1. Provisioning in Slovenian banks Provisioning in Slovenian banks Presentation for 17th BSCEE Conference Ms. Nataša Pukl, Director of the Banking Supervision Department Dubrovnik, 27 May 2004

2. PRESENTATION OUTLINE Introduction History Current provisioning and the tax regime –specific provisions –provisions for general banking risks Future –Application of IFRS –Statistical or dynamic provisions

3. INTRODUCTION Loan rewiev and provisioning as a core elements of : –any bank’s risk management system and –of prudential oversight Supervisors in many countries rely on standard systems of loan classification and set standard provisioning levels

4. HISTORY OF PROVISIONING IN SLOVENIA Starting with general provisions in 1991 Since the beginning of 1994 to 1999 –general provisions –and specific provisions both based on classification of assets From 1999 - –provisions for general banking risks –specific provisions for credit and country risks –specific provisions for other risks

5. SPECIFIC PROVISIONS Specific provisions for credit risks : –based on loan classification (also off-balance items) –minimum level 1% on group A (except state and central bank) 10, 25, 50 and 100 % on group B-E –tax deductibility allowed –not considered as a capital component

6. SPECIFIC PROVISIONS Specific provisions for country risks: –minimum level (%) on risky countries –tax deductibility allowed –not considered as a capital component Specific provisions for other risks –for other known risks (bank’s assessment) –not tax deductable, not part of capital

7. PROVISIONS FOR GENERAL BANKING RISKS the level not prescribed included in capital (Tier 1) as funds for general banking risks (EU Directive 2000/12 - Article 34 (2) not tax deductable

8. LEVEL OF PROVISIONS High level of established provisions in banking system in % Ratios 2000200120022003 Adjustments / Bad and doubtful Assets (B-E) 45,344,638,035,1 Specific provisions / Total classified on- and off-balance sheet items 6,26,38,47,7 Specific provisions / Capital (calculated) 90,8103,597,289,9

9. FUTURE – Application of IFRS EU (1606/2002 EC) regulation on the mandatory application of IFRS for consolidated accounts of listed companies EU Endorsement of IFRS standards with the exception of IAS 32/39 Expectation that from 1 January 2005 the Slovenian banks will use IFRS

10. FUTURE – Application of IFRS Application of IFRS (IAS 39) means fair value principle in evaluation of financial instruments A financial assets is impaired and impairment losses are incurred if there is objective evidence of impairment as a result of a past event that occured subsequent to the initial recognition of assets. Expected losses as a result of future events are not recognised. According to IFRS the Slovenian banks will have a specific provisions surplus (it should be retained as a reserve or capital item that could not be used for distribution to shareholders)

11. STATISTICAL OR DYNAMIC PROVISIONS Thinking about the statistical provisions in Slovenia The StP were first introduced in Spain (in July 2000) Objectives of statistical provisioning: 1. to acknowledge the expected or latent loss as a cost 2. to counterbalance the cyclical behaviour of the existing loan loss provisions (LLP) 3. To correct the excess volatility of bank profits: - Low (high) LLP in the upturn (downturn) may overstate (understate) profits - Bank profitability and solvency could be distorted: overvaluation of dividends, erosion of capital

12. STATISTICAL OR DYNAMIC PROVISIONS Statistical provisions: StP=Lr-SP Lr = Latent risk (estimated expected loss), SP = Specific provisions If Lr > SP => StP > 0 - StP charged in the Profit&Loss Account - Building up the Statistical Fund If SP > Lr => StP < 0 - StP written as income in the Profit&Loss Account - Depletion of the Statistical Fund The Statistical Fund may not exceed three times the value of the latent risk (estimated expected loss)

13. STATISTICAL OR DYNAMIC PROVISIONS Calculation of expected loss by: - internal models that must be approved by central bank - standard approach: six risk categories with the corresponding coefficients : -without risk (0%) – public sector -low risk (0,1%) -medium risk (0,6%) -medium-high risk (1%) -high risk (1,5%) - credit card balances, current account overdrafts and credit account excesses Latent risk = coefficients multiplied by the exposure The Statistical provision is set aside on quarterly basis by one fourth of the annual amount

14. DILEMMAS !!! Is the system of dynamic provision in accordance with IAS 39 rules (fair value principle) ? Would the system of dynamic provision have the desired effect ? The Slovenian banks have a significantly higher level of provisions than Spanish banks when dynamic provisions were introduced. When the system of dynamic provision should be introduced to Slovenian banks? Adequate tax treatment of dynamic provisions and their inclusion in the calculation of capital (tier II)