latvia regulations, the Bank has to comply with the obligatory reserve requirement ranging from 0% to 5%, depending on the Bank s total attracted resources subject to the reserve requirement at the end of each month. The average monthly balance of the correspondent account with the Bank of Latvia should exceed the amount of the required reserve. The amount of obligatory reserve as at 31 December 2008 was 25,970 (31 December 2007: LVL 35,365). The Bank was in compliance with obligatory reserve requirement in 2008 and 2007. 16. DUE ON DEMAND FROM CREDIT INSTITUTIONS 31/12/2008 31/12/2007 Credit institutions registered in Latvia 9,913 15,112 Credit institutions registered in OECD countries 207,944 412,838 Credit institutions registered in other countries 20,057 112,041 237,914 539,991 17. FINANCIAL ASSETS AND LIABILITIES HELD FOR TRADING The Bank s portfolio of financial assets and liabilities held for trading represents currency swaps. Currency swaps are over-the-counter derivative financial instruments that represent commitments to exchange one set of cash flows to another. There is an exchange of the principal in foreign currencies in the beginning and in the end of the transaction, based on the exchange rate effective at the date of the transaction. The table below shows the fair values and notional amounts of derivative financial instruments. The notional amount, recorded gross, is the amount of the underlying asset and is the basis upon which changes in the fair value of a derivative are measured. Changes in the fair value of a derivative instrument are subject to fluctuations of currency exchange rates and interest rates resulting in the derivative instrument becoming favourable (asset) or unfavourable (liability). The fair value of derivatives is defined on the basis of the official exchange rates fixed at the balance sheet date. Notional amount Fair value Assets Liabilities 31/12/2008 31/12/2007 31/12/ 31/12/ 31/12/ 31/12/ 2008 2007 2008 2007 Currency swaps - 2,662-25 - - The Bank uses derivates for generating risk-free trading profits and hedging currency risk. Transactions with derivatives are performed in accordance with the derivative usage strategy. The strategy for using derivatives is reviewed by the Asset and Liability Management Committee and approved by the Board. Hedge effectiveness is assessed for the derivatives used for hedging purposes. 34
17. FINANCIAL ASSETS AND LIABILITIES HELD FOR TRADING (CONT D) The Bank s transactions with derivatives are not exposed to position risk related to the underlying asset. The Bank s credit risk represents the potential cost to replace the swap contracts if the counterparties default on their obligations. To control the level of credit risk taken, the Bank assesses counterparty credit risk. The Bank s transactions with derivatives performed for hedging purposes qualify for application of the fair value hedge accounting according to IAS 39. However, hedge accounting is not used by the Bank as it is not economically reasonable in the light of insignificant transaction volumes and other than regular nature of such transactions. 18. LOANS AND RECEIVABLES: TERM DEPOSITS DUE FROM CREDIT INSTITUTIONS 31/12/2008 31/12/2007 Credit institutions registered in Latvia 12,388 7,275 Credit institutions registered in OECD countries 49,519-61,907 7,275 19. LOANS AND RECEIVABLES: LOANS TO CUSTOMERS The breakdown of loans is as follows: (a) by borrower 31/12/2008 31/12/2007 Private enterprises - 2 Private individuals 177 70 Loans to non-banking customers, net 177 72 Loans secured by deposits (30) (33) Loans to non-banking customers subject to credit risk 147 39 (b) by the term of agreement 31/12/2008 31/12/2007 Up to one year 48 30 More than one year 126 40 Accrued interest 3 2 Loans to non-banking customers, net 177 72 (c) by industry 31/12/2008 31/12/2007 Other industries 177 72 Loans to non-banking customers, net 177 72 (d) by geographical region 31/12/2008 31/12/2007 Residents of Latvia 174 71 Residents of other countries 3 1 Loans to non-banking customers, net 177 72 35
20. AVAILABLE-FOR-SALE FINANCIAL ASSETS 31/12/2008 31/12/2007 Shares and other non-fixed income securities 9 9 Total available-for-sale financial assets 9 9 Shares and other non-fixed income securities represent an immaterial amount of unlisted and non-liquid shares of a Latvian private company, as well as S.W.I.F.T shares. S.W.I.F.T membership is required for ensuring payment services of the Bank. 21. INTANGIBLE ASSETS LVL 000 Intangible assets Historical cost As at 31 December 2007 247 Additions 12 Disposals (6) As at 31 December 2008 253 Accumulated amortisation As at 31 December 2007 175 Amortisation charge 34 Disposals (6) As at 31 December 2008 203 Net carrying amount As at 31 December 2007 72 As at 31 December 2008 50 LVL 000 Intangible assets Historical cost As at 31 December 2006 214 Additions 33 As at 31 December 2007 247 Accumulated amortisation As at 31 December 2006 137 Amortisation charge 38 As at 31 December 2007 175 Net carrying amount As at 31 December 2006 77 As at 31 December 2007 72 All intangible assets including software are used in the operating activities of the Bank. 36
22. PROPERTY, PLANT AND EQUIPMENT LVL 000 Leasehold Other Total improvements assets Historical cost As at 31 December 2007 102 470 572 Additions - 33 33 Disposals - (16) (16) As at 31 December 2008 102 487 589 Accumulated depreciation As at 31 December 2007 37 320 357 Depreciation charge 10 50 60 Disposals - (16) (16) As at 31 December 2008 47 354 401 Net carrying amount As at 31 December 2007 65 150 215 As at 31 December 2008 55 133 188 LVL 000 Leasehold Other Total improvements assets Historical cost As at 31 December 2006 102 428 530 Additions - 72 72 Disposals - (30) (30) As at 31 December 2007 102 470 572 Accumulated depreciation As at 31 December 2006 27 285 312 Depreciation charge 10 65 75 Disposals - (30) (30) As at 31 December 2007 37 320 357 Net carrying amount As at 31 December 2006 75 143 218 As at 31 December 2007 65 150 215 All items of property, plant and equipment are used in the operating activities of the Bank. 23. PREPAID EXPENSE AND ACCRUED INCOME 31/12/2008 31/12/2007 Prepaid expense 56 53 Accrued income 14 7 Less: allowance for impairment (2) (4) 68 56 37
24. TAX ASSETS 31/12/2008 31/12/2007 Current tax assets 124 - Deferred tax assets (Note 14) 9-133 - 25. OTHER ASSETS 31/12/2008 31/12/2007 Cash in transit - 13 Currency transactions in progress 136 2 Other 38 65 174 80 26. DUE ON DEMAND TO CREDIT INSTITUTIONS 31/12/2008 31/12/2007 Due to credit institutions registered in non-oecd countries 38 100 As at 31 December 2008 and 2007, the largest amounts due on demand were to AB Bankas Snoras (Lithuania). 27. FINANCIAL LIABILITIES CARRIED AT AMORTISED COST: BALANCES DUE TO CREDIT INSTITUTIONS 31/12/2008 31/12/2007 Due to credit institutions registered in non-oecd countries - 582 28. FINANCIAL LIABILITIES CARRIED AT AMORTISED COST: DEPOSITS FROM CUSTOMERS Deposits from customers include accrued interest expense in the amount of LVL 36 thousand, as prescribed by the regulations of the Financial and Capital Market Commission. As at 31 December 2008, the largest deposit from one customer with the Bank amounted to LVL 87,185 thousand, or 30% of the total deposits (2007: LVL 298,037 thousand, or 54%), while the deposit from one group of related customers amounted to LVL 106,437 thousand, or 37% of the total deposits (2007: LVL 298,349 thousand, or 55%). As at 31 December 2008, deposits from customers of LVL 30 thousand (2007: LVL 30 thousand) were pledged as a security for the loans issued to customers. The Bank also provides its customers with card account overdrafts amounting to 75% of the security deposit. 38
28. FINANCIAL LIABILITIES CARRIED AT AMORTISED COST: DEPOSITS FROM CUSTOMERS (CONT D) The breakdown of deposits from customers is as follows: (a) by the term of the agreement 31/12/2008 31/12/2007 Demand deposits, including accrued interest 281,717 534,098 Term deposits: up to six months 1,095 7,547 from six months to one year 2,939 1,661 more than one year 201 3,420 Accrued interest 36 97 Total deposits 285,988 546,823 (b) by depositor 31/12/2008 31/12/2007 Demand deposits Residents: Private enterprises 220 287 Private individuals 77 170 Public organisations 4 3 Bank employees 36 33 337 493 Non-residents: Financial institutions 18,298 344 Private enterprises 261,986 532,643 Private individuals 1,096 618 281,380 533,605 Total demand deposits 281,717 534,098 Term deposits Residents: Private enterprises 61 51 Private individuals 486 840 Public organisations - 8 Bank employees 20 31 567 930 Non-residents: Private enterprises 3,606 11,524 Private individuals 98 271 3,704 11,795 Total term deposits 4,271 12,725 Total deposits 285,988 546,823 39
28. FINANCIAL LIABILITIES CARRIED AT AMORTISED COST: DEPOSITS FROM CUSTOMERS (CONT D) Interest rates applied to deposits of the Bank s employees do not differ from interest rates on deposits from other customers. (c) by geographical region 31/12/2008 31/12/2007 Residents of Latvia 904 1,423 Non-residents: Residents of OECD countries 9,784 17,551 Residents of other countries 275,300 527,849 Total deposits 285,988 546,823 29. DEFERRED INCOME AND ACCRUED EXPENSE 31/12/2008 31/12/2007 Accrued expense 244 266 30. PROVISIONS LVL 000 Employee Bonuses Other Total holiday pay As at 31 December 2007 68-8 76 Increase in provisions 109 94-203 Amounts charged against provisions (127) - (8) (135) As at 31 December 2008 50 94-144 31. TAX LIABILITIES 31/12/2008 31/12/2007 Current corporate income tax liabilities - 181 Other current tax liabilities 2 12 Deferred tax liabilities (Note 14) - 10 2 203 32. OTHER LIABILITIES 31/12/2008 31/12/2007 Cash in transit 48 47 Currency transactions in progress - 23 Payment card liabilities 10 12 Other - 2 58 84 40
33. PAID-IN SHARE CAPITAL As at 31 December 2008 and 2007, the paid-in share capital of the Bank was LVL 8,200 thousand and consisted of 820,000 voting ordinary registered shares with the nominal value of LVL 10 each. The share capital is fully paid in. All the shares rank equally with regard to the Bank s residual assets, to the right to dividends and to vote at meetings of the Bank. The shareholders as at 31 December 2008 are as follows: Shareholder Country 31/12/2008 31/12/2007 % of the paid-in % of the paid-in share capital share capital MDM Bank Russian Federation 100.00 100.00 34. CASH AND CASH EQUIVALENTS 31/12/2008 31/12/2007 Cash and demand deposits with the Bank of Latvia 26,666 32,999 Balances due from credit institutions 299,810 547,255 Less balances due to credit institutions (38) (682) 326,438 579,572 35. CONTINGENT LIABILITES AND COMMITMENTS 31/12/2008 31/12/2007 Contingent liabilities Guarantees 1 - Commitments Other commitments 100 89 To meet the financial needs of customers, the Bank enters into various contingent liabilities and commitments. Even though these financial liabilities are not recognised in the balance sheet, they do contain credit risk and are therefore part of the overall risk of the Bank. However, the potential credit loss is less then the total unused part of the liability since these are contingent upon customers maintaining specific standarts. The Bank employs collateral mainly in the form of term deposits for mitigation of related credit risk. Issued guarantees commit the Bank to make payments on behalf of the customers in the event of a specific act. Other commitments respresent contractual obligations on payment cards overdraft facilities. Since contingent liabilities and commitments may expire without being drawn on, the total contract amount do not necessarily represents future cash requirements. 41
36. FUNDS UNDER TRUST MANAGEMENT 31/12/2008 31/12/2007 Assets under management Non-residents: Loans 21,384 5,663 Placement of resources 2,241 31,168 23,625 36,831 Liabilities under management Non-residents: Credit institutions 9,900 4,840 Private enterprises 13,725 31,991 23,625 36,831 37. RELATED PARTY DISCLOSURES Related parties are shareholders and actual owners with significant shareholdings in the Bank, members of the Council and the Board, head and staff of internal audit, their close relatives, and companies in which they hold significant investments. The Law on Credit Institutions defines significant investment as a shareholding of 10 or more per cent of the company s capital or voting shares, obtained directly or indirectly, or providing an opportunity to exercise significant influence over the company s activities. The definition of related parties of the Law on Credit Institutions generally complies with the requirements of IAS 24 which also specifies the requirements for disclosure of related party transactions in the financial statements. The Bank enters into transactions with related parties in the ordinary course of business. All the loans, advances and financing activities to related parties are given at market rates. For the year ended 31 December 2008, these are performing and free of any allowances for possible credit losses (2007: Nil). The Bank s financial statements comprise the following outstanding balances, off-balance sheet items and profit and loss items of related parties: Balance sheet items Parent Key management Other related Bank personnel parties 31/12/ 31/12/ 31/12/ 31/12/ 31/12/ 31/12/ 2008 2007 2008 2007 2008 2007 Assets Due from credit institutions 20,045 112,021 - - - - Loans - - 132 30 - - 20,045 112,021 132 30 - - Liabilities Due to credit institutions 12 17 - - - - Deposits - - 1 3 74,264 602 12 17 1 3 74,264 602 42
37. RELATED PARTY DISCLOSURES (CONT D) Off-balance sheet items Parent Key management Other related Bank personnel parties 31/12/ 31/12/ 31/12/ 31/12/ 31/12/ 31/12/ 2008 2007 2008 2007 2008 2007 Assets under management - 28,567 - - 2,241 2,601 Liabilities under management - - - - - 28,567 Other commitments - - 3 2 - - Income statement Parent Key management Other related Bank personnel parties 31/12/ 31/12/ 31/12/ 31/12/ 31/12/ 31/12/ 2008 2007 2008 2007 2008 2007 Interest revenue 32-4 2 - - Interest expense - - - (2) (7) (270) Commission and fee revenue 6 29 - - 29 50 Commission and fee expense (2) (1) - - - - 236 28 4-22 (220) 38. FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES Set out below is the comparison of the carrying amounts and fair values of the Bank s financial instruments that are recognised in the financial statements. 31/12/2008 31/12/2007 Carrying Fair Carrying Fair amount value amount value Cash and demand deposits with central banks 26,666 26,666 32,999 32,999 Due from credit institutions 299,821 299,827 547,266 547,259 Derivative financial instruments - - 25 25 Loans to customers 177 180 72 72 Shares and other non-fixed income securities 9 9 9 9 Total financial assets 326,673 326,682 580,371 580,364 Due to credit institutions 38 38 582 682 Deposits from customers 285,988 286,014 546,823 546,874 Total financial liabilities 286,026 286,052 547,405 547,556 The methodology for determining the fair value is disclosed in Note 3. 43
38. FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES (CONT D) The following table presents interest rates used to discount estimated cash flows, where applicable, by the classes of financial assets and financial liabilities. 31/12/2008 31/12/2007 Due from and to credit institutions 0.4 4.1% 4.1 4.6% Loans to customers 4.9% 8.4% Deposits from customers 1.4 10.5% 2.0 11.2% The following table shows an analysis of financial instruments recorded at fair value as at 31 December 2008, depending on the input data used for fair value determination purposes. Valuation techniques non-market observable inputs Shares and other non-fixed income securities 9 Total financial assets 9 The following table shows an analysis of financial instruments recorded at fair value as at 31 December 2007, depending on the input data used for fair value determination purposes. Valuation Valuation Total techniques techniques partly market non-market observable inputs observable inputs Derivative financial instruments 25-25 Shares and other non-fixed income securities - 9 9 Total financial assets 25 9 34 As discussed in Note 3, the fair value of currency swaps is estimated by a valuation technique, which utilises the exchange rates of foreign currencies set by the Bank of Latvia as partly market observable input and EURIBOR or LIBOR interest rates as market observable input data. For financial instruments whose fair value is estimated using valuation techniques with non-market observable inputs, no net unrealised amount was recorded in the income statement in the year 2008 due to changes in the inputs (2007: Nil). 44
39. CREDIT RISK Maximum credit risk exposure The table below shows the maximum exposure to credit risk for the components of the balance sheet. Exposures are based on net carrying amounts as reported in the balance sheet, less impairment allowances. The maximum credit exposures are shown both gross, i.e. without taking into account any collateral and other credit enhancements, and net, i.e. after taking into account any collateral and other credit enhancements. Notes Gross maximum credit Net maximum credit exposure exposure 31/12/ 31/12/ 31/12/ 31/12/ 2008 2007 2008 2007 Demand deposits with central banks 15 26,120 32,598 26,120 32,598 Due from credit institutions 16,18 299,821 547,266 299,821 547,266 Derivative financial instruments 17-25 - 25 Loans to customers 19 177 72 147 39 Shares and other non-fixed income securities 20 9 9 9 9 Prepaid expense and accrued income 23 68 56 68 56 Tax assets 24 133-133 - Other assets 25 174 80 174 80 Total balance sheet items 326,502 580,106 326,472 580,073 Guarantees 1 - - - Other commitments 100 89 100 19 Total contingent liabilities and commitments 101 89 100 19 Total maximum credit risk exposure 326,603 580,195 326,572 580,092 As it is shown above, 92% of the total gross maximum credit exposure is derived from balances due from credit institutions (2007: 94%). 45
39. CREDIT RISK (CONT D) Concentrations of the maximum credit risk exposure The following table breaks down the gross exposure related to balances due from credit institutions by geographical regions and major counterparties or groups of related counterparties. 31/12/2008 31/12/2007 Latvia AS UniCredit Bank 22,278 16,950 AS SEB banka 12 41 AS Hansabanka 11 5,348 Other credit institutions - 49 Total Latvia 22,301 22,388 OECD countries HSBC BANK USA USA 99,001 - Raiffeisen Zentralbank Oesterreich AG Austria 74,269 24,221 UBS AG Switzerland 46,605 213,596 Deutsche Bank group USA, Germany, UK 37,505 174,975 Other credit institutions 83 45 Total OECD countries 257,463 412,837 Other countries MDM Bank Russian Federation 20,045 112,021 Other credit institutions 12 20 Total other countries 20,057 112,041 Total balances due from credit institutions 299,821 547,266 The gross maximum credit risk exposure to a single counterparty or a group of related counterparties and to a single country as at 31 December 2008 comprised 33% of the total gross credit exposure attributable to balances due from credit institutions (2007: 39%). The Deutsche Bank group includes the following credit institutions: Deutsche Bank Trust Company Americas (USA), Deutsche Bank (Germany), and Deutsche Bank London Branch (UK). As at 31 December 2008, the largest credit risk exposure in this group was in relation to the Bank s receivables from Deutsche Bank Trust Company Americas. 46
39. CREDIT RISK (CONT D) Credit quality per class of financial assets Credit quality of financial assets is managed by the Bank by employing debtors (borrowers ) financial analysis techniques, analysis of the counterparty s reputation and historical cooperation with the counterparty, as well as using credit ratings granted by external rating agencies. The transactions subject to credit risk are divided into four credit quality groups depending on the credit ratings published by external rating agencies. There are the following credit quality groups: Group 1: AAA, AA (Standard& Poor s, Fitch) / Aaa, Aa (Moody s) This group includes first class transaction partners who ensure low-risk investments. The largest exposure included in this group relates to receivables from Deutsche Bank Trust Company Americas and HSBC Bank USA (2007: UBS AG, Deutsche Bank Trust Company Americas and Raiffeisen Zentralbank Oesterreich AG.) Group 2: A, BBB (Standard& Poor s, Fitch) / A, Baa (Moody s) This group includes transaction partners with a market position ranging from medium to good. The largest exposure included in this group relates to receivables from UBS AG and Raiffeisen Zentralbank Oesterreich AG. As at 31 December 2007, these transaction partners were included in Group 1. Group 3: BB, B, CCC, CC, (Standard& Poor s, Fitch) / Ba, B, C (Moody s) The largest credit risk exposure in this group relates to receivables from transaction partners below medium rating BB (Standard& Poor s, Fitch) / Ba (Moody s). Out of the above group, the most significant receivables are from MDM Bank (2007: MDM Bank). The Bank has no receivables from transaction partners whose rating is lower than B (Standard & Poor s, Fitch, Moody s). No rating Transaction partners who have not been assigned an external credit rating are primarily Latvian private credit institutions. In this group, the largest receivables are from AS UniCredit Bank (2007: AS UniCredit Bank and AS Hansabanka). The table below shows the credit quality by class of financial assets as at 31 December 2008 based on external ratings. Neither past due nor impaired Past due Impaired Total but not impaired Group 1 Group 2 Group 3 No rating Demand deposits with central banks - 26,120 - - - - 26,120 Due from credit institutions 136,588 120,875 20,057 22,301 - - 299,821 Loans to customers - - - 177 - - 177 Shares and other non-fixed income securities - - - 9 - - 9 Prepaid expense and accrued income - - - 68-2 70 Tax assets - 133 - - - - 133 Other assets - - - 174 - - 174 Total balance sheet financial assets, gross 136,588 147,128 20,057 22,729-2 326,504 Less: allowances for impairment - - - - - (2) (2) Total balance sheet financial assets, net 136,588 147,128 20,057 22,729 - - 326,502 47
39. CREDIT RISK (CONT D) The credit quality by class of financial assets as at 31 December 2007 based on external ratings was as follows: Neither past due nor impaired Past due Impaired Total but not impaired Group 1 Group 2 Group 3 No rating Demand deposits with central banks - 32,598 - - - - 32,598 Due from credit institutions 412,815 23 112,043 22,385 - - 547,266 Derivative financial instruments - - - 25 - - 25 Loans to customers - - - 72 - - 72 Shares and other non-fixed income securities - - - 9 - - 9 Prepaid expense and accrued income - - - 55 1 4 60 Other assets 15 - - 65 - - 80 Total balance sheet financial assets, gross 412,830 32,621 112,043 22,611 1 4 580,110 Less: allowances for impairment - - - - - (4) (4) Total balance sheet financial assets, net 412,830 32,621 112,043 22,611 1-580,106 48
40. CURRENCY RISK Currency risk exposure The currency analysis of assets and liabilities by currency profile as at 31 December 2008 was as follows: LVL USD EUR RUB Other Total currencies Assets Cash and demand deposits with central banks 26,267 106 269 15 9 26,666 Due from credit institutions - 273,586 20,668 4,822 745 299,821 Loans to customers 60 117 - - - 177 Shares and other non-fixed income securities - - 9 - - 9 Intangible assets and property, plant and equipment 238 - - - - 238 Prepaid expense and accrued income 30 32 3-3 68 Tax assets 133 - - - - 133 Other assets 172 1 1 - - 174 Total assets 26,900 273,842 20,950 4,837 757 327,286 Liabilities and shareholders equity Due to credit institutions - 26 1-11 38 Deposits from customers 334 254,966 18,353 11,595 740 285,988 Deferred income and accrued expense 198 3 43 - - 244 Provisions 144 - - - - 144 Tax liabilities 2 - - - - 2 Other liabilities 47-11 - - 58 Shareholders equity 40,812 - - - - 40,812 Total liabilities and shareholders equity 41,537 254,995 18,408 11,595 751 327,286 Net balance sheet position (14,637) 18,847 2,542 (6,758) 6 Spot transaction receivables 12,100 - - 6,840-18,940 Spot transaction liabilities - 18,765 - - - 18,765 Net open position (2,537) 82 2,542 82 6 49
40. CURRENCY RISK (CONT D) The currency analysis of assets and liabilities by currency profile as at 31 December 2007 was as follows: LVL USD EUR RUB Other Total currencies Assets Cash and demand deposits with central banks 32,690 106 169 6 28 32,999 Due from credit institutions 1 476,599 18,776 49,835 2,055 547,266 Loans to customers 57 14 1 - - 72 Shares and other non-fixed income securities - - 9 - - 9 Derivative financial instruments 25 - - - - 25 Intangible assets and property, plant and equipment 287 - - - - 287 Prepaid expense and accrued income 29 23 2-2 56 Other assets 49 1 17-13 80 Total assets 33,138 476,743 18,974 49,841 2,098 580,794 Liabilities and shareholders equity Due to credit institutions - 665 - - 17 682 Deposits from customers 558 476,258 18,236 49,654 2,117 546,823 Deferred income and accrued expense 257 3 6 - - 266 Provisions 76 - - - - 76 Tax liabilities 203 - - - - 203 Other liabilities 74-10 - - 84 Shareholders equity 32,660 - - - - 32,660 Total liabilities and shareholders equity 33,828 476,926 18,252 49,654 2,134 580,794 Net balance sheet position (690) (183) 722 187 (36) Spot transaction receivables 2,639 309 - - 87 3,035 Spot transaction liabilities - 2,749 307 - - 3,056 Net balance sheet position, including net spot position 1,949 (2,623) 415 187 51 Forward transaction receivables - 2,662 - - - 2,662 Forward transaction liabilities 2,640 - - - - 2,640 Net open position (691) 39 415 187 51 50
40. CURRENCY RISK (CONT D) The open foreign currency position as at 31 December 2008 was as follows: Assets, Liabilities, Open % of equity including including position spot receivables spot liabilities USD 273,842 273,760 82 0.20% EUR 20,950 18,408 2,542 6.24% RUB 11,677 11,595 82 0.20% Other 757 751 6 0.01% Total long position 2,714 Total short position (2) Total open position 2,714 6.65% Capital requirement for currency risk 217 The total net foreign currency position is the higher absolute value of net long positions or net short positions of certain foreign currencies. The capital requirement for currency risk is calculated as 8% of the total net currency position. The open foreign currency position as at 31 December 2007 was as follows: Assets, Liabilities, Net position Open % of including including arising from position equity spot spot forward foreign receivables liabilities exchange transactions USD 477,052 479,675 2,662 39 0.12% EUR 18,974 18,559-415 1,27% RUB 49,841 49,654-187 0.57% Other 2,185 2,134-51 0.16% Total long position 692 Total short position - Total open position 692 2.12% Capital requirement for currency risk 55 As at 31 December 2008 and 2007, the Bank was in compliance with the restrictions as to open currency positions set by the Law on Credit Institutions. 51
40. CURRENCY RISK (CONT D) Sensitivity analysis The scenario used for the analysis is based on reasonable volatility of exchange rates equal for all exposures of the Bank in foreign currencies assuming that all other variables, in particular interest rates, remain constant. The analysis is performed on the same basis for both years. A five percent and three percent strengthening of the following foreign currencies against the lat as at 31 December 2008 and 31 December 2007 respectively would have increased profit by the amounts shown below: 31/12/2008 31/12/2007 EUR 127 13 RUB 4 6 USD 4 1 Other currencies (aggregated effect) 1 1 Total 136 21 A five percent and three percent weakening of the above foreign currencies against the lat as at 31 December 2008 and 31 December 2007 respectively would have had equal absolute value but opposite effect on the above currencies, i.e. decreased profit by the amounts shown above. As the sensitivity analysis shows, as at 31 December 2008 and 2007 there was no direct effect on the shareholders equity from exposures in the financial instruments whose changes in fair value related to movements of the currency rates. 52
41. LIQUIDITY RISK Maturity analysis The table below reflects the maturity analysis of assets and liabilities based on the term from the balance sheet date until the maturity dates of the respective assets and liabilities. The maturity analysis of balance sheet and off-balance-sheet items as at 31 December 2008 was as follows: On Up to 1 From 1 From 3 From 6 From 1 Over 5 Total demand month to 3 to 6 to 12 to 5 years months months months years Assets Cash and demand deposits with central banks 26,666 - - - - - - 26,666 Due from credit institutions 237,914 61,896 - - 11 - - 299,821 Loans to customers 36 9 14 43 75-177 Shares and other nonfixed income securities - - - - - - 9 9 Intangible assets and property, plant and equipment - - - - - - 238 238 Prepaid expense and accrued income - 15 1 - - - 52 68 Tax assets - 124 - - - 9-133 Other assets - 174 - - - - - 174 Total assets 264,580 62,245 10 14 54 84 299 327,286 Liabilities and shareholders equity Due to credit institutions 38 - - - - - - 38 Deposits from customers 281,717 317 406 574 2,883 91-285,988 Deferred income and accrued expense - 203 41 - - - - 244 Provisions - - - 144 - - - 144 Tax liabilities - 2 - - - - - 2 Other liabilities 58 - - - - - - 58 Shareholders equity - - - - - - 40,812 40,812 Total liabilities and shareholders equity 281,813 522 447 718 2,883 91 40,812 327,286 Other commitments 101 - - - - - - 101 Net liquidity position (17,334) 61,723 (437) (704) (2,829) (7) (40,513) Amounts due from credit institutions repayable, according to contracts, by prior notice of withdrawal are included in the category On demand. Other assets and liabilities are disclosed in accordance with their remaining contractual maturities except for assets and liabilities with non-fixed maturities which are included in the category Over 5 years. 53
41. LIQUIDITY RISK (CONT D) The maturity analysis of balance sheet and off-balance-sheet items as at 31 December 2007 was as follows: On Up to 1 From 1 From 3 From 6 From 1 Over 5 Total demand month to 3 to 6 to 12 to 5 years months months months years Assets Cash and demand deposits with central banks 32,999 - - - - - - 32,999 Due from credit institutions 539,991 7,264 - - - 11-547,266 Loans to customers 32 2 3 5 21 9-72 Shares and other non-fixed income securities - - - - - - 9 9 Derivative financial instruments - 25 - - - - - 25 Intangible assets and property, plant and equipment - - - - - - 287 287 Prepaid expense and accrued income 2-3 4 18 1 28 56 Other assets 65 15 - - - - - 80 Total assets 573,089 7,306 6 9 39 21 324 580,794 Liabilities and shareholders equity Due to credit institutions 100 582 - - - - - 682 Deposits from customers 534,098 5,039 2,649 848 4,107 82-546,823 Deferred income and accrued expense - 244 22 - - - - 266 Provisions - 8-68 - - - 76 Tax liabilities - 12-181 - 10-203 Other liabilities 49 35 - - - - - 84 Shareholders equity - - - - - - 32,660 32,660 Total liabilities and shareholders equity 534,247 5,920 2,671 1,097 4,107 92 32,660 580,794 Other commitments 89 - - - - - - 89 Net liquidity position 38,753 1,386 (2,665) (1,088) (4,068) (71) (32,336) 54
41. LIQUIDITY RISK (CONT D) Analysis of financial liabilities contractual undiscounted cash flows The table below presents the cash flows payable by the Bank under contractual financial liabilities, including derivative financial liabilities, by remaining contractual maturities as at the balance sheet date. The amounts disclosed in the table are the contractual undiscounted cash flows in comparison with the carrying amounts of financial liabilities, comprising discounted cash flows as at the balance sheet date. The analysis as at 31 December 2008 was as follows: Carrying Contractual Up to 1 From 1 From 3 From 1 amount cash flows month to 3 to 12 to 5 months months years Non-derivative financial instruments Due to credit institutions 38 (38) (38) - - - Deposits from customers 285,988 (286,102) (282,036) (409) (3,565) (92) Total 286,026 (286,140) (282,074) (409) (3,565) (92) The analysis as at 31 December 2007 was as follows: Carrying Contractual Up to 1 From 1 From 3 From 1 amount cash flows month to 3 to 12 to 5 months months years Non-derivative financial instruments Due to credit institutions 682 (683) (683) - - - Deposits from customers 546,823 (547,044) (539,139) (2,659) (5,112) (134) 547,505 (547,727) (539,822) (2,659) (5,112) (134) Derivative financial instruments Incoming cash flows - 2,662 2,662 - - - (Outgoing) cash flows - (2,640) (2,640) - - - - 22 22 - - - Total 547,505 (547,705) (539,800) (2,659) (5,112) (134) 55
42. INTEREST RATE RISK Exposure to interest rate risk The Bank s exposure to interest rate risk is characterised by the maturity of assets, liabilities, and off-balance-sheet assets and liabilities subject to interest rate risk based on the shorter of the remaining maturity dates of financial instruments subject to interest rate risk and the interest rate review dates. The repricing maturity analysis of assets, liabilities, and off-balance-sheet items as at 31 December 2008 was as follows: Up to 1 From 1 From 3 From 6 From 1 Interest Total month to 3 to 6 to 12 to 5 free months months months years Assets Cash and demand deposits with central banks 25,970 - - - - 696 26,666 Due from credit institutions 279,531 - - - - 20,290 299,821 Loans to customers 36 9 14 43 75-177 Shares and other non-fixed income securities - - - - - 9 9 Intangible assets and property, plant and equipment - - - - - 238 238 Prepaid expense and accrued income - - - - - 68 68 Tax assets 133 133 Other assets - - - - - 174 174 Total assets 305,537 9 14 43 75 21,608 327,286 Liabilities and shareholders equity Due to credit institutions - - - - - 38 38 Deposits from customers 117,423 406 574 2,883 91 164,611 285,988 Deferred income and accrued expense - - - - - 244 244 Provisions - - - - - 144 144 Tax liabilities - - - - - 2 2 Other liabilities - - - - - 58 58 Shareholders equity - - - - - 40,812 40,812 Total liabilities and shareholders equity 117,423 406 574 2,883 91 205,909 327,286 Interest rate risk 188,114 (397) (560) (2,840) (16) (184,301) 56
42. INTEREST RATE RISK (CONT D) The repricing maturity analysis of assets, liabilities, and off-balance-sheet items as at 31 December 2007 was as follows: Up to 1 From 1 From 3 From 6 From 1 Interest Total month to 3 to 6 to 12 to 5 free months months months years Assets Cash and demand deposits with central banks 32,598 - - - - 401 32,999 Due from credit institutions 453,361 11 - - - 93,894 547,266 Loans to customers 34 3 5 21 9-72 Shares and other non-fixed income securities - - - - - 9 9 Derivative financial instruments - - - - - 25 25 Intangible assets and property, plant and equipment - - - - - 287 287 Prepaid expense and accrued income - - - - - 56 56 Other assets - - - - - 80 80 Total assets 485,993 14 5 21 9 94,752 580,794 Liabilities and shareholders equity Due to credit institutions 582 - - - - 100 682 Deposits from customers 393,993 2,649 848 4,107 82 145,144 546,823 Deferred income a nd accrued expense - - - - - 266 266 Provisions - - - - - 76 76 Tax liabilities - - - - - 203 203 Other liabilities - - - - - 84 84 Shareholders equity - - - - - 32,660 32,660 Total liabilities and shareholders equity 394,575 2,649 848 4,107 82 178,533 580,794 Forward transaction receivables 2,662 2,662 Forward transaction liabilities 2,640 2,640 Interest rate risk 91,440 (2,635) (843) (4,086) (73) (83,781) 57
42. INTEREST RATE RISK (CONT D) Average weighted effective interest rates The table below shows interest rate sensitive assets and liabilities as at 31 December 2008 and 2007 and the corresponding average weighted effective interest rates in 2008 and 2007. 2008 2007 average average Carrying weighted Carrying weighted amount effective amount effective LVL 000 interest rate LVL 000 interest rate Interest rate sensitive assets Demand deposits with the Bank of Latvia 25,970 2.88% 32,598 1.98% Due from credit institutions 279,531 2.43% 453,372 5.03% Loans to customers 177 7.87% 72 7.25% Total 305,678 486,042 Interest rate sensitive liabilities Due to credit institutions - 4.60% 582 4.73% Deposits from customers 121,377 1.23% 401,679 3.74% Total 121,377 402,261 Sensitivity analysis The following table demonstrates the sensitivity to reasonably possible changes in interest rates of the Bank s net interest revenue. The analysis assumes that all other variables remain constant. The sensitivity of net interest revenue is the effect of the assumed changes in interest rates on net interest revenue for one year following the balance sheet date, based on the interest rate sensitive non-trading financial assets and financial liabilities held as at 31 December 2008 and 2007. Sensitivity of net Sensitivity of net Increase in interest revenue Decrease in interest revenue basis points basis points As at 31 December 2008 EUR +54 101-54 (59) USD +110 1,412-110 (973) GBP +100 5-100 (5) LVL +190 222-190 (222) RUB +294 197-294 (131) Total effect 1,937 (1,390) As at 31 December 2007 EUR +30 43-30 (43) USD +25 76-25 (76) GBP +30 1-30 (1) LVL +250 (65) -250 65 Total effect 55 (55) There is a mismatch between sensitivity of net interest revenue as a result of assumed increase and decrease in interest rates, since for some assets and liabilities zero interest rates has been reached. There were no financial instruments held by the Bank as at 31 December 2008 and 2007, whose changes in fair value related to movement of the interest rates are attributable directly to shareholders equity. 58
43. CAPITAL ADEQUACY CALCULATION The below capital adequacy calculation as at 31 December 2008 is performed in accordance with the regulations of the Financial and Capital Market Commission. The capital adequacy ratio as at 31 December 2008 and 2007 was 48.2% and 16.3% respectively. The Bank s equity as at 31 December 2008 used for capital adequacy calculation in line with the Regulations of the Financial and Capital Market Commission on Capital Adequacy Calculation was as follows: Tier 1 capital Paid-in share capital 8,200 Share premium 4,470 Reserves 1 Retained earnings 19,988 Profit for the reporting year 8,152 Intangible assets (50) Total Tier 1 capital 40,761 Equity used for capital adequacy calculation 40,761 59
43. CAPITAL ADEQUACY CALCULATION (CONT D) The capital adequacy calculation in accordance with the requirements of the Financial and Capital Market Commission as at 31 December 2008: Capital requirement calculation for credit risk in the banking book Risk Risk Risk Capital exposure degree weighted requirement LVL 000 value for credit risk in the banking book Assets Balances due from the Latvian government and the Bank of Latvia in the national currency that are financed in the national currency 750 0% - - Balances due from the Latvian government and the Bank of Latvia in the national currency that are not financed in the national currency 25,503 20% 5,101 408 Total balances due from the Latvian government and the Bank of Latvia 26,253 5,101 408 Balances due from credit institutions with original maturities of three months or less 299,810 20% 59,962 4,797 Balances due from credit institutions with original maturities of more than three months 11 100% 11 1 Total balances due from institutions 299,821 59,973 4,798 Balances due from private individuals secured with term deposits 30 0% - - Unsecured balances due from private individuals 147 100% 147 12 Cash on hand 546 0% - - Prepaid expense and accrued income 68 100% 68 5 Shares and other non-fixed income securities 9 100% 9 1 Other assets 174 100% 174 14 Property, plant and equipment 188 100% 188 15 Total other items 1,162 586 47 Total assets 327,236 65,660 5,253 Off-balance-sheet liabilities Balances due to companies with security not recognised for credit risk mitigation 34 100% 34 2 Balances due to private individuals with security not recognised for credit risk mitigation 9 100% 9 1 Total off-balance-sheet liabilities 43 43 3 Total assets and off-balance-sheet liabilities 327,279 65,703 5,256 The minimal capital requirement for credit risk is calculated as eight per cent of the risk weighted value. The risk weighted value is calculated by multiplying the risk exposure by the risk degree defined for the respective counterparty s liabilities, applying the respective correction degree to determine the value of off-balance-sheet exposures. The risk degree for the counterparty s liabilities is determined on the basis of the respective credit quality group, which depends on the credit ratings granted by external rating agencies. 60
43. CAPITAL ADEQUACY CALCULATION (CONT D) Capital requirement calculation for operational risk Basic indicator Multiplier Capital requirement for operational risk 8,627 0,15 1,294 The capital requirement for operational risk is calculated by multiplying the basic indicator by 0.15. The basic indicator is the arithmetic average of audited net income for the last three years. Summary of capital requirements and capital adequacy ratio Equity to be used in the capital adequacy ratio 40,761 Total of capital requirements, including: (6,767) Capital requirement for credit risk in the banking book (5,256) Capital requirement for currency risk (Note 40) (217) Capital requirement for operational risk (1,294) Surplus of available equity over capital requirement 33,994 Capital adequacy ratio 48.19% 44. EVENTS AFTER BALANCE SHEET DATE As of the last day of the reporting year until the date of signing these financial statements there have been no events requiring adjustment of or disclosure in the financial statements or notes thereto. 61
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