according to an evaluation of their financial statements,
payment discipline, market positioning and other risk factors.
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borrowers’ risk levels according to an evaluation of their financial statements, payment discipline, market positioning and other risk factors. Alongside work on credit risk improvement, current practice, international experience and cumulative statistics of ratings and losses were evaluated. At the end of this evaluation process, new methods for ranking borrowers were approved for certain categories of corporate client, namely large clients and authority bodies (constituent entities of the Russian Federation and municipal districts); for extraction companies and for medium sized clients. In addition, the methods for ranking separate client categories were aligned, allowing the Bank to conduct a comparative analysis of the level of applicable risk in various market segments.
The Bank also approved and implemented a new pricing system for credit deals based on the analysis of borrower’s ranking results, the transaction risk level for each separate deal/ category, the Bank’s real costs for credit resources and the units’ working hours in relation to the different client categories. The new pricing system was implemented in a phased roll-out through the Bank’s business divisions and was adapted according to changes in the financial markets.
Another important initiative in credit risk management was the implementation of a centralised system to monitor permanently the risk of credit deals. This helps the Bank to identify negative trends in the changes to borrowers’ risk profiles at an early stage and act upon credits/clients that are exposed to certain credit risk factors. In the second half of 2008, the crisis in the financial markets began to affect some of the Bank’s clients such that they suffered difficulties in meeting commitments. Under these circumstances, the Bank took efficient measures in order to lower the Bank’s credit risk. These included:
introducing limit-settings in relation to the security for credit operations and the specification of parameters for security forming, as well as
approaches for determining the value of items put up for collateral;
tightening conditions for issuing separate credit products;
specifying responsibilities amongst the Bank’s regional divisions in terms of independent acceptance of credit risk.
Special attention during the year was paid to the systematic modernisation of credit service models for large business clients, aimed at optimising the credit processes and improving the analysis of the quality of clients and certain credit deals.
Liquidity risk
Liquidity risk is the risk of a mismatch between the maturities of assets and liabilities which may result in the inability to liquidate a position in a timely manner at a reasonable price to meet funding obligations (including not utilising funds at an above average market rate). VTB is exposed to liquidity risk primarily in the funding of its customer loan and securities portfolio. VTB seeks to have sufficient liquidity to meet the Group’s current and future obligations and funding needs at reasonable market rates.
The Bank separates current and instant liquidity risk management.
Current liquidity management is the main task handled by VTB in asset and liability operational management. Its aim is to determine and maintain the minimum level of liquid assets and maturity mismatch limits necessary to ensure cash/non-cash balance settlement by currencies.
Current liquidity management is carried out by the Bank’s Treasury by prompt (intraday) determination of VTB’s current payment position and forecast future payment position, taking into account the Bank’s payment schedule and other scenarios.
The main task in instant liquidity management is to develop and implement a number of instruments for managing assets and liabilities, aimed at supporting the Bank’s instant funding ability, as well as to plan
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increases in its asset portfolio by optimising the ratio of liquid assets and profitability.
This is achieved by VTB Bank’s Assets and Liability Management Committee, which establishes internal standards for overall liquid asset reserves (including highly-liquid assets) in all currencies and in each individual currency. In addition, forecasted liquidity management is conducted according to liquidity accounting standards imposed by the Bank of Russia. Instant liquidity management is carried out by the Treasury in a centralised manner.
Liquidity risk analysis for VTB Bank and VTB Group is performed by the Market and Operational Risk Division, which presents the results of its analysis in a consolidated report to the Assets and Liability Committee, the VTB Management Committee and the Assets and Liability Commission operating under the Management Committee.
Capital flow forecasts include receivables and payments according to contractual terms, and take the following into consideration:
credit risk level;
planned operations, including outflow of unstable “on demand” capital.
In addition, the Market and Operational Risk Division conducts contingency modelling so that liquid assets can be mobilised in order to alleviate a lack of liquidity, taking into consideration factors that might influence the Bank’s forecasted liquidity.
Importantly, during the year, liquidity risk assessment was performed not only by VTB Bank but by VTB Group as a whole.
Operational risk
Operational risk is the risk of a loss resulting from the inadequacy or failure of the Bank’s internal processes, employees and IT systems, inconsistencies with legislative requirements or from
external events not controlled by the Bank (primarily, natural disasters).
The Bank’s operational risk management system aims to prevent possible losses and reduce the possibility of failures of business processes and the inability to provide high level service to the Bank’s clients caused by staff mistakes, system breakdown, internal or external fraud and law violation.
In its operational risk management practices, VTB follows the principles set by the Bank of Russia regulations as well as recommendations of the Basel Committee on Banking Supervision (including Basel II). To implement the Bank’s internal operational risk management strategy, VTB carries out regular procedures for identifying, assessing, controlling and limiting risk. All significant deficiencies from a risk perspective, identified within the internal control system, are subjected to strict analysis. Based on the analysis, measures are developed and implemented to eliminate the cause and source of the risk. A mechanism for collecting information regarding operational losses and key risk indicators was introduced at the beginning of 2007 according to Basel II and the Bank of Russia requirements in order to form a consolidated assessment of VTB’s operational risk. Currently, an analogous system is being introduced in VTB Group’s banking organisations and participants.
The Bank’s key operational risk limitation instruments are:
a complex system of internal control that is common to all business units and operations throughout the Bank;
the regulation of key operations by internal statutory documents;
the registration and documentation of banking operations and transactions and the regular control of primary documents and the accounts of operations;
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Annual Report 2008
the application of the principles of: division and limitation of the functions, powers and responsibilities of employees; double control; collegiate decision-making and limit-setting for the terms and volumes of operations (limits for certain operations, individual limits for certain employees);
the automation of banking operations, the use of information systems and their constant monitoring and immediate repair;
the provision of physical and information security, control over access to the Bank’s facilities;
a careful HR policy, staff training and education.
These proactive measures to limit risk are supported by appropriate insurance programmes. In 2008, the Bank’s operational risk insurance amounted to US$ 425 million and included complex crime insurance (incl. electronic and computer), the insurance of precious metals and other valuables during transit and while in storage, the insurance of the “card business” including cash dispensers and currency exchange machines and insurance against bank card fraud.
Market risk
Market risk is the risk that the fair value of future capital flows from financial instruments will fluctuate as a result of changes in market parameters, such as percentage rates, currency rates or securities prices. The Group is subject to market risks, including the risk of change in the price of the securities portfolio, currency risk and the risk of changes in interest rates.
VTB Bank and VTB Group are subject to the risk of a change in interest rates. The risk of a change in interest rates is defined as the risk of lowering interest revenues or raising interest expenditures as a result of unfavourable changes to market interest rates.
The general principles for managing interest rate risk are as follows:
1. establishing standard interest rates for deposits and basis point rates for borrowing that take the current state of the market into consideration;
2. calculating interest rate risk indicators and establishing limits/reference points of interest rate risk for VTB Group and individual banks by currency and temporary pools:
the susceptibility of a bank’s interest rate gap to a change in Basis Point Value, the degree of sensitivity to Interest Rate Risk. The reduction in monetary terms of the Net Present Value of a bank’s interest position under an unfavourable parallel movement of the Base Yield Curve by 1 basis point;
the capital for covering interest rate risk, or Interest Rate Risk Charge; assessment of a reduction in a bank’s NPV of assets and liabilities under an unfavourable parallel movement of BYC;
a limit to the susceptibility of the NPV balance to a change in the interest rate (BPV limit);
the RSA/RSL ratio, i.e. susceptibility to a change in the interest rate of assets compared to analogous liabilities in the temporary pool for up to one year.
Stress tests are calculated based on the current size of the interest position and hypothetical stress scenarios (a parallel shift of the BYC by 4% annually). They are conducted monthly.
The general principles for managing currency risk are as follows:
the bank does not support structured long-term open currency positions (with the exception of capital investment in its foreign subsidiary banks);
centralised management of the open foreign
exchange position of the central office and branches;
establishment of internal limits (stricter than those proscribed by normative documents) of the open
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5. Risk management and internal controls
foreign exchange position for the central office and branches;
establishment of internal limits for taking on currency risk for arbitrage operations by the Treasury.
Currency risk management is controlled by the Asset and Liability Risk Management Committee.
A quantitative risk assessment is carried out using the VaR method (historical modelling, a 99% confidence level, a time span of one and ten trading days, and a historical period of two years).
Stress tests are calculated based on the current size of the open foreign exchange position and hypothetical stress scenarios (reduction of the rouble rate by 50%). They are conducted monthly.
The general principles for managing price risk are as follows:
restricting (limiting) the size of price risk that the Bank will take on;
control over adherence to the established limits and restrictions (a minimal discount size for “reverse repo” operations, margin call conditions, etc.) for taking on price risk;
organisation of ongoing monitoring, analysis and reporting of price risk that the Bank has taken on;
applying adequate identification methodology and a quantitative assessment of price risk for Bank activity. A quantitative risk assessment is carried out using the VaR method (historical modelling, a 99% confidence level, a time span of one and ten trading days, and a historical period of not less than one year).
Restrictions on the size of the price risk that the Bank can take on are set by establishing and adhering to a two-tiered system of limits:
limits on taking on risks in securities operations, established by the Asset and Liability Management Committee and split by securities type in relation to the following types of operation: trading operations, “reverse repo” operations, collateral operations and derivative operations;
individual limits on conducting securities operations for authorised Bank employees (operational limits).
Limits are established taking into consideration the Bank’s need to conduct operations with the corresponding securities, the condition of its resource base, and an assessment of the size of the price risk by type of operation and securities category.
The limits are established by restricting the sum of the investments. For trading and derivative operations there is also an established limit for the maximum permissible amount of losses, including limits on operations by authorised Bank employees. The Asset and Liability Management Committee may also establish additional restrictions in regards to derivative operations on an as-needed basis depending on the type of operation.
Programme for implementing Basel II standards
During the year, the readiness of VTB Bank and other VTB Group banks to implement Basel II standards was analysed. The analysis included the evaluation of compliance of existing risk management instruments and procedures with Basel II, as well as the assessment of project implementation options and necessary organisational, human, technical and material resources. Furthermore, the risk management regulatory and methodological base was reviewed, in accordance with Basel II recommendations (mainly oriented at conservative approaches to prevent excessive risk in times of financial crisis).
In accordance with plans for Basel II
recommendations to be introduced to the Russian Federation legislation for Banking, the Bank intends
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Annual Report 2008
to align its risk management strategy so that it incorporates these prescribed standards and will submit a regulatory filing, stating how the project will be coordinated across the Bank’s activities and the corresponding budget.
VTB Group banks based in Western Europe have already introduced new Basel II standards as Basel II principles were introduced to EU legislation on 1 January 2008.
Risk management objectives and tasks for 2009
In 2009, which is expected to be no less difficult than 2008 in terms of the global economic situation, VTB Bank plans to improve its risk management system in three key directions:
further implementation of best global banking practices and Basel II standards along with raising efficiency and conservatism in the assessment of the risks taken by the Bank;
completion of the large-scale implementation of risk control procedures at VTB Group level (based on the consolidated risk management concept developed and approved by Group);
development of a mature risk management system within the Group’s investment business, taking into consideration its active development.
In order to achieve these improvements, it is necessary to establish consolidated limits of credit risk for general VTB Group contractors (among corporate clients and banks) and total limits of country and industry risk concentration, taken by the whole Group from the start of 2009. VTB has revised and approved the “JSC VTB Bank Credit Policy 2009-2010” taking into account the global financial situation. The Bank will improve its ranking system for borrowers and its procedures for issuing credits to different categories of client within the framework of the new policy. In particular, the delegation of credit issuing responsibilities will be improved.
In 2009, it will be especially important to develop an information and technical infrastructure specialised in risk management, in order to meet stringent requirements (quality, accuracy and timeliness) concerning quantitative evaluation of risk. In order to improve the availability of data and to utilise sophisticated mathematical models, VTB Bank is leading several high technology projects including:
1. The implementation of the Oracle OFSA Risk Manager “Balance Risk Analysis” module that will help to automate the assessment of interest risk and which is due to be completed in 2009.
2. The launch of an automated risk management system for VTB Group based on the world leading software by Kamakura Risk Manager. The first stages of this project are:
identify market risks and ALM and automate the methods for assessing the rank of market risk associated with the financial instruments in VTB Group portfolios (securities, derivatives);
implement interest and liquidity risk assessment methods based on stochastic modeling.
5.2. System of internal controls
The Internal Control System at VTB was established and operates in accordance with Russian legislation and international standards. VTB’s Internal Control System aims to:
improve the efficiency and effectiveness of operations conducted by VTB Group;
optimise the activities of VTB Bank and its management bodies;
ensure the adequacy and timeliness of financial and administrative information and reporting;
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5. Risk management and internal controls
ensure compliance with legal requirements and standards regulating the activity of VTB Group;
improve the efficiency with which assets and liabilities are managed;
ensure the safety of VTB Group’s assets;
ensure that neither VTB Bank nor the Group’s employees are involved in criminal conduct such as money laundering or the financing of terrorism.
Strong internal controls are crucial to ensure that the business of the Group is conducted according to the highest standards, and to increase its attractiveness for customers, shareholders, investors and other stakeholders on both the domestic and international markets. The Group is seeking to comply with international best practice (the rules of the Basel Committee on Banking Supervision, the Institute of Internal Auditors and the Committee of Sponsoring Organisations of the Treadway Commission) in order to optimise its internal control system.
Strong internal controls improve VTB Group’s management system in the following areas:
the creation of a unified control environment and unified systems of strategic and financial planning and risk analysis within VTB Group;
the integration of information systems at Group level, in the Bank and in subsidiaries and separate business units;
the creation of a clear and transparent system for decision-making and reporting at the Bank, its branches and VTB Group as a whole.
In 2008, VTB Group’s Internal Audit / Control Management Policy was produced with a focus on enhancing the role and the quality of internal controls in Group companies.
To implement these principles of internal control at VTB Bank effectively, a system of control and inspection bodies is in place including:
The Audit Committee of the Board
The Statutory Audit Commission
The Internal Control Department
The Audit Committee
The Audit Committee was created in 2007 with the aim of analysing, supporting and further developing the internal audit system.
Members of the Audit Committee:
Matthias Warnig – Committee Head (independent member of the Supervisory Council of VTB Bank);
Alexey L. Savatyugin – Committee Member (member of the Supervisory Council of VTB Bank);
Alexei V. Ulyukaev – Committee Member (member of the Supervisory Council of VTB Bank).
More detailed information on the activity of the Audit Committee can be found in the Corporate