Assessment and control of risk is critical to the Bank's success. The principal risks inherent in the Bank's business are credit risk, liquidity risk, market risk (including interest rate risk and foreign exchange rate risk) and operational risk. For further information on the risks faced by the Bank, see the notes in Section Four, II-VIII to the 2013 Unconsolidated Annual Financial Statements.
Risk Management Organisation
The Bank's current system of risk control and risk management, including its operational risk framework, operational risk policy, application principles and emergency action plans, has been in place since 2001 and is fully integrated into the Bank's internal systems for planning, management and control. In 2012 the Bank implemented a new credit scoring system. Senior management believes that it will be at least three years before it can fully assess the new system and 41.0% of the current loan portfolio as of 31 December 2013 was comprised of loans granted under the new system. Senior management expects that the Bank will benefit from more effective credit evaluation and monitoring as the new scoring system is increasingly used in the coming years. The Bank expects to continue to evaluate and develop its risk management system, which has been established both to meet the Bank's ongoing internal risk management needs and to comply with legal and regulatory requirements and other applicable standards, including BRSA regulations and the Basel II criteria.
The Board is ultimately responsible for developing and monitoring the Bank's risk management, internal control and internal audit policies and strategies. The Board approves the Bank's general principles of risk control and risk management, its limits for all relevant risks and the procedures that the Bank applies in controlling and managing its risks. ICAAP reports, including stress test results, are submitted to the BRSA annually with the approval of the Board of Directors of the Bank. Reporting on asset and liability management is conducted within the relevant departments and reports are prepared on a daily, weekly, monthly and quarterly basis and presented at the Assets and Liabilities Committee's meetings.
In line with legal and regulatory requirements, the Board has established an Audit Committee whose mandate is to ensure that the Board's monitoring functions are duly carried out. The Audit Committee is composed of two non-executive members of the Board. The Audit Committee reports to the Board on the results of the Bank's risk management, internal control and internal audit activities, as well as its views on any other risk-related issues that it deems important. See "Management—Board Committees". The Bank has also established a Risk Management department, an Internal Control department and a Board of Inspectors, all of which report to the Board through the Audit Committee.
Risk Management department
The Risk Management department is in charge of identifying, measuring, monitoring and reporting the Bank's credit, liquidity, interest rate risk on balance sheet, market and operational risks, as well as ensuring compliance with the Basel II criteria and carrying out necessary stress tests on a monthly basis. The Risk Management department also undertakes prospective compliance with Basel III. The stress tests apply various sensitivity analyses on interest rates and foreign exchange parameters, as well as on certain credit and macroeconomic parameters. The capital adequacy ratio recommended by the BRSA, as well as the ratio that is required by the BRSA as a condition for banks to open new branches, is 12.0%. The Bank does not set a specific capital adequacy ratio in respect of stress tests. The capital adequacy policy of the Bank is for its capital adequacy ratio to be over 12.0% taking into account its internal growth projections. The Bank has met the BRSA legal capital adequacy ratio in respect of all stress tests conducted to date. The mission of the Risk Management department is to ensure, together with senior management, that risks taken by the Bank align with its policies and are compatible with its profitability and credit-rating objectives. The Bank has also established a Risk Management department, an Internal Control department and a Board of Inspectors, all of which report to the Board through the Audit Committee. Within the frame of credit risk management the Bank undertakes prospective compliance tests with a view to compliance with Basel III.
As of 31 December 2013, the Risk Management department is comprised of a team of 17 employees trained in statistics, economics, engineering and management.
Internal Control department
The Internal Control department supports senior management on safeguarding the Bank's assets and efficiency of operations. Internal control activity covers the control of credit at all business levels (branch and head office), operational activity and compliance control. In addition the Internal Control department conducts preliminary research about operations related to fraud. Furthermore, the Internal Control department analyses business flows and makes suggestions for improving the Bank's overall operational efficiency.
As of 31 December 2013, the Internal Control department was comprised of 221 employees and comprised four divisions (head office controls and compliance, branch controls, preliminary investigation, R&D and reporting).
Board of Inspectors
The Board of Inspectors is responsible for monitoring the activities of the Bank to ensure that these activities are carried out in compliance with legal and regulatory requirements and other applicable standards, as well as the Bank's own internal strategies, policy guidelines and targets. The Board of Inspectors inspects and audits the entire business, both the domestic units and the units abroad, in an attempt to identify any deficiencies, errors or misconduct and to conserve the Bank's assets and the efficiency of the Bank's operations. In addition, the Board of Inspectors gives advice and makes proposals for the elimination of such deficiencies and for the prevention of the recurrence of such errors or misconduct. Further, the Board of Inspectors assesses the accuracy and reliability of non-financial information and reporting forwarded to the Board and the BRSA. As of 31 December 2013, the Board of Inspectors comprised 167 inspectors.
Management of Specific Risks
The Bank's risk management processes are distinguished by the type of risk, as set out below. Credit Risk
Credit risk is the risk that counterparties may be unable to meet their obligations in accordance with the terms of their agreements with the Bank. The Bank is subject to credit risk through its lending, trading, hedging and investing activities and in cases where it acts as an intermediary on behalf of third parties. The Bank's primary credit risk exposure relates to its lending activities and is focused in Turkey where its main operations take place.
The Bank manages its exposure to credit risk through involvement with highly credible banks and entities, and by limiting the aggregate risk from any sector or geographical region. Exposure to credit risk is also managed through regular analysis of the ability of borrowers and potential borrowers to meet interest and capital repayment obligations and by changing lending limits where appropriate. The Bank also attempts to obtain adequate collateral for loans given and other receivables. Such collateral may include suretyships, mortgages on property, government securities, cash blockages and customer or real person cheques.
The Bank rates each of its loans given to its corporate and commercial customers, and rates many of its loans to its SME customers, using the internal risk rating methodologies described below in "—Internal Risk Rating Methodologies for Loans to Companies". The Bank requires additional guarantees from its customers with high risk ratings, does not provide loans to such customers or applies strategies in order to decrease the level of risk from loans to such customers.
As prescribed in the Communiqué on "Determining the Nature of Loan and Other Receivable Provisions Allocated By the Banks and Procedures and Principles of Allocating Provisions", the creditworthiness of the debtors of the loans and other receivables is monitored regularly. Loan limits and guarantee factors are monitored and updated at least once a year and also as deemed necessary and in accordance with changes in economic conditions.
development of performing loan portfolios, distribution by sector and region of performing cash commercial loans, top 50 loans by customer segments, development and age of NPL portfolios, distribution of top ten and total NPLs by types of loan portfolio, NPL ratio and close monitoring loans. Credit risk limits are monitored and vintage analysis is conducted for NPLs on a monthly basis.
As of 31 December 2013, the share of cash loans from the Bank's top 50 cash loan customers was 19.9% of its total cash loans and 10.1% from the Bank's top 10 cash loan customers. As of 31 December 2012, the share of non-cash loans from the Bank's top 50 non-cash loan customers was 57.6% of its total non-cash loans and 33.8% of the Bank's top 10 non-cash loan customers.
Counterparty Credit Risk
Counterparty credit risk is concerned with financial derivatives, repos, securities, long-term swaps and loan exchanges. In the scope of counterparty credit risk management, ISDA and GMRA contracts have been signed with large banks. The Bank's collateral debt and receivables are monitored on a monthly basis and included in credit risk weighted assets in capital adequacy ratio calculations.
Credit-Related Commitments
The primary purpose of these instruments is to ensure that funds are available to a customer as required. Guarantees and standby letters of credit (which represent irrevocable assurances that the Bank will make payments in the event that a customer cannot meet its obligations to third parties) carry the same credit risk as loans. Documentary and commercial letters of credit (which are written undertakings by the Bank on behalf of a customer authorising a third party to draw drafts on the Bank up to a stipulated amount under specific terms and conditions) are collateralised by the underlying shipments of goods to which they relate and therefore carry less risk than a direct borrowing. Commitments to extend credit represent unused portions of authorisations to extend credit in the form of loans, guarantees or letters of credit. With respect to credit risk on commitments to extend credit, the Bank is potentially exposed to loss in an amount equal to the total unused commitments.
Liquidity Risk
Liquidity risk is the current or prospective risk to earnings and capital arising from an institution's inability to meet its liabilities when they fall due without incurring unacceptable costs. It reflects the potential mismatch of payment obligations to incoming payments, taking into account unexpected delays in repayments (term liquidity risk) or unexpectedly high payment outflows (withdrawal/call risk). Liquidity risk involves the risk of unexpected mismatches in maturities of assets and liabilities and the risk of being unable to liquidate a position in a timely manner on reasonable terms.
The Bank uses domestic and foreign markets for its liquidity needs. The Bank's senior management believes the Bank has relatively low external capital requirements, which historically it has met by borrowing on local markets. However, the Bank is seeking to expand its wholesale borrowing, particularly to meet its need for longer-term liabilities due to the asset-liability mismatch common to many Turkish banks. Potential cash sources include syndicated loans, money market borrowings from domestic banks and repurchase transactions in international markets, as well as through the issuance of debt instruments into international debt capital markets. In April 2014 the Bank entered into a US$ 800 million syndicated loan facility with 39 international lenders. In addition the Bank cooperates with IFIs such as the World Bank and the EIB, which provide the Bank with access to long-term funding opportunities to address the investment and working capital needs of its SME customers.
Historically, the Bank's primary source of funding has been its deposits from customers. As of 31 December 2013, 2012 and 2011, deposits from customers represented 64.4%, 68.6%, and 68.2%, respectively, of the Bank's total liabilities.
The Bank's investment securities portfolio consists mainly of held-to-maturity and available for sale investments. As of 31 December 2013, approximately 74.9% of the Bank's investment securities portfolio was composed of available-for-sale investment securities, whereas the remaining approximately 25.1% was composed of held-to-maturity investment securities.
Net liquidity gap
The matching and controlled mismatching of the maturities and interest rates of assets and liabilities is fundamental to the management of the Bank. It is unusual for banks to be completely matched, as transacted business is often of uncertain term and of different types. Furthermore, due to the short-term maturity structure of deposits in Turkey, maturity mismatches are a common problem for Turkish banks. An unmatched position potentially enhances profitability, but also increases the risk of losses. To minimise these risks and losses senior management conducts Time to Maturity, Liquidity Gap, Structural Liquidity Gap and Liquidity Stress Test analyses.
The Bank's senior management believes that liquidity requirements to support calls under guarantees and standby letters of credit may be considerably less than the total outstanding contractual amount of the commitments, as a commitment to extend credit does not necessarily represent future cash requirements, as many of these commitments may expire or terminate without being funded. See "Risk Factors—Risks Related to the Bank—The Bank's risk management strategies and internal control capabilities may leave it exposed to unidentified or unanticipated risks". Senior management's strategy to deal with maturity and repricing gaps is to increase the share of floating rate loans in the Bank's loan book and to diversify the Bank's funding structure through non-deposit sources such as bonds, syndications and securitisations. The Bank also aims to decrease its interest rate risk exposure through hedging transactions such as cross-currency and interest rate swaps.
The following tables set out information about the remaining maturities of the Bank's assets and liabilities as of the dates indicated:
As of 31 December
2013 Demand 1 monthUp to 1-3 months months3-12 1 year to 5 years Over 5 years Undistributed (1)(2) Total
(TL thousands)
Assets:
Cash (Cash in Vault, Effectives, Money in Transit, Cheques Purchased) and Balances with the Central Bank the
Republic of Turkey ...26,602,413 — — — — — — 26,602,413
Banks... 873,798 1,009,261 148,038 433,914 — — — 2,465,011
Financial Assets at Fair Value Through
Profit and Loss ...— 139,935 3,559 146,372 159,118 4,953 — 453,937
Money Market Placements... — — — — — — — — Financial Assets Available-for-Sale...— 339,903 2,202,042 7,622,424 20,289,568 15,867,273 362,587 46,683,797 Loans Given ... — 4,747,155 7,844,527 42,503,296 46,909,967 8,248,490 794,538 111,047,973 Investments Held-to-Maturity ...— 236,685 441,966 5,665,705 6,102,239 3,213,755 — 15,660,350 Other Assets ...1,543,965 — — 551 7,852 — 3,064,105 4,616,473 Total Assets ...29,020,176 6,472,939 10,640,132 56,372,262 73,468,744 27,334,471 4,221,230 207,529,954 Liabilities Interbank Deposits... 155,347 6,560,601 1,301,672 132,492 — — – 8,150,112 Other Deposits...28,680,623 73,258,698 19,475,208 11,857,329 313,050 126 — 133,585,034 Funds Provided from
Other Financial Instruments... — 79,696 704,688 5,511,329 976,492 1,287,124 — 8,559,329 Money Market Borrowings... — 19,861,007 2,579,722 2,130,121 — — — 24,570,850 Issued Marketable Securities ... — 961,251 579,892 1,095,744 — — — 2,636,887 Sundry Creditors ...785,209 567,719 — — — — — 1,352,928 Other Liabilities(3)...1,884,914 259,791 188,615 8,574 4,018,741 701,643 21,612,536 28,674,814 Total Liabilities...31,506,093 101,548,763 24,829,797 20,735,589 5,308,283 1,988,893 21,612,536 207,529,954 Liquidity Gap ...(2,485,917) (95,075,824) (14,189,665) 35,636,673 68,160,461 25,345,578 (17,391,306) —
(1) Assets which are required for banking operations and could not be converted into cash in the short term, such as tangible assets, associates, subsidiaries and entities under common control, office supply inventory, prepaid expenses and net NPLs as well as securities representing a share in capital, and other liabilities such as provisions which are not considered as payables and equity, are classified as undistributed.
(2) Deferred tax asset is included under the "Undistributed" column.
(3) TL 3,997,095 of the funds balance, whose risk is not borne by the Bank, is included in other liabilities and shown under the "1-5 years" column, the fund balance amounting to TL 39,396 is not granted as a loan and is included under the "Up to 1 month" column.
As of 31 December 2012 Demand Up to 1 month 1-3 months 3-12 months 1 year to 5 years Over 5 years Undistributed (1)(2) Total (TL thousands) Assets:
Cash (Cash in Vault, Effectives, Money in Transit, Cheques Purchased) and Balances with the Central Bank the
Republic of Turkey ...20,713,331 — — — — — — 20,713,331
Banks... 766,649 685,342 134,417 337,593 9,470 — — 1,933,471
Financial assets at fair value through profit
Money Market Placements... — — — — — — — — Financial Assets Available-For-Sale ...— 1,736,316 769,153 6,921,136 22,714,893 5,666,966 259,553 38,068,017 Loans Given ... — 2,618,333 5,815,373 26,187,072 32,313,687 3,695,829 796,185 71,426,479 Investments Held-To-Maturity...— 222,028 163,175 12,648,858 9,957,896 4,262,868 — 27,254,825 Other Assets ...848,724 — — 321 2,144 — 2,474,228 3,325,417 Total Assets ...22,328,704 5,390,872 6,882,152 46,095,368 65,005,647 13,635,048 3,529,966 162,867,757 Liabilities Interbank Deposits ...81,659 5,230,613 1,219,405 724,837 — — — 7,256,514 Other Deposits...21,693,006 67,999,971 14,012,130 7,733,709 270,857 117 — 111,709,790 Funds Provided from
Other Financial Instruments... — 487,124 212,514 1,138,940 22,203 1,211,658 — 3,072,439 Money Market Borrowings... — 8,334,493 2,023,843 804,138 — — — 11,162,474 Issued Marketable Securities ... — 2,409 1,035,674 729,184 176,721 — — 1,943,988 Sundry Creditors ...679,871 477,612 — — — — — 1,157,483 Other Liabilities (3)...1,541,700 182,413 351,186 224 4,328,518 774,200 19,386,828 26,565,069 Total Liabilities...23,996,236 82,714,635 18,854,752 11,131,032 4,798,299 1,985,975 19,386,828 162,867,757 Liquidity Gap ...(1,667,532) (77,323,763) (11,972,600) 34,964,336 60,207,348 11,649,073 (15,856,862) —
(1) Assets which are required for banking operations and could not be converted into cash in the short term, such as tangible assets, associates, subsidiaries and entities under common control, office supply inventory, prepaid expenses and net NPLs as well as securities representing a share in capital, and other liabilities such as provisions which are not considered as payables and equity, are classified as undistributed.
(2) Deferred tax asset is included under the "Undistributed" column.
(3) TL 4,277,386 of the funds balance, whose risk is not borne by the Bank, is included in other liabilities and shown under the "1-5 years" column, the fund balance amounting to TL 14,843 is not granted as a loan and is included under the "Up to 1 month" column.
Market Risk
Market risk arises from the uncertainty concerning changes in market prices and rates (including interest rates and foreign exchange rates) and their levels of volatility. The Bank's senior management believes that interest rate risk is the most important component of market risk that the Bank faces.
The Bank seeks to hedge market risk in accordance with the Communiqué on "Measurement and Assessment of Capital Adequacy of Banks". The Board sets the limits for the level of market risk that the Bank may be exposed to. Those limits are reviewed and revised periodically in line with market conditions and the strategies of the Bank.
The interest rate and exchange rate risks related to the financial positions taken by the Bank (both on balance sheet and off balance sheet) are measured and monitored by the Risk Management department. In the computation of capital adequacy, the amount subject to Value At Risk ("VAR") is calculated by using the standard method as required by the BRSA. Beside the standard method, VAR is also calculated by using the Bank's internal model. In order to measure the performance of the internal model, retrospective tests of model outputs are performed regularly. In addition, stress tests and scenario analyses are carried out periodically to measure the effects of unexpected events on the Bank's capital adequacy ratios. VAR is calculated with a confidence interval of 99.99% and a one day holding period daily by three different methods – historical simulation, parametric and Monte Carlo simulation. Internal reporting is made by using Weighted Historical Simulation Methodology only.
Measurement of market risk data is included in monthly and quarterly legal reporting to the BRSA. In addition, daily market risk analysis reports are prepared and presented to relevant personnel, including the heads of the Bank's Treasury Management and Risk Management departments.
The tables below set out the Bank's VAR (calculated using the Bank internal method as required by the BRSA) as of the year ended 31 December 2013 and the years ended 31 December 2012, and 2011.
As of and for year ended 31 December 2013 Interest
rate VAR Currency VAR TotalVAR
(TL thousands)
As of 31 December 2013... 173,825 23,975 177,319 Average ... 69,532 6,298 71,684 Maximum ... 174,322 23,975 178,186 Minimum... 13,717 2,826 15,673
As of and for year ended 31 December 2012 Interest
rate VAR Currency VAR Total VAR
(TL thousands)
As of 31 December 2012... 31,894 3,869 31,709 Average ... 60,580 2,067 60,933 Maximum ... 153,570 5,454 153,479 Minimum... 23,534 648 25,275
As of and for year ended 31 December 2011 Interest
rate VAR Currency VAR Total VAR