Risk management in banks Leoš Souček, Komerční banka

Introduction / Czech economic specifics… 1/2 Private sector indebtedness at the lower end of EU levels Indebtedness of corporate sector at 22% of GDP Indebtedness of households 30% of GDP Dynamic growth of mass retail exposure (above 30% yoy in 2003-2008) slow-downed in 2010/2011 (6.6% yoy in 07/2011) Also public sector indebtedness lower than EU peers CZ at 38.5% end of 2010 (FR: 82%, DE: 83%, HU: 80%, PL: 55%, SK: 41%, IT: 119%, GR: 143%) Budget deficit narrowed to ‑4.7% GDP in 2010 (SK: ‑7.9%, HU: ‑4.3%, GR: ‑10.5%, FR: ‑7.0%, DE: ‑3.3%, AT: ‑4.8%) Despite fragile political stability some progress in reforms, which help to secure fiscal sustainability Health care and pension reforms under progress S&P raised the LTFC Czech Republic rating to 'AA-' No concrete plans on EUR adoption Limited dependence on external financing Relative low level of external debt in terms of GDP External financing needs covered by FDI and EU funds

Introduction / Czech economic specifics… 2/2 Limited share of private foreign currency debt 13.0% for private sector (in 7/2011, both residents and non residents) 17.4% for corporate, 0.14% for households (residents only) export-oriented corporates as main users 150% coverage ratio by foreign currency deposits (res. only) Healthy banking sector Confirmed by CNB stress tests Sustained banking sector profitability since early 2000s Favorable loan-to-deposit ratio at 78% July 2011 Strongly capitalized (in end-June, 15.9% average regulatory capital ratio) Growth largely relying on external factors … Share of nominal exports on GDP at 80% in 2010 84% of exports concentrated on the EU-27 in 2010 (two predominant partners: Germany 32% and Slovakia 9%) Absence of major macroeconomic imbalances - current account worsened to 3.8% of GDP in 2010 Substantial foreign ownership following high FDI inflows ... and on the cyclical industry sectors Industry sectors represents 30% of GDP (vs. 22% in Germany and 12% in France) Highly cyclical (predominant car industry and machinery)

Introduction / Banking sector As of 12/2011 Three key banks (market share at about 70%) KB (SG Group) ČS (ERSTE Group) ČSOB (KBC Group) Net profit 9,5 13,6 11,2 Deposits (Bn CZK) 586,0 783,3 721,6 Loans (Bn CZK) 441,4 483,5 440,5 Cost of Risk (Bn CZK) -7,3 -5,5 -5,0 o/w loans -2,0 -1,8 o/w other risks (Gr) -5,3 0,0 -3,2 Cost of Risk (bps) 181bps (39bps) 114bps 36bps Loan to Deposits 77,5% 71,9% 69,5% LUSR 5,7% 6,0% 5,2% CIR 41.2% 41,8% 44,8% CAR 14,6% 13,1% 15,6% ROE 12,3% 18,2% 17,3% Zoom on KB: SG Group member since 2002. Third largest bank in ČR: about 7 800 employees. about 400 point of sales. KB initially corporate bank. Retail developed after 2000. KB’s market share on credit lending: Mortgages: 23% Small Business: 20% Corporates: 30% Municipalities: 40%

Risk Management / Functions & Missions Credit Risk Management Retail: model based and statistical approach (PD, LGD, EL) Individual approach for non-retail (Corporate, Banks, Sovereign) Collateral Evaluation (independent on client or distribution channel, on-site visits) Market Risk Management FX, IR, commodity, credit risk, … Monitoring and reporting Quality of portfolio / Focus on sensitive sections / Distribution channels / Sensitivity to market (FX, IR, ..) Back-testing of models Recovery / Collection Pre-early collection (-5DPD - 5DPD), Soft collection (5DPD – 90DPD) Hard recovery (90DPD +) Operational Risk Management Antifraud policy, Insurance, Business continuity plans, estimations of operational losses, …

Risk Management / Zoom on KB organization Universal Risk Management Function / OpRisk out of scope. Matrix organization / One of largest Risk Management in the SG Group (330FTE). SG RISQ KB RISQ A. Viry (L. Souček) Credit Risk Assessment Corporate deal-flow Capital Markets Risks Market risk Capital markets Assets Valuation & Recovery Hard recovery Collateral Evaluation Risk Information Systems Risk databasis Supervision and Measurement Scoring models Monitoring Risk Methodology Credit frauds Functional links with SG RISQ departments

Risk Management / History of model development in KB In-house score-card development since 1998 (IND, SB, Corp, Muni). SG models used for sovereign and banks since 2002. KB historical view: 1990 – 1997: Score-card developed by analysts (very simple expert models). 1997 – 1998: Score-card developed by statisticians (consumer loans, mortgages, corp). 2002 – 2003: Models implemented to the central rating system. 2001 – 2002: Behavioural scoring model developed (IND, SB). 2002 – 2005: Review of models with SG after acquisition. 2002 – 2007: Progressive usage of credit bureaus for retail (CBCB, SOLUS). 2005 – 2007: Implementation of Ba2 standards in KB (advanced methods for all credit portfolios). 2008 – 2011: Development and implementation of credit fraud prevention.

MONITORING / REPORTING Risk Management / Key risks for the bank MONITORING / REPORTING CREDIT RISK OPERATIONAL RISK MARKET RISK RECOVERY 3 DANGERS NOT INTEGRATED CYCLE LOW UNDERSTANDING MODEL RISK

Default, PD= 100% “90DPD or unlikely to pay” Credit Risk / Key elements PD, LGD, EaD Expected Loss (EL) = EaD * 1Y PD * LGD Risk Weighted Assets (RWA) = RW * EaD RW = Function (PD, LGD, Maturity, Regulatory correlation, Regulatory interval of conf. 99.9%) 1Y PD = Probability of Default during following 1Y LGD = Loss Given Default EaD = Exposure at Default RW = Risk Weight RWA = Risk Weighted Assets Actual Exposure = On B/S + Off B/S Exposure at Default (EaD) = On B/S + Off B/S * CCF Off B/S CCF LGD Recovered cash On B/S Non-Default, PD < 100% Default, PD= 100% “90DPD or unlikely to pay” Recovery process

Market Risk RWA + Credit Risk RWA + Operational Risk RWA Credit Risk / Ability to absorb a loss Bank Capital Market Risk RWA + Credit Risk RWA + Operational Risk RWA CAR = > 8% CAR = Capital Adequacy Ratio Regulatory minimum at 8% Unexpected Loss as a variation of Expected Loss FREQUENCY OF LOSSES Stress Testing Probability 99,9% Probability 0,1% Expected Loss covered by revenues Unexpected Loss covered by the capital Extreme Loss !!! DEFAULT !!! SIZE OF LOSSES

Credit Risk / Credit portfolios per PD & LGD Expected Loss (given by PD and LGD) is reflected in pricing. Expected Loss Client rate: 3,5% Net margin 1,0% Expected Loss 0,5% Cost of funds 2,0%

Credit Risk / Corporates / Rating Model Individual assessment is prevailing. Financial assessment (financial data) Economic assessment (position in market, …) Model rating revised by credit analyst. Rating scales for non-retail Moody’s S&P 1Y PD Country Aaa AAA 0,01% DE, USA, FR (M) Aa1 AA+ FR (S&P) Aa2 AA 0,02% BE, SI Aa3 AA- 0,03% IT, JP A1 A+ CZ, SK, CN A2 A 0,04% PL A3 A- 0,06% Baa1 BBB+ 0,13% Baa2 BBB 0,26% RU, BR Baa3 BBB- 0,50% Ba1 BB+ 1,10% HU, RO Ba2 BB 2,12% Ba3 BB- 3,26% BUL B1 B+ 4,61% B2 B 7,76% UA B3 B- 11,42% Caa1 CCC+ 14,33% Caa2 CCC 20,44% Caa3 CCC- 27,25% Default 100,00% GR Financial Rating Behavioural Rating Economic Rating Model Rating Credit analyst Final Obligor Rating

Credit Risk / Retail / Granting process Maximally automated (95% of approvals) / Maximally parameterized / Maximally centralized. Data collection / Independent verification / Assessment by statistical model. DATA COLLECTION (COMPLEX INFORMATION ABOUT CLIENT) APPLICATION FORM (DEMOGRAPHIC DATA) INTERNAL BANK DATA (BEHAV. DATA) CREDIT REGISTERS (CREDIT HISTORY) TRANSACTION PARAMETERS COLLATERAL CREDIT ANTIFRAUD SYSTÉM (IDENTITY, EMPLOYER, DATA) SCORING MODEL (YES / NO) INSTALLMENT LIMIT (YES / NO) COLLATERAL EVALUATION (YES / NO)

(data in subsidiaries) (data from the register) Credit Risk / Retail / Scoring Model MAIN DRIVER OF PREDICTING POWER Basic Behavioural SM (Bank) Behavioural Model (data in the bank) IN KB SINCE 2002 Complex Behavioural SM (Group) Advanced Behavioural SM Advanced Application SM Behavioural Models (data in subsidiaries) IN KB SINCE 2007 Application rating Credit Register Model (data from the register) IN KB SINCE 2006 3 KEY ADVANTAGES High predicting power. Complex assessment. High flexibility (4 boxes). Demographic Model (application form) IN KB SINCE 1998

Credit Risk / Retail / Scoring Model 3 KEY ADVANTAGES Fast and easy process High volume of production Top quality of production 3 KEY RISKS No view of expenditures Limited assessment Change of behaviour 1 200 ths. clients EUR 6 400M 300 ths. clients EUR 1 200M 170 ths. clients EUR 400M 80 ths. clients EUR 32M 2002 2004 2006 2011 PRODUCTS AO AO, CL, CC AO, CL, CC AO, CL, CC MAX LIMIT EUR 400 EUR 2 400 EUR 6 000 EUR 10 000 CLIENTS KB KB KB KB GROUP

CONTACT RNDr. Ing. Leoš Souček Deputy Head of Risk Management Komerční banka, a.s. Tel: +420 222 435 141 Email: leos_soucek@kb.cz