Statement on Information Disclosure

Risk management of the Bank subsidiary companies is completely integrated in the Bank risk management process, and remuneration policy of the bank subsidiaries is completely integrated in the Bank remuneration policy, thus ensuring unified approach and use of single methods within the Group.

Statement of Information Disclosure is available at the Group level of consolidation. General information on risk management and capital management has been detected in the Bank's consolidated annual report, published in the Bank's website.

Assessment of own funds adequacy

Assessment of own funds adequacy is a component of maintaining capital adequacy, and it is regulated by Capital Adequacy Maintenance Policy, developed in accordance with Regulations on Establishing an Internal Control System, issued by FCMC, and requirements of Credit Institution Law, Regulations for Calculating the Minimum Capital Requirements, and Regulations on the Internal Capital Adequacy Assessment Process.

Within the process of assessing capital adequacy, the Bank ensures its capital adequacy, in terms of the capital amount, constituents and their share, to be sufficient for covering existing and possible risks pertaining to the Bank current and planned operations.

Capital adequacy assessment process includes several stages:

1. estimating capital amount at the Bank’s disposal;
2. determining capital amount required for covering risks;
3. determining capital reserves;
4. determining total amount of the required capital;
5. planning capital at least for three following years and determining desired level of capital:
   • capital adequacy planning, as a component of the Bank overall planning process, is performed based on the financial plan for the following financial year, approved by the Board, and relying on financial forecasts at least for two more subsequent years;
   • making the forecast, both market changes (external factors) and the Bank changes (internal factors) are considered, including changes in main strategic areas;
   • during planning, a need for additional capital and its raising possibilities are considered.

The Bank applies Pillar I Plus approach for assessing capital adequacy:

• the amount of capital required for covering risks for which regulatory minimum capital requirements are set is determined by the Bank following the FCMC Regulations for Calculating the Minimum Capital Requirements, making corrections in accordance with the FCMC Regulations on the Internal Capital Adequacy Assessment Process, if necessary;
• the amount of capital required for covering other material risks for which no regulatory minimum capital requirements are set, as well as amount of capital reserves, is determined by the Bank following simplified methods of the Regulations on the Internal Capital Adequacy Assessment Process.

Material risks are determined based on identifying major types of activities and analyzing their associated risks.

The following risks are material for the Bank:

1. credit risk, including:
   • concentration risk, including:
     • claims against one customer
     • claims against one group of mutually related customers
     • claims against customers involved in activities within the same sector
     • claims against customers operating in the same state or region
     • claims secured with collateral of the same type
   • residual risk in case of using Credit Risk Mitigation Techniques
2. trading portfolio (TP) and non-trading portfolio (non-TP) market risk, including:
   • TP position risk, including:
     • specific risk
     • overall risk
   • counterparty risk
   • foreign exchange risk
   • non-TP interest rate risk
3. operational risk, including:
   • personnel risk
   • process risk
   • information technologies and system risk
   • external risk
4. money laundering and terrorism financing risk
5. liquidity risk, including:
   • market liquidity risk
   • funding liquidity risk
6. other non-quantifiable activity risks, including:
   • reputational risk
   • compliance risk
   • strategy and business risk

Credit risk

The amount of capital required for covering credit risk is determined based on stress test results.

For the purposes of stress testing, loan portfolio is divided into 3 parts:

• mortgage loans
• loans granted for real estate development and investments
• business loans to corporate customers, not related to real estate development
• card credits, consumer loans, and overdrafts are not accounted for in stress tests.

Sensitivity analysis is performed on each portfolio part.

Overall outcome – the Bank possible losses arising out of the loan portfolio – is calculated defining 3 possible scenarios: basic, pessimistic, and emergency scenario. The scenarios should reflect possible impact of negative events on the Bank risk level, financial and capital indicators. A negative event is considered to be an event the probability of which is extremely small but yet possible, and such event causes additional losses for the Bank.

Considering the defined scenarios, their impact on minimum capital requirements to loan portfolio as of the end of examination period is determined. Calculation takes account of loans’ shifts between degrees of risk due to increasing insolvency and decreasing real estate prices, and also of lower net loan balance due to making provisions.

Amount of credit risk capital reserves is calculated considering difference between made provisions and expected total losses, and also taking account of changes in minimum capital requirements within the stress test period.

Concentration risk

Concentration risk is analyzed following simplified method and in accordance with stress test results corresponding to plans on granting loans.

Assessing loan portfolio concentration, loan balances, without deducting made provisions, and off-balance liabilities, with no conversion factor applied, are taken into account.

Loan portfolio breakdown into sectors and collateral types is performed according to the Bank of Latvia Regulation for the Credit Register.

Under loan portfolio concentration risk analysis, the following is performed:

• individual concentration analysis,
• sector concentration risk analysis;
• collateral concentration risk analysis;
• currency mismatch risk analysis.

Overall amount of capital required for covering loan portfolio concentration risk is calculated as total of the said constituents.

Under claims to credit institutions, individual concentration is assessed as well, and individual concentration and currency mismatch concentration risk is assessed for securities.

Overall amount of capital required for covering concentration risk is calculated as total of the said constituents.

Market risk

Since the Bank trading portfolio is insignificant (<5% of assets), the Bank determines market risk minimum capital requirements pursuant to the instruction on Calculating Market Risk Minimum Capital Requirements on Trading Portfolio Transactions (INS.238), making the following corrections:

• minimum capital requirements under foreign exchange risk are compared with aggregate value of possible foreign exchange risks calculated on total net position, and the largest of these two values is used. Possible risk value is calculated on foreign exchange positions that exceed 5% of the total of absolute values of all open positions. Possible risk value is calculated as a product of annual standard deviation of the respective currency’s market rate and the position value, given the probability of 99%.
• minimum capital requirements under position risk of trading portfolio capital securities are compared with total possible risk value of these securities, which is calculated as a product of annual standard deviation of the respective security’s price and the position value, given the probability of 99%.

Market risk of non-trading portfolio has been assessed as well, and capital required for it has been calculated based on assessment of interest rate risk of non-trading portfolio and assessment of liquidity risk.

Interest rate risk of non-trading portfolio

The amount of capital required for covering interest rate risk of non-trading portfolio is determined by the Bank according to simplified method and taking into account that the Bank will also gain profit within a year in case of unexpected parallel change of interest rate (interest rate shock parameters) by 200 basis points, which were used for calculating decrease of economic value.

Money laundering and terrorism financing risk

The amount of capital required for covering money laundering and terrorism financing risk is determined by the Bank according to simplified method. 

The customers to which enhanced due diligence should be applied are identified in accordance with the FCMC Regulations for Enhanced Customer Due Diligence.

For assessing internal control system quality (ICSQ) on anti-money laundering and terrorism financing, expert assessment method is applied, where the following persons are considered experts: Chief Compliance Officer (CCO) and Head of Internal Audit Department (Head of IAD). For assessing ICSQ on anti-money laundering and terrorism financing, the average of assessments provided by CCO and Head of IAD is used.

For assessing quality of internal control system on anti-money laundering and terrorism financing, a grade between 1 and 4 is applied, and a correction factor and capital required for ICSQ is calculated based on this grade.

The calculated ISCQ capital is added to the required amount of capital calculated applying simplified method.

Operational risk

The capital requirements for covering operational risk are determined by the Bank as equal to the minimum capital requirements. Assessing its adequacy, the Bank considers the following:

• the Bank actual operational risk losses during at least three previous years;
• internal audit evaluation of operational risk management system efficiency;
• available information on operational risk events within the sector;
• additional possible risks not covered by minimum requirements;
• results of the performed operational risk stress tests.

For performing stress test, VaR (Value at Risk) concept – OpVaR is used, the value of which represents potential extraordinary losses. The following parameters are used for determining OpVaR calculated by the Bank:

• probability level – 99.99%;
• time horizon (holding period) – one year;
• historical data (risk event database);
• information on external events registered in the operational risk event database;amount of loss under external events is determined taking into account the ratio of the company’s and the Bank’s income, and assuming that such events might occur once in 10 years.

Liquidity risk

The amount of capital required for covering liquidity risk is determined by the Bank based on results of liquidity risk stress tests. The amount of required capital is stated to be equal to the value of losses of security portfolio available for sale (including negative revaluation reserve) and costs of overcoming liquidity crisis, making additional assumptions, if necessary.

Other risks

Since some risks are difficult to assess in quantitative terms, the Bank establishes qualitative and efficient environment for managing those risks.
The amount of capital required for covering other risks is determined based on qualitative and quantitative assessment of risks and estimation of possible losses.

The following risks are included in other non-quantifiable risks:

• reputational risk;
• compliance risk;
• strategy and business risk.

Determining capital reserves

For determining the amount of capital reserves, the bank analyses, assesses possible bank development scenarios for the following two years depending on different macroeconomic situation development scenarios, events, or market changes, and also assesses impact of such scenarios, events, or market changes on the bank’s overall financial status, amount of the capital at the bank’s disposal, capital requirements, and capital adequacy.
Determining the amount of reserves, the Bank takes into account assumptions and results of performed stress tests of particular risks.

Determining total amount of the required capital

Total amount of the required capital is equal to the aggregate amount of capital required for covering all risks.

Remuneration policy and practice

The Bank remuneration policy ensures unified approach and use of single methods within the Group.

Existing remuneration policy is based on the Bank’s objectives and long-term interests. The remuneration policy is dependent on execution of the financial plan, which in turn is dependent on the strategy and risk management policies.

The remuneration policy provides for variable remuneration part, which depends on compliance with values and ethical standards, cooperation between organization units, and also performance over a quarter, a half of the year, or a year.

Currently, there are 17 bonus schemes in the Bank, and those apply to and cover all staff of the Bank and its subsidiaries. Variable remuneration part (bonuses) includes incentives for the employees to maintain acceptable level of risk in their work. Variable remuneration part is constituted of money. The remuneration policy takes into account assessment of the assets’ quality, which applies both to an individual employee and the whole organization unit.

The Bank’s Council approves the Bank’s Personnel Policy, which determines powers of the Bank’s institutions in personnel management, remuneration system, bonus scheme, etc.

Remuneration of the Board is determined by the Bank’s Council.

Since 2005, Remuneration Committee functions at the Bank, and its operations are regulated by the Statutes of Remuneration Committee. The Remuneration Committee is a permanent institution that operates in accordance with the principles of the Bank’s Personnel Policy and supervises efficiency of the remuneration system of the Bank and its subsidiaries.

The members of the Remuneration Committee are: Chief Executive Officer, Deputy Chief Executive Officer, Chief Operating Officer, Chief Financial Officer, Chief Compliance Officer, Head of Human Resources Department and Head of Financial Analysis Department.

Main tasks of the Committee are as follows:

• to review proposals on changes in the parts of the remuneration system and on their improvement;
• to make decisions on changes in the parts of the remuneration system of the Bank and its subsidiaries and on their improvement within the scope of powers set by the Board;
• to supervise efficiency of remuneration systems and their compliance with set objectives;
• to advise heads of organization units on improvement of remuneration system;
• to initiate changes in the Bank’s normative documents concerning personnel management;
• to address other issues within its scope of competence pursuant to the Board’s decision and the Bank’s normative documents.

Issues concerning remuneration of the Board are not included in the Remuneration Committee scope of competence.

At the Group’s level, variable part of the whole remuneration system is determined based on performance results over the quarter, half of the year, or year.

There is 25% to 50% deferred part limit set on variable remuneration part.

The Group’s remuneration policy stipulates that for assessing performance of the Group members and separate organization units, which impacts components of the variable remuneration part, both financial and non-financial indicators are used.

Major non-financial indicators included in performance evaluation:

• quality of cooperation between organization units;
• compliance with normative documents and internal code of conduct;
• quality of providing services to customers of organization units.

Major financial indicators included in performance evaluation:

• return on assets and their quality;
• amount and quality of investments;
• commission income;
• trading result;
• reporting period profit.

* Including allowances for liabilities to employees, health insurance expenses, etc.

** Variable remuneration part consist of money funds.

The employees have not acquired irrevocable right to unpaid deferred part of the variable remuneration part. No corrections have been made to the amount of the variable remuneration part paid out in 2011, but it is possible that those can be made to the unpaid remuneration part in future periods. Payout of the unpaid variable remuneration part has been deferred for 5 years.

During the reporting year, employment of 43 (52) employees has been terminated; the total amount of severance pay equalled LVL 33 139 (86 401). The largest severance paid to one person was LVL 7 313 (10 133).