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32. Financial Risk Management

Integrated risk management system (IRMS) of the Group is defined by Integrated risk management policy of the Bank stated in the Resolution of The Bank’s Management Board in February 2012. In accordance with its Policy risk management for the Group is represented as three-level process defined below:

  • first management level (performed by The Bank’s Management Board, The Group’s Risk Committee of the Bank) — is management of aggregated risk. This process results in setting requirements and limits to the management of specific groups of risks, to the management of the Group members’ risks as well as appointment of collective bodies and subdivisions of the Group responsible for the management of certain risk groups;
  • second management level (performed by the appropriate Bank’s committees) — the management of specific groups of risks considering requirements and limits stated on the first management level;
  • third management level (performed by collective bodies and structural subdivisions of the Group) — the management of specific groups of risks in the companies of the Group considering requirements and limits stated on the first and second management level.

Integrated risk management process includes five core group steps:

  • risk identification and measurement of its materiality for the Group — aimed to identify all the significant risks which the Group is exposed to;
  • developing system for managing significant risks — aimed to allocate functions (or actualize such allocation) of risk management between executives, subdivisions and collective bodies of the Bank and its subsidiaries as well as developing (or actualize such development) methodological framework regulating risk management for the Group;
  • forecasting risk exposure level — aimed to define target risk level using risk-metrics in business-plan of the Group and each of its members;
  • setting risk appetite for the Group and each of its members — aimed to confirm by the Bank and then by its Supervisory Board maximum allowable risk exposure for the Group and launch of limit and restriction system that will enable not to exceed the maximum risk level;
  • management of aggregated risk level of the Group — aimed to provide correspondence between risk level and target values.

In order to implement IRMS the following initiatives were realised during 2012:

  • risk identification was performed resulting in definition of significant risks divided into specific groups for the management purposes: credit, country, market and credit risks of the operations on financial markets, interest rate risk and currency risk of non-trading positions; risk of losses in case of changes in property value, operational risk, legal and regulatory risk, compliance risk, liquidity risk, risk of impairment of goodwill, strategic and business risks, risk of models and tax risk;
  • due to the decision of The Group’s Risk Committee of The Bank significant risk management functions are allocated between collegial authorities and structural subdivisions of the Bank;
  • methodological framework was developed defining risk-metrics which characterize aggregate risk level for the Group, their calculation procedure and the way of stress-test performance;
  • risk-metrics which characterize aggregate risk level for the Group are included in Bank business-plan for the 2013-2015;
  • bank risk appetite is stated in accordance with the resolution of the Group’s Risk Commitee.

Distribution of methodology and integrated risk management processes between Group’s members is planned on year 2013.

The Group is constantly developing risk management system in order to correspond to the best practices and recommendations of regulators. In accordance with these decisions it is expected that during 2013-2015 risk management methods and processes would be integrated and improved on aggregate level as well as on the level of specific risks management systems.

Credit Risk

The Group is exposed to credit risk, which is a risk of a counterparty being unable to meet its credit obligations in whole or in part when due. The Group’s risk management policy is performed in accordance with IRMS and aims at increasing competitive advantage of the Group by expanding the list of counterparties and the range of credit products, implementing systemic approach to credit risk to maintain or bring down the level of credit risk losses, optimization of credit portfolio structure by industry, region and product.

The Group applies the following basic methods of credit risk management:

  • prevention of credit risk by identifying, analyzing and assessing potential risks before entering the transaction creating risk exposure;
  • planning the level of credit risk by assessing the level of expected losses;
  • implementation of common assessment processes and identification of risks;
  • limiting credit risk by setting exposure or risk limits;
  • structuring of transactions;
  • collateral management for transactions on financial markets;
  • monitoring and control of credit risk level;
  • application of the system of decision-making authority;
  • provisions for impairment losses.

Assessment of the Group’s credit risk is made in aggregate, by individual portfolios of credit risk bearing assets, by individual counterparties, transactions and groups, by country, geographic region and by industry.

The Group operates a system of internal ratings based on economic-mathematical models for estimating the probability of default of counterparties and transactions. Assessment of individual credit risks of the Group’s counterparties in transactions which carry credit risks depends on the counterparty category:

  • corporate customers, credit institutions, financial companies, individual entrepreneurs, sovereigns, subjects of the Russian Federation and municipal entities, insurance and leasing companies are assessed on the basis of the system of credit ratings and expected cash flow models or other important indicators;
  • individuals are assessed based on their creditworthiness in accordance with the Bank’s internal regulatory documents and express assessment.

The Group’s system of credit ratings provides a differentiated assessment of probability of default/non-execution by the counterparties of their obligations by analyzing quantitative (financial) and qualitative factors of credit risk, materiality of their impact on the ability of the counterparty to serve and repay their obligations.

The Group’s internal procedures provide for a multi-factor approach, the factor list being standardized depending on the counterparty category.

Risk factors related to counterparty’s creditworthiness and its volatility, ownership structure, business reputation, credit history, cash flow and financial risks control, transparency, position of the client in the industry and the region, strength of support from local administration and parent companies (in case of a holding) as well as the so-called early warning factors are subject to mandatory monitoring and control. Based on the analysis of these risk factors the probability of default is assessed and graded by counterparty/transaction with their subsequent classification ratings.

The Group closely monitors its credit risk concentration and compliance with prudential regulations of the Bank of Russia, making analysis and forecast of credit risk level. In analysis, monitoring and management of credit risk concentration the following methods are used:

  • a distributed criteria mechanism for identifying legally and economically related borrowers, followed by the centralized maintenance of a uniform hierarchical list of groups of related borrowers;
  • control of large loans per borrower in groups of related borrowers;
  • identifying groups of borrowers by industry, country and region.

The system of controlling and monitoring credit risk level is based on the principles stipulated by the Group’s internal regulatory documents that provide for a preliminary, current and follow-up control of transactions creating exposure to credit risk, of keeping within set risk limits and their timely update.

The Group developed a multi-tier system of limits to separate credit risk of lending business and operations on financial markets.

The Group usually requires collateral for granted loans. Different kinds of collateral could be approved in order to limit credit risk simultaneously. In accordance with Group’s policy collateral for loans provided to legal entities (pledge amount and/or liability amount (limit of responsibilities) through surety agreement and/or guarantee amount) should cover the amount of credit and interests, accrued during not less than 3 months.

One of the concepts concerning hedge of credit deals risks is represented by developed Pledge policy (as a part of Credit policy) which defines basis principles and elements of work organization for pledges in case of loan granting.

Pledge policy is concentrated on the improvement of quality of credit portfolio in the part of collateral. Collateral quality depends on the probability of cash receipt in amount of supporting pledge in case of enforcement or realization of pledge. Collateral quality can be indirectly characterized by the list and materiality of risks conjugated to the pledge and is represented by the range of factors (liquidity, reliability of cost determination, impairment risks, susceptibility to the risks of loss and damage, law risks and others).

Pledge amount assessment is performed on the base of internal expert valuation of Group experts, assessment of independent valuers or pledge amount stated in borrower’s financial reports with discount correction. Using surety of creditworthiness legal entities as the collateral requires risk assessment from the side of guarantor as well as from borrower’s side.

For the purpose of effective management of credit risk on transactions with legal entities Group defines two main types of operations:

  • corporate lending operations;
  • financial market transactions with clients and counterparties — legal entities (corporate clients and financial institutions).

In 2012, the common Group’s credit risk management process on financial market transactions was drafted and approved. Implementation of this process in the Group as well as common principles of identifying, evaluating and limiting of credit risks on financial market transactions will be carried out in 2013. Also, the strategic IT-programme “Automatization of risk management system on Corporate-Investment unit” was launched making the base for automated common risk management process on financial markets, including credit risk.

At the same time, the Group operates a multi-dimensional system of authority to determine the level of decision-making for each loan application. Each territorial unit is assigned a risk profile, which defines the discretionary powers of the unit to take independent decisions, depending on the risk category of the requested loan. In its turn, the risk category of the requested loan depends on the aggregate risk limit and the risk category of the borrower/group of related borrowers and also on loan product category. Thus, existing systems of limits and decision-making authority allows to optimize the lending process and provides for proper management of credit risk.

In 2012, the Group has spread credit risk management methods used by the Bank to its subsidiaries. However, the Group is working to further improve the methodology for setting limits, including through implementation of Basel II in the Bank. In particular, in December 2012, the Bank has developed and approved approaches to set portfolio limits on consumption of economic capital for the industries, largest borrowers and retail products in order to control risk concentrations.

Considering the focus of the Bank and the Group for the using of modern technics and instruments of credit risk managing, the Bank is in the process of constructing the most common standardized processes of retail lending considering the customer segmentation by risk profile and minimizing the number of participants in the process by centralizing and automatizing. In particular, in 2012, the risk management system of retail customers based on “Credit factory” technology was further developed at the Bank and at the Group level.

The Bank provides basic types of loan products to individual customers — consumer loans, auto and mortgage loans, credit cards under “Credit Factory” technology.

In 2012, in the technology at the Bank’s level the following changes were made:

  • scoring assessment of credit history of individual clients on the basis of the statistical approach has been implemented under “Credit Factory” technology for mortgage loans;
  • Risk-Based-Pricing technology, used for consumer loans, spread to new customer segments;
  • rating models of reliability customers estimating introduced for all products;
  • integrated scoring model introduced for car loans, mortgage loans and credit cards;
  • regional scoring cards of risk level by accounting regional specificity of risk profile have been implemented for the purpose of consumer loans;
  • fraud-monitoring system introduced in the pre-credit data processing. It will be further developed in 2013.

At the Group’s level the implementation of the “Credit Factory” technology is continued in the subsidiaries — Belpromstroy Bank OJSC (OAO BPS Bank) (Belarus), Sberbank of Russia JSC (Ukraine), Sberbank SB JSC (Kazakhstan).

In addition, in 2012, the process of transfer to the “Credit factory” technology of retail loan products in subsidiaries of Sberbank Europe has started. Thus, in December 2012 consumer loans were launched in the Czech Republic, new projects were initiated in Slovakia, Serbia and the Czech Republic.

As part of the introduction of Basel II in the Bank, the complete set of behavioral models of Basel for all retail lending products has been developed. Also, there were identified indicators required to calculate economic capital (total developed 42 models PD, 21 LGD models and 18 EAD models).

During 2010-2011, the Bank progressed towards an intra-bank automated lending system resulted to achieve end-to-end automation of the lending process. During 2012, works under optimizing and expanding the functionality of this system have been continued. In particular, significant changes in the accounting credit risk methodology, aiming in compliance methods with recommendations of the Basel Committee on Banking Supervision, were taken into account.

In addition, in 2012, the Group progressed towards a complex automated systems:

  • credit risk management systems, which allows to assess the current status, dynamics and prediction of credit risks;
  • corporate credit limits management system, which is able to provide a flexible mechanism for controlling the structure of limits, in case of further development of a methodology, to optimize the process of preparation of analytical materials.

Integration of existing and implementing automated systems, scheduled for 2013-2014, will ensure adequacy of the credit risk management process to requirements of the Basel Committee on Banking Supervision.

Using the macroeconomic scenarios, the Group conducts sensitivity analyses of credit risk level by both counterparty and credit portfolio to identify macro factors of maximum correlation with the counterparties’ probability of default. Statistics on radical changes of macro factors is used in stress-scenario for ratings models for the purpose of stress-testing.

The Group monitors debt recovery at all phases of debt collection. In case of identification of problem areas/phases in the process of debt recovery, drop in debt recovery ratio and non-performing loans growth in territorial units, customer or product segments, the optimization of lending/collection process is performed.

Following performances have been taken in 2012 in order to improve the effectiveness of the debt recovery process for overdue loans to individuals the number of actions has been taken. In particular, functional improvements of the “Tallyman” system, making the base for automated debt collection process for individual loans at an early stage of delays in loan repayments, were implemented. Also, the automated system of outgoing call (PDS) on the base of AVAYA PROACTIVE CONTACT programme complex were implemented. This system has led to a substantial increase of the number of overdue loans that are processed by a single operator.

Also in 2012, implementation of the “Development and automation of business process of debt collection of individuals at an early stage” program in the subsidiaries of the Bank (in particular in BPS Sberbank OJSC(Belarus)), was continued.

Country risk is the risk of losses due to the default by sovereign and other counterparties in a particular country for reasons other than the standard risks (caused by the Government actions but beyond the control of the counterparties).

Risk exposure of the Group when financing non-residents or foreign Governments is minimized by assessment of the country related risk and setting country risk limits. Assessment of country risks is based on the ratings by international rating agencies (Fitch, Moody’s, S&P), the nominal GDP, the level of economic development of the country and its strategic relevance for the group. Countries without international ratings are assessed in accordance with internal procedures, which include the analysis of risk factors related to sovereign solvency, current development trends, efficiency of external debt management, offshore status and international reputation, public policy and domestic political situation. To reduce the country risk, transactions with counterparties are conducted within the risk limits on the countries concerned.

Market risk is the possibility of the Group’s financial losses as a result of unfavorable movements in exchange rates, equity prices, interest rates, precious metal prices and other market indicators. The main goal of Market Risk Management is the optimization of market risk level within the Group, compliance of the risk level risk with limits set and minimization of loss in case of unfavorable scenario realization.

The Group categorises market risk into:

  • Currency risk is the risk of losses or reduction of income due to fluctuations in the prevailing foreign currency exchange rates;
  • Interest rate risk is the risk of losses or reduction of income due to fluctuations in interest rates;
  • Equity price risk is the risk of losses or reduction of income due to changes in fair value of equity securities, for example, ordinary and preference shares;
  • Commodity risk is the risk of losses or reduction of income due to changes in value of commodity assets, in particular, precious metals;
  • Volatility risk is the risk of losses or reduction of income on option operations due to changes in imputed option volatility of underlying assets;
  • Liquidity risk is the risk of inability to open / close or change of a market position on the market, exchange, or in case of market quotation against a particular counterparty, and an inability to fulfill contractual obligations in time without incurring losses unacceptable to the financial stability.

The Group manages its market risks through securities portfolios management and control over open positions in currencies, interest rates and derivatives. For this purpose the Committee on Assets and Liabilities Management (the ALMC) sets limits on securities portfolios, open positions, stop-loss and other limits. Authorized bodies and departments determine the methodology for the market risk management and set limits on particular transactions.

Market risk limits are set on the basis of the value-at-risk analysis (VaR), scenario analysis and stress-testing as well as regulatory requirements of the Bank of Russia and recommendations of the Basel Committee on Banking Supervision. The Group calculates VaR for the operations on financial markets both by components and in aggregate, determining the diversification effect.

The Group divides the principles of market risk management under the trading and banking book. Authority to manage the market risks are divided between the ALMC and Trading Risk Committee (TRC) by type of market risk on a group of operations (trading and non-trading operations).

Market risk management is carried out in accordance with the “Policy for managing market and credit risk operations on financial markets” and “Policy for managing interest rate and currency risk of the banking book”.

Market risk on non-trading positions

Interest rate risk on non-trading assets and liabilities. The Group accepts risk on market interest rate fluctuations effect on cash flows. Interest rate risk of non-trading positions is a result of unfavourable interest rate movement and includes:

  • the risk of a parallel shift, change in the slope and shape of the yield curve resulting from the maturities (repricing) mismatch of assets and liabilities sensitive to interest rate changes;
  • basis risk, which results from a mismatch in the degree of interest rate sensitivity, of assets and liabilities with similar maturity (repricing term); and
  • risk of early repayment (repricing) of interest rate sensitive assets and liabilities.

Increasing interest rates can drive the cost of borrowed funds up faster and at a higher growth rate than return on investments, thus worsening financial results and interest rate margin, whereas decreasing interest rates can decrease return on working assets faster than the cost of borrowed funds.

The objective of managing this type of market risk is minimization of potential losses caused by realization of interest rate risk and currency risk and stabilization of bank interest margin regardless of market conditions. To manage interest rate risk the ALMC sets maximum interest rates on corporate deposits/ current accounts and minimum rates on corporate loans, minimum rate of return on investments into securities and limits on investments into long-term assets bearing inherently the maximum interest rate risk. The Bank’s Management Board approves fixed interest rates on deposits for the Bank’s Head Office and Regional Head Offices, which require preliminary approval from the ALMC. Interest rates on deposits depend on loan or deposit maturity date, amount and the client’s category. Interest rates on loans for individuals are confirmed by ALMC.

ALMC of each regional bank approves interest rates for corporate clients taking into account the regional market situation and the efficiency of the regional bank’s transactions on the assets and liabilities side as well as the limits on interest rates set by the ALMC of the Bank’s Head Office for corporate funds and placements.

This type of interest rate risk is assessed using the standardized shock in accordance with Basel Committee for Banking Supervision (BCBS) recommendations. Forecasting of possible changes in interest rates is carried out separately for Russian Rouble positions and positions in foreign currency. The shock of interest rates is calculated as 1% and 99% of the allocation quantile of average annual interest rate’s change by historical simulations method on the base of data for the last 5 years. As basic rate for the purpose of shock assessment in RUR the indicative rate is used for interest swap in RUB with 1 year terms (RUB IRS 1Y) as well as LIBOR 3M for the foreign currency position.

The table below shows the impact of bps interest rates increase and decrease on profit before tax as at 31 December 2012:

Change in profit before tax as at 31 December 2012 (in billions of Russian Roubles) RUB positions Foreign currency positions Total
Decrease in interest rates by 302 bps 50.7 50.7
Increase in interest rates by 583 bps (98.0) (98.0)
Decrease in interest rates by 20 bps 0.3 0.3
Increase in interest rates by 85 bps (1.4) (1.4)

In calculation of the impact of interest rates increase and decrease on profit before tax as of 31 December 2012 new methodology for the estimation of interest rates volatility in RUR and foreign currency was used:

  • the estimation of interest rate changes scenario has changed in comparison with the report dated 31 December 2011. In the report for the previous year interest rates decrease and increase were calculated as 10% and 90% of the allocation quantile of interest rate’s change by historical simulations method on the base of data for the last 1 year;
  • as the indicative rate in RUR as of 31 December 2011 was used rate for 3 month-term loans at the Moscow interbank market (MOSPRIME 3M).

The table below shows the impact of bps interest rates increase and decrease on profit before tax as at 31 December 2011:

Change in profit before tax as at 31 December 2012 (in billions of Russian Roubles) RUB positions Foreign currency positions Total
Decrease in interest rates by 290 bps 22.2 22.2
Increase in interest rates by 412 bps (31.5) (31.5)
Decrease in interest rates by 31 bps 1.0 1.0
Increase in interest rates by 83 bps (2.6) (2.6)

In order to ensure in correspondence between comparative data for the 2012 and 2011 the table of impact of bps interest rates increase and decrease on profit before tax as at 31 December 2011, calculated on the base of interest rate volatility in RUB and foreign currency in accordance with methodology stated in 2012, is presented below:

Change in profit before tax as at 31 December 2012 (in billions of Russian Roubles) RUB positions Foreign currency positions Total
Decrease in interest rates by 299 bps 22.9 22.9
Increase in interest rates by 599 bps (45.9) (45.9)
Decrease in interest rates by 38 bps 1.2 1.2
Increase in interest rates by 167 bps (5.2) (5.2)

The sensitivity analysis above shows changes in profit before tax given a parallel shift of the yield curve across all interest rate sensitive positions, i.e. when interest rates move by the same value for all maturities. In addition, interest rate risk is assessed considering the following simplifications: the calculation disregards possible early repayment or call of instruments.

From the beginning of 2012 the Group has started the development of Interest rate risk of non-trading positions management system in accordance with BCBS recommendations. New approaches for measurement, stress-testing, setting limit and hedging of interest rate risk of non-trading positions are being developed within the framework of this project. The methodology and models of assessment of sensitivity to interest rate risk based on client behavior that allows to increase the accuracy and efficiency of interest rate and currency risks of non-trading positions management significantly are also being developed. At the same time there is the project of ALMC system integration, which will cover all the goals of management over assets and liabilities of the Group members including goals of management of interest rate risk for non-trading positions.

Currency risk of non-trading assets and liabilities

Currency risk results from fluctuations in the prevailing foreign currency exchange rates. The Group is exposed to foreign exchange risk on open positions (mainly US dollar/RUB and EUR/RUB exchange rate fluctuations).

As part of managing foreign exchange risk the Group sets sublimits for open foreign exchange positions for Regional Head Offices. Besides, limits and control system are in place for arbitrage operations which sets open position limits for foreign currencies, limits on operations on the international and domestic markets, and stop-loss limits.

The Bank’s Treasury Department undertakes daily aggregation of the currency position of the Group and takes measures for maintaining of the Group’s currency risk exposure at a minimum level. The Group uses swaps, forwards and USD futures contracts tradable on MICEX as the main instruments for risk management.

Market risk on the operations on financial markets

Among credentials of TRC there is management over market risk of the trade operations, concerning liquidity risk TRC obeys to ALMC.

Market risks are controlled by monitoring of operations on foreign exchange and securities market by departments independent of trading divisions. Monitoring of market risks implies continual control over trading deals at all steps of operational process.

For the purposes of market risk management of the financial markets’ operations, trade operations are aggregated in portfolios with hierarchical structure defined in accordance with risk types and responsibilities allocation. Market risk management of the trade operations in Group is performed through the system of authorized bodies, making decisions depending on risk level and portfolio hierarchy, such system allows to reach efficiency and flexibility of decision making.

The Group derives following most important types of market risk of the trade operations.

Interest rate risk on the trade operations

The Group is exposed to interest rate risk of its trade operations with debt securities and derivatives.

For managing and limiting interest rate risk in accordance with the “Policy for managing market and credit risk operations on financial markets” TRC as well as persons authorized by it set following types of limits and restrictions: limits on investments, limits on sensitivity to interest rate changes (DV01), concentration limits, limits on losses of trade operations, VaR limits, limits on direct and reverse REPO-deals.

Equity Price Risk

The Group is exposed to equity price risk through changes in fair value of corporate lobar securities as well as its derivatives in case of Group having positions in them. In order to limit equity price risk the TRC and persons authorized by it set common position limits, limits on losses of trade operations, VaR limits, sensitivity limits. Regional Head Offices does not take part in trade operations with shares.

Currency Risk

In order to limit the foreign exchange risk of financial market operations TRC as well as persons authorised by it set VaR limits and limits for open foreign exchange positions for all operations, which are sensitive to currency risk.

Value-at-Risk, VaR

The VaR methodology is one of the main instruments of assessing market risk of the Group. VaR allows to estimate the maximum financial loss with a defined confidence level of probability and time horizon.

The Group calculates VaR using the historical modeling methodology. This method allows to evaluate probability scenarios of future price fluctuations on the basis of past changes taking into account market indicators correlations (e.g. interest rates and foreign exchange rates) as well as changes in price of specific instruments not due to changes in the market situation.

VaR is calculated using the following assumptions:

  • historical data on changes in financial market indicators comprise 2 years preceding the reporting date;
  • the market indicators used include currency exchange rates, bond, equity and precious metal prices as well as interest rates levels;
  • movements in financial market indicators are calculated over a 10-day period, i.e. an average period when the Group is able to close or hedge its positions exposed to market risk; and
  • a 99% one-way confidence level is used, which means that losses in the amount exceeding VaR are expected by the Group maximum once every 100 trading days.

For evaluating the adequacy of the applied VaR calculation model the Group regularly back-tests the model by comparing the modeled losses with actual losses.

Despite the fact that VaR allows to measure risk, its shortcomings must be taken into account such as:

  • past price fluctuations are not sufficient to assess accurately future price fluctuations;
  • calculation of financial market price indicators over a 10-day period is based on the assumption that the Group will be able to close (or hedge) all positions within this period. This assessment may be far from accurate in measuring risk exposure at the time of reduced market liquidity, when the period of closing (or hedging) the Group’s positions may increase;
  • using 99% one-way confidence level of probability does not provide for estimating losses with a probability below 1%; and
  • VaR is calculated based on end-of-day position and misses the intra-day risks accepted by the Group.

Taking into account the shortcomings of the VaR methodology the Group applies scenario analysis and stress-testing to have a better understanding of market risk exposure.

The table below shows the interest rate, equity and currency risk calculation using the VaR methodology as at 31 December 2012:

In billions of Russian Roubles Value as at 31 December 2012 Average value for 2012 Maximum value for 2012 Minimum value for 2012 Impact on equity Impact on profit
Interest rate risk on debt securities 18.1 16.6 21.7 12.1 1.1% 5.2%
Equity price risk 4.0 9.0 12.6 4.3 0.2% 1.2%
Currency risk 5.3 3.1 7.0 1.4 0.3% 1.5%
Market risk including diversification effect 19.6 17.6 24.5 12.1 1.2% 5.7%
Diversification effect 7.8 0.5% 2.3%

In 2012 a new model of calculation was confirmed in accordance with which more accurate way of VaR estimation for debt instruments portfolio was developed. Weighted average number of days to maturity of debt securities (duration) are used in this calculation that allows to significantly decrease the market risk of the debt instruments portfolio. The new model more accurately defines equity risks of illiquid securities which can increase equity risk.

The table below shows the interest rate, equity and currency risk calculation using the VaR methodology as at 31 December 2011:

In billions of Russian Roubles Value as at 31 December 2011 Average value for 2011 Maximum value for 2011 Minimum value for 2011 Impact on equity Impact on profit
Interest rate risk on debt securities 41.7 35.3 63.5 21.8 2.8% 13.4%
Equity price risk 9.9 9.3 10.7 7.4 0.7% 3.2%
Currency risk 5.4 5.4 6.9 2.5 0.4% 1.7%
Market risk including diversification effect 43.0 37.6 64.6 28.8 2.8% 13.8%
Diversification effect 14.0 0.9% 4.5%

In order to ensure in correspondence between comparative data for the 2012 and 2011 the table below shows the interest rate. equity and currency risk calculation using the VaR method as at 31 December 2011 based on the methodology accepted in 2012:

In billions of Russian Roubles Value as at 31 December 2011 Average value for 2011 Maximum value for 2011 Minimum value for 2011 Impact on equity Impact on profit
Interest rate risk on debt securities 12.7 12.6 15.5 10.7 1.0% 4.1%
Equity price risk 10.3 11.7 14.8 9.3 0.8% 3.3%
Currency risk 2.0 1.5 2.0 0.8 0.2% 0.6%
Market risk including diversification effect 13.9 15.0 17.2 13.2 1.1% 4.5%
Diversification effect 11.1 0.9% 3.6%

Data in the tables above are calculated on the basis of the Bank’s internal management accounting system which is based on the statutory accounting reports of the Bank.

The table below summarizes the Group’s exposure to foreign exchange risk in respect of monetary assets, liabilities and notional positions on currency derivatives as at 31 December 2012. Foreign exchange risk on forward and future contracts is represented by their notional positions. Foreign exchange options are disclosed in the amount that reflects theoretical sensitivity of their fair value to reasonable change in exchange rates.

In billions of Russian Roubles Russian Roubles USD Euro Turkish Lyra Other Total
Cash and cash equivalents 946.0 125.6 118.8 19.8 80.6 1,290.8
Mandatory cash balances with central banks 122.6 32.8 31.5 5.6 18.7 211.2
Debt trading securities 40.5 23.9 0.4 7.3 2.4 74.5
Debt securities designated at fair value through profit or loss 8.9 0.6 0.7 10.2
Due from banks 60.6 1.7 39.6 12.9 114.8
Loans and advances to customers 7,714.9 1,783.9 366.4 367.9 266.2 10,499.3
Debt securities pledged under repurchase agreements 882.1 25.8 32.6 940.5
Debt investment securities available for sale 356.1 216.9 71.4 77.6 37.0 759.0
Debt investment securities held to maturity 85.0 13.2 2.5 2.4 2.8 105.9
Other financial assets (less fair value of derivatives) 123.8 18.7 3.0 6.5 1.2 153.2
Total monetary assets 10,340.5 2,243.1 633.6 519.7 422.5 14,159.4
Due to banks 1,289.4 52.7 57.7 22.3 30.3 1,452.4
Due to individuals 5,660.1 521.8 452.1 170.5 178.7 6,983.2
Due to corporate customers 1,958.3 747.8 171.6 153.3 165.1 3,196.1
Debt securities in issue 297.7 327.3 17.2 12.9 36.6 691.7
Other borrowed funds 0.7 362.9 76.8 25.4 3.4 469.2
Other financial liabilities (less fair value of derivatives) 97.2 21.9 4.5 20.5 2.0 146.1
Subordinated debt 303.4 71.6 4.7 5.0 384.7
Total monetary liabilities 9,606.8 2,106.0 784.6 404.9 421.1 13,323.4
Net monetary assets/ (liabilities) 733.7 137.1 (151.0) 114.8 1.4 836.0
Net foreign exchange derivatives (323.3) 223.9 178.9 (39.1) (7.6) 32.8
Credit related commitments (Note 33) 1,848.2 621.7 236.8 258.4 64.6 3,029.7

The table below summarizes the Group’s exposure to foreign exchange risk in respect of monetary assets, liabilities and notional positions on currency derivatives as at 31 December 2011.

In billions of Russian Roubles Russian Roubles USD Euro Other Total
Cash and cash equivalents 488.7 58.9 20.9 57.1 625.6
Mandatory cash balances with central banks 99.5 0.6 0.1 1.0 101.2
Debt trading securities 47.9 17.1 2.4 2.6 70.0
Debt securities designated at fair value through profit or loss 30.6 0.2 30.8
Due from other banks 23.7 8.1 0.1 3.2 35.1
Loans and advances to customers 6,074.4 1,385.5 157.4 102.4 7 719.7
Debt securities pledged under repurchase agreements 178.4 65.8 0.1 0.5 244.8
Debt investment securities available for sale 696.6 73.4 39.5 14.9 824.4
Debt investment securities held to maturity 273.4 12.9 0.1 0.1 286.5
Other financial assets (less fair value of derivatives) 93.1 17.1 1.3 0.5 112.0
Total monetary assets 8,006.3 1,639.4 221.9 182.5 10,050.1
Due to other banks 404.6 98.9 21.0 7.9 532.4
Due to individuals 4,959.6 366.6 265.2 134.9 5,726.3
Due to corporate customers 1,517.5 524.6 88.2 75.5 2,205.8
Debt securities in issue 64.4 181.8 1.8 20.7 268.7
Other borrowed funds 0.3 222.3 19.8 1.6 244.0
Other financial liabilities (less fair value of derivatives) 145.5 48.3 0.8 1.5 196.1
Subordinated debt 303.3 0.2 303.5
Total monetary liabilities 7,395.2 1,442.7 396.8 242.1 9,476.8
Net monetary assets/ (liabilities) 611.1 196.7 (174.9) (59.6) 573.3
Net foreign exchange derivatives 6.0 (167.4) 167.6 16.2 22.4
Credit related commitments (Note 33) 1,406.3 594.1 113.3 41.8 2,155.5

The Group provides loans and advances to customers in foreign currency. Fluctuations of foreign currency exchange rates may negatively affect the ability of borrowers to repay loans, which will in turn increase the probability of loan loss.

Liquidity risk

Liquidity risk is defined as the risk of mismatch between the maturities of assets and liabilities. The Group is exposed to daily calls on its available cash resources from overnight deposits, customer’s current accounts, term deposits, loan drawdowns, guarantees and from margin and other calls on cash settled derivative instruments. The Group does not maintain cash resources to meet all of the above mentioned needs, as according to historical data a minimum level of reinvestment of maturing funds can be predicted with a high level of certainty. Liquidity risk is managed by the ALMC.

The Group liquidity risk management is aimed at ensuring timely and complete fulfillment of its payment obligations at minimum cost. For this purpose the Group:

  • maintains a stable and diversified liabilities structure including both term resources and funds on demand;
  • reserves capacity for immediate borrowing of funds on financial markets; and
  • invests in highly liquid assets diversified by currencies and maturities for quick and effective coverage of unexpected gaps in liquidity.

Policy and Procedures

The Treasury performs analysis and forecasts and advices Management on regulation of current, short-term, medium-term and long-term liquidity of the Group. Liquidity position and execution of requirements on managing the liquidity risk are controlled by the ALMC of the Bank. Liquidity risk is assessed, managed and controlled on the basis of “Policies of the Bank for Management and Control of Liquidity” and the guidelines of the Bank of Russia and the Basel Committee for Banking Supervision.

Provisions of this Policy lay down the guidelines for organizing the liquidity management in the Regional Head Offices of the Bank and subsidiaries. The Management Board of the Bank’s Regional Head Office and subsidiaries are responsible for efficiently managing and controlling the Regional Head Office liquidity. They are also responsible for monitoring limits and controls required by the Group’s internal regulations. Guided by the limits, controls, requirements and policies, the Regional Head Office selects evaluation methods and the necessary level of liquidity and develops and implements measures to ensure liquidity. In case of an insufficient liquidity the Treasury provides funds to the Regional Head Office or subsidiary (according to an established procedure) in the required amount.

Liquidity risk management includes the following procedures:

  • forecasting payment flows by major currencies to ensure the necessary volume of liquid assets to cover liquidity deficit;
  • forecasting assets and liabilities structure based on scenario analysis to control the required volume of liquid assets in medium-term and long-term perspective;
  • forecasting and monitoring liquidity ratios compliance with regulatory and internal policy requirements;
  • control over liquidity reserves of the Group to assess maximum opportunities for the Group to attract funds from various sources in different currencies;
  • diversification of funding sources in different currencies taking into account maximum amounts, cost of funding and maturity;
  • stress-testing and planning actions for restoring the required liquidity level in unfavorable conditions or during crisis periods; and
  • setting limits on risk metrics including but not only components of risk appetite of the Group.

The tables below show distribution of undiscounted contractual cash flows (taking into account future interest payments) on liabilities by remaining contractual maturities.

The analysis of undiscounted cash flows on the Group’s liabilities by remaining contractual maturity at 31 December 2012 is set out below:

In billions of Russian Roubles On demand and less than 1 month From 1 to 6 months From 6 to 12 months From 1 to 3 years More than 3 years Total
Due to banks 1,050.3 230.8 123.0 24.4 39.9 1,468.4
Due to individuals 1,871.6 1,252.4 1,159.6 2,599.8 361.4 7,244.8
Due to corporate customers 1,271.1 375.1 91.0 1,558.5 5.7 3,301.4
Debt securities in issue 74.3 145.7 159.0 163.1 242.1 784.2
Other borrowed funds 29.6 75.7 174.4 192.6 42.3 514.6
Other liabilities (including derivative financial instruments) 137.1 41.4 11.7 45.2 37.9 273.3
Subordinated debt 1.8 22.0 46.0 500.3 570.1
Total liabilities 4,434.0 2,122.9 1,740.7 4,629.6 1,229.6 14,156.8
Credit related commitments 3 029.7 3,029.7

The analysis of undiscounted cash flows on the Group’s liabilities by remaining contractual maturity at 31 December 2011 is set out below:

In billions of Russian Roubles On demand and less than 1 month From 1 to 6 months From 6 to 12 months From 1 to 3 years More than 3 years Total
Due to banks 356.2 119.8 48.2 12.7 1.6 538.5
Due to individuals 1,639.7 1,584.9 1,271.5 1,757.4 229.4 6,482.9
Due to corporate customers 1,626.0 194.3 78.5 341.6 14.7 2,255.1
Debt securities in issue 42.1 38.5 18.9 62.1 144.4 306.0
Other borrowed funds 0.3 23.4 54.1 160.9 20.4 259.1
Other liabilities (including derivative financial instruments) 187.4 18.7 2.6 13.1 5.0 226.8
Subordinated debt 0.1 19.5 39.2 400.9 459.7
Total liabilities 3,851.7 1,979.7 1,493.3 2,387.0 816.4 10,528.1
Credit related commitments 2,155.5 2,155.5

Following principles underlying gap analysis presentation and the Group liquidity risk management are based on the mix of CBR initiatives and the Bank’s practice:

  • cash and cash equivalents represent highly liquid assets and are classified as “on demand and less than 30 days”;
  • trading securities, securities designated at fair value through profit or loss and highly liquid portion of investment securities available for sale, including those pledged under repurchase agreements are considered to be liquid assets as these securities could be easily converted into cash within short period of time. Such financial instruments are disclosed in gap analysis table as “on demand and less than 30 days”;
  • investment securities available for sale which are less liquid are disclosed according to remaining contractual maturities (for debt instruments) or as “no stated maturity” (for equities);
  • investment securities held to maturity including those pledged under repurchase agreements are classified based on the remaining maturities;
  • loans and advances to customers, amounts due from other banks, other assets, debt securities in issue, amounts due to other banks, other borrowed funds and other liabilities are included into gap analysis table based on remaining contractual maturities;
  • customer deposits aren’t disclosed as “on demand and less than 30 days” although customers have an opportunity to withdraw money from any account, including term deposits, before maturity date, losing the right on accrued interest. Customer deposits diversification by number and type of depositors and the past experience of the Group indicate that such accounts and deposits provide a long-term and stable source of funding, and as a result they are allocated per expected time of funds outflow in the gap analysis table on the basis of statistical data accumulated by the Group during the previous periods and assumptions regarding the “permanent” part of current account balances.

The liquidity position of the Group’s assets and liabilities as at 31 December 2012 is set out below.

In billions of Russian Roubles On demand and less than 1 month From 1 to 6 months From 6 to 12 months From 1 to 3 years More than 3 years No stated maturity Total
Cash and cash equivalents 1,290.8 1,290.8
Mandatory cash balances with central banks 61.4 32.4 25.6 80.7 11.1 211.2
Trading securities 90.4 90.4
Securities designated at fair value through profit or loss 19.2 19.2
Due from banks 57.0 46.2 0.6 2.4 8.6 114.8
Loans and advances to customers 469.5 1,403.5 1,538.5 3,496.5 3,591.3 10,499.3
Securities pledged under repurchase agreements 723.6 21.4 39.4 89.4 75.9 949.7
Investment securities available for sale 788.3 2.7 2.6 8.4 2.2 0.3 804.5
Investment securities held to maturity 0.2 5.8 8.8 38.5 52.6 105.9
Deferred income tax asset 7.5 7.5
Premises and equipment 436.0 436.0
Other assets 174.3 72.7 36.3 94.3 46.3 144.2 568.1
Total assets 3,674.7 1,584.7 1,651.8 3,810.2 3,788.0 588.0 15,097.4
Due to banks 1,046.3 226.6 115.4 18.5 45.6 —  1,452.4
Due to individuals 1,848.2 1,162.9 1,091.2 2,521.1 359.8 —  6,983.2
Due to corporate customers 1,245.5 363.4 82.3 1,500.7 4.2 —  3,196.1
Debt securities in issue 70.9 140.6 142.5 131.2 206.5 —  691.7
Other borrowed funds 29.1 69.9 169.6 160.1 40.5 469.2
Deferred income tax liability 33.2 33.2
Other liabilities 135.5 53.4 21.2 21.9 6.0 25.1 263.1
Subordinated debt 0.1 0.7 383.9 384.7
Total liabilities 4,375.5 2,016.9 1,622.9 4,353.5 1,046.5 58.3 13,473.6
Net liquidity (gap)/ surplus (700.8) (432.2) 28.9 (543.3) 2,741.5 529.7 1,623.8
Cumulative liquidity (gap)/ surplus at 31 December 2012 (700.8) (1,133.0) (1,104.1) (1,647.4) 1,094.1 1,623.8

The liquidity position of the Group’s assets and liabilities as at 31 December 2011 is set out below.

In billions of Russian Roubles On demand and less than 1 month From 1 to 6 months From 6 to 12 months From 1 to 3 years More than 3 years No stated maturity Total
Cash and cash equivalents 625.6 625.6
Mandatory cash balances with central banks 27.7 10.7 8.9 47.7 6.2 101.2
Trading securities 102.0 102.0
Securities designated at fair value through profit or loss 52.0 52.0
Due from other banks 19.0 13.8 1.8 0.2 0.3 35.1
Loans and advances to customers 253.2 1,043.4 1,243.3 2,477.6 2,702.2 7 719.7
Securities pledged under repurchase agreements 163.7 39.0 82.1 16.0 300.8
Investment securities available for sale 869.3 2.8 3.1 8.4 0.9 884.5
Investment securities held to maturity 0.7 11.7 9.0 116.9 148.2 286.5
Deferred income tax asset 7.8 7.8
Premises and equipment 359.9 359.9
Other assets 138.3 35.7 29.9 39.7 19.1 97.3 360.0
Total assets 2,251.5 1,115.3 1,334.7 2,767.3 2,900.4 465.9 10,835.1
Due to other banks 373.1 118.9 36.7 3.2 0.5 532.4
Due to individuals 1,243.7 739.2 654.1 2,726.0 363.3 5 726.3
Due to corporate customers 973.9 88.0 50.8 1,081.8 11.3 2 205.8
Debt securities in issue 35.3 36.7 17.9 53.5 125.3 268.7
Other borrowed funds 0.2 19.7 52.3 152.0 19.8 244.0
Deferred income tax liability 21.2 21.2
Other liabilities 186.0 47.5 9.6 11.9 6.5 3.7 265.2
Subordinated debt 0.2 303.3 303.5
Total liabilities 2,812.2 1,050.0 821.4 4,028.6 830.0 24.9 9,567.1
Net liquidity (gap) / surplus (560.7) 65.3 513.3 (1,261.3) 2,070.4 441.0 1,268.0
Cumulative liquidity (gap)/ surplus at 31 December 2011 (560.7) (495.4) 17.9 (1,243.4) 827.0 1,268.0

The Management believes that matching and/or controlled mismatching of the maturities and interest rates of assets and liabilities is fundamental to the management of the Group. It is unusual for banks ever to be completely matched since business transacted is often of an uncertain maturity with deviation from contract terms being observed. An unmatched position potentially enhances profitability, but can also increase the risk of losses. The maturities of assets and liabilities and the ability to replace, at an acceptable cost, interest-bearing liabilities as they mature, are important factors in assessing the liquidity of the Group and its exposure to changes in interest and exchange rates.

Operational Risk

Operational risk management is performed by the Group in accordance with CBR recommendations and requirments of Basel Committee on Banking Supervision and defined by the Group’s Policy for operational risk management aimed at prevention or/and decrease of losses arised from deficiencies in operational management, technologies and information systems in use, unauthorised actions or errors of the staff, or by external events.

In order to prevent or/and decrease losses arised from operational risk the Group has developed and used mechanisms and procedures such as overall reglamentation of business-processes and procedures, segregation of duties, rules and procedures for deals and transactions execution, control over credit limit discipline, action plan for information security, continuity, improvement of an audit procedures and quality control over performance of automatized systems and hardware complex, property and assets insurance, ongoing professional development of staff across the Group’s hierarchy, etc.

Accordingly there are risk-coordinators in the Bank’s Head Office, Regional Head Offices, all subdivisions responsible for interaction with operational risk subdivisions concerning identification, valuation, monitoring and control over operational risk.

In 2012 the Bank was continuing collection and sistematization of information concerning realized risk actions, development of internal data base of realized risk actions and losses.

During the period of data base development valuation, forecast and monitoring of operational risk level are performed using base indicative method, recommended by Basel Committee on Banking Supervision, on the basis of income statement and with expert assessments. Current operational risk level for the Group is estimated as acceptable.

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