Sberbank - Annual Report 2010 - 31 Financial Risk Management

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# 31 Financial Risk Management

The risk management function within the Group is carried out in respect of major types of risks: credit, market, liquidity and operational risks. Market risk includes interest rate risk, equity risk and currency risk. The Group's risk management policies are designed to identify and analyse these risks, to set appropriate risk limits and controls, and to monitor and manage the risks and limits. The operational risk management functions are intended to ensure proper functioning of internal policies and procedures to minimise operational risk.

The Group's Management Board under authority delegated by the Shareholders Meeting sets the Group's general risk policy as well as specific policies for managing each type of major risk. The Bank's Assets and Liabilities Management Committee (ALMC) and Credit and Investment Committee (CIC) in Head Office set limits for operations that create risk exposure according to principles determined by risk policies of the Group and initiated by the departments responsible for risk monitoring and control. The risk-controlling departments operate separately from the business departments involved in developing operations with clients.

The Group performs stress-testing for all major types of risk at least once a year. Test results are reviewed and discussed by Group Management.

The Supervisory Board is informed about all main types of risk on a quarterly basis.

Credit Risk. The Group is exposed to credit risk, which is a risk of a counterparty being unable to meet its credit obligations in whole or in part when due. The Group manages credit risk in accordance with internal policies and procedures, which are reviewed and updated periodically, as well as on an ad-hoc basis. The credit risk management as a component of the general risk management system is aimed to maintain a sustainable development of the Group. The Group's maximum exposure to credit risk is reflected in the carrying amounts of financial assets in the consolidated statement of financial position. For guarantees and commitments to extend credit, the maximum exposure to credit risk is the amount of the commitment. Refer to Note 32.

The Group's lending policies focus on the improvement of the credit quality and profitability of the loan portfolio, optimisation of its regional, product and industry structure as well as minimization and diversification of credit risks. To minimize exposure to credit risk at the branch level, the CIC at the Bank's Head Office sets limits on loan transactions for the Regional Head Offices. The Regional Head Offices then allocate these limits among branches, sub-branches and outlets that report to them. Loans that exceed these lending limits must be approved by the CIC of the Bank's Head Office.

The Group defines the following stages of credit risks management:

- Identification of credit risks;
- Analysis and assessment of credit risks;
- Elaborating and carrying out measures for minimisation, decrease and prevention of the risk;
- Monitoring of the Group's credit risk level, control of compliance with the established procedures of risk assessment;
- Reporting to the Management on the Group's credit risk level;
- Monitoring and optimisation of procedures of risk identification and assessment, as well as methods of risk minimisation, restriction and control, taking into account assessment of the Group's performance.

The Group usually requires collateral and/or guarantees for loans. Acceptable collateral includes real estate, securities, transportation and production equipment, inventory, precious metals, contract rights and personal property. The Group accepts guarantees from controlling shareholders, government entities, banks, other solvent legal entities, individuals. In order to reduce credit risk, several types of collateral may be used simultaneously. A guarantor is evaluated on the same basis as the borrower.

The Group assesses value of collateral on the basis of an internal expert evaluation performed by the Group's specialists, an independent appraiser's evaluation or on the basis of the discounted book value of the collateral. In accordance with the Group's policy the value of collateral or the amount of guarantee must cover the principal and interest on the loan for a period of three months.

The estimation of individual credit risk of corporate clients, individual entrepreneurs, banks, state bodies of the Russian Federation, insurance companies is made on the basis of internal credit ratings system, definition of classes of counterparties' creditworthiness, as well as on the basis of forecast cash flow models or other indicators.

The system of internal credit ratings classifies borrowers in certain categories of credit risk depending on assessment of external and internal factors of credit risk (groups of factors) and degree of their influence on the ability of the borrower to serve and repay the accepted obligations. To cover credit risks the Group structures its credit products which includes requirements for particular quality collateral, level of interest rates and control over sources of loan repayment. In the process of credit decision the Group uses the principle of independent review of credit risk by credit risk management division.

Exposure Limits. Principles of credit risk minimization are performed through a system of exposure limits, segregation of duties on setting up exposure limits and carrying out operations bearing credit risk. To manage its credit risk, the Group places its counterparties into risk groups, which reflect the probability of default on obligations. Counterparties placed into particular risk groups are assigned exposure limits. The Group has procedures for calculation and review of risk limits for the following categories: corporate clients, subfederal and municipal bodies, domestic and foreign banks, individuals. Exposure limits are also set for foreign countries, single borrower and group of related borrowers and one-off banking operations bearing credit risk.

Exposure limits for corporate clients are set on the basis of their ownership structure, business reputation, credit history, financial position, expected financial trends, quality of financial management, transparency, industry and regional position and facilities and equipment quality. On the basis of these factors, corporate clients are placed into risk groups and assigned long-term and short-term exposure limits.

Credit risk of subfederal and municipal bodies is evaluated on the basis of their financial position and the level of region development. The financial position is evaluated on the basis of credit history, debt level, dependence on higher level budgets and budget quality compliance indicators. The level of development is evaluated on the basis of dynamics of gross regional product, quality of tax proceeds' sources and other indicators of social and economic development level. Exposure limits are calculated on the basis of subfederal and municipal bodies' budgets taking into account legal basis for borrowing.

Exposure limits for counterparty banks are set on the basis of their financial position, ranking among comparable banks, transparency of asset and liability structure and operations, operating environment (for nonresident counterparty banks), capital structure, concentration of banking operations, credit history, business reputation and relationship with the Group.

The amount of a loan granted to an individual is limited by his/her creditworthiness, which is calculated individually for each client by using reducing ratios to the amount of his/her income taking into account the amount of his/her previous loans received and guarantees given. Also the amount of a loan depends on collateral provided by the client. In addition, while calculating amount of a loan to be provided to an individual, his/her family income is also taken into account as well as additional income and other social-demographic data.

In 2010 the Bank launched the new lending technology for individuals - Credit Factory which covers three loan goups - consumer loans, car loans and credit cards. Such technology provides an overall analysis of information about participants of a deal taken from different sources, centralization of analytical and decision taking functions as well as high automatisation of loan application process.

Risk Concentration. In order to minimize and diversify its credit risk, the Group monitors its credit risk concentration, sets exposure limits for single borrowers and groups of related borrowers that are more strict than those set by the standards of the Bank of Russia and sets limits for loans and bank guarantees granted to related parties. Concentration and exposure limits for large credit operations and groups of related borrowers as well as high-risk credit operations are approved by the Bank's Head Office.

Monitoring. The Group constantly monitors credit risks and exposure limits of various counterparties. Exposure limits for corporate clients are reviewed at least twice a year based on their year-end and interim financial information. Exposure limits for subfederal and municipal bodies are reviewed twice a year on the basis of analysis of the budgets execution and depend on the amount and structure of a loan. For resident banks exposure limits are reviewed on a monthly basis and for non-resident banks and foreign countries at least once a year. Exposure limits may also be reviewed on an ad-hoc basis, if required.

The Group monitors actual losses and expected losses on operations exposed to credit risk and their compensation by the provision for impairment. The Group controls credit risk level of counterparties by monitoring of their financial position, their assessment of solvency throughout life of the limit and/or other covenants of credit product.

To monitor exposure to credit risk credit departments compile regular reports based on a structured analysis of the client's business and financial results. All information about the existing exposures on customers with deteriorating creditworthiness is reported to the Management for further consideration. The Group uses formalized internal credit ratings for monitoring credit risk. Management of the Group carry out follow-up control of past due balances.

Credit risk for financial instruments not recognised in the statement of financial position is defined as the possibility of sustaining a loss as a result of another party to a financial instrument failing to perform in accordance with the terms of the contract. The Group uses the same credit policies in making conditional obligations as it does for financial instruments recognised in the statement of financial position through established credit approvals, risk control limits and monitoring procedures.

Market Risk. Market risk is the possibility of the Group's financial losses as a result of unfavorable movements in exchange rates, equity prices, interest rates, precious metal prices. The Group manages its market risk in accordance with the Policy of the Bank on Market Risk Management. The main goal of Market Risk Management is to optimize risk/return ratio, minimize loss given unfavorable developments and to reduce the deviation of actual financial result from the expected result.

The Group categorises market risk into:

- interest rate risk
- equity risk
- currency risk

The Group manages its market risks through securities portfolios management and control over positions in currencies, interest rates and derivatives. For this purpose the ALMC sets limits on securities portfolios, open positions, stop-loss and other limits. Market risk limits are updated at least once a year and controlled constantly. The ALMC develops market risk management methodologies and sets limits on particular operations for the Bank's Head Office and Regional Head Offices. The Regional Head Offices have their own assets and liabilities management committees that set limits for operations of the Regional Head Offices on the basis of the methodologies and limits set by ALMC of the Bank's Head Office. If necessary, the Regional Head Offices develop their own methodologies based on the methodology of the Head Office.Subsidiary banks and companies manage market risks individually based on the principles set by the Head Office.

Market risk limits are set on the basis of the value-at-risk analysis, scenario analysis and stress testing as well as regulatory requirements of the Bank of Russia.

The Group makes market risk assessment both by components and in aggregate, determining the diversification effect.

Market risks are controlled by monitoring of operations on foreign exchange and securities market performed by trading division of the Treasury Operations and Financial Markets Department (hereafter the Treasury) of the Bank. Monitoring of market risks is performed by departments independent of trading division and implies continual control over trading deals.

Interest Rate Risk. The Group takes on exposure to the effects of fluctuations in the prevailing levels of market interest rates on the value of debt securities and cash flows.

The Group defines two types of interest rate risk:

1. Interest rate risk on debt securities at fair value through profit or loss or other comprehensive income.

The Group is exposed to interest rate risk of its investments in debt securities portfolio, when changing interest rates impact the fair value of bonds. Trading operations with bonds are performed only by the Bank's Head Office.

For managing and limiting interest rate risk across the debt securities portfolio, the ALMC guided by the market risk policy sets the following limits and controls: aggregate limits for bond categories and currencies; limits on investing in one issue of the issuer, loss limits on trading operations, limits on the maturities structure of investments in bonds, minimum return of investments, limits on repo and reverse repo agreements.

This type of interest rate risk is assessed using Value-at-Risk (hereinafter - VaR) methodology described below.

The Group also assesses interest rate risk by bonds type: aggregate for the securities at fair value through profit or loss and for the securities available for sale.

2. Interest rate risk resulting from maturities mismatch (interest rates repricing) across assets and liabilities that are interest rate sensitive (interest rate risk of non-trading positions).

The Group accepts risk of market interest rate fluctuations effect on cash flows. Interest rate risk of non-trading positions is a result of unfavourable interest rate movement and includes:

- the risk of a parallel shift, change in the slope and shape of the yield curve resulting from the maturities (repricing) mismatch of assets and liabilities sensitive to interest rate changes;
- basis risk, which results from a mismatch in the degree of interest rate sensitivity, of assets and liabilities with similar maturity (repricing term); and
- risk of early repayment (repricing) of interest rate sensitive assets and liabilities.

Increasing interest rates can drive the cost of borrowed funds up faster and at a higher growth rate than return on investments, thus worsening financial results and interest rate margin, whereas decreasing interest rates can decrease return on working assets faster than the cost of borrowed funds.

The objective of managing this type of market risk is to reduce the impact of market interest rates on net interest income. To manage interest rate risk the ALMC sets maximum interest rates on corporate deposits/ current accounts and minimum rates on corporate loans, minimum rate of return on investments into securities and limits on investments into long-term assets bearing inherently the maximum interest rate risk. The Group's Management Board approves fixed interest rates on deposits from individuals and individual loans for the Bank's Head Office and Regional Head Offices, which require preliminary approval from the ALMC. As a rule interest rates on retail loans and deposits depend on loan and deposit maturity date, amount and the client's category.

ALMC of each regional bank approves interest rates for corporate clients taking into account the regional market situation and the efficiency of the regional bank's transactions on the assets and liabilities side as well as the limits on interest rates set by the ALMC of the Bank's Head Office for corporate funds and placements.

This type of interest rate risk is assessed using the scenario analysis. Forecasting of possible changes in interest rates is carried out separately for Russian Rouble positions and positions in foreign currency. The indicative rate for 3 month-term loans at the Moscow interbank market (MOSPRIME 3M) is used as the base rate for an estimation of rates volatility on rouble positions and LIBOR 3M and EURIBOR 3M - for positions in foreign currency.

The table below shows the impact of bps interest rates increase and decrease on profit before tax as at 31 December 2010:

Change in profit before tax as at 31 December 2010 (in millions of Russian Roubles) | RR positions | Foreign currency position | Total
--- | --- | --- | ---
Decrease in interest rates by 173 bps | 4,943 | - | 4,943
Increase in interest rates by 311 bps | (8,887) | - | (8,887)
Decrease in interest rates by 25 bps | - | 299 | 299
Increase in interest rates by 55 bps | - | (672) | (672)

The table below shows the impact of bps interest rates increase and decrease on profit before tax as at 31 December 2009:

Change in profit before tax as at 31 December 2009 (in millions of Russian Roubles) | RR positions | Foreign currency position | Total
--- | --- | --- | ---
Decrease in interest rates by 330 bps | (2,956) | - | (2,956)
Increase in interest rates by 410 bps | 3,673 | - | 3,673
Decrease in interest rates by 20 bps | - | 580 | 580
Increase in interest rates by 30 bps | - | (870) | (870)

The sensitivity analysis above shows changes in profit before tax given a parallel shift of the yield curve across all interest rate sensitive positions, i.e. when interest rates move by the same value for all maturities. In addition, interest rate risk is assessed considering the following simplifications: the calculation disregards possible early repayment or call of instruments.

Equity Price Risk. The Group is exposed to equity price risk through investments in corporate shares that may lose value when their market quotations change. In order to limit equity price risk the ALMC shortlists the issuers eligible for investing (this list includes exclusively "blue chips"), sets limits for the aggregate investments in equities, limits on investment into a single issuer, stop-loss limits for the aggregate trading portfolio. The regional offices do not perform trading operations with shares.

Equity price risk analysis is based of the VaR methodology described below.

Currency Risk. Currency risk results from fluctuations in the prevailing foreign currency exchange rates. The Group is exposed to foreign exchange risk on open positions (mainly US dollar/RUB and EUR/RUB exchange rate fluctuations).

As part of managing foreign exchange risk the Group sets sublimits for open foreign exchange positions for Regional Head Offices. Besides, limits and control system are in place for Treasury arbitrage operations which sets open position limits for foreign currencies, limits on operations on the international and domestic markets, and stop-loss limits.

The Bank's Treasury undertakes daily aggregation of the currency position of the Group and takes measures for maintaining of the Group's currency risk exposure at a minimum level. The Group uses swaps, forwards and USD futures contracts tradable on MICEX as the main instruments for risk management.

The table below summarises the Group's exposure to foreign exchange risk in respect of monetary assets, liabilities and notional positions on currency and precious metals derivatives as at 31 December 2010. Foreign exchange risk on forward and future contracts is represented by their notional positions. Foreign exchange options are disclosed in the amount that reflects theoretical sensitivity of their fair value to reasonable change in exchange rates.

In millions of Russian Roubles | Russian Roubles | USD | Euro | Other | Total
--- | --- | --- | --- | --- | ---
Assets |  |  |  |  |
Cash and cash equivalents | 519,447 | 111,079 | 41,781 | 47,294 | 719,601
Mandatory cash balances with the Bank of Russia | 50,532 |  |  |  | 50,532
Debt trading securities | 52,516 | 9,354 | 1,510 | 17 | 63,397
Debt securities designated at fair value through profit or loss | 78,738 |  | 4,233 |  | 82,971
Due from other banks | 2,086 | 8,452 | 2,484 | 13 | 13,035
Loans and advances to customers | 4,322,771 | 954,172 | 123,606 | 88,838 | 5,489,387
Debt securities pledged under repurchase agreements | 15 | 72,646 | - | 556 | 73,217
Debt investment securities available for sale | 1,020,150 | 55,075 | 38,179 | 17,165 | 1,130,569
Debt investment securities held to maturity | 352,996 | 4,478 | 298 | 419 | 358,191
Other financial assets (less fair value of derivatives) | 98,217 | 7,449 | 1,288 | 371 | 107,325
Total monetary assets | 6,497,468 | 1,222,705 | 213,379 | 154,673 | 8,088,225
Liabilities |  |  |  |  |
Due to other banks | 63,932 | 118,574 | 2,053 | 3,872 | 188,431
Due to individuals | 4,214,842 | 262,845 | 267,768 | 89,004 | 4,834,459
Due to corporate customers | 1,265,948 | 407,369 | 88,167 | 55,188 | 1,816,672
Debt securities in issue | 110,350 | 1,352 | 2,236 | 5,488 | 119,426
Other borrowed funds | - | 250,395 | 7,332 | 13,038 | 270,765
Other financial liabilities (less fair value of derivatives) | 44,018 | 1,752 | 720 | 1,131 | 47,621
Subordinated debt | 303,299 | 214 | - | - | 303,513
Total monetary liabilities | 6,002,389 | 1,042,501 | 368,276 | 167,721 | 7,580,887
Net monetary assets/(liabilities) | 495,079 | 180,204 | (154,897) | (13,048) | 507,338
Foreign exchange derivatives | 63,914 | (215,079) | 128,121 | 13,573 | (9,471)
Credit related commitments (Note 32) | 621,754 | 561,599 | 107,667 | 35,122 | 1,326,142

The table below summarises the Group's exposure to foreign exchange risk in respect of monetary assets, liabilities and notional positions on currency and precious metals derivatives as at 31 December 2009:

In millions of Russian Roubles | Russian Roubles | USD | Euro | Other | Total
--- | --- | --- | --- | --- | ---
Assets |  |  |  |  |
Cash and cash equivalents | 585,295 | 63,753 | 50,270 | 26,203 | 725,521
Mandatory cash balances with the Bank of Russia | 40,572 |  |  |  | 40,572
Debt trading securities | 61,716 | 26,357 | 1,074 | - | 89,147
Debt securities designated at fair value through profit or loss | 100,640 |  | 4,644 |  | 105,284
Due from other banks | 7,014 | 125 | - | 3,080 | 10,219
Loans and advances to customers | 4,021,182 | 695,047 | 111,750 | 36,052 | 4,864,031
Securities pledged under repurchase agreements | - | 583 | - | - | 583
Debt investment securities available for sale | 662,264 | 113,643 | 42,074 | 10,188 | 828,169
Other financial assets (less fair value of derivatives) | 55,496 | 4,395 | 1,306 | 359 | 61,556
Total monetary assets | 5,534,179 | 903,903 | 211,118 | 75,882 | 6,725,082
Liabilities |  |  |  |  |
Due to other banks | 40,601 | 6,151 | 2,080 | 5,115 | 53,947
Due to individuals | 3,152,717 | 253,309 | 318,294 | 62,992 | 3,787,312
Due to corporate customers | 1,137,729 | 335,422 | 139,555 | 38,853 | 1,651,559
Debt securities in issue | 117,408 | 3,131 | 2,733 | 1,327 | 124,599
Other borrowed funds | - | 108,686 | 6,522 | 5 | 115,213
Other financial liabilities (less fair value of derivatives) | 21,956 | 250 | 198 | 125 | 22,529
Subordinated debt | 504,346 | 14,715 | - | - | 519,061
Total monetary liabilities | 4,974,757 | 721,664 | 469,382 | 108,417 | 6,274,220
Net monetary assets/(liabilities) | 559,422 | 182,239 | (258,264) | (32,535) | 450,862
Foreign exchange derivatives | 34,289 | (302,897) | 242,940 | 16,203 | (9,465)
Credit related commitments (Note 32) | 430,229 | 383,716 | 117,288 | 25,409 | 956,642

The Group provides loans and advances to customers in foreign currency. Fluctuations of foreign currency exchange rates may negatively affect the ability of borrowers to repay loans, which will in turn increase the probability of loan loss.

The Group's analysis of currency risk is based on the VaR methodology described below.

Value-at-Risk, VaR. The VaR methodology is one of the main instruments of assessing market risk of the Group. VaR allows to estimate the maximum financial loss with a defined confidence level of probability and time horizon. The Group calculates VaR using the historical modeling methodology. This method allows to evaluate probability scenarios of future price fluctuations on the basis of past changes taking into account market indicators correlations (e.g. interest rates and foreign exchange rates).

VaR is calculated using the following assumptions:

- historical data on changes in financial market indicators comprise 500 trading days preceding the reporting date;
- the market indicators used include currency exchange rates, bond, equity and precious metal prices;
- movements in financial market indicators are calculated over a 10-day period, i.e. an average period when the Group is able to close or hedge its positions exposed to market risk; and
- a 99% one-way confidence level is used, which means that losses in the amount exceeding VaR are expected by the Group maximum once every 100 trading days or not more than 5 times within 2 years.

For evaluating the adequacy of the applied VaR calculation model the Group regularly back-tests the model by comparing the modeled losses with actual losses.

Despite the fact that VaR allows to measure risk, its shortcomings must be taken into account such as:

- past price fluctuations are not sufficient to assess accurately future price fluctuations;
- calculation of financial market price indicators over a 10-day period is based on the assumption that the Group will be able to close (or hedge) all positions within this period. This assessment may be far from accurate in measuring risk exposure at the time of reduced market liquidity, when the period of closing (or hedging) the Group's positions may increase;
- using 99% one-way confidence level of probability does not provide for estimating losses with a probability below 1%; and
- VaR is calculated based on end-of-day position and misses the intra-day risks accepted by the Group.

Taking into account the shortcomings of the VaR methodology the Group applies scenario analysis and stress-testing to have a better understanding of market risk exposure.

To measure interest rate risk for non-trading positions, the Group applies scenario analysis rather than the VaR methodology.

The table below shows the interest rate, equity and currency risk calculation using the VaR methodology as at 31 December 2010:

In millions of Russian Roubles | Value as at 31 December 2010 | Average value for 2010 | Maximum value for 2010 | Minimum value for 2010 | Impact on equity | Impact on profit
--- | --- | --- | --- | --- | --- | ---
Interest rate risk on debt securities | 40,074 | 48,428 | 56,852 | 33,768 | 3.23% | 23.0%
Equity price risk | 9,439 | 13,165 | 20,675 | 5,252 | 0.76% | 5.4%
Currency risk | 1,910 | 2,431 | 3,064 | 1,359 | 0.15% | 1.1%
Market risk including diversification effect | 46,621 | 56,140 | 67,639 | 38,572 | 3.75% | 26.8%
Diversification effect | 4,802 | 7,884 | 17,832 | 3,146 | 0.39% | 2.8%

The table below shows the interest rate, equity and currency risk calculation using the VaR methodology as at 31 December 2009:

In millions of Russian Roubles | Value as at 31 December 2009 | Average value for 2009 | Maximum value for 2009 | Minimum value for 2009 | Impact on equity | Impact on profit
--- | --- | --- | --- | --- | --- | ---
Interest rate risk on debt securities | 45,589 | 29,200 | 49,851 | 19,566 | 3.75% | 137.0%
Equity price risk | 5,507 | 4,492 | 5,775 | 2,679 | 0.42% | 15.2%
Currency risk | 1,560 | 1,437 | 2,414 | 37 | 0.12% | 4.3%
Market risk including diversification effect | 52,845 | 31,158 | 53,393 | 20,223 | 3.99% | 146.0%
Diversification effect | 3,811 | 3,972 | 11,526 | 1,243 | 0.29% | 10.5%

Data in the tables above are calculated on the basis of the Bank's internal management accounting system which is based on the statutory accounting reports of the Bank.

Liquidity Risk. Liquidity risk is defined as the risk of mismatch between the maturities of assets and liabilities. The Group is exposed to daily calls on its available cash resources from overnight deposits, customer's current accounts, term deposits, loan drawdowns, guarantees and from margin and other calls on cash settled derivative instruments. The Group does not maintain cash resources to meet all of the above mentioned needs, as according to historical data a minimum level of reinvestment of maturing funds can be predicted with a high level of certainty. Liquidity risk is managed by the ALMC.

The Group liquidity risk management is aimed at ensuring timely and complete fulfillment of its payment obligations at minimum cost. For this purpose the Group:

- maintains a stable and diversified liabilities structure including both term resources and funds on demand,
- reserves capacity for immediate borrowing of funds on financial markets, and
- invests in highly liquid assets diversified by currencies and maturities for quick and effective coverage of unexpected gaps in liquidity.

Policy and Procedures. The Treasury of the Bank together with the Finance department perform analysis and forecasts, and advise Management on regulation of current and short-term liquidity of the Group. Analysis, forecasts and proposals on regulation of medium-term and long-term liquidity are produced by the Finance department of the Bank. Liquidity position and execution of requirements on managing the liquidity risk are controlled by the ALMC of the Bank. Liquidity risk is assessed, managed and controlled on the basis of "Policies of the Bank for Management and Control of Liquidity" and the guidelines of the Bank of Russia and the Basel Committee for Banking Supervision.

Provisions of this Policy lay down the guidelines for organizing the liquidity management in the Regional Head Offices of the Bank. The Management Board of the Bank's Regional Head Office is responsible for efficiently managing and controlling the Regional Head Office liquidity. It is also responsible for monitoring limits and controls required by the Group's internal regulations. Guided by the limits, controls, requirements and policies, the Regional Head Office selects evaluation methods and the necessary level of liquidity and develops and implements measures to ensure liquidity. In case of an insufficient liquidity the Treasury provides funds to the Regional Head Office (according to an established procedure) in the required amount.

Liquidity risk management includes the following procedures:

- forecasting payment flows by major currencies to ensure the necessary volume of liquid assets to cover liquidity deficit;
- forecasting assets and liabilities structure based on scenario analysis to control the required volume of liquid assets in medium-term and long-term perspective;
- forecasting and monitoring liquidity ratios compliance with regulatory and internal policy requirements;
- control over liquidity reserves of the Group to assess maximum opportunities for the Group to attract funds from various sources in different currencies;
- diversification of funding sources in different currencies taking into account maximum amounts, cost of funding and maturity; and
- stress-testing and planning actions for restoring the required liquidity level in unfavorable conditions or during crisis periods.

The tables below show distribution of undiscounted contractual cash flows (taking into account future interest payments) on liabilities by remaining contractual maturities.

The analysis of undiscounted cash flows on the Group's liabilities by remaining contractual maturity at 31 December 2010is set out below:

enlarge

In millions of Russian Roubles | Demand and less than 1 month | From 1 to 6 months | From 6 to 12 months | From 1 to 3 years | More than 3 years | Total
--- | --- | --- | --- | --- | --- | ---
Liabilities |  |  |  |  |  |
Due to other banks | 69,865 | 57,329 | 60,927 | 787 | 2,648 | 191,556
Due to individuals | 1,157,004 | 1,302,046 | 891,456 | 1,475,067 | 256,027 | 5,081,600
Due to corporate customers | 1,442,153 | 124,428 | 92,195 | 173,099 | 2,003 | 1,833,878
Debt securities in issue | 35,994 | 50,175 | 36,200 | 3,251 | 3,691 | 129,311
Other borrowed funds | 1,771 | 4,885 | 66,624 | 108,214 | 116,639 | 298,133
Other liabilities (including derivative financial instruments) | 44,069 | 5,785 | 302 | 1,329 | 253 | 51,738
Subordinated debt | 2 | 8 | 19,509 | 39,223 | 420,392 | 479,134
Total liabilities | 2,750,858 | 1,544,656 | 1,167,213 | 1,800,970 | 801,653 | 8,065,350
Credit related commitments | 1,326,142 | - | - | - | - | 1,326,142

In millions of Russian Roubles | Demand and less than 1 month | From 1 to 6 months | From 6 to 12 months | From 1 to 3 years | More than 3 years | Total
--- | --- | --- | --- | --- | --- | ---
Liabilities |  |  |  |  |  |
Due to other banks | 69,865 | 57,329 | 60,927 | 787 | 2,648 | 191,556
Due to individuals | 1,157,004 | 1,302,046 | 891,456 | 1,475,067 | 256,027 | 5,081,600
Due to corporate customers | 1,442,153 | 124,428 | 92,195 | 173,099 | 2,003 | 1,833,878
Debt securities in issue | 35,994 | 50,175 | 36,200 | 3,251 | 3,691 | 129,311
Other borrowed funds | 1,771 | 4,885 | 66,624 | 108,214 | 116,639 | 298,133
Other liabilities (including derivative financial instruments) | 44,069 | 5,785 | 302 | 1,329 | 253 | 51,738
Subordinated debt | 2 | 8 | 19,509 | 39,223 | 420,392 | 479,134
Total liabilities | 2,750,858 | 1,544,656 | 1,167,213 | 1,800,970 | 801,653 | 8,065,350
Credit related commitments | 1,326,142 | - | - | - | - | 1,326,142

The analysis of undiscounted cash flows on the Group's liabilities by remaining contractual maturity at 31 December 2009 is set out below:

enlarge

In millions of Russian Roubles | Demand and less than 1 month | From 1 to 6 months | From 6 to 12 months | From 1 to 3 years | More than 3 years | Total
--- | --- | --- | --- | --- | --- | ---
Liabilities |  |  |  |  |  |
Due to other banks | 49,619 | 628 | 2,342 | 370 | 1,997 | 54,956
Due to individuals | 794,755 | 834,616 | 1,092,847 | 1,130,781 | 178,910 | 4,031,909
Due to corporate customers | 1,255,098 | 238,998 | 77,489 | 92,868 | 83 | 1,664,536
Debt securities in issue | 35,905 | 45,711 | 43,731 | 7,067 | 9 | 132,423
Other borrowed funds | 571 | 2,512 | 3,642 | 89,048 | 29,685 | 125,458
Other liabilities (including derivative financial instruments) | 19,439 | 10,659 | 1,234 | 1,520 | 306 | 33,158
Subordinated debt | - | 442 | 24,442 | 81,780 | 812,738 | 919,402
Total liabilities | 2,155,387 | 1,133,566 | 1,245,727 | 1,403,434 | 1,023,728 | 6,961,842
Credit related commitments | 956,642 | - | - | - | - | 956,642

In millions of Russian Roubles | Demand and less than 1 month | From 1 to 6 months | From 6 to 12 months | From 1 to 3 years | More than 3 years | Total
--- | --- | --- | --- | --- | --- | ---
Liabilities |  |  |  |  |  |
Due to other banks | 49,619 | 628 | 2,342 | 370 | 1,997 | 54,956
Due to individuals | 794,755 | 834,616 | 1,092,847 | 1,130,781 | 178,910 | 4,031,909
Due to corporate customers | 1,255,098 | 238,998 | 77,489 | 92,868 | 83 | 1,664,536
Debt securities in issue | 35,905 | 45,711 | 43,731 | 7,067 | 9 | 132,423
Other borrowed funds | 571 | 2,512 | 3,642 | 89,048 | 29,685 | 125,458
Other liabilities (including derivative financial instruments) | 19,439 | 10,659 | 1,234 | 1,520 | 306 | 33,158
Subordinated debt | - | 442 | 24,442 | 81,780 | 812,738 | 919,402
Total liabilities | 2,155,387 | 1,133,566 | 1,245,727 | 1,403,434 | 1,023,728 | 6,961,842
Credit related commitments | 956,642 | - | - | - | - | 956,642

The above analysis is based on undiscounted cash flows on liabilities of the Group taking into account all future payments (including future payments of interest throughout life of the relevant liability). The liabilities were included in the time intervals according to the earliest possible repayment date. For example:

- Demand liabilities (including demand deposits) are included in the earliest time interval; and
- Guarantees issued are included in the earliest period when they may be called.

However, in accordance with the Civil Code of the Russian Federation individuals have the right to withdraw their deposits from any accounts (including time deposits) prior to maturity if they forfeit their right to accrued interest. The Group utilises a wide range of market instruments to maintain its liquidity on the level sufficient for timely execution of the current and forecasted financial obligations including the disposal of liquid assets or funding in domestic and international markets.

The derivative contracts entered into by the Group may be deliverable or settled on net basis. If the derivatives are closed by delivery of underlying asset, inflow and outflow of funds occur simultaneously.

The table below shows assets and liabilities at 31 December 2010 by their remaining expected maturity.Following principles underlying gap analysis presentation and the Group liquidity risk management are based on the mix of CBR initiatives and the Bank's practice:

- Cash and cash equivalents represent highly liquid assets and are classified as "on demand and less than 30 days"
- Trading securities, securities designated at fair value through profit or loss, securities pledged under repurchase agreements and highly liquid portion of investment securities available for sale are considered to be liquid assets as these securities could be easily converted into cash within short period of time. Such financial instruments are disclosed in gap analysis table as "on demand and less than 30 days"
- Investment securities available for sale which are less liquid are disclosed according to remaining contractual maturities (for debt instruments) or as "no stated maturity" (for equities)
- Investment securities held to maturity are classified based on the remaining maturities
- Loans and advances to customers, amounts due from other banks, other assets, debt securities in issue, amounts due to other banks, other borrowed funds and other liabilities are included into gap analysis table based on remaining contractual maturities
- Customer deposits diversification by number and type of depositors and the past experience of the Group indicate that such accounts and deposits provide a long-term and stable source of funding, and as a result they are allocated per expected time of funds outflow in the gap analysis table on the basis of statistical data accumulated by the Group during the previous periods and assumptions regarding the"permanent" part of current account balances.

The liquidity position of the Group's assets and liabilities as at 31 December 2010 is set out below:

In millions of Russian Roubles | Demand and less than 1 month | From 1 to 6 months | From 6 to 12 months | From 1 to 3 years | More than 3 years | No stated maturity | Total
--- | --- | --- | --- | --- | --- | --- | ---
Assets |  |  |  |  |  |  |
Cash and cash equivalents | 719,601 | - | - | - | - | - | 719,601
Mandatory cash balances with the Bank of Russia | 10,880 | 8,987 | 6,089 | 20,949 | 3,627 | - | 50,532
Trading securities | 66,168 | - | - | - | - | - | 66,168
Securities designated at fair value through profit or loss | 106,875 | - | - | - | - | - | 106,875
Due from other banks | 150 | 9,998 | 2,111 | 345 | 431 | - | 13,035
Loans and advances to customers | 186,302 | 745,278 | 998,398 | 1,960,855 | 1,598,554 | - | 5,489,387
Securities pledged under repurchase agreements | 81,493 | - | - | - | - | - | 81,493
Investment securities available for sale | 1,183,231 | 1,460 | 2,404 | 13,748 | 7,543 | 2,535 | 1,210,921
Investment securities held to maturity | - | 13,069 | 5,541 | 177,661 | 161,920 | - | 358,191
Deferred income tax asset | - | - | - | - | - | 7,518 | 7,518
Premises and equipment | - | - | - | - | - | 283,756 | 283,756
Other assets | 122,498 | 14,745 | 20,080 | 8,733 | 21,395 | 53,599 | 241,050
Total assets | 2,477,198 | 793,537 | 1,034,623 | 2,182,291 | 1,793,470 | 347,408 | 8,628,527
Liabilities |  |  |  |  |  |  |
Due to other banks | 68,222 | 57,730 | 59,116 | 1,555 | 1,808 | - | 188,431
Due to individuals | 1,040,936 | 859,810 | 582,571 | 2,004,184 | 346,958 | - | 4,834,459
Due to corporate customers | 861,805 | 34,828 | 18,788 | 897,122 | 4,129 | - | 1,816,672
Debt securities in issue | 34,706 | 44,831 | 33,077 | 4,572 | 2,240 | - | 119,426
Other borrowed funds | 83 | 2,060 | 63,446 | 99,414 | 105,762 | - | 270,765
Deferred income tax liability | - | - | - | - | - | 15,921 | 15,921
Other liabilities | 45,165 | 23,870 | 10,513 | 4,179 | 492 | 7,954 | 92,173
Subordinated debt | - | - | - | 214 | 303,299 | - | 303,513
Total liabilities | 2,050,917 | 1,023,129 | 767,511 | 3,011,240 | 764,688 | 23,875 | 7,641,360
Net liquidity surplus/(gap) | 426,281 | (229,592) | 267,112 | (828,949) | 1,028,782 | 323,533 | 987,167
Cumulative liquidity surplus/(gap) at 31 December 2010 | 426,281 | 196,689 | 463,801 | (365,148) | 663,634 | 987,167 | -

The liquidity position of the Group's assets and liabilities as at 31 December 2009 is set out below:

In millions of Russian Roubles | Demand and less than 1 month | From 1 to 6 months | From 6 to 12 months | From 1 to 3 years | More than 3 years | No stated maturity | Total
--- | --- | --- | --- | --- | --- | --- | ---
Assets |  |  |  |  |  |  |
Cash and cash equivalents | 725,521 | - | - | - | - | - | 725,521
Mandatory cash balances with the Bank of Russia | 10,669 | 4,175 | 5,343 | 17,977 | 2,408 |  | 40,572
Trading securities | 91,022 | - | - | - | - | - | 91,022
Securities designated at fair value through profit or loss | 124,439 | - | - | - | - | - | 124,439
Due from other banks | 4,065 | 3,706 | 68 | 1,693 | 687 | - | 10,219
Loans and advances to customers | 205,924 | 730,974 | 968,615 | 1,539,964 | 1,418,554 | - | 4,864,031
Securities pledged under repurchase agreements | 2,699 | - | - | - | - | - | 2,699
Investment securities available for sale | 835,937 | - | - | 64 | - | 9,974 | 845,975
Premises and equipment | - | - | - | - | - | 249,881 | 249,881
Other assets | 72,525 | 8,949 | 2,912 | 1,167 | 21,289 | 43,865 | 150,707
Total assets | 2,072,801 | 747,804 | 976,938 | 1,560,865 | 1,442,938 | 303,720 | 7,105,066
Liabilities |  |  |  |  |  |  |
Due to other banks | 49,570 | 574 | 2,177 | 281 | 1,345 | - | 53,947
Due to individuals | 356,084 | 513,251 | 697,007 | 1,901,545 | 319,425 | - | 3,787,312
Due to corporate customers | 1,088,570 | 52,884 | 19,588 | 490,270 | 247 | - | 1,651,559
Debt securities in issue | 35,603 | 43,841 | 38,910 | 6,245 | - | - | 124,599
Other borrowed funds | 88 | 395 | 1,308 | 83,762 | 29,660 | - | 115,213
Deferred income tax liability | - | - | - | - | - | 4,598 | 4,598
Other liabilities | 32,060 | 9,414 | 7,067 | 1,392 | 2,215 | 17,693 | 69,841
Subordinated debt | - | 14,504 | - | - | 504,557 | - | 519,061
Total liabilities | 1,561,975 | 634,863 | 766,057 | 2,483,495 | 857,449 | 22,291 | 6,326,130
Net liquidity surplus/(gap) | 510,826 | 112,941 | 210,881 | (922,630) | 585,489 | 281,429 | 778,936
Cumulative liquidity surplus/(gap) at 31 December 2009 | 510,826 | 623,767 | 834,648 | (87,982) | 497,507 | 778,936 | -

The Management believes that matching and/or controlled mismatching of the maturities and interest rates of assets and liabilities is fundamental to the management of the Group. It is unusual for banks ever to be completely matched since business transacted is often of an uncertain maturity with deviation from contract terms being observed. An unmatched position potentially enhances profitability, but can also increase the risk of losses. The maturities of assets and liabilities and the ability to replace, at an acceptable cost, interest-bearing liabilities as they mature, are important factors in assessing the liquidity of the Group and its exposure to changes in interest and exchange rates.

Operational Risk. Operational risk is a possibility of a loss from deficiencies in operational management, technologies and information systems in use, unauthorised actions or errors of the staff, or by external events.

The Group considers management of operational risk as part of its overall risk management system. To manage operational risk the Group uses appropriate Policies for prevention and/or minimisation of operational risk.

The Group's Policies for Operational Risk Management include segregation of duties, overall reglamentation of business processes and internal procedures, control over credit limit discipline, rules and procedures for deals and transactions execution; action plan for information security, continuity and recovery in case of emergency and ongoing professional development of staff across the Group's hierarchy.

Management of operational risk depends on the volume of transactions, multi-branch operational structure and diversity of information systems in place.

The Group monitors operational risk data, collects, analyses and systematises the loss data and monitors losses caused by processes and operations exposed to operational risk.

## History

- 30 Segment Analysis
- 6 New Accounting Pronouncements
- 5 Adoption of New or Revised Standards and Interpretations
- 4 Critical Accounting Estimates and Judgements in Applying Accounting Policies
- 3 Basis of Preparation and Significant Accounting Policies

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