Sharing TBC Bank experience on Credit Risk under ICAAP.

Sharing TBC Bank experience on Credit Risk under ICAAP

Overview

Credit Risk Governance

Credit Risk Management

Credit Risk Stress test

Way Forward

1

2

Agenda

POS Terminals

3,295

ATMsTBC / TBC&Constanta

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No 1 in Retail Deposits – 34% of market share as at 30 September 2013;

A leading bank in the country with 27% and 25% market share of total customer loans and total assets respectively as at 30 September 2013;

Number of customers: over 900k; Number of employees: c. 4,000;

Entered microfinance segment in May 2011 through acquiring Bank Constanta

Presence in Azerbaijan-subsidiary TBC Kredit - non-banking credit organizationBranches

TBC / TBC&Constanta

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TBC Bank at a GlanceKey Facts About TBC Bank

Shareholder Structure

Source: Market Shares are based on National Bank of Georgia and include Bank Constanta.

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Loan Portfolio Composition by Business Segments – 30 Sep 2013

TBC Financial Highlights and Ratios (30 September 2013)

Note: Exchange Rate Used: USD/GEL 1. 6644 as at 30 September 2013

BB-/Stable (FC Long Term IDR) B1/Stable (Bank Deposits – Fgn Curr)

Affirmed on 14 June 2013 Affirmed on 1 November 2012

B (FC Short Term IDR) Ba3 (Bank Deposits – Dom Curr)

Note: Number of accounts and number of employees include Bank Constanta

GEL million USD million

Total assets 4,015 2,412

Net loans 2,618 1,472

Customer deposits 2,614 1,570

Stockholders’ equity 689 414

Financial Ratios

ROaE (annualized) 18%

Cost to income 52%

Tier 1 CAR (BIS) 23%

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Two Founder Shareholders 26.70%

European Bank for Reconstruction and Development (EBRD) 19.80%

International Financial Corporation (IFC) 19.80%

Deutsche Investitions-und Entwicklungsgesellschaft (DEG) 11.31%

JP Morgan 4.96%

Ashmore 4.20%

Netherlands Development Finance Company (FMO) 5.26%

Management and others 7.97%

What is ICAAP

Regulatory Capital requirements of the bank will be defined in Accordance with Basel 2/3 requirements

Pillar 1

Capital charge is calculated based on NBG regulation.

Basel II and III are recommendations on banking regulations published by the Basel Committee on Banking Supervision

National regulators decide to adhere to Basel committee regulations and set the requirements and timeline to the banks.

The banks were required to be compliant with Pillar 1 requirements by June 2014 and submit first ICAAP by September 2014

Components of Basel 2/3

Pillar 2

Banks Estimate its capital requirements. Use stress tests to double check its solvency.NBG approval is needed.

Pillar 3

Banks need to disclose its capital calculations to interested parties.

Basel II/III Overview>>

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TBC Experience in Implementation

Feb 2012 Mar Apr May OctSepJun Jul Aug Nov Dec FebJan 2013

External consultant selection

High Level Gap analysis. Credit review

Detailed Gap Analysis Implementation and Capital CalculationICAAP

Availability of high quality data

Development of adequate framework

Integration of the processes into day to day management

ICAAP implementation included:

Major improvements in risk management including credit, operational, market and other risk management

Significant changes in corporate governance both on the Supervisory and Management board level

In total:

25+ people from the banks side and two outsourcing companies including Ernst & Young were involved in the project

Timeline>>

Summary>>

Main Challenges>>

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Capital assessment and planning in accordance with the risk profile

Better capital management through better capital allocation practice

Better understanding and management of the risk that banks face

Enhanced corporate governance

Enhanced transparency in capital calculation and risk management resulting in enhanced trust from regulators and investors

Main Benefits>>

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Credit Risk Breakdown

Risk Weighted Exposures Pillar 1 Pillar 2

1 Credit Risk

1.1 Credit Risk 3,380 3,380

1.2 FX Induced Credit Risk 1,272 437

1.3 Concentration Risk - 455

2 Market Risk 4 4

3 Operational Risk 344 81

4 Strategic risk - 67

5 Reputational risk - 67

6 Interest rate risk - 127

7 Total Risk Weighted Exposures 5,000 4,619

In million GEL Data as of Dec 2013

Compared to Pillar 1 Pillar 2 contains number of additional risks Credit risk remains significant part of both Pillar 1 and Pillar 2 Risk Weighted Assets

92%

Credit Risk Under ICAAP

Credit Risk Governance

Credit Risk Management

Credit Risk Stress test

Way Forward

2

7

Agenda

8

Introduction to the Risk Management FunctionTBC considers its risk management function to be fundamental to its business

Principles of Risk Management>>

TBC conducts its business with a view towards long-term sustainability

TBC pursues a strategy that excludes any involvement in transactions that could pose an unacceptable risk for TBC’s activities, development and reputation

The materiality of each risk to which TBC is exposed across the corresponding asset classes is mainly determined based on size of exposure, the current nature of processes and related controls

The more material a risk exposure is, the more efforts and resources are devoted to its analysis and more sophisticated approaches and complex methods are applied to its measurement

TBC either accepts exposure to a risk or hedges against it, depending on the type of risk

TBC’s accepts risk exposure according to the predefined risk appetite limits set by the Supervisory Board and Management Board

Risk Management Process>>

TBC conducts its risk management activities within the framework of its unified risk management system

Treasury

Supervisory Board

Risk ethics andcompliance committee Management Board

Financial risks Underwriting

Corporate

SME

Retail

Risk management

Credit risk

Strategic risk

Legal department

Operational risk

Business

Retail

Repossessed assets

Deputy CEO,CFO

Deputy CEO,CRO

Compliance department

AML

Compliance

Audit committee

Credit committee Operational risk committee CEO Problems Loans

Committee Internal audit

Information securityInternal control

Reputational risk

Loan approval committee

ALCO

Problem loans

Risk Management Structure: Overview

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Corporate Governance committee

Remuneration Committee

Define risk management strategy

Define risk tolerance/appetite levels

Review and recommend Supervisory Board on risk management policies

Review and recommend Supervisory Board credit portfolio forecasts and budgets

Review portfolio trends and actual figures vs. budget

Transform the strategic direction set by the supervisory board and institute an effective hierarchy for its implementation

Ensure the existence of effective risk management system

Risk Management Structure: Principal Bodies

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Risk, ethics and compliance committee

Problem loans committee

Underwriting

Risk Management

Management Board

Supervisory board

Credit committee

Data Quality Management

1

2

3

4

5

6

7

8

Responsibilities

Objective

Risk, ethics and compliance committee

Problem loans committee

Underwriting

Risk Management

Management Board

Supervisory board

Credit committee

Data Quality Management

1

2

3

4

5

6

7

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Approve TBC’s overall strategy

Approve TBC’s risk strategy

Approve risk tolerance/appetite levels

Approve risk management policies

Approve credit portfolio forecasts and budgets

Review portfolio trends and actual figures vs. budget

Approve related parties’ loans

TBC’s Overall risk management

Advise the Supervisory Board on high-level risk related matters, via overseeing TBC’s risk strategy and management of risk within TBC, also reviewing Risk Maps

Approve credit facilities to the borrowers in case the aggregated liability of the borrower exceeds 5% of the Bank's Basel capital

Develop an ethical culture within TBC. Periodically review and update TBC’s Code of Ethics

Monitor the compliance of TBC’s operations with the statutory legislation and internal policies

Support the Supervisory Board inits work with and supervision of risk management

Commit TBC to the highest standards of ethical behavior

Oversee TBC’s compliance function

Prin

cipa

l Bod

ies

Prin

cipa

l Bod

ies

Func

tions

Func

tions

Considers and makes decisions on:

(i) the problem asset recovery plan; (ii) repossession or sale of collateral; (iii) collection and recovery of all written-off loans;(iv) approval of costs associated with loan recovery; and(v) restructuring of problem loans

Monitor TBC's portfolio of problem assets through all phases of collection

Is responsible for the timely identification and assessment of credit risks and outlining mitigation actions regarding those risks that should be reduced

Develops adequate tools and models for effective credit risk management, such as application and behavioral scorecards and rating models

Develops models for stress testing in order to assess credit exposures under various scenarios and make corresponding conclusions for capital adequacy and provisioning purposes.

Ensures the maintenance of a balanced loan portfolio and the correspondence of actual risks to the predefined limits

Review the quality of the TBC’s loan portfolio

Discuss industry trends

Ensure timely reaction to the developments on the market

Ensure the quality of the credit portfolio is in correspondence with the TBC’s risk appetite

Ensure TBC’s lending guidelines are consistent with legislation and regulatory policies

Define strategic principles and critical processes of data management Manage planning of data control

Define critical data as well as minimum quality requirement Monitor data quality Manage execution of data control

Data Quality goal is either to reduce or avoid errors and redundancies, as well as set up corrective and preventive controls to achieve and maintain appropriate to business purposes data quality standards

Reviews loan presentations on credit exposures prepared by the loan officers and credit analysts to ensure that

(i) the analysis is complete;(ii) comprehensive information is gathered to assess the borrower's risk

profile;(iii) all relevant risks are identified and adequately addressed and(iv) the loan is properly structured.

Oversees the monitoring process of Corporate and SME Loans in order to discover in a timely manner any deterioration in a borrower's repayment capability

Is involved in the applications approval process as members of corresponding loan approval committees.

Overview

Credit Risk Governance

Credit Risk Management

3.1 Counterparty Default Risk

3.2 Concentration Risk

3.3 Currency Induced Credit Risk

Credit Risk Stress test

Way Forward

3

11

Agenda

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Credit Risk ManagementAs a result of risk identification and assessment process, the following types of credit risks are identified:

Counterparty Default Risk

Concentration RiskCurrency Induced

Credit Risk

Residual Risk

A

B

C

D Credit Risk Types

Risk of deterioration of portfolio quality due to large exposures to small number of

borrowers, or individual industries

Risks due to presence of foreign currency denominated loans in the portfolio

Risk resulting from the use of credit risk mitigation techniques

Risk of negative consequences associated with defaults or non-fulfillment of

concluded contracts in credit risk bearing operations due to a deterioration in the

counterparty’s credit quality

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Credit Risk Management Framework

The Supervisory Board approves and annually reviews TBC’s Risk Management Strategy and key risk polices₋ the Risk Management Strategy outlines key principles for credit risk management, sets risk tolerance levels and a detailed plan

The Management Board oversees:₋ the development of the relevant policies and procedures to identify, measure, monitor and control key risks₋ the implementation of an effective organisational structure to execute and implement these policies

Key principles Establishing an appropriate credit risk environment Operating under a sound credit-granting process Maintaining efficient processes for credit risk measurement, control and monitoring

Comprehensive assessment of a borrower's risk profile Credit approval and covenant Setting Automated processing based on scoring models

Monitoring timeliness of debt repayments Review of business borrowers financial conditions Reassessment of collaterals value Behavioural ratings update

Identification and monitoring of doubtful loans on watch Formulation of collection strategies Cooperation with the external collection agencies

Review/analysis of the overall portfolio dynamics Management of loan exposure / concentration levels Performance of portfolio stress tests (currency induced credit risk assessment, enterprise wide stress test) Development of scoring and rating models

NBG provisioning IFRS provisioning

A1

A2

A3

A4

A5

Policies, process and procedures

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A. Corporate and SME Loans - Credit Approval Process

Origination

SME loans

Corporate loans

Applications originate at TBC’s head office

Credit analyst together with corporate banker analyses loans and company’s financials, structures credit facility and assigns a rating

Collateral is appraised by an independent internal or external appraisers’ group

Corporate credit risk manager (loans> GEL 2mn) ensures complete analysis from credit analyst, identification of all risks and proper structure of loans

Loan submitted to the centralized Corporate loan approval committee

In the event that all members of the relevant Loan approval Committee agree unanimously, the loan is approved

A corporate loan to a "large borrower" (a borrower with exposure to more than 5% of TBC Bank's Basel capital) would require the review and approval of the Risk, Ethics and Compliance Committee

Applications originate at TBC’s branches

Loan officer analyses loan purpose and the company’s financials and assigns a rating. Collateral is appraised by internal appraisers’ group

Loan is reviewed by the branch’s internal committee to ensure completeness of the loan application documents and the loan officer's analysis

The loan is submitted to the centralized SME loan approval committee

In the event that all members of the relevant Loan approval Committee agree unanimously, the loan is approved

Project analysis and review Decision

A1

Retail MicroCorporateSME

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A. Corporate Customers Desired Ratios

Ratios are analyzed in comparison with peer and industry data. Both historical and projected ratios are considered for analysis:

Debt/EBITDA

Debt/Equity

EBIT/Interest

Current Ratio

Debt Service Cover Ratio

In addition, TBC Bank may utilize other ratios – mostly industry-specific ones, that are used for the analysis of specific company or industry. Please also note that these ratios are not mandatory, they rather shape desired limits of respective financial measurements. Out of these ratios, Debt/EBITDA, DSCR and Debt/Equity are more important

Ratio Definition Benchmark

A1

From 1H 2014 this will change and TBC Bank will introduce industry specific ratios Current estimate examples are:

Trading Operations: Debt/Equity < 4, Telecommunications: Debt/EBITDA < 4; Project Finance (Power Generation): Debt Service Cover Ratio (DSCR) > 1.50

Final grade consists of :Industry score (20%)Qualitative Borrower score (15%)Quantitative Borrower score (65%)

Rating models>>

Quantitative criteriaEvaluation of solvency Cover debt service through gross profitEffectiveness of operationsAssessment of profitabilityEarnings volatilityDividends / Net incomeCoefficient of autonomyValuating of client’s liquidityRates of turnover

Industry assessmentFinancial StabilityEconomic VolatilityDemand TrendBarriers to EntrySector CompetitionAccess to InputsOperational Gearing and Capital Intensive

Qualitative criteriaCompany's position in the industryOrganizational and managerial activityCompany’s governanceFinance, accounting and control Business reputationRelationship with the Bank

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A. Corporate and SME Loans – Rating modelA1

Expert model was developed together with Ernst &Young during Basel II/III implementation project At present the model is applied for portfolio quality monitoring. Given the expert origin, the model is carefully monitored for validity Once the model is validated, it will be used as a supporting tool in credit approval process, for limit setting and pricing

purposes, for provisioning purposes

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A. Retail Loans - Credit Approval Process

Origination Project analysis and review Decision

POS loans and Credit Cards

POS loan are originated by merchants acting as TBC's agents or TBC staff located at the merchant

Credit Cards originate in branches

POS loans and Credit Cards applications are assessed using application scoring model and credit bureau ratings

Scoring is applied once the borrower meets the minimum requirements for the product, such as age, minimum income, and similar criteria

Automated Approval and Rejection zones are defined individually for products, based on performance of loans within these segments

Mortgage Loans, Consumer Loans, Car Loans

Applications originate in branches

Loan officer gathers and reviews preliminary information and determines the type of credit facility that best meets the applicant's needs

Checks are made in internal and external databases (Credit Bureau, Public Registry, Civil Registry)

Thorough analysis of credit application is conducted

Collateral is appraised by internal appraiser’s group

Loan submitted to the centralized Retail loan approval committee

A2

Retail MicroCorporateSME

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A. Retail Loans - Credit Approval Process A2

Decision based on scorecards

TBC Bank has started assessing POS loans and Credit Cards applications using Scoring Model from 2008 and 2012 respectively

Automated Approval and Rejection zones are defined individually for products, based on performance of loans within these segments

Applications that fall in manual zone are assessed by Centralized operations management department. Phone calls are undertaken to the work place and family members of the borrower in order to cross check the data provided by the borrower in the application

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A. Retail Loans - Ratios

PTI

LTV

Debt Service Ratio

Maximum portion of revenue, which can be applied to cover the loan

Net Revenue Amount (In case of dividends median of Revenues for the last twelve months)

US Dollars

Revenue Share

Standard Allowed

< 600 25% --< 1 000 30% 40%< 1 500 35% 45%< 3 000 40% 50% >= 3 000 50% 60%

(Borrower’s Family Total Revenue – Total Costs) / Monthly Installment >= 1.3

Real Estate Car / Land

70% 60%

Loan Amount / Collateral Market Value (LTV) differs according to Collateral Types:

A2

Utilisation of facilitiesFrequency of credit limit usage, deposits, current balance of the loan amount, etc

Data from applicationGender, work experience, type of the client, etc

Macroeconomic variablesRefinance rate, GDP, etc

Length of credit historyLength of credit history

Payment behaviourInformation about payment overdues: current overdue days, maximum length of overdues in the last 12 months, etc

Rating models>>

A. Retail Loans – Rating Model

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A2

Behavioural rating model for retail loans was developed by Experian in 2012 based on the Bank’s five years statistical data In compliance with Basel regulation three models were developed for:

(1) loans secured by real estate, (2) credit limits, and (3) other retail loans For each segment the model is further differentiated according to the number of months on books of the loan: less than 6

months on books and more than 6 months on Following variables are included in the model (with approximate weights) books

Overview

Credit Risk Governance

Credit Risk Management

3.1 Counterparty Default Risk

3.2 Concentration Risk

3.3 Currency Induced Credit Risk

Credit Risk Stress test

Way Forward

3

21

Agenda

22

A. Concentration RiskB

Concentration management is a significant function of credit risk management

Already Implemented

The system is already established to identify, measure, monitor, and control credit risk concentrations

TBC limits the level of credit risk it undertakes by placing limits on concentrations of:

(i)single borrowers and groups of related borrowers; (ii) single industry and groups of "higher-risk" industries

New methodology is under development for concentration risk management

Credit concentration risk measurement process will be improved based on the Central Bank of Spain’s guidelines

Reasons for selecting Spanish regulation: Spain was strongly effected by the global financial crisis 2007-2012, the following global recession 2008-2012, and by the European sovereign debt crisis The Spanish credit market is heavily dependent on mortgages in particular and on real estate in general The Spanish simplified option is considered good regulatory practice and implemented in a similar form by several Eastern European regulators (i.e. the Slovenian and the Serbian regulator) The Spanish simplified option is consistent with the Basel 2 standardized approach to credit risk measurement and results into concentration risk numbers that are easily comparable across the banking industry

Two Types of Concentrations are managed: Single name and Sectoral concentration Concentration indexes will be calculated using Herfindahl-Hirshman Index (HHI)

Under Development Process

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A. Concentration RiskB

Single Name Concentration>>

The surcharge should be applied to the capital requirements for credit risk relating to the borrowers included in the calculation of the individual concentration index (Σy).

Number of Borrowers assessed: 1,000Grouping method: Largest Borrowers or Group of Borrowers

Individual Concentration Index

x is the total direct exposure to the groups under the top 1,000y is the direct exposure to the groups under the entire portfolio

Individual Concentration Index Multiplier

0.10% 0%

0.15% 2%0.30% 7%0.60% 15%

1.20% 27%

2.40% 60%

4.80% 129%

9.60% 248%

42.80% 1071%

Sectoral Concentration>>

Number of industries assessed: All industries

The sectoral concentration index (HHIS) of the credit portfolio is calculated as following:

Σxi2 / (Σxi) 2 * 100

x is the value of risk exposure to each economic sector

The surcharge should be applied only to the capital requirements for credit risk relating to the exposures included in the calculation of the sectoral concentration index

Sectoral Concentration Index Multiplier

0 < ICS < 12 0%

12 < ICS < 15 2%15 < ICS < 20 4%20 < ICS < 25 6%

25 < ICS < 100 8%

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A. Concentration RiskB

Limits>>

Stress Tests>>

In addition the Bank will undertake concentration risk stress tests on a quarterly basis

Under stress testing the Bank will assess what would be the loss of regulatory capital if the top 1, 3 and 5 borrowers default in the same time

Results of stress test will be applied for credit risks monitoring purposes and will be communicated to the Management Board on a quarterly basis

In addition to HHI suggested by Central Bank of Spain TBC Bank will limit single name concentration risk, using top 1, 5, 10 and 20 borrowers exposures ratios

Actual limits vs maximum limits will be communicated to the Management Board on a monthly basis and to RECC on a quarterly basis

Overview

Credit Risk Governance

Credit Risk Management

3.1 Counterparty Default Risk

3.2 Concentration Risk

3.3 Currency Induced Credit Risk

Credit Risk Stress test

Way Forward

3

25

Agenda

26

A. Foreign Currency Induced Credit RiskC

Overview

Credit Risk Governance

Credit Risk Management

Credit Risk Stress test

Way Forward

4

27

Agenda

28

Stress Tests

Enterprise Wide Stress Testing>>

Stress-testing is performed to estimate potential losses in case of highly improbable but severe macroeconomic conditions and ensure sufficient capital is in place to withstand the stress

Key actions

Following macroeconomic parameters are stressed:

• GDP Growth -15%• CPI Change -10%• Unemployment 17% • Exchange Rate 18% • Real Estate Change 39%

Stress scenarios are defined based on (i) most severe GDP decline in Georgia and its peer countries during the last 8 years and (ii) stress scenario provided by NBG

Yearly bases dependences and correlations are assessed between these macroeconomic variables and Bank’s losses. Based on identified dependencies, potential credit losses are estimated for individual products and industries in case of stress

scenario

The results of EWST are expressed as the amount of capital needed in order to withstand the full potential losses resulting from the specified stress events.

Stress-testing is performed quarterly or more frequently in case of a significant change in the market conditions

Overview

Credit Risk Governance

Credit Risk Management

Credit Risk Stress test

Way Forward5

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Agenda

30

Way Forward (Credit Risk Focus Under ICAAP)

II PhaseI Phase-Accomplished Results

Developed Risk Strategy that is in line with Bank’s business strategy

Corporate customer rating model was introduced. Existing rating model was updated in accordance with Basel 2 requirements

Retail client rating model was introduced

Currency Induced Credit Risk (CICR) assessment was performed and respective model was developed

Improved Concentration risk management

Enterprise Wide stress test has been developed and performed

Enhanced corporate governance and credit risk management bodies

Introduced risk based audit planning compliant with Basel requirements

Introduced Economic capital framework that is the first step to risk adjusted performance appraisal

Further improving application scorecard for retail loans

Enhance overdue loans management process for retail loans

Implement Internal Rating Based approach for retail loans

Further improve business loans assessment model

More mature Credit Risk management

Better assessment of capital

Direct link from borrowers’ risk profile to capital charge