Risk management system, system improving process
The bank exercises control over its financial, operational and legal risks. Financial risks include market risk (consisting of currency risk, interest rate risk and securities risk), credit risk and liquidity risk. The main objective of financial risk management is determination of risk limits and ensuring compliance with the set limits. Operational and legal risk management should provide proper functioning of internal regulations and procedures in order to minimise these risks.
RISK MANAGEMENT SYSTEM
|Risk||Document||Authority which approved
|Credit risk||Regulations on the organisation of management and control over credit risk||Board of Directors|
|Operating risk||Regulations on the organisation of operating risk management||Board of Directors|
|Liquidity risk||Vozrozhdenie Bank's policy in the area of management and control over liquidity||Board of Directors|
|Regulations on the organisation of management and control over liquidity risk||Management Board|
|Market risk||Regulations on the management of securities risk||Board of Directors|
|Currency risk management policy||Management Board|
Risk management in the bank is performed on several levels – beginning with the branches, working with primary documents and bank’s customers within the requirements and limitations set at higher levels. Next are the levels of internal divisions of the bank’s Head Office, which carry out risk management activities within their competence. The highest level is represented by the bank’s collegial bodies – committees (the Credit and Investment Committee, the Assets and Liabilities Management Committee, the Technological Committee), the Risk Control Department and the Board of Directors. The Management Board and the Board of Directors set management requirements for the groups of risks for the bank and for the departments responsible for the management of particular risks. At the Board of Directors there is an Audit Committee whose area of responsibility includes additional control over the bank’s risk management system.
Also, the bank has created a special Risk Control Department which continuously analyses fundamental risks, and if a high risk is identified, the department informs the bank’s management and the divisions supervising the corresponding area of activity. The department provides quarterly reports to the Management Board and the Board of Directors on the level of each main type of risk: credit, operational, market and liquidity.
The Risk Control Department exercises control over professional activities of the bank as a participant of the security market and control over counteractions to the unauthorised use of insider information and market manipulation. Reports on these areas of focus are provided to the Management Board and the Board of Directors on a quarterly basis.
As part of the overall risk management system, the bank uses standard risk minimisation instruments for each specific type of risk: insurance, provisioning, allocation (including risk premium in the product price), diversification and risk control. In case of an unfavourable risk event, the bank performs the necessary actions to establish the cause of the event and to develop measures to prevent similar events in the future. Among other things, the bank introduces changes in the internal instructions, improves the software and, therefore, enhances the process of the particular risk management.
The main methods of risk mitigation are:
- clear statement of rules and procedures for banking transactions and other deals
- implementation of principles of separation and limitation of functions, powers and responsibilities of employees
- collective decision making, setting a system of limits on particular transactions
- implementation of internal control procedures for the organisation of business processes and compliance with the legislation and internal regulations
- ensuring physical and information security of the bank
- ensuring the necessary level of staff qualification, including professional development
- automation of banking processes and technologies; organisation of effective monitoring over the IT systems functioning
Situation in 2014
The Russian economy experienced several severe negative impacts in 2014, including the introduction of sectoral and financial sanctions against Russia, the retaliatory sanctions to restrict the import of food, the decline in oil prices, the devaluation of the Russian Ruble and, as a consequence, general deterioration of the economic situation in the country.
Under these conditions, Vozrozhdenie Bank adhered to a conservative strategy in assessing the economic situation and risk management, by following the previously developed principles. As part of the implementation of operational management and strategic planning processes, including equity (capital) and liquidity, the Management Board approved the bank’s “Financial activity plan in case of emergency”. The document contains:
- description of stress scenarios at the bank level and in the banking sector in general
- list of key indicators and their critical values that characterise the implementation of these scenarios
- procedure for first response and decision making in respect to anti-crisis and adaptive measures with due account for particular stressful situations
- list of departments responsible for the implementation of measures aimed at reducing the crisis consequences for the bank and ensuring its financial stability
To minimise the risks in the reporting year, the bank implemented a number of projects to improve key business processes: the CRM credit process, building a credit middle office, centralised analysis of investment credits, centralisation of work with large borrowers, transactions officer-cashier, fraud analysis, centralisation of the account opening process, centralisation of work with collateral and electronic records of a legal entity. Additional information on risk management is presented in the IFRS financial statements.
Credit risk is a risk of losses owing to non-performance, delayed or incomplete performance of the debtor’s financial obligations. Risk management of credit risk can be performed by implementing a system of limits and powers, the main objectives of which is to limit the level of risk and to optimise the decision making process.
Powers and particular types of limits as well as conditions of loan disbursements are reviewed and approved by the Management Board on a quarterly basis. There is a Credit and Investments Committee in the bank with a system of subcommittees possessing various authorities, including: the main body of the Credit and Investment Committee, the small committee, the subcommittee on corporate clients, the subcommittee on microbusiness lending and the subcommittee on retail lending. Comprehensive control over the credit risk level is performed in the bank by the Risk Control Department, the members of which are included in all collegial bodies making decisions that could affect the level of the bank’s credit risk and which have the right to block the decisions and submit them for consideration by a higher authority.
The bank annually approves its credit policy, which defines the basic limits and restrictions in the provision of credit products: maximum risk exposure per borrower; maximum risk exposure per group of related borrowers; maximum aggregate size of large credit risks of the bank, etc. In order to reduce the level of credit concentration, in its credit policy for 2014 the bank put further restrictions on the limits for large borrowers or group of related borrowers as well as on the maximum aggregate amount of large credit risks of the bank. The bank assessed the level of concentration of its loan portfolio as moderate.
Also, the credit policy sets additional restrictions – qualitative and quantitative KPIs representing segmental, sectoral and regional structure of the corporate loan portfolio, FX and maturity structure of the loan portfolio. For example, in order to diversify its loan portfolio by various economic sectors, the bank identified the following sectors: manufacturing, trade, construction, agriculture, transport and communications, finance, etc. In 2014, the bank considered construction, agriculture, finance and real estate transactions to be the most risky sectors.
CHANGES TO THE CREDIT POLICY DURING 2012–2015
- Decision-making authorities are fully transferred to the Head Office
- The limit for maximum credit risk exposure per borrower or group of related borrowers is reduced to RUB 1 billion (4.2% of the capital as at January 1, 2015)
- The ratio of the 20 largest groups of related borrowers to the capital is not more than 2.2
- The maximum size of loans issued without collateral is no more than 10% of the portfolio
- Powers and authority of the credit risk personnel were increased – if the specialist of the Risk Control Department is against the decision to take the risk concerned in the course of the Credit Committee, then its consideration is transferred to a higher level
- The bank created an internal division to work with collateral and tightened collateral requirements
- The bank introduced an early warning system
- The bank set risk limits depending on the customer segments and industries
YEAR 2014 RESULTS
The size of the loan portfolio did not change by the year’s end in 2014. The portfolio increased by RUB 2.0 billion (by 1.2%). The growth of the retail loan portfolio, including bank card loans, amounted to RUB 3.6 billion (8.4%) mainly on the back of mortgage loans and consumer lending to payroll clients. Reduction of the corporate portfolio amounted to RUB 1.6 billion (1.3%).
In 2014 charges to provisions for loan portfolio impairment amounted to RUB 3.2 billion with Cost-of-Risk ratio at 1.9%. Total provisions reached RUB 14.4 billion as of December 31, 2014, up 16.6% from the year 2013 result. Coverage of non-performing loans overdue 90+ days was 115%.
The bank significantly tightened requirements on collateral in the reporting year. One of the bank’s advantages is its Collateral Department organised for the reduction of credit risks by centralised assessment and monitoring of property assets taken as loan collateral in 2013. About 70% of the portfolio is secured by hard collateral and liquid security (government guarantees).
In summer 2014 the bank started to convert a substantial part of FX corporate loans into rubles, which helped to mitigate credit risks.
The bank tested the automated system for centralised monitoring of the corporate loan portfolio during the year. The system was put into commercial operation based on the test results. The so-called “early warning system” allows to identify negative signals from the activities of corporate borrowers monthly-based.
From January 1, 2015, within the framework of the early warning system, all branches of the bank identify the following risk factors by borrowers: overdue debt, outstanding commitments to other counterparties, decrease of turnovers in settlement accounts, analysis of sources for repayment of interest, incurrence of penalties and penalty fees, conversion into cash and availability of arbitration cases, including bankruptcy. The early diagnostics allow us to make management decisions in time and to minimise the risk of transition of loans to the default category.
Implementation of the credit risk calculation based on internal ratings continued, as recommended by the Bank of Russia and as required by Basel II. Today the bank is at the stage of collecting, accumulating and processing statistics on clients for its subsequent inclusion in the bank’s model.
Currently, to assess the creditworthiness of corporate borrowers, the bank uses the RiskCalc v3.1 Russia model by Moody’s Analytics. The model allows calculating specific indicators of default risk for Russian private companies on the basis of financial statements. After the development of an internal rating system, the RiskCalc v3.1 Russia is supposed to be used for analysis and calibration of the bank’s own rating system. The future transition to the evaluation of counterparties’ credit risks on the basis of internal ratings would eliminate a part of the standard manual methods of client creditworthiness analysis due to the assignment of an internal rating to each counterparty, which would significantly simplify the risk evaluation process of credit transactions.
In addition, in the reporting year the bank continued implementation of the Microsoft Dynamics CRM system. The CRM system will be used for corporate lending, both for organisation of the sales process and for support of the entire loan process, including the review process, control of limits (on the borrower, on the product), issuance and verification of conditions precedent, and support of credit products after disbursement.
EARLY WARNING SYSTEM: OBSERVED BORROWER-SPECIFIC RISK FACTORS
Operating risk is a risk of losses resulting from inadequate or faulty internal processes, people, systems or external events. In 2014 the bank updated its regulatory documents in respect of operating risks, including the Procedure for the collection of information on operating risk events and the Order on the procedure for informing about emergency situations as well as tightened control over the implementation of plans on minimisation of identified risks. In addition, the bank developed a method for evaluation of losses from work stoppage caused by system and technology related failures and prepared an operating risk training course for all the bank’s employees.
The bank uses a wide range of insurance instruments to minimise the financial impact of operating losses. The bank concluded a comprehensive risk insurance contract for a financial institution (BBB - Bankers Blanket Bond) as well as Directors and Officers Liability Insurance (D&O). Movable and immovable property (including electronic devices and cash therein, valuables, vehicles) is insured by the largest insurance companies in Russia.
The bank makes special efforts to maintain stable functionality and reduce operating risk of IT systems and communication channels. It performs a comprehensive analysis of the bank’s IT processes, from ensuring uninterrupted power supply of the equipment to evaluating the effectiveness of IT architecture.
YEAR 2014 RESULTS
1,441 incidents of operating risk were recorded in 2014, which exceeds the figure of 2013. The increase was due to improvements in the process of identifying and gathering information on operating risks. Moreover, there is no significant changes in the nature of the events identified in 2014. Internal investigations were conducted in respect of significant incidents, and, based on their results, changes were introduced to business processes in order to reduce the risk probability or the financial impact of occurred operating risk events.
Growth in the number of wrongful acts from third parties was noted, including cases associated with the use of remote banking service.
Bank card transactions by individuals remain an important area of control. The main losses from this type of risk occur in cases of cash withdrawal from compromised credit cards. To reduce the losses from fraudulent actions with cards, the bank developed rules of conduct and a system of restrictions on card transactions. All bank cards issued by the bank are equipped with a microchip, which significantly reduces the amount of losses due to the rule of responsibility transfer. Theft of cash from ATMs is also one of the main risks, however installation on the ATMs of video surveillance and alarm systems prevented the most part of thefts in 2014.
Liquidity risk refers to the probability that at a certain time the bank will not have free funds or assets that can be immediately transformed into cash in order to make all necessary payments on the instructions of its clients and on its own behalf and to meet all other cash requirements; or the bank will not be able to buy the necessary funds on the market at affordable prices.
The purpose of liquidity management is to create and maintain the structure of assets and liabilities by types and basic maturities, that would allow the bank to ensure timely fulfillment of obligations to its creditors, meet the customer demand for borrowing funds and maintain the bank’s reputation as a reliable partner. The process of management and control over liquidity risk is regulated by the instructions of the Bank of Russia and internal documents. The function of this risk management is distributed between the collegial bodies and internal divisions:
- The Board of Directors determines and approves the general strategy in the area of liquidity risk management
- The Management Board is responsible for the general management and control
- The Assets and Liabilities Management Committee performs liquidity management within the requirements set by the Management Board
- The Treasury performs operating management of liquidity
Liquidity risk management is performed by matching the repayment dates of assets and liabilities as well as by maintaining an appropriate amount of highly liquid assets (cash on hand, balances on correspondent accounts in the Bank of Russia, interbank loans and deposits, trading securities portfolio, resources pledged under REPO). The bank’s liquidity is considered not only as of the current date, but at certain time intervals in the future.
At the end of 2014, the share of liquid assets in the balance sheet amounted to 24.9%. The bank strengthened its liquidity position at the end of the year thanks to growth of funds and cash equivalents and the increase of its portfolio of liquid securities.
In order to analyse the liquidity risk, the bank performs evaluation of its dependence on transactions in the interbank market, operations of large clients and credit risk concentration. The bank aims to maintain a stable source base, consisting mainly of deposits from the population, legal entities and funds due to other banks. Special attention is paid to the quality and diversification of assets. The securities portfolio formed with due account for the Lombard List of the Bank of Russia provides access for the bank to refinancing instruments.
The bank complied with all liquidity ratios set by the Bank of Russia on a daily basis and with a sufficient margin of safety, during 2014, including standards of instant, current and long-term liquidity as well as introduced international standards in the areas of capital maintenance and liquidity ratios (Basel III). Thus, in accordance with the recommendations of the Basel Committee and the requirements of the Bank of Russia, in order to improve procedures for managing short-term liquidity, the bank applied the method of analysis and control over the short-term liquidity indicator based on the assessment of needs for immediately available funds in the next 30 calendar days under a stress scenario.
At the end of 2014, a significant depreciation of the Ruble exchange rate, occurred amid anti-Russian sanctions and declining oil prices, resulted in an outflow of some Ruble deposits. In this situation, the Ruble liquidity regulation was carried out using the available liquidity cushion as well as refinancing instruments offered by the Bank of Russia, including REPO operations and loans secured by non-marketable assets.
The bank did not incur a deficit of foreign currency liquidity during 2014, and did not use the Bank of Russia’s instruments of foreign currency refinancing.
In 2015, the bank’s efforts will be focused on ensuring adequate liquidity and expansion of potential sources of additional liquidity against the possibility of exceptional but potentially possible situations. The bank plans to continue work on improving the methodology and development of IT systems to ensure the accuracy of estimation and reliability of the liquidity risk management process.
MATURITY STRUCTURE OF THE BALANCE SHEET
In order to increase equity (capital) and enhance the volume of active operations, at the beginning of 2014 the bank received a subordinated deposit in the amount of USD 7 million maturing on January 28, 2022.
Adequacy ratios of the total capital and of the Tier-1 capital as of January 1, 2015 in accordance with the requirements of Basel I were 14.9% and 12.7%, respectively. The bank also calculates capital adequacy in accordance with the requirements of Basel III, which were introduced by the Bank of Russia as mandatory standards from January 1, 2014.
As at the reporting date, the total regulatory capital adequacy ratio (standard H 1.0.) was 12.0% and the Tier-1capital adequacy ratio (standard H 1.1.) — 9.3%, which significantly exceeds the minimum acceptable values. During the year the adequacy ratios improved from 11.2% and 8.8%, respectively. We should also note the high quality of the capital structure, the share of core capital was 77%. Due to the conservative balance sheet structure, the bank did not have to use the options provided by the Bank of Russia for levelling negative effects of the sharp Ruble depreciation and the volatility of the securities market on the capital adequacy ratios.
In 2015, Vozrozhdenie Bank is planning to increase the amount of equity (capital), primarily due to the capitalisation of profits and also through the possible acquisition of subordinated loans.
CAPITAL ADEQUACY (IN ACCORDANCE WITH BASEL I)
Market risk (currency, interest rate and securities)
Market risks arise from the bank’s open positions in respect of interest, currency and equity instruments, which are exposed to general and specific market changes. The Management Board and the Assets and Liabilities Management Committee set limits on the level of exposure and supervise their implementation on a daily basis.
The bank’s Treasury calculates, monitors and manages market risk daily within the set limits. Individual risk limits in respect of individual issuers are set by the Credit and Investment Committee by the proposal of the Treasury, and are approved by the Management Board. The bank performs regular stress testing of market risks, which allows evaluating the bank’s asset portfolio sustainability to “extreme” events that could lead to abnormally large losses. To calculate the market risk, the bank uses the methodology of the Bank of Russia.
The bank is exposed to currency risk due to the fact that its assets and liabilities are denominated in different currencies as well as due to the presence of open FX positions resulting from foreign currency transactions. Foreign exchange risk management provides the maximum possible consistency between the asset currency and the liability currency. To assess the risks associated with the maintenance of open positions in foreign currencies, the bank uses the methodology of the Bank of Russia.
The bank adheres to a conservative foreign exchange policy in its efforts to limit the level of accepted currency risk by maintaining the minimum possible level of open positions. In order to effectively manage the currency risk, the bank uses a daily revaluation procedure and the system of volume and stop limits on the positions bearing a foreign exchange risk. The bank sets limits on the cash and term operations by type of transaction and type of currency. All foreign currency transactions are conducted within the limits established for counteragents. The bank determines the limit of maximum losses in respect of dealers’ transactions (stop-loss limit); upon reaching this limit, all open positions must be closed with losses. The limit restricts the losses for a certain period: per day, per five consecutive working days, or per month.
The bank periodically revaluates the assets and liabilities in the balance sheet by doing a stress test, including the calculation of hypothetical losses of the bank, which may incur as a result of sharp changes in the foreign exchange rates. The frequency depends on the changes of market conditions and the level of foreign exchange risk.
Assets and liabilities in the bank’s currency structure are balanced. In general, the revaluation of the foreign currency side was one of the reasons for the growth of balance, especially with regard to corporate loans and retail deposits. The bank converted a portion of corporate loans into rubles, replacing them with FX assets associated with less risks, namely with bonds of sovereigns and quasisovereigns. In the retail loan portfolio, the share of foreign currency loans is not significant, therefore revaluation had almost no effect on the dynamics of the ratio.
The relevance of the currency risk management has sharply increased under the current conditions of financial and economic crisis, accompanied by increased volatility of markets, including foreign exchange rates. In 2015, the bank, as before, will adhere to conservative policies in order to limit the level of accepted foreign exchange risk by maintaining the lowest possible level of open positions. In addition, particular attention will be paid to the quality of the bank’s assets denominated in foreign currencies, and, above all, to the quality of the loan portfolio as well as to maintaining an adequate level of highly liquid assets in foreign currencies to ensure necessary liquidity in the context of foreign currencies.
CURRENCY STRUCTURE OF THE BALANCE
AS AT THE END OF 2014
INTEREST RATE RISK
Interest rate risk of the bank book
The interest rate risk of the bank book is related to the effects of fluctuations of market interest rates on the bank’s financial position and cash flows. Evaluation of the interest rate risk is based on a gap analysis of financial instruments sensitive to changes in the interest rate. Interest rate risk management allows minimising the net gap resulting from the analysis of assets and liabilities, which are sensitive to interest rate changes. Depending on the size of the net gap, the bank makes a decision to provide or acquire resources at certain rates for a certain period of time. General parameters of the interest rate risk management are determined by the bank’s financial plan for the current year.
Interest rate risk of the securities portfolio
The interest rate risk of the commercial register is connected to the bank’s operations on the bond market, since bonds constitute over 95% of the bank’s securities portfolio. The main volume of the bank’s operations with debt instruments accounted for the government bonds in foreign currencies, high-quality municipal and corporate bonds denominated in Russian Rubles and foreign currencies. The share of bonds in the portfolio as of January 1, 2015 with a maturity less than one year was 94.9%. When building the securities portfolio, the bank was guided by the Lombard List of the Bank of Russia.
In 2014, the bank took advantage of the rising bond yields in the fourth quarter and increased its investments in the low-risk liquid debt securities in order to maintain the net interest margin. As a result, the securities portfolio increased by RUB 9.9 billion to RUB 22.1 billion.
The bank carries out transactions with stock securities (shares of Russian companies and ADR and GDR on them), but this activity is not a priority. Securities risk management is governed by the Regulation “On the management of securities risk in Vozrozhdenie Bank”. The system of limits on securities risk used by the bank includes limits on the securities portfolio, including REPO transactions, some sub-portfolios within its structure and limits on the trading portfolio of securities. Parameters of the share portfolio are reflected in the “Order of performing by the Treasury of Vozrozhdenie Bank of securities portfolio transactions in 2014”. Given the limited maximum size of the investments in shares, the bank considers it sufficient to assess securities risk by using the methods set in the Regulation of the Bank of Russia No.387-P dated September 28, 2012 “On the procedure of market risk calculation by credit organisations”.