middle east bank risk management...
TRANSCRIPT
Contents
1 Risk Management .................................................................................................................................... 1
1.1 Risk Management Strategy .............................................................................................................. 1
1.1.1 Asset side strategy ....................................................................................................................... 1
1.1.2 Liability side strategy .................................................................................................................. 3
1.1.3 Capital Conservation Strategy .................................................................................................... 3
1.2 Risk Management Structure ............................................................................................................. 4
1.3 The Bank’s Risks ............................................................................................................................. 5
1.3.1 Credit Risk .................................................................................................................................. 5
1.3.2 Liquidity Risk and Assets and Liability Management ................................................................ 8
1.3.3 Market Risk ............................................................................................................................... 11
1.3.4 Interest Rate Risk ...................................................................................................................... 12
1.3.5 Foreign Exchange Risk ............................................................................................................. 13
1.4 Capital Adequacy Ratios (CAR) .................................................................................................... 13
1.4.1 CAR according to IRB-Foundation Approach .......................................................................... 13
1.4.2 Basel-III Standardized Approach .............................................................................................. 15
1.4.3 FX Market Risk and Operational Risk Calculation .................................................................. 16
1.4.4 Tier 1 and Tier 2 Capital Adequacy Ratios Using Different Approaches ................................ 16
1.5 Stress Testing ................................................................................................................................. 17
1
1 Risk Management
Middle East Bank (MEB) continued building and enhancing its information technology infrastructures for risk
management. In light of MEB’s commitment to implementing Basel-III accord, we further developed our
internal rules and procedures for Internal Capital Adequacy Assessment Process (ICAAP). We expect to have
a complete set of internal rules and regulations approved and signed by the Board of Directors by the fall of
2016.
Central Bank of Iran (CBI) has taken major steps bringing the Iranian banking regulations in line with the
latest Basel accords and International Financial Reporting Standards (IFRS). The CBI has emphasized
implementation of IFRS particularly for matters related to disclosures and market discipline for the current
reporting period (Year ended March 19, 2016); however matters related to fair valuations are to be introduced
for the next reporting period; i.e. Year ended March 20, 2017. Although CBI has not yet issued guidance on
capital adequacy and liquidity ratios conforming to Basel-II or Basel-III accords, we report these ratios
according to the latest guidance from Basel Committee on Banking Supervision “Basel-III” documents in
addition to current CBI rules. It should be noted that recently CBI issued preliminary recommendations for the
implementation of Basel-II standardized model for the calculation of capital adequacy ratio; and, has sought
comments from banks for a final decision yet to be made. The Table 1 illustrates some highlights of MEB’s
risk profile.
Table 1- Risk Highlights
Select Risk Ratios as of March 19, 2016 Percentage
Doubtful loans /Total Loans 0.6
Capital Adequacy Ratio Basel-III Foundation-IRB 12.8
Capital Adequacy Ratio Basel-III Standardized Approach 12.5
Liquidity Coverage Ratio (LCR) 77.1
Net Stable Funding Ratio (NSFR) 134.8
Liquid Assets1/Total Assets 10.7
(Liquid Assets + Regulatory Deposits)/Total Assets 18.2
Loans / Total Assets 67.5
Loans / Deposits 81.3
1.1 Risk Management Strategy
1.1.1 Asset side strategy
MEB defines itself as a corporate bank, providing financing services to ongoing businesses for their working
capital needs. Our loans mostly cover short term needs of our customers, usually payable in three months and
reusable up to one year. Longer period financing or project finance is only done when the viability of the
project passes credit committee’s stringent requirement and funding is provided by the National Development
Fund (NDF) against our guarantee. Larger projects may also be handled, but against guarantee of a syndicate
of banks. MEB’s strategy is to minimize market risks related to equity share holdings and so engages 1.2% of
its assets in a diversified marketable equity securities portfolio.
We carried on our strategy of lending short-term loans to select corporate clients with whom we had developed
and maintained strong long-term banking relationships. Our loan portfolio constitutes about 68% of total assets
and consists mostly of working capital financing (receivables and inventory purchases) of our corporate clients
and individuals who run their businesses as proprietorship. MEB’s credit rating and credit extension is based
on our assessment of the borrowers’ ability to generate the required cash flows, in addition to borrower’s
1 Cash & Cash Equivalent + Unencumbered due from other Banks+ Guaranteed Bonds + Short - term liquid investments
2
ability to pay back the interest and principal at maturity of their loans; mostly in three months. This strategy
has allowed the bank to maintain a ratio of doubtful loans to total loans of less than 1%, well below the 12%
stated national average of doubtful loans as reported by CBI. The ratio of non-performing loans (more than 60
days late) to total loans is about 4.4% at MEB. The national average for loans 60 days past due was not
available at the time of writing this report, however, one can expect a much higher figure than the nationwide
doubtful loans of 12%.
Table 2 – Loans’ Status
Loan Class Each Item as a % of Total Loans
March 19, 2016 March 19, 2015
Standard 95.6 98.3
Overdue (Late between 60 days and 6 months) 3.7 1.1
Suspended (Late between 6 months and 18 months) 0.1 0.6
Doubtful (Late more than 18 months) 0.6 0.0
Total 100.0 100.0
Also, on the asset side, MEB’s short-term investments in equity stock market constitute 1.2% of total assets.
MEB plans to reduce even further the short-term equity investments considering the low Sharpe Ratio and the
very high risk weight associated with these assets. Our estimate of risk weight for our short-term investments
is about 304%. For these short-term investments, the standardized Basel-III risk weight is 300%. These risk
weights are to be contrasted with the Basel-I risk weight of 100% for short-term stock market investments.
These high risk weights impose a policy of minimal and prudent short-term stock market investments. The
overall asset side strategy of MEB is reflected in its strong capital ratios as depicted in the section “Capital
Conservation Strategy”.
As of March 19, 2016, MEB’s Long-term and strategic investments were about 1% of total assets and were
used for facilitating the financial needs of our customers. These investments include a brokerage house, an FX
trade company and an investment bank, and an information technology company used for development of
MEB’s core banking and related IT products. Considering the current economic situation, MEB adopts a
conservative liquidity strategy and maintains about 18% of its total assets in very liquid assets plus regulatory
reserves. Customers’ loan portfolio constitutes about 68% of total assets; while about 11% of total assets are
tangibles, intangibles and other assets supporting the core activities of the bank.
Table 3 - Assets composition
Asset Type Each Item as a % of Total Assets
March 19, 2016 March 19, 2015
Liquid Assets1 10.7 8.8
Regulatory Deposits with CBI 7.5 9.4
Long term and strategic investments 1.4 0.8
Loans 67.5 69.7
Tangibles, Intangibles, Receivables, and others 10.4 11.3
Encumbered Assets with CBI 2.5 -
Total 100.0 100.0
The risk profile of our on balance sheet assets is such that considering an average risk weight of 107% for our
loans, the average risk weight of our on balance sheet assets is about 92%. This results in MEB having a
1 Cash & Cash Equivalent + Unencumbered due from other Banks+ Guaranteed Bonds + Short - term liquid investments
3
relatively high Capital Adequacy Ratio of 12.8%. Despite a relatively high CAR, we have stayed one of the
most profitable banks in Iran. MEB’s profitability can be attributed to an efficient work force, lower cost of
capital and high regulatory interest rate for loans. MEB has a lower cost of capital because relatively large
section of our deposits consists of our customers’ current account deposits.
1.1.2 Liability side strategy
We do not rely on large number of branches for expanding our financial resources. Instead, we rely on our
business borrowers to bring their banking activities and financial resources to the bank. Essentially with this
strategy we work as an intermediary to help our clients with occasional excess resources to finance our other
clients with occasional short-term working capital needs. We also rely on the high quality of our services to
attract the employees, managers and the customers of our borrowers to do their banking with us. We also
attract high net worth individuals (HNWI) and business owners/managers and high income earners (HIE)
because of the high quality of our services and the good reputation established among the business leaders.
Majority of the deposits and funds provided by the HNWI and HIEs are related to our corporate clients.
MEB’s depositors have stayed loyal despite the fact that higher deposit rates were available at other banks.
During much of this reporting period there was an unusual situation where the interbank overnight rates were
higher than regulatory deposits interest rate. MEB was generally a provider of funds in the interbank market
which provided a window of opportunity to profit from the high interbank rates and low deposits rates. The
reason for unusual high interbank rates was that CBI imposed a high interest rate penalty on banks with
deficiencies in their statutory reserves. This high penalty interest rate pushed interbank loans to levels higher
than regulatory fixed interest rates imposed on term deposits. This situation also forced some banks with
deficient reserves to offer deposit interest rates higher than CBI regulatory deposit rates to avoid the much
higher penalty for deficiency in statutory reserves.
Table 4 - Composition of liabilities
Items Each Item as a % of Total Liabilities
March 19, 2016 March 19, 2015
Current account deposits 14.8 10.9
Short term deposits 44.2 36.3
Long term deposits 37.7 50.0
Due to other banks 0.2 0.1
Due to CBI 1.1 0.9
Other liabilities 2.0 1.8
Total 100.0 100.0
1.1.3 Capital Conservation Strategy
Considering the current economic situation, MEB continues to maintain high liquidity and more capital than
regulatory requirements. Despite higher than required liquidity and capital ratios, MEB has been able to stay
one of the most profitable banks in the country for the reasons explained in the “Asset side strategy” of this
report. The result of capital conservation strategy is depicted in the following table where several Capital
Adequacy Ratios are estimated based on different models.
MEB reports its capital adequacy ratio (CAR) based on several models: Basel-I, Basel-III Foundational
Internal Rating and Basel-III Standardized Approach. Also, for March 19, 2016, MEB reports its CAR based
on 2014 Basel-III Revised Standardized Approach for comparison with previous year March 19, 2015.
4
Table 5 - Capital Adequacy Ratios
CAR Approaches and Stress Scenarios
CAR % (1)
March 19, 2016 March 19, 2015
Tier1 only Tier 1 + Tier 2 Tier1 only Tier 1 + Tier 2
CAR according to Basel-I (required by CBI and displayed here for
comparison)
- 18.1 19.7 20.9
CAR according to IRB-Foundation (2)
11.9 12.8 13.0 13.8
CAR according to Basel III Standardized Approach (Loans risk
weight and off balance sheet risk weights = 100%)
11.6 12.5 12.7 13.5
CAR according to “Revised Standardized Approach(3)
10.2 11.0 12.1 12.9
Stress Test scenario 2 (less severe) (4)
9.0 9.9
Not Available Stress Test scenario 3 (more severe) (4) 7.3 8.1
Stress Test scenario 4 (most severe) (4)
5.9 6.7 (1)
(Tier 1% +Tier 2%) / (RWA + Operational & FX Risk) (2)
This is also the base case scenario for scenario 1 of stress testing. Off-balance sheet items are risk weighted at 70% in contrast
to 100% of Standardized Approach, hence the higher CAR compared to Standardized Approach. Loans risk weight in 2016=
106.8%, Off balance sheet risk weights in 2016 = 70% (3)
Loans risk weight, and off balance sheet risk weights in 2016 = 118% (4)
Please refer to the section 1.5 “Stress Testing”
1.2 Risk Management Structure
Risk Management in MEB consists of Risk Committee (RC) and Risk Department. The duties of the RC are
modeled based on the Basel document entitled “Guidelines - Corporate governance principles for banks”,
issued in October 2014. The RC consists of five Board members and the head of Risk Department (or Senior
Risk Manager - SRM). SRM is responsible for reporting risk related matters to RC, discussing relevant
information with members of the RC/Board members, as well as executing various resolutions of RC.
Risk Department operates under the guidance of Risk Committee (RC) and carries the policies set forth by the
RC. The Risk Department is headed by the SRM and employs four additional risk analysts. The risk analysts
and SRM share the duties of credit risk modeling, credit risk rating and liquidity risk measurements.
Because of the regulatory fixing of lending and deposits interest rates and an almost flat effective yield curve,
interest rate risk comprised a non-significant portion of overall risks of MEB. A sensitivity analysis did not
reveal a major impact on MEB’s profitability ratios from a significant regulatory change in interest rates.
However, regulatory risks remain where MEB may face loss of funds in case MEB abides by the CBI rules on
fixed interest rates and other banks deviate significantly from CBI rules. The equity stock portfolio of the bank
is relatively small, however, it is regularly monitored and the relevant risk measurements such as VaR and
concentration are reported.
Foreign exchange rate risk in MEB arises from the off-balance sheet commitments related to imports of goods.
MEB engages only with clients who are not listed as a sanctioned entity and whose activities are allowed
according to the imposed international sanctions. The foreign exchange commitments required direct dealing
with CBI where the exchange rates were both guaranteed and allowed by CBI. MEB did not engage in direct
market related foreign exchange activities or hedging. With expected increase in international activities
following the implementation of JCPOA, the foreign exchange risk is expected to increase for future reporting
periods albeit such risk is always passed on to the importers or exporters. The Board assures independence of
the risk function from other business activities of the bank. The Senior Risk Manager leads the implementation
of a rigorous ICAAP in MEB which is expected to be finalized by the fall of 2016.
5
1.3 The Bank’s Risks
1.3.1 Credit Risk
MEB’s credit extension policies ensure CBI’s rules and regulations are properly implemented. MEB’s primary
credit clients are incorporated entities with whom MEB develops and maintains strong long-term banking
relationships. However, natural persons who manage their business activities personally and are not under a
legal umbrella are welcomed and treated as proprietorships. Obviously in such cases, Chamber of Commerce
registration and a proper tax code are necessities prior to extension of any facilities. Concentration of MEB’s
credit is in short-term requirements of its clients; namely inventory and receivable financing. Even
international activities are limited to the importation of raw materials, spare parts and finished consumer
goods. MEB occasionally arranges and participates in syndicated guarantee facilities when funding is provided
through the capital market or State financed, National Development Fund.
The Risk Department assigns credit risk rates to non-financial incorporated clients based on their audited
financial statements, past payment history, competitive position in the market, management quality and other
qualitative information. Risk Department’s assessment, among others, is based on a client’s ability to generate
the required cash flows for short-term financing of receivables and or inventories. All incorporated
non-financial clients are independently evaluated by the Risk Department and are given an internal credit rate.
Credit Department performs its own evaluation before submitting client information for risk rating. It is
MEB’s risk policy to maintain an average credit risk rate of B+ or better. Collaterals as well as “supplementary
collaterals” are used to augment the credit quality of clients with credit rates in the lower ranges.
1.3.1.1 Credit Risk Distributions
We provide several tables describing quality measures of credit portfolio, including internal rating, late
payment behavior, and concentrations.
Table 6 - Loans Internal Rating
Loans Internal Ratings as of March 19, 2016
Internal Rating Risk Weight (%) Each Item a % of Total Loans
AAA 4 0.0 AA 14 3.7 A 34 7.4 A- 42 2.3 BBB+ 50 4.2 BBB 60 3.9 BBB- 70 3.4 BB+ 80 3.3 BB 92 3.5 BB- 102 3.0 B+ 112 2.5 B 122 6.9 B- 129 4.5 CCC+ 137 3.3 CCC 144 9.6 CCC- 150 2.9 CC,C 250 6.9 Corporates and SMEs not rated 100 13.9 Natural person borrowers not rated 100 10.4 Overdue 150 3.7 Suspended 150 0.1 Doubtful - 0.6 Average Risk Weight 106.8 100.0
6
The above table shows the credit quality of loans based on internal rating and the associated risk weights used
for capital adequacy ratio calculations based on Basel-II IRB-Foundation Approach. In this approach the Loss
Given Default is set to the Basel-III standardized value of 45%. The overall IRB-Foundation risk weight of
loan portfolio for the March 19, 2016 is calculated to be 106.8%. The overall IRB-Foundation risk weight of
loan portfolio for the March 19, 2015 was calculated to be 105.6%.
The following graph shows the contribution of each credit rate in the overall risk weight of loans.
Figure 1 Risk-Weighted Distribution
1.3.1.2 Credit Risk– Borrowers payment behavior distribution
Risk department monitors and measures the payment behavior of its clients. These measurements help the risk
department to improve its internal rating model. In the following table, the past payment behavior of current
customers with outstanding loans are reported.
Table 7 - Credit Risk– Borrowers payment behavior distribution
Customer categorization based on days late (1)
Each Item as a % of Total Loans
March 19, 2016 March 19, 2015
Customers with only payments after the year ended (2)
6.9
To be provided
Excellent (3)
43.9
Good 10.0
Average 25.2
Below average 6.1
Unsatisfactory (however current) 3.5
All current customers 95.6 98.3
Late between 60 days and 6 months 3.7 1.1
Late between 6 months and 18 months 0.1 0.6
Late more than 18 months 0.6 0.0
Non-current customers 4.4 1.7
All customers 100.0 100.0
(1) The past payment behavior of clients with outstanding and current loans is evaluated and categorized according to a measure similar to standard deviation of days clients have been late. (2) First time customers who were current and had no previous payments recorded (all their payments were due in a future date after the year ended) (3)
Quality of Payment Behavior for Customers Current on Loans Risk Dept. Measure of Past Late Payments (days)
Excellent Less than 1 day late Good Between 1 and less than 2 days late Average Between 2 and less than 25 days late Below average Between 25 and less than 60 days late Unsatisfactory (however current on outstanding loans) Greater than 60 days late
0.0%2.0%4.0%6.0%8.0%
10.0%12.0%14.0%16.0%18.0%
7
1.3.1.3 Credit Risk – Loans Distribution based on leverage and sales (BCBS 2014 Revised
Standardized Approach)
For the previous financial year ended March 19, 2015, we reported the risk weight 115% for our loan portfolio
based on BCBS 2014 revised standardized approach. The BCBS 2014 approach has been superseded with a
new model issued January 2016. For reasons of comparability we continue to report based on the 2014
approach.
Table 8 - Loans risk weight according to Basel III Revised Standardized Approach (Issued December 2014)
Customer type categorized by sales and leverage Risk
weight
Each Item as a % of Total
Loans March 19, 2016 March 19, 2015
Leverage < 3, Sales >= 1bn euros 60 0.0 0.0
Leverage between 3 and 5, Sales >= 1bn euros 70 0.0 0.0
Leverage < 3, Sales between 50m and 1bn euros 80 1.0 3.6
Leverage < 3, 5m<= Sales < 50m euros 90 7.6 6.6
Leverage > 5, Sales >= 1bn euros 90 0.0 0.0
Leverage between 3 and 5, Sales between 50m and 1bn
euros
90 8.2 7.0
Leverage < 3, Sales < 5m euros 100 1.5 2.1
Leverage between 3 and 5, 5m<= Sales < 50m euros 100 7.2 10.3
Natural Persons Borrowers with financial data 100 0.0 0.0
Natural Persons Borrowers with no financial data 100 9.9 9.3
Leverage > 5, Sales between 50m and 1bn 110 17.6 15.4
Leverage between 3 and 5, Sales < 5m euros 110 3.1 2.8
Corporate and SME Borrowers with no financial data 110 12.1 13.9
Leverage > 5, 5m<= Sales < 50m euros 120 18.0 17.3
Leverage > 5, Sales < 5m euros 130 5.7 5.1
Past due 60 days, and 180 days 150 3.6 3.9
Negative Equity (Standard) 300 4.1 2.6
Past due 18 months 300 0.5 0.0
Average Risk Weight 117.9 115.9
Table 9 - Credit Risk / Concentration Per Economic Sector
Economic Sector Each Item as a % of Total Loans
March 19, 2016 March 19 2015
Industrial
35.2 32.2
Housing 15.4 15.1
Agriculture 1.8 0.4
Mining 1.6 3.9
Services 10.1 7.8
Commercial 35.7 40.7
Other 0.2 0.0
Total 100.0 100.0
8
Table 10 – Off-Balance Sheet Commitments (Local Currency)
Off balance sheet commitments Local Currency in Million IRR
March 19, 2016 March 19, 2015
Letters of credit 370,000 21,704
Guarantees 14,775,364 10,276,387
Managed accounts 70,154 0
Others 957,530 880,890
Total 16,173,048 11,178,981
Table 11- Off- Balance Sheet Commitments (Foreign Currencies)
Off balance sheet commitments Foreign Currencies in Million IRR
March 19, 2016 March 19, 2015
Letters of credit 2,137,746 648,329
Guarantees 1,974,815 1,503,346
Managed accounts 0 0
Others 0 0
Total 4,112,561 2,151,675
1.3.2 Liquidity Risk and Assets and Liability Management
A daily report regarding changes in funds, uses of funds, costs of funds, asset profitability and return on equity
is provided by the finance department. Additionally a weekly meeting of managing director, assistants to
managing director and other senior level managers including senior risk manager is held where the reports are
discussed and decisions regarding future directions of the bank are taken. The Risk Management department
periodically provides reports on Liquidity Coverage Ratio (LCR), Net Stable Funding Ratio (NSFR) and
Liquidity Gaps. Additionally, Risk Management Department provides reports on concentration of funds and
loans.
Table 12 – Liquidity Coverage Ratio – Part 1: HQLA as of March 19, 2016
High Quality Liquid Assets Amount
(Million IRR) % of Total
HQLA
Level 1 Assets
Cash and Cash Equivalent
281,202
Regulatory Deposit with CBI
3,099,233
Due from other banks (short term less than one week) 1,124,508
Checks in clearing due from other banks 34,754
Total level 1 Assets
4,539,697 65.8
Level 2 Assets
Level 2A Assets
85% of participation bonds backed by government
2,107,875
Total level 2A Assets
2,107,875 30.5
Level 2B Assets
50% of Short term investments in stock exchange
255,796
15% of HQLA 1,035,505
Amount of Level 2 Assets above 15% of HQLA to be deducted
0 Total level 2B Assets
255,796 3.7
Total Level 2 Assets
2,363,671 34.2
40% of HQLA 2,761,347
Amount of Level 2 Assets above 40% of HQLA to be deducted 0
Total HQLA 6,903,368 100.0
9
Table 13 – Liquidity Coverage Ratio – Part 2: Net Outflows & Result
Liquidity Coverage Ratio as of March 19, 2016
Outflows Amount (Million IRR)
Exit
rate% Outflow
Stable Deposits
Cash Collaterals and blocked deposits 3,041,665 0% 0
Deposits of bank employees 246,826 5% 12,341
Less Stable Deposits
Long-term deposits with less than one month maturity date 171 10% 17
Short-term deposits of natural persons 3,227,944 10% 322,794
Long-term deposits of natural persons with more than one month maturity date 10,067,924 10% 1,006,792
Short-term deposits of legal entities with less than 200 Billion IRR deposits each 6,882,806 10% 688,281
Short-term deposits of legal entities with more than 200 Billion IRR deposits each 2,014,052 25% 503,513
Other deposits and dues to natural persons 173,076 15% 25,961
Special investment deposits 1,178,847 15% 176,827
Long-term deposits with maturity of more than one month of legal entities 3,035,532 15% 455,330
Wholesale Funding
Long-term deposits with maturity of less than one month of legal entities 0 25% 0
Short-term deposits of legal entities categorized as corporate with more than 200
Billion IRR deposits each 581,376 40% 232,550
Other deposits and dues to legal entities 1,628,311 40% 651,324
Deposits from other banks and financial institution 2,333,800 100% 2,333,800
Other dues to banks and financial institutions 469,037 100% 469,037
Total outflow from funds 34,881,367
6,878,569
Other dues that must be paid within 30 days
Dividend payable 4,718 100% 4,718
Tax provision 143,452 0% 0
Employee termination provisions 37,423 0% 0
Other dues and provisions 390,654 14% 54,785
Payable interest 150,230 100% 150,230
Off balance sheet commitments 20,258,609 10% 2,025,861
Estimated unused loan limits - - 2,332,365
Total outflow from funds and other dues 35,607,844
11,446,528
Inflows
Estimated inflows due to loans (under stressed condition) (2,487,856)
LCR Ratio
Net Cash Outflows
8,958,672
HQLA
6,903,368
LCR = HQLA/Net Cash Outflows 77.1%
10
Table 14 – Net Stable Funding Ratio (NSFR)
Net Stable Funding Ratio as of March 19, 2016
Available Stable Funds (ASF) Amount
(Million IRR) Factor
ASF
(Million IRR)
Liabilities and capital receiving a 100% ASF factor
The total amount of regulatory capital , before the application of capital
deductions, as defined in paragraph 49 of the Basel III text, excluding the
proportion of Tier 2 instruments with residual maturity of less than one
year
5,808,485 100% 5,808,485
Liabilities receiving a 95% ASF factor
Stable funds from LCR 3,288,491 95% 3,124,067
Liabilities receiving a 90% ASF factor
Term deposits from natural persons with residual maturities of less than one
year , short-term deposits, demand deposits, qard-al-hasaneh deposits and
similar deposits
13,296,039 90% 11,966,435
Liabilities receiving a 50% ASF factor
Other deposits and prepayments from natural persons, short-term special
investment deposits, investment deposits from legal entities
13,865,689 50% 6,932,844
Liabilities receiving 0% ASF factor
Investment deposits from other banks, due to other banks and financial
institutions, other liabilities
5,190,041 0% 0
Total ASF 41,448,745
27,831,831
Required Stable Funds (RSF) Amount
(Million IRR) Factor
RSF
(Million IRR)
Assets assigned a 0% RSF factor Cash & Cash Equivalent, All central bank reserves (including required reserves and excess reserves), All unencumbered loans to banks subject to prudential supervision (including interbank placements) with residual maturities of less than six months.
4,539,697 0% 0
Assets assigned a 5% RSF factor
Debt securities representing claims on or guaranteed by sovereigns, central banks that are assigned a non-0% risk-weighted sovereign or central bank debt securities as specified in the LCR
1,531,776 5% 76,589
Assets assigned a 15% RSF factor Corporate debt securities (including commercial paper) and covered bonds with a credit rating equal or equivalent to at least AA-
948,077 15% 142,212
Assets assigned a 50% RSF factor All other non- HQLA not included in the above categories that have a residual maturity of less than one year, including loans to non- bank financial institutions , loans to non -financial corporate clients, loans to retail customers (i.e. natural persons) and small business customers, and loans to sovereigns, central banks and PSEs.
27,988,380 50% 13,994,190
Assets assigned a 100% RSF factor
All other assets not included in the above categories 6,440,815 100% 6,440,815
Total RSF 41,448,745
20,653,805
NSFR1= ASF/RSF 134.8%
1 Off-balance sheet commitments are not considered
11
Table 15 - Concentration of Funds
Number of Top Depositors Each Row as a % of Total Deposits
March 19, 2016 March 19, 2015
20 27 42
100 50 63
200 63 74
400 76 85
1000 91 94
13684 99 100
21455 100
Table 16 - Concentration of Loans
Number of Top Borrowers Each Row as a % of Total Loans
March 19, 2016 March 19, 2015
20 31 33
100 76 79
200 94 96
432 99 100
496 100
Table 17 - Other Liquidity Ratios
Other Liquidity Ratios March 19,
2016
March 19,
2015
Local currency Loans / Local Currency Deposits 81.4 89.2
Local Currency off Balance Sheet Commitments/ Local Currency Deposits 48.8 46.4
Foreign currency Loans / Foreign Currency Deposits 88.6
Foreign Currency off Balance Sheet Commitments/ Foreign Currency Deposits 323.2 245.9
1.3.3 Market Risk
Risks related to short-term equity investments, and changes in foreign exchange rate and interest rate are
discussed in this section.
1.3.3.1 Short-term equity Investments
The equity stock portfolio of the bank is relatively small, however, is regularly monitored and the relevant risk
measurements are reported. The stock portfolio consists of 48 corporate shares (637,693 million IRR), 41
corporates are listed companies in Tehran Stock Exchange (597,269 million IRR) and others (40,424 million
IRR) are shares of privately held companies.
Table 18 - Short-Term Equity Investments Portfolio Composition
Investment Type
Each Item as a % of total short term investments
March 19, 2016 March 19, 2015
Tehran Stock Exchange Short-term Investments 93.7 93.7
Other Short-Term Investments (Farabourse) 6.3 6.3
Total Short-Term Investments 100.0 100.0
12
According to Basel II, market risk can be calculated using the Value at Risk (VaR) methodologies. The “Value
at Risk” calculation must be done based on 0.5% probability (one tail) using daily standard deviation and 10
days horizon time. Each bank must meet, on a daily basis, capital requirement illustrated as the higher of
previous day’s value at risk or an average of the daily value at risk in 60 working days. According to Basel II
notes, the capital requirement equals to VaR Amount *(3 + X) with X between 0 and 1. Our estimate of risk-
weight of the short-term equity investments using a Basel-III Value at Risk model is 304% (the standardized
Basel-III risk weight for equity investment in acceptable equity exchanges is 300%). The high risk weight of
304% imposes a policy of minimal and prudent equity investments in TSE listed companies.
Table 19 – Calculation of Short-Term Equity Investments Risk Weight using IRB-Foundation Basel-III
Short-Term Equity Investments Risk Weight as of March 19, 2016
10 days portfolio standard deviation of returns 2.61%
Basel-III VaR multiplier 4
Risk Weight 304%
The annualized standard deviation of stock portfolio return is estimated to be 13% and annualized return is
estimated to be 27.8%. Assuming risk-free rate for term deposits to be 22%, the risk premium for stock
portfolio is estimated to be 5.8%. From the 5.8% risk premium and the standard deviation of 13% a Sharpe
Ratio of 0.4 is calculated. The Sharpe Ratio 0.4 is too low (1.0 is considered ok), and considering the higher
capital requirements for equity investments, MEB plans to further reduce its short-term equity investment. The
following table shows the concentration of MEB’s investments in Tehran Stock Exchange (TSE).
Table 20 –Concentration of TSE Short-Term Equity Portfolio
Tehran Stock Exchange (TSE) Equity Short-
Term Investments
Each Row as a % of Total TSE Investments
March 19, 2016 March 19, 2015
Top 5 Stocks 52 45
Top 10 Stocks 70 63
Top 20 Stocks 90 83
Top 45 Stocks 100 99
Top 58 Stocks 100
1.3.4 Interest Rate Risk
1.3.4.1 Interest Rate Risk on Banking Book (IRRBB)
MEB did not have any loans with floating rates, or significant optionality (e.g. early payment) affecting the
profitability of its loans portfolio. IRRBB comprised a non-significant portion of overall risks of MEB because
of the regulatory fixing of lending and deposits interest rates and an almost regulatory fixed flat yield curve.
We have not observed any significant changes on profitability ratios due to regulatory changes on fixed rates
of deposits and loans. However, regulatory interest rate risks remain where MEB may face loss of funds in
case where MEB abides by the CBI rules on fixed interest rates and other banks may deviate significantly from
CBI rules.
1.3.4.2 Interest Rate Risk on Trading Book
During the year ended March 19, 2016, there was no secondary market for trading bonds at discount or
premium. All the bonds were traded at the nominal value plus coupons due. Towards the end of financial year
(March 19, 2016), the government issued new bonds tradable in secondary markets with discount. For next
year ending March 19, 2017 we would report interest rate risk on trading book.
13
1.3.5 Foreign Exchange Risk
Foreign exchange rate risk in MEB arises from the off-balance sheet commitments related to imports of goods.
MEB engages only with clients who are not listed in internationally recognized sanctions lists and whose
activities are allowed according to the imposed international sanctions. The foreign exchange commitments
required direct dealing with CBI where the exchange rates were both guaranteed and allowed by CBI. MEB
did not engage in direct market related foreign exchange activities or related hedging activities. MEB does not
engage in profiting from changes to foreign currency exchange rates, however, occasionally, MEB would end
up with open long or short positions in its normal activities for servicing clients engaging in import/export or
other foreign exchange activities. With expected increase in international activities following the
implementation of JCPOA, the foreign exchange risk is expected to increase for future reporting periods.
Table 21- Foreign Exchange Open Positions Value at Risk (VaR )
FX Value at Risk (VaR) _ 10 days, 0.5% probability as of March 19, 2016
Foreign Currency Open Position Equivalent Million IRR VaR Equivalent Million IRR
US Dollar -6,078 21
Swiss Frank 84 3
Indian Rupiah 613 14
Emirate Dirhams 1,345 5
Turkish Lira 2,532 120
Iraqi Dinar 1,898 130
Chinese Yuan 3 0
Korean won -9,815 347
Euro 27,050 1080
Omani Rial 6,418
6,418
30
Total 24,050 1750
Diversification effect -508
With diversification effect 1,242
FX market risk contribution to RWA 4,968
Total Risk Weighted Assets including off balance sheet items, Market risk,
and Operational Risk (RWA) 48,132,277
FX market risk contribution to RWA 0.01%
The above table illustrates foreign exchange guarantees and commitments and impact of a major change in the
foreign exchange rates.
1.4 Capital Adequacy Ratios (CAR)
1.4.1 CAR according to IRB-Foundation Approach
According to IRB-Foundation the average risk weight of loan portfolio was estimated to be 106.8%. We risk
weighted our loans to other banks at a higher rate of 100%, because of our estimated low Basel-III capital
adequacy ratio for other banks, The total long term and short term investment of the bank in financial
institutions were less than 10% of the bank’s Basel-III Tier 1 capital, so there were no deductions concerning
these investments; however these investments were risk weighted at 250%. We risk weighted our investments
in Tehran Stock Exchange at 300%. The market risk related to interest rate risk was estimated to be nil. The
market risk due to foreign exchange rate fluctuations was extremely small and constituted about 0.01% of the
total risk weighted assets.
14
Regarding off balance sheet items, on average, the customers of Letters of Credit and Bank Guarantees have a
much lower risk profile than our on balance sheet loan customers. For this reason we estimated the average
risk weight of our off balance sheet items to be 70% equivalent to “BBB-“credit rating.
Table 22 - Assets Risk Weights - IRB-Foundation
On Balance Sheet Assets as of March 19, 2016 Amount
(Million IRR)
Each Item
as % of
Total
Assets
Risk
Weight
(%)
Risk
Weighted
Assets
(Million IRR)
Cash and equivalents 281,202 0.7 0 0
Regulatory Deposits with CBI 3,099,233 7.5 0 0
Due from other banks (Checks in clearing) 34,754 0.1 0 0
Due from other banks (Unencumbered Deposits) 1,124,508 2.7 100 1,124,508
Due from CBI & other banks (Encumbered) 1,061,902 2.6
Participation Bonds 2,479,853 6.0 0 0
Investments in financial institutions less than 10% of Tier 1 Capital 564,777 1.4 250 1,411,943
Investments in financial institutions in excess of 10% of Tier 1 Capital 0
Non-financial short-term equity investments in Tehran Stock
Exchange
511,591 1.2 300 1,534,773
Other long-term investment 4,230 0.0 100 4,230
Account Receivables 812,901 2.0 100 812,901
Loans to employees 249,043 0.6 100 249,043
Loans excluding doubtful loans (Net of Provisions) 27,890,257 67.3 106.8 29,786,794
Doubtful Loans (Net of Provisions) 98,123 0.2
Due from subsidiaries 183,157 0.4 100 183,157
Tangible Fixed Assets 2,003,930 4.8 100 2,003,930
Intangible Assets 857,137 2.1 100 857,137
Goodwill 6,165 0.0
Other Assets 185,982 0.4 100 185,982
Total of Assets 41,448,745 100.0
38,154,398
Table 23- Off-Balance Sheet Risk Weights - IRB-Foundation
Off Balance Sheet Commitments as of March 19, 2016 Amount
(Million IRR)
Conversion
Factor %
Risk
Weight
%
Risk
Weighted
Guarantees for Participation Bonds 835,740 50 70 292,509
Warranties in Local Currency 14,775,364 50 70 5,171,377
Warranties in Foreign Currencies 1,974,815 50 70 691,185
Letters of Credits (Local Currency) 370,000 20 70 51,800
Letter of Credits (Foreign Currencies Equivalent to Local Currency) 2,137,746 20 70 299,284
Trust Account Commitments 121,790 100 70 85,253
Managed Accounts 70,154 100 70 49,108
Credit Card Obligations 0 100 70 0
Total of Commitments 20,285,609 6,640,157
Total of Risk weighted Assets and Commitments 44,794,555
15
1.4.2 Basel-III Standardized Approach
For calculation of CAR according to Basel-III Standardized Approach, the average risk weight of the
performing loan portfolio will be set to 100% as opposed to 106.8% for IRB-Foundation. We risk weighted
our exposure to other banks at 100% considering our estimated low Basel-III capital adequacy ratios for other
banks. The long term investment of the bank in financial institutions were less than 10% of the bank’s
Basel-III Tier 1 capital, so there were no deductions from capital concerning these investments, however these
investments were risk weighted at 250%. We risk weighted our investments in Tehran Stock Exchange at
300%. The market risk related to interest rate risk was estimated to be nil. The market risk due to foreign
exchange rate fluctuations was extremely small and constituted 0.01% of the total risk weighted assets.
Table 24 - Assets Risk Weights - Basel-III Standardized Approach
On Balance Sheet Assets as of March 19, 2016 Amount
(Million IRR)
Each Item
as a % of
Total Assets
Risk
Weight
(%)
Risk
Weighted
Assets
Cash and equivalents 281,202 0.7 0 0
Regulatory Deposits with CBI 3,099,233 7.5 0 0
Due from other banks (Checks in clearing) 34,754 0.1 0 0
Due from other banks (Unencumbered Deposits) 1,124,508 2.7 100 1,124,508
Due from CBI & other banks (Encumbered) 1,061,902 2.6 0 0
Participation Bonds 2,479,853 6.0 0 0
Investments in financial institutions less than 10% of Tier 1 Capital 564,777 1.4 250 1,411,943
Investments in financial institutions in excess of 10% of Tier 1 Capital 0 0.0 0 0
Non-financial short-term equity investments in Tehran Stock
Exchange
511,591 1.2 300 1,534,773
Other long-term investment 4,230 0.0 100 4,230
Account Receivables 812,901 2.0 100 812,901
Loans to employees 249,043 0.6 100 249,043
Loans excluding doubtful loans (Net of Provisions) 27,890,257 67.3 100 27,890,257
Doubtful Loans (Net of Provisions) 98,123 0.2 0 0
Due from subsidiaries 183,157 0.4 100 183,157
Tangible Fixed Assets 2,003,930 4.8 100 2,003,930
Intangible Assets 857,137 2.1 100 857,137
Goodwill 6,165 0.0 0 0
Other Assets 185,982 0.4 100 185,982
Total of Assets 41,448,745 100.0
36,257,861
16
Table 25 - Off Balance Sheet Risk Weights - Standardized Approach
Off Balance Sheet Commitments
Amount
(Million
IRR)
Conve
rsion
Factor
%
Risk
Weight
%
Risk
Weighted
Guarantees for Participation Bonds 835,740 50 100 417,870 Warranties in Local Currency 14,775,36
4
50 100 7,387,682
Warranties in Foreign Currencies 1,974,815 50 100 987,408
Letters of Credits (Local Currency) 370,000 20 100 74,000
Letter of Credits(Foreign Currencies Equivalent to Local Currency) 2,137,746 20 100 427,549
Trust Account Commitments 121,790 100 100 121,790
Managed Accounts 70,154 100 100 70,154
Credit Card Obligations 0 100 100 0
Total of Off Balance Sheet Commitments 20,285,60
9
9,486,453
Total of Risk weighted Assets and Off Balance Sheet
Commitments 45,744,314
1.4.3 FX Market Risk and Operational Risk Calculation
Table 26 - Market Risk and Operational Risk
Risk Type Amount
(Million IRR)
Conversion
Factor Multiplier
Risk
Weighted
Market risk due to exchange rate volatility 4,968 - 12.5 62,100
The risk weight for Operational Risk using basic
indicator approach and applying the corporate
business factor of 18% to the average of last 3 years
gross income and multiplying by 12.5
1,458,054 18% 12.5 3,280,622
FX Market Risk and Operational Risk 3,342,722
1.4.4 Tier 1 and Tier 2 Capital Adequacy Ratios Using Different Approaches
Table 27 – Summary of Total Risk Weighted Assets with Different Approaches
Risk Items (Million IRR) IRB-Foundation Standardized
Approach
Revised Standard
Approach
On Balance Sheet Assets 38,154,398 36,257,861 2,907,961 Off Balance Sheet Commitments 6,640.157 9,486,453 9,486,453 Operational Risk 3,280,622 3,280,622 3,280,622 FX Market Risk 62,100 62,100 62,100
Total Risk Weighted Assets 48,132,277 49,087,036 55,737,136
17
Table 28 - CAR Calculation
Eligible Capital (Million IRR) Basel-III IRB-Foundation Standardized
Approach
Revised
Standard
Approach
Paid in Capital 4,000,000 4,000,000 4,000,000 Retained earnings 1,290,851 1,290,851 1,290,851 Loss due to remaining amount of doubtful loans
1 (98,123) (98,123) (98,123)
Statuary reserves 517,634 517,634 517,634 Common Equity Tier1 5,710,362 5,710,362 5,710,362 Less investments in financial institutions above 10% of
bank capital
- - - Less goodwill (6,165) (6,165) (6,165) Eligible Common Equity Tier1 5,704,197 5,704,197 5,704,197
Additional Tier 1 - - -
Total Eligible Tier 1 Capital 5,704,197 5,704,197 5,704,197
General Loss Provision 419,956 419,956 419,956 Less exceeding 1.25% of total risk 0 0 0
Tier 2 Capital 419,956 419,956 419,956
Total Eligible Tier 1 and Tier 2 Capital 6,124,153 6,124,153 6,124,153
Total Risk Weighted Assets + Operational Risk + FX
Risk
48,132,277 49,087,036 55,737,136
CAR Tier 1 11.9 11.6 10.2
CAR Tier 2 0.9 0.9 0.8
CAR (Tier1+Tier2) 12.8 12.5 11.0
1.5 Stress Testing
In order to perform our stress testing we assume that MEB will maintain the same balance sheet size and
composition as of March 19, 2016 for the year ending March 20, 2017. We assume the credit quality of our
clients would depend on national real GDP, which in turn would depend on average oil price for the year. The
table below summarizes the severity of economic situations dependent on average oil price for the year and the
effect on credit worthiness of our clients and the resulting loss/profit and the Capital Adequacy Requirement
(CAR).
Table 29 - Stress Test Assumptions & Results
Economic stress
scenarios
Year
Average
Oil Price/
Barrel
Real GDP
Growth rate
Doubtful
loans as a
% of
Total
Loans
Loans
Risk
Weight
%
Expected
Loss/Profit
(Million IRR)
Profits
Distribution
%
CAR
IRB-F
Scenario 1 (Base case) $40 +3% to +4% 0.6 107 1,271,735 80 12.8
Scenario 2 (Less severe) $35 +1% to +3% 5.3 101 -48,983 0 9.8
Scenario 3(more severe) $30 -1% to +1% 7.3 113 -616,620 0 8.1
Scenario 4 (most severe) $20 -4% to -1% 9.2 121 -1,184,256 0 6.7
1 This item is the difference between the amount of provision already taken by the financial department for doubtful loans and the amount the
Risk Department decided to take which is 100% of doubtful loans
18
1- Scenario 1 - Base case scenario: Similar to current situation. For the year ending March 20, 2017, we
assume the same assets composition and the same credit worthiness for loans as of March 19, 2016 as
reported in the Table 6 – Loans Internal Rating.
2- Scenario 2 - Less severe scenario: For the year ending March 20, 2017, we assume the same assets
composition; however, the credit ratings of all performing loans with rating of CCC and above are knocked
down by one notch. 90% of performing loans rated CCC- to C go to overdue status. All currently overdue,
suspended, and doubtful loans and 10% of performing loans rated CCC- to C go to default status. Also we
assume 20% of all not-rated loans go to overdue status.
3- Scenario 3 - More severe scenario: For the year ending March 20, 2017, we assume the same assets
composition; however, the credit ratings of all performing loans with rating of CCC and above are knocked
down by two notches. 80% of performing loans rated CCC- to C go to overdue status. All overdue,
suspended, and doubtful loans and 20% of performing loans rated CCC- to C and 4% of not-rated loans go
to default status. Also we assume 25% of all not-rated loans go to overdue status.
4- Scenario 4 - Most severe scenario: For the year ending March 20, 2017, we assume the same assets
composition; however, the credit ratings of all performing loans with rating of CCC and above are knocked
down by three notches. 70% of performing loans rated CCC- to C go to overdue status. All overdue,
suspended, and doubtful loans and 30% of performing loans rated CCC- to C and 8% of not-rated loans go
to default status. Also we assume 50% of all not-rated loans go to overdue status.
Figure 2 Comparison of CAR and Doubtful Loans/Total Loans Among Scenarios
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
1 2 3 4
Comparing CAR and Doubtful Loans at Different Scenarios
Doubtful loans /Total Loans Capital Adequacy Ratio