Contents. Annual report 2008

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2 Annual report 2008 Contents Chairman and CEO Statement MDM Bank s Mission, Vision and Values Key Indicators Legal and Ownership Structure Overview of the Russian Economy and Banking Sector Planned Merger of MDM Bank and URSA Bank Regional Expansion and Branch Network Management Discussion and Analysis Review of Business Units Corporate and Investment Banking Private Banking Retail Banking Small Business Banking Information Technology Corporate Governance and Management Internal Control Risk Management Compliance Control Internal Audit Human Resources Corporate Communications Consolidated Financial Statements Contact Details Principal Correspondent Accounts Licenses Memberships

3 2 MDM Bank Annual report 2008 Chairman and CEO Statement OLEG VIYUGIN IGOR KIM

4 3 Dear shareholders, clients and partners: 2008 marked the next step forward in the progressive development of MDM Bank. During the reported period, we maintained a stable balance sheet and profitability. This held true even during the second half of the year, when conditions in the country s banking sector sharply deteriorated. According to the Company s IFRS audited financials for the period, the Bank s total profit for the year was 3.3 billion rubles, including 1.2 billion rubles during the second half of the year. Financial results for the reported period were lower than in 2007, primarily due to the conservative policy MDM Bank adopted in response to the global financial crisis and the fact the Bank focused on protecting the interests of its depositors and lenders: while the Bank s loan portfolio and working assets continued to provide stable high returns, the conscious decision to sustain a large liquidity cushion negatively affected the Bank s profit level. At the same time, the Bank foresaw the difficulties that its borrowers would face in servicing debts during the serious economic downturn. As a result, MDM abandoned its policy of actively expanding its loan portfolio and instead chose to build loan loss reserves in advance. This strategic shift decreased potential profits by at least 3 4 billion rubles. In our internal policy, we proceeded from the understanding that the crisis, which became pronounced in the fall of 2008, would continue, and that it would begin to affect the country s real economy. Russia s industrial and financial organizations will need to adapt to a sharp fall in external demand and an almost complete shut-down of the capital markets. In these new economic conditions, the optimization procedures undertaken by the Bank at the end of 2008, which helped reduce the annual cost/income ratio to 42.9%, was clearly a necessary step to preserve shareholder capital, as well as to protect our depositors and clients from any negative impact of the economic downturn. We plan that this the cost/income ratio will reach 30 35% in 2009, when the full effect of the optimization measures will be achieved. The Bank also re-assessed its risk evaluation approach, temporarily limiting lending to those sectors of the economy that were most sensitive to the crisis, and doing so well in advance of its onset. This led to a temporary decline in the loan portfolio, which, combined with a decrease in overall risk, allowed the Bank to avoid any balance sheet liquidity issues without depending on help from Russian monetary authorities. Finally, to strengthen the liabilities side of the balance sheet, the Bank paid particular attention to attracting retail deposits. In 2008, the growth in retail deposits reached 80%, bettering our main competitors and for the Russian banking sector as a whole. These measures enabled MDM Bank to maintain a strong Basel accord capital adequacy ratio of 17.9%. The Bank finished 2008 with the highest credit ratings among Russian non-state banks from Standard & Poor s, Moody s and Fitch.

5 4 MDM Bank Annual report 2008 During the reported period, the Bank continued to implement its strategy of transforming MDM from a financial institution primarily focused on corporate clients into a fully-fledged universal bank. The Bank gradually changed the structure of its loan portfolio to place greater emphasis on small- and medium-sized enterprises. This also led to a greater diversification of liabilities and increased stability. At the end of 2008, S&P increased the corporate governance rating of the Bank to CGS-6.9 on the Russian scale, which corresponds to its 6+ score on the international scale. An important, real step toward implementing this strategy was the decision to merge MDM Bank and URSA Bank. The merger, which will be finalized in 2009, will enable both banks to make significant progress on implementing their strategies of increased diversification and better stability in assets and liabilities for the consolidated bank. Synergies from the merger of the two banks competencies in the retail and corporate sectors, as well as consolidation on the operations side, will allow the merged bank to occupy a leading position in the Russian banking sector. MDM Bank is basing its long-term plans on the assumption that the global financial crisis will continue to negatively affect the Russia s economy and banking sector. Our asset and liability management and capital management policies take into account the inevitable decline in quality of the old loan portfolio. In terms of client services, we understand that our clients need new types of banking products aimed at preserving and protecting companies core businesses and overcoming systemic problems in the context of the current crisis. With these factors in mind, the Bank maintains its conservative approach to liquidity management and risk management and intends to carefully monitor and preserve sufficient capital adequacy levels. Despite increased credit risks, MDM Bank will offer credit resources and a broad range of services to meet today s challenges to companies that seek constructive solutions, can effectively use borrowed capital, and are capable of efficiently running their businesses, either themselves or with the assistance of the bank. With the goal of completing the merger in 2009, MDM Bank and URSA Bank have independently begun coordinating their business development and balance sheet management in order to begin the real operational merger with harmonized businesses and an effective team of managers. In terms of business results, we have taken a realistic view of We believe that the measures taken by banking regulators in developed countries are in line with the measures that have helped overcome banking crises in many countries. It is reasonable to assume that these actions will help to decrease the level of accumulated ineffective leverage, to replenish banks capital and to gradually re-establish confidence in the sector. Eventually positive trends will return to both financial and credit markets. As such, in 2009 we will concentrate on completing the merger between MDM Bank and URSA Bank and on offering our clients practical new credit and commission-based products and services that will help them successfully negotiate the the

6 current global financial crisis. We are convinced that our client-centered approach during the crisis period is particularly effective, since in the long-term it will build the foundation for faster growth of our clients, and therefore for MDM Bank as well. Based on this, in the year to come, the Bank s management intends to maintain an adequate level of return on average equity and to sustain a capital adequacy level that corresponds with regulatory requirements. At the same time, the Bank will seek to minimize risks focusing on growth through the development of client relations. We understand that 2009 will be a challenging year for the Bank, but we believe that we have a management team capable of working efficiently in these new conditions. MDM Bank will remain fully focused not only on fulfilling its obligations to depositors, creditors and clients, but also on significantly increasing its base of clients and business partners. Respectfully yours, OLEG VIYUGIN Chairman of the Board of Directors MDM Bank IGOR KIM Chairman of the Management Board MDM Bank

7 MDM Asset Management has developed new investment strategies and programs specifically designed for the current economic situation

8 MDM Bank s Mission, Vision and Values 7 Mission MDM Bank s Mission is to be a respected and successful universal financial institution, achieving market leadership by adhering to globally accepted standards of banking services and principles of corporate ethics. Vision MDM Bank strives to ensure consistent high returns on equity capital by pursuing the following goals: Provide the highest quality and cost effective services to all our corporate and retail clients; Offer products and services that support our clients at each stage of their development, helping them grow their business and prosperity; Extend and deepen our nationwide franchise by developing our business with small- and medium-size companies and establishing a strong regional presence; Ensure exceptional career opportunities to our employees and maintain the highest standards of corporate governance. Values Expertise. We are guided by the highest professional standards and thorough market analysis; we continuously augment our capabilities by fostering initiative and professional development of our staff. Client focus. A partnership philosophy forms the basis of our client relations. We strive to be a model of reliability and efficiency for all our counterparties. Integrity and confidentiality. We act with honesty and integrity with regard to our employees, clients and competitors. We comply with both the spirit and the letter of the law. Transparency. We support productive communications within the Bank and open relationships with our external stakeholders. Social responsibility. We contribute to the wellbeing of society by offering first-class economic opportunities to our clients and implementing environmental programs, as well as supporting educational and cultural projects.

9 8 MDM Bank Annual report 2008 Key Indicators Revenue Return on Average Equity (excl. one-off transactions) 27, ,832 21,832 24,000 21, , , ,000 12, , , , Revenues, RUR mln Change, % ROAE, % Change, pp Net income Corporate and investment banking: Total operating income before impairment losses and provisions 3, , ,304 5,400 4,800 4,200 3,600 3,000 9, , ,822 13,500 12,000 10,500 9,000 7,500 2,400 6,000 1,800 4,500 1,200 3, , Net income, RUR mln Change, % RUR mln Change, % Retail banking: Total operating income before impairment losses and provisions Treasury: Total operating income before impairment losses and provisions 3, ,751 4,500 4,000 1,386 1,450 1,300 3,500 1, , ,087 2,500 2,000 1, , RUR mln Change, % RUR mln Change, %

10 9 Corporate and investment banking results before central overhead Retail banking results before central overhead 6, , ,172 9,900 8,800 7,700 6,600 1, , ,452 2,700 2,400 2,100 1,800 5,500 1,500 4,400 1,200 3, , , CIB results before centralized costs, RUR mln Change, % Retail results before centralized costs, RUR mln Change, % Treasury results before central overhead Capital adequacy ratio, as per Basel Agreement, % 1,341 1,350 1, , Treasure results before centralized costs, RUR mln Change, % Tier I capital ratio Total capital ratio MDM Bank s other competitive advantages include: The highest international credit ratings among privately-owned Russian banks; A stable financial standing, which will allow the Bank to strengthen its market position during the economic crisis (capital adequacy ratio, as per Basel Agreement totaled 17.9% at the end of 2008); The Bank s shareholders are prepared to provide financial support to the Bank, if necessary; A large liquidity cushion (approximately USD 1.6 bln in highly liquid assets at the end of 2008); The highest quality corporate governance and transparency among Russian banks, affirmed by Standard & Poor s corporate governance score.

11 10 MDM Bank Annual report 2008 MDM Bank offers retail clients a broad range of financial products and services, including term deposits, consumer lending, money transfers

12 11 Legal and Ownership Structure MDM Bank s subsidiaries include Russian leasing and asset management companies, LTB Bank (based in Riga), and securities brokerage and investment companies in Cyprus. AS LTB Bank MDM Asset Management Asset management MDM Investments Ltd (Cyprus) Securities brokerage company LeasingPromHolding Leasing company MCM Russian Investments (Cyprus) Investment company Shareholder Structure MDM Bank s principal owners include: Mr. Sergey Popov, as the majority beneficial shareholder (with an approximately 77% beneficial interest); Olivant Limited, which holds a 9.5% beneficial interest, and Mr. Martin Andersson with an 8.5% beneficial interest. In addition, the IFC holds a 5% direct interest in the Bank.

13 12 MDM Bank Annual report 2008 Overview of the Russian Economy and Banking Sector Operating Environment 2008 was the year when the crisis that had started as turmoil in a limited segment of the financial markets US subprime mortgages swept first through the financial industry, then into the real sector of all OECD countries, and finally, by 3Q 2008, hit Russia. In 1H 2008, world liquidity had still been plentiful enough to sustain economic growth in Europe and emerging markets, as well as to keep natural resource prices at elevated levels. Nonetheless, the situation had started to deteriorate by mid-year, when signs of the crisis began to materialize in Eurozone countries, from there deepening and sweeping through all segments of all economies, regardless of geographical boundaries. The entire world witnessed a massive and agonizing process of deleveraging that shook the international banking system and incited a universal flight to safety, as investors sought secure ports of call in the form of the most liquid and risk-free assets, mainly dollar denominated. Meantime, in 3Q 2008, as inflated natural resource prices started to plunge, capital headed out of Russia. The average price for Urals crude in 2008 was USD 92 per bbl, as compared to USD 70 the year before, but a sharp decline in oil prices in 2H 2008, coupled with a growing net capital outflow in 1Q, 3Q and 4Q 2008, completely reversed the positive external market conditions of 1H08, leading to the Russian economy s aboutface from growth to recession. Russia s Balance of Payment Performance Over 2008 Current Account Balance, bln USD Current Account Balance, as % of GDP Net Private Capital Flows, bln USD Capital Flight, bn USD USD/ RUR Rate Change, % Average Urals Oil Price, USD/ Bbl 1Q Q Q Q Entire * * Average for period. The key factor behind Russia s buoyant economic growth from 2005 to 1H 2008 was plentiful global liquidity that propped up both international demand for crude and Russia s domestic liquidity. A healthy growth in fixed capital investments (FCI) in Russia that persisted in double digits reaching as high as 21% in 2007 made a record contribution of 4.2pp to total GDP growth that year, and, as the global crisis started to damage the Russian economy, was at 3pp over 9M 2008 (the most recent data available officially as of the date of this report s writing). In 3Q 2008, Russia posted a net private outflow of near USD 17 bln, which turned out to be only a prelude to a massive outflow of USD 133 bln in 4Q Looking deeper at the Russian balance of payments, we note the following: in 2007, net private capital inflow had been comparable to the current account surplus and even surpassed it, hitting USD 83 bln vs. USD 77 bln, respectively, helping Russia s gold and forex reserves grow by USD 150 bln, which translated to approximately USD 160 bln worth of net currency purchases (excluding non-dollar reserve component revaluation) by

14 13 the CBR, according to our estimates. In 2008, according to preliminary data from the Ministry of Finance of the Russian Federation, the net capital outflow reached as much as USD 138 bln on the back of a record current accounts surplus of USD 99 bln. While the new methods of measuring international reserves applied by the CBR since mid-2008 and based on the mark-to-market approach, rather than the earlier amortizationbased approach, makes it difficult to reliably monitor the selling and buying activities of the Central Bank on the domestic FX market, Ministry of Finance data shows that the Russian Federation s gross reserve figure declined by USD 45.3 bln during An important factor that provoked intense pressure on the ruble at the end of 2008 in addition to the repatriation of funds by foreign investors was the large volume of external corporate debt, roughly USD 500 bln, of which USD 135 bln was to be paid in the course of one year. The fact total gross Russian external debt of more than USD 540 bln had approached the gross international reserve amount of USD 580 bln as of late August 2008, exacerbated by refinancing fears, boosted the demand for hard currency, both for hedging and speculative purposes. For several months in 3Q 2008 it appeared that the CBR possessed adequate resources to protect the ruble. However, the ruble s convertibility (the absence of any capital control), the drop in oil prices in November 2008 below USD 60 per bbl and the continuing and deepening devaluation of peer currencies against the dollar finally forced the CBR to start the so-called gradual ruble devaluation, which by year end had resulted in a devaluation of 17% vs. the bi-currency basket and approximately 30% vs. the dollar. Besides FCI, another important driver of Russian economic growth between 2005 and 1H 2008 was fastgrowing consumer demand, which contributed more than 7pp in 2007 and 6.5pp over 9M 2008 to overall GDP growth. The latter figure is the second highest in history (following the 2007 record). Consumer expenditures by households rose 13.1% in real terms in 2007 and a further 12.9% over 9M 2008, which outpaced GDP growth, which was 7.4% over 9M 2008, significantly. Oil Prices, Industrial Growth and Fixed Capital Investment in Russia in Change in oil price, % year-on-year (left axis) Fixed capital investment, % year-on-year (right axis) Industrial growth (without axis) Source: State Statistics Service, Reuters, MDM

15 14 MDM Bank Annual report 2008 Russia s GDP Growth Components Investment in growth, % Final consumption expenditure Net export Gross savings Investment Source: State Statistics Service, MDM Total estimated GDP growth for 2008 has been estimated at 5.6% by the Economic Ministry, which effectively means stagnation began in 4Q 2008, with growth of only 0.5%. However, the consumption boom of 2007 and early 2008, stemming from high domestic liquidity, had so much inertia that in the last month of 2008 Russia s households showed negative savings for the first time in the country s post-1998 history. In 4Q 2008, all economic indicators sharply deteriorated. According to our internal evaluation (based on data from the Russian Federation State Statistics Service), industrial production declined 6%; investment in property, plant and equipment dropped approximately 2%; and real household income decreased approximately 0.6%. As of end of the year, according to data from the State Statistics Service, the increase in investment in property, plant and equipment totaled 9.1%; real disposable income grew only 2.7% (compared with 12% in 2007), and the volume of industrial production rose by only 2%. However, it must be noted that industrial production growth had already slowed down by the middle of 2008 and many of Russia s extraction industries had demonstrated serious indications of stagnation in The CBR s policy throughout 2008, excluding the fourth quarter, was still aimed at ensuring ruble exchange rate stability and curbing inflation. Throughout 2007 and the early part of 2008 the Russian monetary authorities were active in sterilizing the excess liquidity that originated from high currency inflows in the controlled ruble float environment. According to our estimates, in 2008 the federal budget, including the reserve and the sovereign wealth funds, sucked in approximately 70% of the entire ruble issuance through currency purchases by the CBR in the first half of the year. Later on, as capital inflows had almost dried up, ruble issuance by the CBR practically ceased, and the source of liquidity shifted toward borrowing from the Central Bank and fiscal expenditure. The growth of the broad monetary base totaled a mere RUR 65 bln over 2008, as compared to RUR 1.4 trn in M2 expansion was at an unprecedented low of 3% over 2008, compared to 48% a year ago. As a result, the M2 to GDP ratio fell to the level of early 2007, 31%.

16 15 Adversely, despite all efforts by the CBR and Ministry of Finance, CPI inflation reached 13.4% in 2008 vs. 11.8% the previous year, its highest level since The CPI acceleration was mainly attributable to the very high ruble issuance of late 2007 and to elevated oil prices in 1H 2008 that exceeded USD 100 per bbl and played on domestic energy prices as well. The late 2008 ruble devaluation had little effect on inflation that year, as a significant lag occurs before this inflationary factor comes onto play (up to six months). The Banking Sector Key developments in was a very challenging year for the Russian banking system, as it was for almost all banking systems worldwide. The first half of 2008 was relatively benign for Russian banks, as they still retained access to capital markets and issued bond placements both locally and internationally. Consolidated banks balance sheets expanded in January-June 2008 by 20% to reach almost USD 1 trn. However, in the second half of last year the situation changed dramatically. The sequence of events, of which the bankruptcy of Lehman Brothers was the most significant, hit the Russian banking system hard. Debt markets shut down completely, while capital flight from Russia intensified. The latter, combined with a sharp decline in oil prices, led to a significant devaluation of the ruble. Confidence in Russian banks was shaken. As a result, we saw significant volatility in the deposit base of the banks specifically a redistribution of market share in favor of state-controlled giants and a partial conversion of customer accounts into foreign currency. Needing to stabilize their liquidity positions, banks have significantly scaled down lending activities. The effects of the credit squeeze and financial crisis have started feeding through into the real economy, which, in turn, has led to the rise in default rates and deterioration of banks asset quality. In dollar terms, the consolidated balance sheet of the banking system shrank in the second half of 2008 a first in recent times closed with banks total assets standing at USD 921 bln, 6.5% lower than the midyear high watermark. In fact, the damage to the Russian banking system could have been far worse if not for unprecedented support from the regulators. The most important items on the long list of support measures included a significant expansion of Central Bank of Russia (CBR) refinancing tools, a relaxation of mandatory cash reserves requirements, large subordinated loan injections into key state banks and select privately-owned banks, as well as, of course, five bailouts of sizeable banks that had become technically insolvent. There are also ongoing discussions in the government about further recapitalization of Russian banks. Experience elsewhere shows that regulators are extremely supportive toward local financial institutions of significant size, as they see the failure of such institutions as threatening to the sustainability of the entire financial system. Outlook for 2009 In 2009, the development of the Russian banking sector will be fundamentally affected by the following factors: Support from state regulators. We assume that during this period the government and the CBR will continue to provide liquidity resources for Russian banks. Additionally, we believe that the CBR will continue to maintain a relatively soft approach on mandatory reserves regulation and oversight.

17 16 MDM Bank Annual report 2008 Concentration on re-capitalization issues. It is quite likely that in 2009 the quality of Russian banks loan portfolios will continue to deteriorate. The acceleration loan impairment losses will have an extremely negative effect on profitability and, more importantly, on capital adequacy ratios. During the fourth quarter of 2008, the negative effect from the increase in past-due debt was largely compensated for by profits from the revaluation of banks net currency position (due to ruble devaluation). However, this was a oneoff event. In 2009, many financial institutions will be required to recapitalize, whether through taking on subordinated loans, or by issuing preferred and common shares. These capital injections will be financed primarily by the government and by existing private shareholders of the affected banks. Active efforts aimed at strengthening the deposit base. Most wholesale capital markets will likely remain inaccessible for the majority of Russian banks in As a result, deposits will be a key source for bank funding, along with re-financing instruments from the CBR. Russian banks have the possibility to improve their deposit-to-loans ratio, which stood at 54% at the beginning of Intensive consolidation. We expect that 2009 will see numerous acquisitions in the Russian banking system: large institutions will actively acquire smaller competitors (which have become cheaper). Some mergers are possible as well, but the number of mergers will be minimal. The government actively supports these processes, because it believes that they will help maintain economic and social stability in Russia. To accelerate these processes, in December 2008, the Russian President signed amendments abolishing provisions under which all depositors and creditors of a bank had a put option on any liabilities in the event of structural reorganizations, such as a merger or takeover. The newly signed version of the legislation grants creditors these rights only in situations in which they are explicitly spelled out in a contract with the bank.

18 17 Russian Federation total banking assets, bln USD Deposit/Loans ratio, % F Source: Data from the Central Bank of Russia and MDM Bank estimates F Source: Data from the Central Bank of Russia and MDM Bank estimates Russian banks total capital adequacy ratio, % F Source: Data from the Central Bank of Russia and MDM Bank estimates

19 MDM Bank applies a bespoke approach to clients depending on their needs. Alcoholic beverages and food manufacturer OJSC Synergy MDM Bank Corporate & Investment Banking client Vladislav Bazehnov, deputy operations director of OJSC Synergy

20 Planned Merger of MDM Bank and URSA Bank 19 On 3 December 2008, the major shareholders of MDM Bank and URSA Bank announced their intention to merge the two banks. The new organization will be created based on the legal entity and general banking license of URSA Bank, but will operate under the brand name of MDM Bank. The planned transaction has received broad-based support from shareholders, the Central Bank of Russia and the Russian government, as well as by investors and analysts. Following the merger, the Bank will have equity of approximately RUR 60 bln and assets of around RUR 500 bln (based on MDM Bank and URSA Bank Russian Accounting Standards reporting for year-end2008), will become one of Russia s leading universal financial institutions and will have significant competitive advantages. The merged bank will realize considerable advantages from integrating its commercial and financial activities. At the same time, it will also posses a large and diversified liability base, relying on an extensive regional branch network with approximately 500 points of sale across Russia. The strategic rationale for the merger between MDM Bank and URSA Bank is as follows: The creation of one of Russia s largest private banks. The newly merged bank will be one of the five largest Russian banks and will also be among the top ten competitors for key banking products. Complementary structures of business and client bases. The considerable achievements of MDM Bank in corporate and investment banking will be combined with the successful experience of URSA Bank in serving retail clients and small- and medium-sized enterprises. Diversifying the product line and business process will enable the merged bank to strengthen its position in both the retail and corporate sectors. Complementary regional presence. MDM Bank has a broad retail network throughout Central and Western Russia. The home regions of URSA Bank are Siberia, the Urals and the Russian Far East. As a result, the merged bank will be widely represented in all key Russian regions. High corporate governance standards. MDM Bank adheres to best practice corporate governance and acts on the basis of informational transparency. These guiding principles will also be practiced in the merged bank. Better access to funding. The merged bank will enjoy significant advantages in areas such as attracting retail deposits. It will be able to more actively and effectively attract deposits due to both its broad geographical coverage and its reputation as a strong and stable bank. In the current economic situation, retail deposits have become an increasingly important source of funding; over time, however, debt financing costs will also come down as the market re-opens. Cost and revenue synergies. The merged bank will maintain and strengthen its position in the market through centralization and optimization of operations, including switching to a unified IT-platform, decreasing personnel costs, implementing best practices, elimination of duplicate structures, increased commission revenues from corporate clients through an improved product line and information sharing on best products in these areas.

21 20 MDM Bank Annual report 2008 According to the Bank s business plan, the synergy effect from the merger (measured in monetary terms) will range from RUR 4.6 bln to RUR 7.3 bln between 2009 and Approximately 70% of this benefit will be obtained through cost synergies (including the integration of business processes, network optimization, personnel cost optimization through increased labor productivity, as well as decreased advertising expenses because of a strengthened, unified brand), while the other benefits will be obtained through revenue synergies (RUR bln) and financial synergies (RUR 0.3 bln). The Bank estimates that the synergetic effect in 2009 will total RUR 0.3 bln. In , the merged bank intends to significantly broaden its retail network by opening 400 new branch banks.

22 21 Regional Expansion and the Branch Network An effective branch network is a key factor for attracting both retail and corporate clients, and it is therefore integral to the implementation of MDM Bank s development strategy. The Bank s branches offer the up-to-date banking services to a broad spectrum of customers throughout Russia, including large corporations, small- and medium-sized enterprises, entrepreneurs and individual consumers. During the reported period, MDM Bank successfully opened 63 new facilities in its branch network. New offices began working in Moscow, Achinsk, Volgograd, Ekaterinburg, Nevinnomysk, Novosibirsk, Omsk, Rostov-on- Don, Samara, St. Petersburg, Tuapse, Tyumen and Chita. In total, MDM Bank s regional Russian network now has 199 offices. In 2009, MDM Bank will continue to develop its regional business, and its branch network will play an increasingly important role in the Bank s activity. This focus on the local branches and regional business will allow the Bank to build a close relationship with its clients and offer the full spectrum of high quality services to its clients. In 2008, the Bank implemented a matrix structure for network management, according to which control over MDM s administrative functions is carried out at the regional level. On a functional level, employees in the regional networks are fully accountable to the management of the respective business units at the Head Office. To improve the work of the Bank s branch network, to optimize the system of its administrative management and to centralize the activities of the Bank s middle and back office, the Bank created three regional centers at the beginning of These three regional centers unified the Bank s work across the whole country. Regional center directors report to the Network Management unit, which is in turn overseen by head of the Network Management unit. Within the regions in which they operate, the directors of the regional centers are charged with responsibility for fulfilling the Bank s strategic goals. Gradually, MDM s head office is transferring business development powers to the local level. MDM Bank branches, working within regional centers, bear responsibility for their own managerial decisions in the regions and for providing the Bank s products and services to clients. Budgeting and operational management is mainly performed according to the bottom-up principle along the management chain. The Bank uses the same principles in respect to support functions (such as human resources, legal support, internal audit, corporate communications, etc.) At the same time, the system of branch network management is based on fostering strong partnerships between functional and regional managers.

23 22 MDM Bank Annual report 2008 Expanding banking services for small businesses is a strategic priority for MDM Bank. MDM Bank Small Business Lending Department client Mikhail Nepryntsev Children s goods retailer

24 23 Distribution of responsibility within the regional network Central office Regional center Branch Outlet General management and control Strategic planning, risk assessment, asset and liability management, financial reporting and methodology Centralized back office and underwriting Call-center Supervision and administrative control Coordination of business HR department at regional level, branch network development and financial reporting Supervision and control over outlet sales Middle office Sales of services to large companies, small- and medium- enterprises and individuals Sales of services to small- enterprises and individuals Transactions The matrix structure allows the Bank to adjust its branch network activities to the specific conditions prevalent in each individual region. At the same time, this structure allows the Bank to centralize the functions of its middle and back offices. Most importantly, this paradigm significantly boosts client services and the effectiveness of all of the Bank s structures, while simultaneously cutting costs through economies of scale.

25 24 MDM Bank Annual report 2008 MDM Bank works with a broad array of companies from nearly every sector of the Russian economy Media-corporation VGTRK MDM Bank Corporate & Investment Banking client Maria Sittel, Vesti news anchor

26 Management Discussion and Analysis 25 Consolidated Performance The main factors that influenced MDM Bank s performance in 2008 were: The development of the global economic crisis The strategic decision by the Bank protect clients and depositors by placing stability and liquidity ahead of profitability during the time of crisis. Increased net interest margin, and increased net interest income Increased income from financial operations: early redemption of debt, trading in precious metals Securities losses and decreased foreign exchange income Impact of early cost optimization measures Decreasing asset quality and high coverage ratio of NPLs by loan loss provisions The Bank s consolidated net profit for 2008 totaled RUR 3,304 mln (USD 133 mln), a decrease of 40.1% from the RUR 5,516 mln (USD 216 mln) reported in Return on average equity was also lower in 2008, at 8.2% versus 16.6% (excluding a one-off capital gain from sale of premises) for MDM Bank in The decrease in net profit and return on average equity (ROAE) is due to substantial deterioration of the economic environment in the world and in Russia. A list of metrics reflecting the Bank s principal strategic objectives determined at the beginning of 2008 is presented below. The list of indicators reflects, directly and indirectly, the following objectives, which will facilitate maximum growth of the Bank s business value if achieved in a balanced way: effective use of capital, financial stability and high quality of revenues high level of customer service productive, competent and loyal staff efficient internal processes

27 26 MDM Bank Annual report 2008 Primary performance indicators RUR mln or % Change 2007/ Change 2006/2007 Revenues 21,832 17, % 13, % Net profit 3,304 5,516 (40.1)% 3, % Net interest margin 5.7% 5.2% 0.5 pp 6.1% (0.9) pp Cost of risk (Provision expense / Average risk-weighted assets) 3.2% 0.9% 2.3 pp 1.0% (0.1) pp ROAE 8.2% 17.8% (9.6) pp 13.0% 4.8 pp ROAA 1.0% 1.9% (0.9) pp 1.8% 0.1 pp Cost / income 42.9% 48.3% (5.4) pp 51.5% (3.2) pp Total Assets/Employee (6) 55 1 Cost of risk (provisioning expense on loans to average loans for the year) 3.2% 1.1% 2.1 pp 1.5% (0.4) pp NPLs to total portfolio (Nonperforming loans / Gross loans) 4.2% 2.0% 2.2 pp 1.3% 0.7 pp Coverage of NPLs (Provisions / NPLs) 139.3% 163.7% (24.4) pp 197.6% (33.9) pp Tier I 16.0% 14.5% 1.5 pp 10.9% 3.6 pp Total Capital ratio 17.9% 17.2% 0.7 pp 13.7% 3.5 pp Deposits (excluding volatile customer accounts at Latvian Trade Bank) / Loans 47.5% 51.7% (4.2) pp 47.1% 4.6 pp Employees (end of period) 6,563 5, ,421 1,354 Network (branches, additional offices and operating offices)

28 27 Secondary performance indicators RUR mln or % Change 2007/ Change 2006/2007 ROAE before investments (excluding oneoff items) 9.1% 16.0% (6.9) pp 12.9% 3.1 pp Operating expenses (before investments) / Revenue before result from trading in securities 39.3% 48.2% (8.9) pp 52.9% 4.7 pp Operating expenses (before investments) / Revenue before result from FX 42.5% 51.2% (8.7) pp 56.1% (4.9) pp Share of net fees and commissions in revenue before result from trading in securities 10.0% 13.4% (3.4) pp 10.3% 3.1 pp Share of net fees and commissions in revenue before result from FX 10.8% 14.2% (3.4) pp 10.9% 3.3 pp Revenue / Average staff (RUR 000) 3,486 3, , In 3Q 2008, the Bank s management and Board of Directors took the decision to focus on shorter-term strategic goals that would help to ensure MDM Bank s stability and strength during the crisis. The six tactical goals for the Bank in 2009 are the following: Goal Increase deposit base by 50% Maintain excess liquidity cushion that is adequate for the market situation Maintain ROAE of at least 10% Increase MDM Bank s share of profit in strategically important segments (small and mid-sized companies) relative to competitors Maintain international credit ratings at levels higher than those of MDM Bank s leading competitors Maintain regulatory capital adequacy ratio (N1) of at least 12% Achievements The Bank has introduced a number of attractive, competitive deposit products for standard retail clients, high net worth individuals and small businesses Retail term deposits increased 79.9% y-o-y from RUR 14,094 mln on 31 December 2007 to RUR 25,362 mln as of 31 December This trend has continued in Q As of YE 2008, MDM Bank had USD 1.6 bln in excess liquidity held as cash in overnight accounts. This sum is more than adequate to enable the Bank to meet all international wholesale funding coming due in 2009 (approximately USD 800 mln) The Bank began taking measures to decrease costs in 3Q 2008, and aims to reduce operating expenses by 25% y-o-y in MDM Bank s small business loan portfolio grew by 89.1% from RUR 8,214 mln at YE 2007 to RUR 15,529 as of YE 2008 As of YE 2008, MDM Bank had the highest combined ratings from Standard & Poor s, Fitch and Moody s among privately-owned Russian Banks As of YE 2008, MDM Bank s regulatory capital adequacy ratio was 14.6% (including post-balance sheet events)

29 28 MDM Bank Annual report 2008 Review of the Income Statement RUR mln Year Ended December Year Ended December Year Ended December Interest income 32,893 28,345 17,326 Interest expense (15,985) (14,213) (7,269) Net interest income 16,908 14,132 10,057 Loan impairment losses (6,616) (2,083) (1,741) Net interest income after loan impairment losses 10,292 12,049 8,316 (Losses)/gains arising from trading securities, net (997) Gains/(losses) arising from trading in precious metals, net 504 (22) 50 Gains from foreign exchange, net 914 1,364 1,083 Gains/(losses) from interest-based derivative financial instruments, net 520 (520) (100) Gains from early redemption of debt 1,134 Fee and commission income 3,142 2,978 2,022 Fee and commission expense (883) (634) (634) Other assets impairment losses (518) (3) (2) Impairment of investment securities held to maturity (371) 13 Other provisions (330) (2) Other operating income Operating income 14,003 15,751 11,317 Operating expenses (9,366) (8,622) (6,715) Result on disposal of premises 498 (39) Profit before taxation 4,637 7,627 4,563 Income tax expense (1,333) (2,111) (1,243) Profit for the year 3,304 5,516 3,320

30 29 Revenues The Bank increased its consolidated revenue (excluding the impact of a one-time gain of RUR 498 mln before tax in 2007) by 22.4% to RUR 21,832 mln (USD 878 mln), primarily due to increases in net interest income and gains from early redemption of debt. 27,000 17, ,832 24,000 21,000 18,000 13, ,000 12,000 9,000 6,000 3, RUR mln Change, % RUR mln or % Interest income Change 2007/2008, % 2006 Change 2007/2006, % Loans and advances to customers 28,647 23, , Overnight deposits and due from other banks 2,860 3,098 (8) 1, Investment securities available for sale 399 Investments securities held to maturity 66 Total interest income on financial assets not at fair value through profit and loss 31,972 26, , Trading securities 916 1,361 (33) Other financial assets at fair value through profit and loss 5 21 (76) 291 (93) Total interest income 32,893 28, ,326 64

31 30 MDM Bank Annual report 2008 RUR mln or % Change 2007/2008, % 2008 Change 2007/2006, % Interest expense Customer accounts (6,628) (4,446) 49 (2,167) 105 Due to other banks (5,758) (4,966) 16 (2,390) 108 Debt securities in issue (3,111) (4,267) 27 (2,483) 72 Subordinated debt (488) (534) 9 (229) 133 Total interest expense (15,985) (14,213) 12 (7,269) 96 Net interest income 16,908 14, , Average, % Change (p.p.) Average, % Change (p.p.) / /2007 Average yield for Loans Interest-bearing investment securities loans and other interest-bearing funds placed in banks (1.0) 4.8 (0.2) Total interest-bearing assets Average rate paid for Term deposits (0.4) Other interest-bearing deposits Short-term debt Long-term debt (0.3) Total interest-bearing liabilities (0.1) Net interest income accounted for 77.4% of total revenue, growing by 19.6% during 2008 to RUR 16,908 mln (USD 680 mln), while net interest margin increased to 5.7%, up from 5.2% in Two factors contributed to growth in net interest income in 2008: resumed growth in the corporate loan portfolio in the first two quarters of 2008 and ongoing repricing in the corporate and small business loan portfolios (discussed below).

32 31 Net interest margins rose in 2008 despite an increase in interest rates on customer accounts, as increased borrowing costs corresponded with the overall growth of the gross margin. Relative to 2007, the overall cost of funds increased by less than asset yields, which resulted in an overall increase of the net interest margin. Annual data 2008 quarter data Yield on Assets, % Cost of funds, % Net Interest Margin, % 1Q2008 2Q2008 3Q2008 4Q2008 Yield on Assets, % Cost of funds, % Net Interest Margin, % Net fees and commissions decreased by 3.6% in 2008 to RUR 2,259 mln (USD 91 mln) from RUR 2,344 mln (USD 92 mln), primarily as a result of a decline in investment banking and brokerage commissions (2008: RUR 177 mln; 2007: RUR 504 mln), as well as increased commission expenses on settlement transactions, principally due to the growing number of transactions with debit and credit cards issued by MDM Bank, in addition to the increased number of transactions with non-mdm Bank cards using MDM Bank s acquiring network. Total fee and commission income, however, rose slightly, led by increases in commissions on settlement and trade finance transactions (2008: RUR 1,834 mln; 2007: RUR 1,417 mln) and commissions on foreign currency transactions (2008: RUR 545 mln; 2007: RUR 364 mln). As a result, fee and commission income decreased as a share of net revenues before result from trading in securities to 10% from 13.4% in 2007.

33 32 MDM Bank Annual report 2008 RUR mln or % Change 2007/2008, % 2006 Change 2006/2007, % Commission on settlement and trade finance 1,834 1, , Commission on foreign exchange transactions Commission on cash transactions (12) Commission for business referral (23) Brokerage and investment banking commissions (65) Commission for trust and fiduciary assets Other 6 7 (14) Total fee and commission income 3,142 2, , Commission on settlement transactions (409) (297) 38 (258) 15 Commission on foreign currency transactions (164) (73) 125 (126) (42) Commission on cash transactions (133) (185) (28) (73) 153 Commission on banking transactions (128) Other (49) (79) (38) (177) (55) Total fee and commission expense (883) (634) 39 (634) Net fee and commission income 2,259 2,344 (4) 1, Net result from trading, including trading in securities, foreign exchange and precious metals, decreased by 16.8% in 2008 to RUR 941 mln (USD 37.9 mln) from RUR 1,131 mln (USD 44.2 mln) in The result was impacted by the turbulence in the capital markets in the first and third quarters, when the Bank recorded losses from securities trading of RUR 297 mln (USD 12.4 mln) and RUR 575 mln (USD 23.9 mln), respectively, and a YE 2008 result of RUR (997) mln from trading securities. This was partly offset by net gains from trading in precious metals (2008: RUR 504 mln; 2007: RUR (22) mln). Additionally, a gain of RUR 1,134 mln (USD 45.6 mln) from early redemption of debt was recorded in Q

34 33 1,083 1, , (22) 309 (997) , (Losses)/gains arising from trading securities, net, RUR mln Gains /(losses) arising from trading in precious metals, net, RUR mln Gains from foreign exchange, net, RUR mln Operating expenses Growth in operating expenses in 2008 equaled 8.6%, which compares favorably both to 2007 operating expenses (28.4%) and the rate of revenue growth in 2008 (22.4%)(2007: 36.7%). This resulted in the overall cost / income ratio improving from 48.3% to 42.9%. The ratio of operating costs to revenues before trading results in securities, which is more indicative of efficiency levels, also improved, from 48.2% the previous year to 39.3% in Staff costs, representing 60.6% in 2008 of the Bank s overall operating cost base, declined by 1.3% to RUR 5,673 mln (USD 228 mln), despite new staff hires and network expansion (number of personnel increased by 788 and the Bank increased the number of outlets by 35 in 2008). This was primarily due to cost-saving efforts undertaken beginning in Q and continuing through the end of the year. Average cost per employee decreased by 18.6% to RUR thsd (USD 36.4 thsd) per year, while staff productivity, as evidenced by revenue per staff, rose by 6.4%, from RUR 3,393 thsd (USD thsd) to RUR 3,611 thsd (USD thsd).

35 34 MDM Bank Annual report ,921 3,393 3, ,052 1, Staff costs per average staff, RUR thsd Revenue before result from trading in securities per average staff, RUR thsd Non-staff operating costs grew by 28.4% to RUR 3,693 mln (USD mln), a slower pace than in the previous two years. Over 95% of the increase in non-staff expenses was attributed to depreciation, rent and other expenses related to property, plant and equipment, which grew in 2008 by RUR 818 mln, an increase of 69%, on branch expansion (all new outlets opened by the Bank are being rented) and increasing rental rates in the first half of the year. Details of non-staff costs are presented in the table below. RUR mln or % Change 2007/2008, % 2006 Change 2006/2007, % Depreciation, rent and other expenses related to property, plant and equipment 1,999 1, Professional services Taxes other than on income (9) Advertising and marketing (35) Security Telecommunications Software (3) Other (44) Total non-staff operating costs 3,693 2, ,143 34

36 35 Provisions and asset quality In 2008, the Bank maintained its conservative provisioning policy across all asset classes. During the third and fourth quarters of 2008, the effects of the global economic crisis began to have an increasing impact on credit quality in the Russian Federation, leaving Russian corporations dependent on refinancing in a challenging position, and precipitating a decline in asset quality throughout the banking sector. The Bank s total provisioning expense, including provision for losses on credit related commitments, was RUR 6,616 mln in 2008 (USD mln), up 217.6% from RUR 2,083 mln (USD 81.4 mln) in Cost of risk, or the provisioning expense over average risk exposure, increased compared to 2007 levels for the overall loan portfolio, as well as in the corporate, small business and loans to individuals portfolios. Cost of risk, % 9 8,2 7,5 6,5 5,9 6 4,5 3,7 3,0 3,2 3 1,4 1,1 1,5 2,2 1,5 0,5 0, Corporate Consumer Small Business Total * Non-performing loans are defined as loans with principal and/or interest overdue by more than 90 days and other loans classified as nonperforming by management. A loan is usually classified as non-performing by management if it is not probable that it will be recovered through means other than repossession and subsequent realization of collateral. As a result of provisioning, non-performing loans* (NPLs) were comfortably covered by provisions at the end of 2008 across all portfolio segments, with total coverage at 139.3%, despite a significant increase in NPL levels. Going forward, MDM Bank will continue to maintain adequate loan loss provisions in line with the market situation.

37 36 MDM Bank Annual report 2008 Non-performing loans more than doubled in 2008 from 2.0% of gross loans at YE 2007 to 4.2% of gross loans at YE 2008 (from RUR 3,784 mln to RUR 8,763 mln). This increase was driven primarily by worsening asset quality in the corporate loan portfolio: NPLs in this portfolio increased from 0.8% to 3.5% of loans to corporate customers during 2008 (RUR 1,014 mln to RUR 4,756 mln). Coverage of NPLs, % NPLs (as % of gross loans), % Corporate Retail Small Business Total Corporate Retail Small Business Total Taxation Tax expense in 2008 amounted to RUR 1,333 mln (USD 53.6 mln), down 36.9% from The effective tax rate in 2008 stood at 28.7% (2007: 27.7%; 2006: 27.2%), mainly due to non-deductible losses on securities. Segments MDM Bank reported three main reportable operating segments in 2008: Corporate and Investment Banking, Retail Banking and Central Treasury.

38 37 Corporate and Investment Banking RUR mln or % Change 2007/2008, % 2006 Change 2005/2007, % External interest income 24,222 21, , External interest expense (9,472) (7,311) 29.6 (4,117) 77.6 Internal funding charge (4,208) (5,564) (24.4) (3,526) 57.8 Allowance for capital benefit 1,937 1, , Net interest income 12,479 10, , Fee and commission income 1,805 1,831 (1.4) 1, Fee and commission expense (445) (401) 11.0 (459) (12.6) Trading, other financial assets at fair value through profit or loss and foreign exchange results (16.4) 1,315 (25.4) Other operating income (6.9) Total operating income before impairment losses and provisions 14,822 13, , Direct operating expenses (1,739) (2,450) (29.0) (2,363) 3.7 Impairment losses and provisions (5,418) (514) (469) 9.6 Reversal of accounting impairment losses and provisions 5, Risk charges (3,911) (811) (567) 43.0 Segment result before central overhead 9,172 10,120 (9.4) 6, Allocation of central overheads (1,387) (940) 47.6 (1,817) (48.1) Profit before taxation 7,785 9, ,

39 38 MDM Bank Annual report 2008 Corporate and Investment Banking (CIB) includes deposit taking and lending to corporate clients, leasing, factoring, settlements, cash management, cash collection, trade finance, syndications, a forfait financing, export credit agency financing, corporate finance, debt and equity capital markets, money markets, trading and brokerage in securities, foreign exchange and precious metals, repo transactions, banknote trading, and trading in derivatives. Net income before taxes and allocation of central overheads decreased by 9.4% in 2008 to RUR 9,172 mln (USD 369 mln) from RUR 10,120 mln (USD mln) in At the same time, net interest income rose 15.6% from RUR 10,795 mln (USD 422 mln) to RUR 12,479 mln (USD mln) in 2008, primarily due to rate repricing on the corporate loan portfolio: the weighted average interest rate for RUR loans to corporate clients increased from 13.9% in 2007 to 17.0% in The decrease in income before taxation first of all was due to provision growth in the corporate loan portfolio. The result was also affected by a 29.2% decrease in direct operating expenses, from RUR 2,450 mln (USD 95.8 mln) in 2007 to RUR 1,739 mln (USD 70 mln) in 2008, which was primarily due to cost and staff optimizations in line with market developments and the Bank s business focus in the third and fourth quarters. December 31 Average Balance RUR mln Total loans, net 142, , , , , ,061 Total earning assets 180, , , , , ,567 Total assets 210, , , , , ,721 Total deposits 94, ,775 71, ,792 94,204 64,495

40 39 Retail Banking RUR mln or % Change 2007/2008, % 2006 Change 2006/2007, % External interest income 7,863 5, , External interest expense (664) (312) (235) 32.8 Internal funding charge (3,848) (2,491) 54.5 (1,315) 89.4 Allowance for capital benefit Net interest income 3,795 2, , Fee and commission income 1,337 1, Fee and commission expense (353) (225) 56.9 (170) 32.4 Trading, other financial assets at fair value through profit or loss and foreign exchange results (41) 72 (156.9) 73 (1.4) Other operating income Total operating income before impairment losses and provisions 4,751 3, , Direct operating expenses (1,629) (1,447) 12.6 (865) 67.3 Impairment losses and provisions (1,726) (1,564) 10.4 (1,164) 34.4 Reversal of accounting impairment losses and provisions 1,726 1, , Risk charges (670) 367 (282.6) Segment result before central overhead 2,452 2, , Allocation of central overheads (2,326) (1,785) 30.3 (1,264) 41.2 Profit before taxation (66.6)

41 40 MDM Bank Annual report 2008 Retail banking includes deposit taking and lending to individuals, small and medium enterprises and individual entrepreneurs, money transfer and foreign exchange services, a range of banking card products provided to individual customers, as well as settlements, cash management, and cash collection for small and medium enterprises. Net income before taxes and allocation of central overheads increased 13.4% in 2008 to RUR 2,452 mln (USD 98.7 mln) from RUR 2,162 mln (USD 84.5 mln) in The increase was due both to net interest income, which rose 27.3% from RUR 2,980 mln (USD mln) to RUR 3,795 mln (USD mln) in 2008, and a 7.4% increase in fee and commission income to RUR 984 mln (USD 39.6 mln) in 2008 from RUR 916 mln (USD 35.8 mln) in Net interest income rose both as a result of an increase in the size and margins in the small business loan portfolio, as well as growth of the retail portfolio. The small business and retail loan portfolios increased in size by RUR 7,315 mln (USD 249 mln) and RUR 3,611 mln (USD mln) respectively, with small business loans totaling RUR 15,529 mln (USD mln) and retail loans totaling RUR 40,460 mln (USD 1,377.1 mln) at YE Weighted average interest rates on RUR loans to small businesses rose from 15.5% in 2007 to 18.6% in Direct operating expenses for retail banking increased by 12.6% from RUR 1,447 mln (USD 58.2 mln) in 2007 to RUR 1,629 mln (USD 63.7 mln) in 2008, on the back of significant network expansion during the year. At the same time, the Bank optimized costs for existing offices and staff, as indicated by operating costs per point of sale (2008: RUR 8.19 mln; 2007: RUR 8.82 mln) December 31 Average Balance RUR mln Total loans, net 52,284 42,287 29,544 48,566 37,484 25,764 Total earning assets 52,284 42,287 33,874 48,566 37,484 25,764 Total assets 53,776 42,825 31,412 49,279 38,343 31,191 Total deposits 20,514 14,669 10,808 17,142 11,585 13,623

42 41 Central Treasury RUR mln ro % Change 2007/2008, % 2006 Change 2006/2007, % External interest income 808 1,019 (20.7) External interest expense (5,608) (6,000) (6.5) (2,888) Internal funding charge 4,794 5,419 (11.5) 3, Allowance for capital benefit Net interest income (78.6) Fee and commission income 6 (100.0) Fee and commission expense (83) (8) (3) Trading, other financial assets at fair value through profit or loss and foreign exchange results 1, ,606.3 Other operating income 2 11 (81.8) Total operating income before impairment losses and provisions 1, Direct operating expenses (45) (73) (38.4) (34) Direct operating expenses 1, Allocation of central overheads (2) (1) (7) (85.7) Profit before taxation 1, Central Treasury includes treasury, which undertakes the Bank s funding and centralized risk management activities through borrowings, issue of debt securities, use of derivatives for risk management and investing in liquid assets such as short-term placements. The segment result before taxation and allocation of central overheads increased 172.6% to RUR 1,341 mln (USD 54 mln) in 2008 vs. RUR 492 mln (USD 19.2 mln) in The primary driver of this result was a gain from the repurchase of MDM Bank s own debt securities (RUR 1,134 mln; USD 45.6 mln). External interest income, which primarily represents earnings from the Bank s placement of its excess liquidity, declined by

43 42 MDM Bank Annual report % from RUR 1,019 mln (USD 39.8 mln) in 2007 to RUR 808 mln (USD 32.5 mln) in 2008 as a result of lower volumes on excess liquidity that were held during the year. December 31 Average Balance RUR mln Total loans, net Total earning assets 2,940 7,046 7,960 3,232 26,476 5,459 Total assets 56,401 66,985 19,176 36,698 41,554 15,403 Total liabilities 106,675 83,896 62,442 83,375 80,447 n/a* Balance Sheet Review RUR mln December December December Assets Cash and cash equivalents 77,271 83,434 32,642 Mandatory cash balances with central banks 1,942 5,538 4,030 Due from other banks 31,651 27,834 13,201 Trading securities: owned by the Group ,875 13,510 pledged under sale and repurchase agreements 2,987 3,624 Derivative financial instruments 3, Available-for-sale financial assets: owned by the Group 8, pledged under sale and repurchase agreements 379 Investment securities held to maturity 108 Loans and advances to customers 194, , ,875 Property, plant and equipment and intangible assets 6,832 5,956 4,443 Other assets 4,175 3,997 4,542 Total assets 329, , ,122 * Due to changes in the sector reporting beetween 2006 and 2007

44 43 December December December Liabilities Due to central bank 35, ,526 Due to other banks 97, ,516 59,346 Derivative financial instruments 2, Customer accounts 115, ,132 92,805 Debt securities in issue 28,700 46,631 52,870 Subordinated debt 5,966 5,066 5,452 Deferred tax liability Other liabilities 2,004 2,749 2,480 Total liabilities 288, , ,798 Equity Share capital 1,794 1,794 1,736 Share premium 14,198 14,198 9,588 Revaluation of premises 3,143 2,986 1,942 Revaluation of available-for-sale financial assets (1,566) 21 Cumulative translation reserve (21) Retained earnings 23,179 19,875 14,079 Total equity 41,074 38,898 27,324 Total liabilities and equity 329, , ,122 The Bank s total assets increased by 2.4% to RUR 329,117 mln (USD 11,202 mln) in 2008, following 32.2% growth in The balance sheet grew only during the second quarter of 2008, as the Bank focused primarily on liquidity, and in 4Q 2008 accelerated efforts to reduce exposure to riskier sectors of the economy and temporarily significantly reduced new corporate lending pending analysis of the sectors to which the Bank would seek to lend going forward.

45 44 MDM Bank Annual report 2008 Total assets, RUR mln 305, , , , , , , , ,000 60,000 0 Q Q Q Q December 31 Average RUR mln Interest-earning assets Loans 194, , , , , ,346 Interest-bearing investment securities 8,335 12,065 16,360 12,835 15,789 12,969 Loans and other interestbearing funds placed in banks 70,746 94,653 38,677 80,368 67,106 31,137 Total assets 329, , , , , ,181 Interest-bearing liabilities Term deposits 78,413 87,852 54,461 89,860 68,391 32,703 Other interest-bearing deposits 36,658 36,280 38,344 45,148 40,182 38,429 Debt securities in issue and other obligations 34,666 51,697 58,322 44,715 60,028 38,978 Interbank lending 132, ,362 60, ,001 84,973 45,945 Total liabilities 288, , , , , ,179 Liquidity Starting from 3Q 2007, the Bank moved to bolster its liquidity position to a level that would be adequate in response to the unprecedented deterioration in global credit markets. This was achieved mainly through active management of the corporate loan portfolio. As a result of these efforts, a sizeable excess liquidity cushion was built up, and a substantial positive liquidity gap was achieved for maturity of up to 12 months, by the end of 2007, and was maintained throughout 2008.

46 45 Lending The Bank plans to maintain its conservative stance on liquidity, at the expense of profitability and growth, until economic stability returns and more visibility on international borrowing is achieved. For a more detailed discussion of liquidity risk management, please refer to note 28 of the Financial Statements. The Bank s overall gross loan portfolio reached RUR 207,009 mln (USD 7,045.8 mln) at the end of 2008, up 8.0% over the previous year. Gross loans to corporate customers and loan to individuals grew by 13.3% and 9.8% respectively, while small business loans, a strategic priority for the Bank, grew significantly faster, increasing 89.1% during Loans to corporate customers amounted to RUR 137,800 mln (USD 4,690 mln) and continue to make up the majority of the portfolio, representing 66.6% of gross loans (2007: 65.2%), while the faster-growing small business portfolio (RUR 15,529 mln; USD mln) made up 7.5% of gross loans, up from 4.4% at YE2007. The remainder is represented by retail lending amounting to RUR 40,460 mln (USD 1,377 mln), which accounts for 19.5% of gross loans. Gross Loans, RUR mln 121, , , , , , , , , , ,849 8,214 37,991 8,951 38,895 10,795 41,277 14,107 40,460 15, Q H 2008 Q YE 2008 Corporate Retail Small Business Total The overall composition of the loan portfolio is shown in the table below. RUR mln or % Change 2007/2008, % 2006 Change , % Commercial loans 137, , , Small business loans 15,529 8, , Net investment in finance lease 2,860 3, , Retail loans 40,460 36, , Investment banking loans 10,360 16, , Total gross loans 207, , , Credit-related commitments (off-bs) 51,775 62, ,

47 46 MDM Bank Annual report 2008 The Bank has continued to make progress on increasing the granularity and diversification of its corporate loan portfolio. Total exposures to the top 20 corporate borrowers represented 17.0% of the total portfolio (including off-balance sheet and excluding reverse repurchase agreements and margin loans), down from 18.9% in 2007 and 23.7% in Significant efforts have been made to preserve industry diversification in the Bank s loan portfolio. The Bank s largest industry exposures at YE 2008 were to Trade, Individuals, Real Estate Management, Manufacturing and Wholesale Trade. Construction is no longer among the top 5 industries, and exposure to this sector dropped by 35.3% from RUR 22,247 mln (USD mln, 12% of gross loans) in 2007 to RUR 14,397 mln (USD 490 mln, 7% of gross loans) in Since 2006, the Bank s exposure to the construction sector has fallen both in terms of its share of the loan portfolio (2008: 7%; 2007: 12%; 2006: 14%) and in absolute terms (2008: RUR 14,397 mln; 2007: RUR 22,247 mln; 2006: RUR 24,381 mln). The following charts show risk concentrations by economic sector within the customer loan portfolio (excluding margin loans, reverse repos and other loans of an investment nature) % 17% 10% 7% Retail trade Wholesale trade Individuals Manufacturing 12% 14% 13% 9% Retail trade Wholesale trade Individuals Manufacturing 16% 17% Real Estate Finance 10% 20% Real Estate Finance 8% 11% Construction Other 13% 9% Construction Other % 17% Retail trade 7% Wholesale trade 5% 11% Individuals Manufacturing Real Estate 13% 12% 19% Finance Construction Other The following table shows loan loss provisions for each of the major sectors listed above.

48 47 Loan Loss Provisions Allocated Sector (UPDATE) Amount of Provisions, RUR mln Provisions as % of gross loans to sector Retail trade 1, Wholesale trade 2, Individuals 2, Manufacturing 1, Real Estate Finance Construction 1, Other 1, Total 12, Loan Currency Breakdown RUR mln or % Change 2008/2007, % 2006 Change 2007/2006, % Corporate Loans 137, , , RUR 54,636 59,261 (8) 56,371 5 Currency 83,164 62, ,959 9 Small Business Loans 15,529 8, , RUR 15,141 6, , Currency 388 1,476 (74) Retail loans 40,460 36, , RUR 32,114 31, , Currency 8,346 5, ,375 (9) The share of foreign exchange loans increased during 2008, primarily due to increasing USD and EUR exchange rates against the RUR (20% and 15% respectively). For a more detailed examination of asset quality and provisioning, please refer to Provisions and Asset Quality section of the Income Statement Review above, and to note 11 of the Financial Statements.

49 48 MDM Bank Annual report 2008 Securities The Bank s exposure to trading securities decreased in 2007 by 98.2% to RUR 194 mln (USD 6.6 mln). The small amount of securities remaining in the Bank s portfolio is made up entirely of corporate shares, which decreased by 87.0% from RUR 1,488 mln in At the same time, in 3Q 2008, following the introduction of amendments to IAS 39 and IFRS 7, the Bank reclassified certain debt trading securities to Available For Sale (RUR 10,009 mln; USD mln), Held To Maturity (RUR 1,184 mln; USD 46.9 mln) and loans and advances to customers (RUR 3,924 mln; USD mln). An examination of the impact of these reclassifications can be found in the audited financial statements 119 of this annual report % of shareholders' equity RUR mln or % % of shareholders' equity % of shareholders' equity Change 2008/ 2007, % Change 2007/ 2006, % Fixed income portfolio government and municipal bonds (77.8) Due in one year or less 1 Over 1 year through 5 years (71.5) Over 5 years through 10 years Over 10 years (64.4) corporate bonds and promissory notes 8, , (27.6) 13, (14.5) Due in one year or less 5, , , (79.8) Over 1 year through 5 years 2, , (75.3) 10, (6.1) Over 5 years through 10 years ( Over 10 years (100.0) Total fixed income: 8, , ( , (20.8) Due in one year or less 5, , , (79.8) Over 1 year through 5 years 2, , (75.4) 11, (7.8) Over 5 years through 10 years (89.7) Over 10 years (30.2) VAR (10 days, 99% confidence) 1, Equities long positions 1, , (55.8) 2, short positions VAR (10 days, 99% confidence) (68.1) (17.3)

50 49 Customer accounts Customer accounts at the end of 2008 totaled RUR 115,071 mln (USD 3,916 mln), down by 7.3% from RUR 124,132 mln (USD 5,057 mln) in The overall decline was driven by a 38% decrease in corporate term deposits from RUR 68,426 (USD 2,787.6 mln) at YE 2007 to RUR 42,451 mln (USD 1,444.9 mln) at YE 2008, which made up 36.9% of overall customer accounts as of YE A more accurate measure of customer accounts, however, can be made by excluding volatile customer accounts MDM Bank s 100%-owned subsidiary Latvian Trade Bank (LTB), which management does not consider for liquidity management purposes due to the short-term and volatile nature of deposits in this bank. Excluding LTB, customer accounts were stable in 2008, increasing from RUR 96,470 mln (USD 3,930.1 mln) at YE 2007 to RUR 98,347 mln (USD 3,347.4 mln) at YE Retail term deposits (including deposits from private banking customers) also grew by 79.9%, reaching RUR 25,362 mln (USD mln) at 31 December In line with the Bank s strategy to develop its retail business and diversify its funding and asset bases, retail deposits now account for 22.0% of customer accounts, vs. 11.4% at the end of Customer accounts RUR mln or % Change 2008/2007, % 2006 Change 2007/2006, % Corporate banking business 78,810 92,422 (15) 68, Small business banking business 5,224 4, , Retail business 15,289 10, , Private banking 15,748 9, , Total customer accounts by business line 115, ,444 (1) 82, Other customer accounts 7,688 7,906 (20) Total customer accounts 115, ,132 (7) 90, The share of current account balances in total customer accounts rose insignificantly from 29.2% at YE 2007 to 31.9% at YE According to the updated strategy, the Bank seeks to increase the share of deposits predominantly in the retail segment in its total liabilities, paying particular attention to diversification and granularity of the deposit base. Management believes that such deposits represent the most stable funding base in the current environment. Average amount, RUR mln Average rate paid, % % of total deposits Accounts and demand deposits 45, Term Deposits 89,

51 50 MDM Bank Annual report 2008 International borrowing During 2008, international markets were largely closed to Russian private banks. Due to its size and highest credit ratings among private Russian banks, however, MDM Bank was able to raise USD 535 mln from an IFC A/B syndicated loan in July The Bank remains largely opportunistic in 2009, with all plans on syndications and capital market transactions subject to market conditions. The following table shows MDM s international borrowings as of 31 December 2008, 2007 and RUR mln or % Included in due to other banks: Change 2008/2007, % 2006 Change 2007/2006, % Syndicated loans 8,281 24,839 (66.7) 12, Trade finance borrowings 31,570 29, , Loans from international financial institutions 29,396 11, Loans from international financial institutions: Unsecured loan participation notes 11,808 11, ,569 (24.2) Loan participation notes secured by diversified payment rights ( DPR ) 9,791 14,133 (30.7) 13, Loan participation notes secured by a pool of car loans 1,282 4,153 (69.1) 9,828 (57.7) Subordinated loan participation notes 5,966 5, ,452 (7.1) Total international borrowings 98,004 99,865 (1.8) 68,

52 51 Capital Following a capital increase completed in 3Q 2007 of RUR 4,668 mln (USD 184 mln) in favor of the International Financial Corporation (IFC), which is now a 5% shareholder in the Bank, the Bank s capital base expanded to a very comfortable level relative to its risk-weighted assets. At YE 2007, the total capital ratio on a consolidated basis rose to 17.2% from 13.7% at the end of 2006 also due to recapitalization of net income. The Bank s capital adequacy ratio as of 31 December 2008 was 17.9%. While management believes that the Bank s minimum total capital ratio consistent with its objective to reach an investment-grade credit rating is around 12%, it is likely that the ratio will remain significantly above this level in This is mainly due to the restricted ability to increase leverage by international borrowing due to the ongoing volatility in the global capital markets Tier I capital, RUR mln 39,497 35,891 25,382 Tier II capital, RUR mln 4,587 6,494 6,709 Total capital, RUR mln 44,084 42,385 32,091 Total risk-weighted assets, RUR mln 246, , ,516 Tier I capital ratio, % Total capital ratio, % Dividends Pursuant to a Resolution of the 26 May 2008 Annual General Shareholders Meeting, dividends on ordinary shares and on preferred registered shares for 2007 were neither accrued nor paid. The Bank s 2007 profits were reinvested in the Bank s development.

53 52 MDM Bank Annual report 2008 In 2009 MDM Bank will focus specifically on establishing long-term relationships with key clients. Electronics and home appliances retailer Technosila MDM Bank Corporate & Investment Banking client Igor Roslyakov, head of sales and trade marketing department at Technosila

54 Review of Business Units 53 Corporate and Investment Banking 2008 key indicators During the reported period, the average volume of funds attracted from MDM Bank s corporate clients increased more than 8.3%: accrued liabilities rose from RUR 52,142 mln in 2007 to RUR 56,476 mln in During the same period, running balances increased more than 44% from RUR 42,062 mln to RUR 60,016 mln. The average increase in the annual loan indebtedness of corporate clients totaled 9.6% rising from RUR 127,928 mln in 2007 to RUR 140,148 mln in At the end of 2008, according to Cbonds ratings, MDM Bank was the second largest organizer of CLN (credit linked notes) issues in the CIS. The reliability of the Bank s professional platform for financial markets was affirmed by the numerous awards won by MDM in 2008, including MMBA first place prizes in the categories Superdealing on the interbank credit market, Superdealing on the currency market and Superdealer of the market. The Bank and its traders regularly top such award categories. MDM Bank works with all types of companies from large corporate holdings to individual entrepreneurs across nearly all segments of the Russian economy. The Bank s corporate and investment banking unit offers a broad range of services to its corporate clients, including deposit accounts, lending, leasing, factoring, cash management services, collection, trade finance, forfaiting and export financing. Among MDM Bank s investment banking services are corporate finance, consulting, inter-bank credit, securities trading and placement, repo, FOREX operations, hedging, money market and precious metals operations, banknote transactions and analytical support. Actively working with corporate clients throughout Russia helps MDM Bank diversify its loan portfolio and to continuously improve its quality. At the start of 2008, the Bank created the Corporate Finance Department by linking investment banking with trade finance, project finance and syndications. Combining these separate units into one department allowed for significant synergistic benefits not only for the Bank, by creating a platform to effectively interact with international financial institutions but also for the Company s corporate clients by offering them access to MDM Bank s highly qualified specialists. In 2008, MDM Bank conducted a comprehensive industry-based analysis of businesses and developed a methodology of how to service these companies based on their specific needs within each sector. The Bank also offered multiple approaches to solving common problems that have occurred during the current financial crisis, including late payments (related to corporate clients clearing payments), promissory notes and counter-trade operation settlements. In addition, the Bank launched working groups to address the needs of debtor companies in sectors of the Russian economy most affected by the global economic crisis. During the reported period, MDM Bank significantly broadened and modernized its range of banking products and services with the goal of increasing corporate customer accounts. In addition, MDM Bank also introduced

55 54 MDM Bank Annual report 2008 new term deposits with interest paid in advance, and allowed clients to change the currency and/or term of a deposit without losing accrued interest. Revenue from inter-bank lending operations in 2008 doubled to USD 12 mln, and daily transaction volumes totaled approximately USD 500 mln. During the reported period, revenue from banknote transactions increased two fold to USD 16 mln and daily transaction volumes totaled USD 100 mln. Operations with derivative instruments brought the bank an additional USD 4 mln in profit (which also doubled the 2007 figure). MDM Bank remains one of Russia s largest traders in the round-the-clock purchase and sale of the world s largest currencies and is also one of the leading traders on the domestic FOREX market (in terms of the purchase and sale dollars for rubles). At the end of 2008, the Bank s market share totaled 40% and 8%, respectively, whereas the average daily volume of exchange operations reached USD 2 bln. Revenue from FOREX operations increased USD 25 mln and reached USD 41 mln. MDM Bank is one of the largest players on the inter-bank market for precious metal operations. In 2008, the Bank held approximately an 8% share of the Russian gold market. During the same time, revenue from these operations increased to USD 20.3 mln from a loss of USD 0.86 mln in In 2008, MDM Bank launched a number of large-scale projects within its Project Finance division. At the same time, the bank was able to raise tied financing from foreign credit institutions for importing companies, which significantly cut borrowers expenses on servicing loans. Despite the fact foreign banks actively decreased credit lines to Russian companies and financial institutions during the reported period, MDM Bank s credit quality remained high. This enabled the Bank to increase the volume of project and structured financing it offered its clients by 50.7% from 2007 to 2008 (from USD 223 mln to USD 336 mln). Despite unfavorable external economic conditions, MDM Bank was able to successfully carry out several landmark transactions on the Russian market, including organizing the issue of USD 200 mln of Credit Linked Notes, CLN for OJSC United Aircraft Corporation and attracting USD 90 mln for OJSC Sibirtelecom. The Bank s Strategic Consulting and Rating Advisory unit (created at the end of 2007) launched a number of successful projects during the reported period, including: securing a rating for OJSC Salavatnefteorgsyntez, supporting the ratings for both OJSC Nizhnekamskneftekhim and OJSC Uralsvyazinform and offering strategic consulting for both the Uniway group of companies and CJSC Ekonomiko-Finansovaya Energetichesko- Stroitelnaya korporatsia (EFESk). In 2009, MDM Bank will focus particularly on developing loyalty programs, creating mechanisms for maintaining long-term relationships with key clients and forming client profiles (based on individual needs). The Bank will continue to actively work on attracting customer accounts from its corporate clients. The Bank s will increase commission income by developing and introducing new services, broadening the Bank s product line and effectively optimizing costs for existing banking products.

56 The Bank has been able to successfully adapt to the rapidly changing economic conditions of the last year. Our goal is not simply to survive in these challenging times, but to actively work and support our clients throughout this period. MDM Bank carefully analyzes global economic trends, as well as capital market dynamics; with this information and a thorough understanding of these problems, the Bank is able to offer its clients the best possible financial solutions. In 2009, MDM Bank will focus on the following areas of corporate and investment banking: debt restructuring services; financing using the CBR Lombard list; developing new credit facilities (combining debt and equity financing); and offering consulting services to clients to effectively address the ongoing economic crisis. MDM Bank strives to ensure that all its clients feel supported by the Bank, and that in turn, these clients are able to use the Bank s financial products and services not only to retain but also to strengthen their market positions during these difficult times. Unit Key Performance Indicators RUR bln or % Change 2007/2008, % Revenues 14,574 13, Operating expenses (before overall banking costs) 1,517 2,301 (34.1) Assets 210, , Liabilities 142, ,710 (13.6)

57 56 MDM Bank Annual report 2008 MDM Bank Private Banking develops personalized investment strategies that balance each client s appetite for risk and return

58 57 Private Banking 2008 key indicators Private Banking clients' customer accounts increased 68.3% to RUR 15,749 mln. Client base expanded from 605 to 1,041 clients. New Swiss franc- and Great British pound-based deposit programs launched together with a deposit converter service. Clients offered precious metals trading accounts offering exposure to metals market. Mutual funds client base increased 60%. Network of offices offering asset management services expanded to 55 throughout the country. The Private Banking unit offers VIP clients with more than USD 200,000 in assets a wide array of investment and banking products and services, including financial planning, consulting and portfolio management. The open architecture platform offers clients access to an unlimited number of services offered by financial institutions worldwide. In addition, MDM Bank offers clients its own banking products, which may be adapted based on each client s individual needs. The principal target segment for MDM s private banking unit are business owners and the senior management of large Russian companies, as well as wealthy foreign clients seeking access to the Russian market through investment products and banking services. Structured investment products available through the open architecture platform performed well in This program was extremely successful: assets under management in this segment increased from negligible levels in 2007 to over RUR 800 mln (these assets are not reflected on the balance sheet of MDM Bank, because the Bank acts as an agent for these products). Beginning in 2008, Private Banking clients were offered precious metal trading accounts from MDM Bank. In addition, new strategies were developed for portfolio management, which include greater focus on asset protection, and a new fund of funds was launched, the MDM-World of Funds unit investment fund. The overall cash inflow into MDM-World of Funds totaled RUR 56 mln during the reported period according to Investfunds, this was the highest cash inflow among Russian funds of funds in MDM Bank cares about its clients and values their time. In 2008, for client convenience MDM Bank began offering its full array of Private Banking services in Ekaterinburg. In addition, MDM Private Banking representatives have expanded the list of cities to which they regularly travel. MDM Bank clients now have access to private banking services in 43 Russian cities. Since 2001, the Bank s asset management business has been performed through MDM Bank s subsidiary OOO MDM Asset Management (referred to throughout the text as MDM AM). The company manages mutual investment funds, pension funds and pension savings. In December 2008, MDM Bank s asset management business was integrated into the Private Banking unit. In 2009, the Private Banking unit intends to expand its client base, further improve service quality and broaden its product line to fully meet the needs of MDM Bank clients. The growth in its customer base should be supported by the synergetic effect from the merger of MDM Bank and URSA Bank. The Private Banking unit expects client liabilities to grow at the same pace as in To broaden the regional reach of the Private

59 58 MDM Bank Annual report 2008 Banking unit and improve the quality of client servicing at the local level, the Bank plans to staff its Tyumen and Novosibirsk branches with Private Banking unit representatives. In turn, MDM AM plans to increase the volume of assets under management in 2009 by raising funds from clients that participate in the state program of co-financing retirement pensions and which had concluded an agreement on the obligatory pension insurance with the non-state MDM pension fund. In addition, MDM AM intends to revise the existing investment strategy and introduce new programs that address the needs of the current economic situation. Unit Key Performance Indicators RUR bln or % Change, % Revenues Operating expenses (before overall banking costs) Assets under management 1,240 4,809 (74.2) Client liabilities 15,749 9,

60 59 Retail Banking 2008 key indicators Retail client deposits increased more than 50% during the reported period, maintaining positive momentum even at the end of the year. This once again demonstrated clients trust in MDM Bank as a reliable financial institution. The network of MDM Bank ATMs and self-service banking kiosks increased 77% from 707 to 1,258 units. MDM Bank placed second in a Senteo International and PricewaterhouseCoopers survey of the quality of retail banking services in Russia, titled Index of client impressions 2008: Who leads the Russian retail banking business? ; the Bank was also among the top three in a ranking of retail service quality prepared by The Retail Finance magazine and SAS Russia/ CIS company. The Retail Banking unit works with individuals, small- and medium-sized enterprises and entrepreneurs, offering clients a broad range of financial products and services, including: cash and settlement services, cash collection for small- and medium-sized enterprises, money transfers, debit and credit cards, currency exchange operations, mortgage and car loans, consumer loans, acquiring and a number of term deposits in rubles, dollars and euros. In 2008, MDM Bank launched new retail deposits and offered several unique services to its depositors, including the Deposit converter (which enabled clients to transfer a deposit from one currency into another without losing accrued interest) and the Deposit time-out (which allowed clients to withdraw a portion of a deposit for up to 14 days without losing any interest). In 2008, MDM Bank also launched the paying card project, which combines the advantages of a bank payment card and a term deposit. In 2008, MDM Bank repeatedly won tenders conducted by the Russian State Deposit Insurance Agency (DIA) to act as the agent bank to pay out insurance compensation to depositors of troubled banks. About one-third of all clients that applied for compensation kept their funds in MDM Bank accounts (the overall sum of deposits exceeded RUR 240 mln), thus illustrating high levels of confidence in the Bank. The Bank s acquiring service was also successful during the reported period: volumes increased 80.8% (from RUR 6,910 to RUR 12,494 mln), whereas the volume of payment acceptance services increased 39.9% (from RUR 263 to RUR 368 million). In 2008, approximately 1,000 new clients joined the acquiring service, and the Bank s terminal network increased 52.5% (from 3,579 to 5,457 units). MDM Bank conducts a conservative financial and lending policy, thoroughly evaluating the creditworthiness of potential borrowers. The Bank was one of the first to foresee changes in Russia s economic outlook. The Bank s retail loan portfolio is well-diversified, which allows the Bank to not only successfully develop long-term relationships with existing clients, but also to actively attract new ones.

61 60 MDM Bank Annual report 2008 In 2008 MDM Bank launched new retail deposits and introduced unique services for its depositors, including the Deposit Converter, which enabled clients to switch term deposits from one currency into another without losing the accrued interest

62 61 During the reported period, MDM Bank implemented unified standards of service quality for all retail front office employees. Training methods were developed and have been implemented, including methods for analyzing complicated situations (which may arise through daily client service work). In the process of the training program, employees also work out the key competencies of case management and how to effectively promote banking products and services. In 2009, the top priority for the Retail Banking unit is to increase profitability, grow volumes and further improve efficiency levels. The Bank will work to steadily improve the quality of its loan portfolio, which in turn will increase profitability. MDM Bank also intends to introduce new approaches to developing a full range of savings products by introducing special offers for target client segments and optimizing sales technologies. In addition, MDM Bank intends to develop a multi-tiered system to support the whole spectrum of banking products and to analyze its effectiveness. Unit Key Performance Indicators RUR bln or % Change, % Revenues 3,146 3, Operating expenses (before overall banking costs) 1,190 1, Assets 39,070 34, Client liabilities 15,289 10,

63 62 MDM Bank Annual report 2008 In 2009 MDM Bank will continue to develop and improve its range of services for small business clients and will focus on high margin products. Meat product manufacturer Myasnoi Dom MDM Bank Small Business Lending Department client Sergey Efimov, company owner

64 63 Small Business Banking 2008 key indicators The small business loan portfolio increased 89% from RUR 8.2 to RUR 15.5 bln. New MDM Energy loans totaling more than RUR 400 mln were approved during the year. Projects financed by MDM Bank helped Russian companies to save more than USD 100 mln yearly and decrease greenhouse gas emissions by 250,000 tons of CO 2 -equivalent. Small business banking is a strategic priority for MDM Bank. The Bank offers small enterprises a wide array of banking products and services, including deposits, credit and leasing and cash management services. In 2008, the Bank conducted a full-scale optimization of its procedures and processes, which helped improve client interaction with the Bank. Simplified contracts were introduced, procedures for credit decisions were improved, the pricing system for small business products was modernized, and the Bank s CRM-systems were updated. During the reported period, MDM Bank improved and introduced products targeted at small businesses. One of the most significant changes was the MDM Micro loan program for private business owners or entrepreneurs. In addition, the compulsory clause requiring collateral insurance was removed for the MDM Small product. This change made the product more affordable for a larger number of clients, while at the same time not increasing the risk for the Bank. The MDM Energy project, implemented in conjunction with the International Finance Corporation (IFC), achieved outstanding results during the reported period. This credit product is aimed at increasing the energy efficiency of Russian enterprises. MDM Energy combines traditional lending with consulting services from IFC experts. To promote MDM Energy in Russia s regions, during the reported period, MDM Bank conducted a series of educational seminars in 30 Russian cities, which more than 600 representatives from small- and medium-sized businesses attended. In order to broaden the services offered to small business clients, the Bank launched in December 2008 a consulting program focused on low-cost energy efficiency measures. The program Economize intelligently offers small businesses the opportunity to significantly decrease operating costs without additional investment and at a minimal cost. During the reported period, MDM Bank also promoted partner programs developed together with regional small business support foundations. Work on these programs was carried out at the Bank s branches in Moscow,

65 64 MDM Bank Annual report 2008 Perm, Penza and Omsk. MDM Bank also actively developed activities in the field of servicing small business clients at the regional level servicing such clients 28 new points of sales throughout Russia. In 2009, MDM Bank plans to continue to optimize its structure, which will also allow it to decrease operational costs connected with selling its banking services. Unit Key Performance Indicators RUR bln or % Change, % Revenues 1, Operating expenses (before overall banking costs) Assets 14,706 7, Client liabilities 5,224 4,

66 Information Technology 65 In 2008, MDM Bank focused on continuing improvements and modernizations to its existing IT infrastructure, laying the foundation for the launch of a completely new core banking system, the first elements of which will be put into operation in This system will serve as the basis for reorganizing the Bank s operational model, which will play an important role in accomplishing the strategic goal of providing the highest quality service to clients, while at the same time increasing the effectiveness of the work of all of the Bank s units. The Core Banking System In connection with the planned merger of MDM Bank and URSA Bank in 2009, work will start on introduction of a fundamentally new IT system that will accelerate transaction processing speed and integrate data processing. As a result, various business units will be able to access information about clients and use it for cross-selling, which should significantly increase the efficiency of the Bank s operations. The core banking system was launched in January 2009, and a special division has been created to focus on its implementation. Main Goals of the New System To create a centralized database of the Bank s clients. To increase the efficiency of all processes, from opening an account to risk analysis and CRM. To support a new client-oriented model of retail business, minimizing input from the middle and back offices when dealing with the Bank s clients. To significantly decrease risks by using improved technology for processing loan applications, underwriting and operating the integrated trade system. To increase the efficiency of procedures in the Bank s middle and back offices by centralizing procedures, obtaining a positive effect for the whole Bank. In 2009, MDM Bank plans to launch the main elements of its centralized banking system. Security of the Systems The security of the Bank s IT systems is paramount for both MDM Bank and its clients. In 2009, the Bank intends to significantly modernize the equipment, software and architecture of its IT-systems to ensure maximum protection from any unauthorized access to the corporate network and client data. At the same time, the clients and partners of the Bank will continue to be able to obtain full remote access to their accounts and conduct on-line banking operations.

67 66 MDM Bank Annual report 2008 System of Credit Applications In 2009, MDM Bank plans to introduce a new Credit conveyor, which will simplify and centralize the sales management process. On the back of this system, the Bank will also re-launch other products for retail clients and small businesses. Electronic Document Management The new system of electronic document management was selected as an IT platform for automating the flow of business documentation. In 2009, the electronic (paperless) document management system for point of sales will be operational. In the future, the Bank plans to expand this system, including the possibility of achieving a paperless environment for the Bank s entire business document flow.

68 Corporate Governance and Management 67 MDM Bank s adheres to global best practice in corporate governance. The Bank s executive bodies are fully responsible for defining and implementing business strategy as well as evaluating client, shareholder, and employee confidence in the Bank. MDM Bank s information transparency policy is recognized as being a cornerstone of the Bank s reputation as a respected and successful private financial institution. The Bank adheres to the code of corporate conduct. In 2008, Standard & Poor s confirmed the Bank s overall international scale Corporate Governance Score (CGS) at 6+, and raised its Russian national scale CGS to 6.9 from 6.7. Board of Directors The MDM Bank Board of Directors approves and oversees the implementation of the Bank s strategy and the fulfillment of the Management Board s set tasks and performance targets, while also providing support as necessary. The members of the Board of Directors are active participants in the Bank s operations and receive timely access to information on the Bank s activities. The Chairman of the Board of Directors is a strong leader and efficiently manages the Board s functions. The Board of Directors combines knowledge and experience, as well as a unified management approach that facilitates constructive discourse when reviewing Bank issues. The Board in 2008 Activity highlights in 2008 included: Approving MDM Bank s mission, vision and values; Improving the quality of corporate governance, particularly with regard to: making the necessary changes to the Bank s internal regulations; optimizing internal processes, specifically interaction between the Board of Directors and the Management Board; and enhancing information transparency policy; Composing a new and efficient risk management system, specifically producing expedited internal and external communications for risk reporting; Adjusting the internal control process by strengthening the functions of the Internal Audit and Compliance departments, respectively; Strengthening management oversight functions by requiring a regular review of the Management Board s reports on business development, competitors activities, budget performance, market position and the Bank s overall results; Changing the organizational structure based on business requirements and to fulfill the Bank s strategic goals.

69 68 MDM Bank Annual report 2008 Biographies & Recent Changes MDM Bank Board of Directors, as of 31 December 2008: Name First appointed Other relevant positions and Bio Oleg Viyugin Chairman 2007 Chairman of the Board of Directors Member of the Audit and Risk Management Committee Member of the Strategy Committee Member of the Nominations and Remuneration Committee Independent Director Before joining the MDM Bank Board of Directors in 2007, Oleg headed the Federal Financial Markets Service of the Russian Federation, a position he had held since Between 1999 and 2002, he was Executive Vice-President at Troika Dialog, Russia s oldest investment bank. Oleg has also held a variety of senior positions within the Russian government, including First Deputy Minister of Finance, First Deputy Chairman of the Central Bank of Russia, and Extraordinary Advisor to the Prime Minister of the Russian Federation. Upon graduating from the Department of Mechanics and Mathematics at Moscow State University in 1974, Oleg successfully defended his Ph.D. in physics and mathematics at the same university in Sergei Popov 2002 Member of the Board of Directors Deputy Chairman of the Board of Directors Sergei joined the MDM Board of Directors in 2002, before which he served on the boards of several blue-chip Russian companies, including RAO UES of Russia, Piping Metallurgy Company (TMK), Eurochem, and MDM Industrial Group, which he co-founded in In 1997, Sergei co-founded Trading and Industrial Group MDM, where he took a senior role in strategy development until Prior to working at Trading and Industrial Group MDM, Sergei was a partner and commercial director at OOO Prodcontract Company. Upon graduating from Urals State Technical University with a major in heat power engineering in 1993, Sergei became a partner in the Urals-Siberia Trading and Industrial Company (USTPK), which specialized in energy and pipe trading as well as supplying raw materials to Russian metallurgical plants. Sergei also currently sits on Board of Directors at SUEK, Russia s leading coal supplier.

70 69 Martin Andersson 2007 Member of the Board of Directors Chairman of the Nominations and Remuneration Committee Member of the Strategy Committee Before joining the MDM Board of Directors in 2007, Martin also chaired the Boards of Directors at Brunswick Rail Leasing ( ) and Brunswick Capital Limited ( ). In 1993 Martin co-founded the Brunswick Group, and was appointed CEO at Brunswick Brokerage in November In 1999 he became Chairman of Brunswick UBS Warburg. Between 1992 and 1993, Martin served as an advisor to the Russian government s privatization committee, and from 1990, he worked as a consultant at Booz Allen Hamilton in Mergers & Acquisitions. Martin also sits on the Board of Directors of SUEK. Luqman Arnold 2007 Member of the Board of Directors Chairman of the Strategy Committee Luqman s 35-year career has spanned commercial, investment and retail banking, insurance, asset and wealth management, and has included posts as President and Chairman of the Group Executive Board of UBS AG and CEO of Abbey National PLC. He has also worked at BNP Paribas and CSFB. Sergei Shapiguzov 2007 Member of the Board of Directors Chairman of the Audit and Risk Management Committee Independent Director Since 1990, Sergei has headed FBK, a leading Russian auditing firm, and is currently a managing partner at the firm. Between 1992 and 1994, he was director of KPMG s Russian branch. Sergei graduated from the Department of Economics at Moscow State University in In 1981 he defended a Ph.D. in economics before earning another degree in applied mathematics and cybernetics from Moscow State University in Edward Nassim 2007 Member of the Board of Directors Independent Director Edward has served as Vice President for Europe, Africa, and the Middle East of the International Finance Council, a World Bank Group member, until his recent retirement. In his previous role as IFC Director of Operations in Europe from 1991 to 2006, Edward helped pioneer investments in many sectors of the Russian economy. In 1989, Edward was appointed as IFC's first Director of Corporate Finance Services. He was involved in several transactions worldwide, including the restructuring and privatizing of some of the first, large state-owned companies in Czechoslovakia and Poland. Edward has also been involved in several advisory services initiatives in areas including corporate governance, improving the business climate in the SME sector, leasing, energy efficiency, and housing finance. Edward holds undergraduate and graduate degrees from Imperial College, London, and an MBA from Harvard Business School.

71 70 MDM Bank Annual report 2008 Igor Kouzin 2008 Member of the Board of Directors Member of the Audit and Risk Management Committee Igor joined MDM Bank as its CEO in October 2008, where he served until the merger with URSA Bank was announced in December Igor joined MDM from DeltaCredit, where he had been CEO since Igor has ten years experience working for fast-growing international financial companies. Prior to joining DeltaCredit, Igor was Vice President for International Markets at Sanchez Computer Associates, Inc., a banking technology provider. He also managed the company s activities in Central and Eastern Europe as well as Asia. Igor was one of the founders of Profile Venture Partners, which had its headquarters in the US, and from 1999 until 2002 he was a managing director there. Igor began his career with McKinsey & Company in Toronto and Washington, D.C., where he participated in the successful initial development, launch and continued development of several banks. Mr. Kouzin has an MBA from the University of Chicago s Graduate School of Business (GSB). As of 31 December 2008, three Board members have the status of independent directors (as defined in Paragraph 6 of the Provisions on the Board of Directors of MDM Bank ( administration/directors), which corresponds to the independence criteria applied in international practice. Board Committees The three board committees that were re-formed in June 2008 and then again in December 2008 following the election of new members to the Board of Directors are the: Strategy Committee; Audit and Risk Management Committee; Nominations and Remuneration Committee. In 2008, the committees continued to play an important role as a forum for detailed analysis, as well as for developing grounded, independent and professional recommendations for the Board of Directors on specific issues relating to the Bank. Working in close contact with management, the committees ensure efficient communication between executive management and the Board of Directors. The vast majority of issues are reviewed by the committees before the Bank s management discusses them with the Board of Directors, which receives responses at every meeting from the committees respective chairmen, as well as the Chairman of the Management Board. The Chairman of the Management Board has a standing invitation to all committee meetings. The members of the Management Board, as well as other managers and representatives of the Bank, are also frequently invited to participate for relevant agenda items. Ernst & Young, the Bank s external IFRS and RAS auditor, regularly participates in Audit and Risk Management Committee meetings.

72 71 Strategy Committee Luqman Arnold Committee Chairman since June 2007 Martin Andersson Committee member since May 2006 Oleg Viyugin Committee member (Independent Director) since June 2007 Sergei Popov Committee member since December 2008 The Strategy Committee is responsible for reviewing all strategy recommendations and any major projects that will involve a significant commitment of management time or the Bank s financial resources. The committee also reviews the annual budget to ensure that it is consistent with long-term strategic goals. Moreover, the committee monitors and enforces the positions taken by the Board of Directors on strategic issues. Key Developments in 2008 In 2008, the committee was essential in approving the Bank s annual budget, taking key decisions on the core banking system, composing the Bank s mission, vision and values as well as developing the retail business strategy. The committee evaluated the Bank s regional strategy and operating model during the year, ultimately deciding to alter the development of the Bank s regional network to improve the efficiency and productivity of those business units which develop services for individuals and small businesses. Beginning in October 2008, the committee became the Bank s main forum for discussion of the economic situation in Russia and the world, as well as on measures that the Bank should take in the fast-changing business environment. The committee specifically concentrated on the effect of inflation on the quality of the Bank s loan portfolios, and developed means to address this issue. The committee supported management s initiative to switch to quarterly budgeting for At the end of October, the Strategy Committee, during a discussion on working with the Board of Directors, approved means for quickly informing the Management Board of suggestions on how the Bank should operate in the unstable economic environment. There was also an in-depth discussion on planning in 2009, resulting in management being assigned responsibility for developing various response scenarios to potential changes in the economic climate and to prepare suggestions for various factors. The committee also discussed how to optimize expenses and improve efficiency and stability, before passing the suggestions to the Board of Directors. The Committee s work resulted in increased business-processes control system efficiency throughout the Bank, particularly in more precise expense planning and improved business profitability.

73 72 MDM Bank Annual report 2008 Audit and Risk Management Committee Sergei Shapiguzov Committee Chairman (Independent Director) since June 2007 Oleg Viyugin Committee member (Independent Director) since June 2007 Igor Kouzin Committee member since December 2008 The Audit and Risk Management Committee reviews the financial reporting process and ensures the publication of comparable, transparent and accurate financial information. It reviews the effectiveness of the internal financial control and risk management systems, as well as the internal and external audit functions, including appointing the Bank s independent auditors and reviewing their performance. The committee also evaluates the procedures for enforcing Bank compliance with legislative and regulatory requirements pertaining to financial reporting. It provides control over banking risks, sets the Bank s risk profiles, appraises the effectiveness of risk level evaluation systems, risk analysis and, if necessary, reviews major transactions. Key Developments in 2008 In 2008, the Audit Committee initiated a regular review of external auditor recommendations to provide more efficient results in addressing those recommendations. The committee also regularly reviewed management reports and Internal Audit Department reports. An independent external audit and risks expert was invited to work with the committee on a permanent basis. The Internal Audit Department regularly tests the Bank s extensive internal control system. The committee participated in the development and introduction into the Bank s internal processes of an electronic database with auditors recommendations, which was created in 2008 to improve the internal auditors efficiency. The database tracks in real time how respective departments are fulfilling the recommendations. The committee reviews all of the Bank s planning and audit methodology documents during its meetings and then passes them to the Board of Directors. The committee has designed a risk-forecasting model that is reviewed at all its meetings, before presenting its recommendations based on a detailed study of the economic climate to the Board of Directors. This enables the Board to make carefully weighted strategic decisions in the fast-changing market. MDM Bank s financial and operating information transparency is highly rated. Standard & Poor s confirmed the Bank s overall CGS-6+ (international scale) and raised the Bank s Russian national scale from CGS-6.7 to CGS-6.9.

74 73 Nominations and Remuneration Committee Martin Andersson Committee Chairman since June 2007 Oleg Viyugin Committee member (Independent Director) since December 2008 Brian Kearns Committee member (external expert) since December 2008 The Nominations and Remuneration Committee provides recommendations on employee policy issues, including the incentive program. The committee also determines the total volume and system of compensation for the Bank s personnel. The Bank has structured its employee social policy on the principle of solid and long-term relationships, as reflected in its approach to forming and managing strategic personnel reserves. Key Developments in 2008 In 2008, the committee sent a team of senior management to study the MDM-INSEAD Bank Leadership Program at the INSEAD business school, which led to the creation of a training scheme for the Bank s middle and senior management. The committee created a new performance-evaluation scale for the Board of Directors, which was endorsed by the Chairman and members of the Management Board. Corporate governance was improved significantly and the interaction between the Bank s management and employees was optimized via examination of the Board of Directors and the Chairman of the Management Board. The committee and the HR Department worked together specifically to implement the Bank s incentive program, drafting recommendations on key efficiency indicators for the Management Board s members. In conjunction with a professional consultant, the committee began developing a long-term incentive program for the Bank s employees. In the current macroeconomic climate, the committee constantly monitors personnel efficiency and makes recommendations on the advisability of changing the Bank s organizational structure.

75 74 MDM Bank Annual report 2008 Statistics on Corporate Events General Shareholders Meetings: Annual (1) May 26, 2008 Extraordinary (3) August 11, 2008 October 10, 2008 December 15, 2008 Revision Commission Meetings: Physical meetings: 3 Board of Directors Meetings: Physical meetings 8 By correspondence/phone 8 Board Committee Meetings: Комитет по стратегии 8 Комитет по аудиту и рискам 9 Комитет по назначениям и вознаграждениям 8 Management Board Meetings: Physical meetings 62 By correspondence/phone 4

76 75 The Management Board The Management Board, as of April 2, 2009: Name Igor Kim Position with MDM Bank Chairman of the Management Board Chief Executive Officer (CEO) Bio Following the announcement of the planned merger between MDM Bank and URSA Bank in December 2008, the MDM Bank Board of Directors appointed Igor as CEO and Chairman of the Management Board of MDM Bank. Since 2006, Igor had been Chairman of the Board of Directors and Chairman of the Strategy Committee at URSA Bank, which was created when Uralvneshtorgbank and Sibacadembank merged. Prior to the merger, Igor served as Chairman of the Board of Directors of Sibacadembank, where he began working in 1997, and Chairman of the Supervisory Board of Uralvneshtorgbank, in which he had acquired a stake in Between 2001 and 2004, Igor served as Chairman of the Management Board of Bank Caspian in Kazakhstan. He began his banking career in 1993 at Russky Narodny Bank as Deputy Chairman of the Management Board. Alexey Drobot Deputy Chairman of the Management Board Head of Corporate & Investment Banking Igor graduated from Novosibirsk State University with a degree in Economic Cybernetics in Alexey was appointed Head of Corporate & Investment Banking in October 2007, and in November 2007, he joined the Management Board. Previously, Alexey was the Head of MDM Bank s Corporate Banking, where he implemented the Bank s strategic objectives in working with corporate clients and managed the Bank s corporate banking divisions. Alexey joined MDM Bank in 2001 as Head of the Credit Department of the Novoarbatsky office. Successive appointments included Deputy Head of the Client Department of the Sukharevsky office as well as Head of the Central District Client Department. In 2006, he was appointed Head of the Moscow Network Development Department, where he managed large corporate client origination and client services. Prior to joining MDM Bank in 2001, Alexey worked as Commercial Director and Deputy General Director of Finance at various companies. In 1999, he started his career in banking as a senior credit expert at KMB Bank. Alexey graduated from the Leningrad Military-Naval College. In 1998, he received a degree from the Norilsk Industrial Institute and, in 2001, received a degree with honors in Finance and Credit from the State Academy of Finance.

77 76 MDM Bank Annual report 2008 Svetlana Mironova Tatyana Pupkova Vadim Sorokin Deputy Chairwoman of the Management Board Head of Network Management Unit Deputy Chairwoman of the Management Board Chief Operating Officer Deputy Chairman of the Management Board Chief Financial Officer (CFO) Svetlana was appointed Deputy Chairwoman of the MDM Bank Management Board and Head of the MDM Network Management unit in March She oversees issues relating to the operation, efficiency and development of the Bank s regional network. Svetlana joined MDM Bank from URSA Bank, where she was a deputy general director and head of the Urals division of the Bank from From 2005 to 2007, Svetlana was a deputy general director and management board member at Sibacadembank, where she was in charge of corporate banking. Prior to that, from 2002, she headed the Kuzbasskiy branch. Svetlana began her banking career in 1995 as an accountant at Russkiy Narodniy Bank. Following Russkiy Narodniy Bank s merger with Sibacadembank, she was a directorate head and then deputy director of the Kusbasskiy branch. Svetlana graduated from the Novosibirsk Engineering and Construction Institute in 1993 with a degree in Construction Economics and Management. Tatyana joined MDM Bank in 2008 as Chief Operating Officer, and was appointed Deputy Chairman of the Management Board in Prior to joining MDM, Tatyana was Chairman of the Management Board at Etalonbank (formerly JSC Zheldorbank), a position she took after resigning from a similar position at Uralvheshtorgbank. Previously, Tatyana worked at Kaspiyskiy Bank, where she was promoted from Director of the Operating Department to Deputy Chairman of the Management Board, and KRAMDS Bank, a commercial innovation bank in Kazakhstan. Tatyana holds diplomas and degrees from the Institute of Energy, the Kazakh State Academy of Management s Market Institute, and the Adilet Higher School of Law. She speaks fluent English. Vadim was appointed Chief Financial Officer (CFO) of MDM Bank in October His candidacy for the position of Deputy Chairman of the MDM Bank Management Board was submitted in November Prior to joining MDM Bank, Vadim worked at Deloitte and Touche (later Deloitte) CIS from 1997 to He became a partner in 2001 and managed the company s financial institutions service practice. From , He worked variously as the financial director for Eastern European Investment Alliance, vice president for finance at Alba Alliance Bank as well as the chief accountant at a transport company. Vadimbegan his professional career at KPMG. He is a graduate of the Moscow Finance Institute, with a major in Accounting, Analysis and Audit.

78 77 Konstantin Leonov Managing Director of the Direct Investments Management Department Konstantin was appointed as Managing Director of the Direct Investments Management Department in March The Department works with clients problem loans from specific sectors of the economy. From October 2007 until his recent appointment, Konstantin was Head of Network Management. He has been a member of the Bank s Management Board since January 2008 and has been with the Bank since From November 2001 through October 2007, he worked as Head of the MDM Bank Branch in Rostov-on- Don. He started his career in banking in December 1995 at the Rostov branch of JSCB INKOMBANK as a specialist in Securities Trading. In 1997, he was appointed Head of Securities Trading and in 1999 Head of the Branch. In November 1999, he moved to the Rostov branch of Vneshtorgbank as Deputy Head of the Branch. Oleg Novolodskiy Head of Risk Management Konstantin graduated from the Rostov-on-Don Institute of National Economy (RINH) in 1994 with a degree in Finance, Credit and Monetary Circulation. Oleg joined MDM Bank in April 2009 as Head of Risk Management. His responsibilities include control of credit, market and operational risks. Oleg will officially join on the Management Board following approval of his candidacy by the Central Bank of Russia. Oleg joined MDM Bank from URSA Bank, where he was Managing Director in charge of risk management. In March 2006, he joined URSA from the Central Bank of Russia s Novosibirsk office as Managing Director of Sibacadembank. From 1993 to 2006, Oleg worked in the head office of the Central Bank of Russia s Novosibirsk office. In 1994 Oleg graduated from Novosibirsk State University with a degree in Economic Cybernetics.

79 78 MDM Bank Annual report 2008 Tatyana Raimova Member of the Management Board Managing Director of Retail Banking Tatyana joined MDM Bank in 2008 as Managing Director of Retail Banking. In March 2009 she became a member of the Management Board. Prior to joining MDM Bank, Tatyana worked at insurance company ZapSib ZhASO,, where she managed all business processes. Between 2007 and 2008, she was Deputy General Director at URSA Bank, in charge of the Siberian retail banking business, the processing center, the contact center and the professional training center. From 2002 until joining URSA, Tatyana worked at Sibacadembank as Head of the Credit and Debit Cards Department, prior to assuming an active role in developing retail banking services. Tatyana has also held various positions at BashKreditBank and the Novosibirsk Bank, and has over 12 years experience in the banking sector. Konstantin Rogov Head of Treasury Tatyana graduated from the Novosibirsk Economics Institute with a degree in Economics in Konstantin was appointed Head of newly-formed Treasury, which includes a section of Corporate & Investment Banking, in March Konstantin will become a formal member of the MDM Bank Management Board following approval of his candidacy by the Central Bank of Russia. From November 2008, Konstantin was Deputy Head of Corporate & Investment Banking. He joined MDM Bank as the Head of Treasury in Before his career at MDM Bank, Konstantin was Head of the Treasury Department at Impexbank from Between 1995 and 1998, Konstantin worked at Russian Credit Bank, where he was eventually promoted to head the treasury department. He has worked in the banking industry since 1994, and has experience dealing with securities trading, liquidity management, as well as assets and liabilities. Konstantin graduated from the Moscow Institute of Physics and Technology in 1993, with a degree in Applied Physics and Mathematics. In 1997, he graduated from the Russian State Academy of Finance with a degree in Finance and Credit.

80 79 Invited to the Management Board on a Permanent Basis Julia Kochetygova Director of Corporate Relations Julia was appointed Director of Corporate Relations of MDM Bank in June She coordinates the Bank s external relations, including relations with investors, government organizations and the press as well as social programs. Prior to joining MDM Bank, Julia was Director of Governance Services at Standard & Poor s (S&P), where her responsibilities included global management of Corporate Governance Scores (CGS), business development as well as analytical due diligence of corporate governance practices in Russia and other emerging markets. In her previous position at S&P, Julia was responsible for the company s business development in Russia and the CIS. Before joining S&P in 2000, Julia held a number of senior executive and analytical positions at SKATE Information and Consulting Agency ( ) as well as teaching and undertaking research at the Higher School of Economics and the Institute of Economics at the Russian Academy of Sciences. Julia graduated from the Plekhanov Moscow Institute of National Economy as well as the World Bank School of Market Economy. She holds a Ph. D. in Economics. Departures New Members* June 2008 N. Blatova January 2008 K Leonov November 2008 A. Ilyin February 2008 S. Babayan November 2008 S. Babayan September 2008 M. Egorov December 2008 M. Perhirin December 2008 I. Kim February 2009 O. Mashtalyar December 2008 V. Sorokin March 2009 M. Egorov March 2009 S. Mironova April 2009 O. Novolodskiy * Date that the Management Board Members appointment was approved by the RF Central Bank.

81 80 MDM Bank Annual report 2008 MDM Bank Management Structure* General Shareholders' Meeting Board of Directors Committees: Audit and Risk Management Strategy Nominations & Remunerations Board of Directors О. Viyugin Internal Audit J. Molotkovskaya Management Board Committees: Credit, ALCO, Tariffs, Counteragents & Financial Instruments Management Board, Chief Executive Officier I. Kim Consultative Bodies Change Management Committee, Main Management Council, Extended Management Council Group Strategic Business Units Group Corporate Services Centre Corporate and Investment Banking A. Drobot Private Banking V. Lewis Retail Banking T. Raimova Treasury K. Rogov Finance V. Sorokin Network S. Mironova Risks O. Novolodskiy Operations Т. Pupkova Corporate Relations J. Kochetygova Strategic Development М. Mazzarelli Compliance Control А. Savushkin Business Support D. Kuznetsov Distressed Assets S. Shaporenko Direct Investments Management Department K. Leonov * Information current as at 2 April 2009.

82 81 Board of Directors and Management Board Compensation The total paid to members of the Board of Directors for their respective positions, including reimbursement for expenses incurred when fulfilling their duties, was RUR 91 mln in Dividends Payments, including accrued reimbursement for expenses, for the Bank s senior management (particularly the members of the Management Board and the chief accountant) in 2008 totaled RUR 635 mln. Pursuant to the decision reached by the General Shareholders Meeting, as of 26 May 2008, dividends were not paid for 2007 on either common or preferred shares. Profits from 2007 were earmarked for growing the Bank. MDM Bank s Corporate Governance Awards in 2008 In 2008, Standard & Poor s (S&P) confirmed the Bank s overall CGS-6+ (international scale). At the same time, S&P raised the Bank s Russian national scale from CGS-6.7 to CGS-6.9. MDM Bank is confident that adherence to global corporate governance best practices enables the Bank to maintain its position as a leader in corporate governance and transparency among private Russian financial organizations. MDM Bank also received Euromoney s The Best Managed Banks in Corporate & Investment Banking in Central and Eastern Europe for 2007 award, which was presented for the first time in the category of Best Companies in the CEE, as judged by European banking experts. The Bank performed particularly well in measurements of its consistency and assuredness when implementing strategy, the success of its operational management, financial statement transparency, corporate governance standards, as well as the level of disclosure to investors and analysts. MDM Bank s 2007 annual report won first place in the category Finance at the annual report competition held by the Krasnodar region administration in Sochi, Russia.

83 82 MDM Bank Annual report 2008 Internal Control The Bank s internal control system encompasses all levels of management within the Bank and its subsidiaries. The system involves all internal processes and interactions, and is not restricted to specialized units such as the Internal Audit Department, Compliance Department or Risk Management. The Bank s internal control system aims to achieve the following important objectives: Efficient and result-oriented financial and operational procedures for executing banking operations and other transactions, and asset and liabilities management, including ensuring the integrity of the bank s assets and risk management; Accurate, complete objective and timely financial statements, as well as accounting, statistical and other reports (for internal and external users) that are necessary for decision-making by the Bank s management, as well as information security; Compliance with applicable laws and regulations, including the charter of the credit organization; Preventing the Bank or its employees from being drawn into unlawful activity, such as money laundering, financing of terrorism, as well as ensuring timely presentation of information to the Central Bank of Russia and other authorities in accordance with the laws of the Russian Federation. The Bank has a created and approved a Regulation on Internal Control that defines the goals and objectives of the internal control system, its functioning principles, as well as the bodies and individuals responsible for internal control. The Regulation on Internal Control is modified and updated to improve the Bank s internal control system when the tasks and internal control functions change, or if the Central Bank of Russia amends the regulatory acts for internal control in credit organizations in the Russian Federation. The internal control system is built on the following five elements: Control Environment The qualitative features of the Bank s management and its corporate governance system are defining factors of a control environment. An important element of the internal control system is the development of a culture of control. The responsibilities of the Board of Directors and management include drawing attention to the importance of internal control through their actions and statements. This includes the ethical standards that that managers demonstrate both within the organization and to third parties. The management bodies of the bank also bear responsibility for building a corporate culture that underlines and demonstrates to personnel on all levels the importance of internal control. In 2008, the Bank continued to refine its corporate governance system, as discussed in the Corporate Governance and Management section on page 67. Risk Identification and Assessment An important element of internal control at MDM Bank is identifying and evaluating risks that the Bank takes upon itself. The Bank has created a system for banking risk management to achieve this goal. The functioning of the Bank s risk management system is controlled on a constant basis in line with the Bank s internal documents. The system covers all types of risks that the Bank is exposed to: credit, currency, market, interest, liquidity, operational, legal, strategic and reputational risks.

84 83 The Bank has implemented a robust risk management system that covers all potential business and financial risks. This system is discussed in detail in the Risk Management section on page 84. Control Activities Control activities relate to the day-to-day functioning of internal policies and procedures designed to ensure, among other things, proper segregation of duties to avoid conflicts of interest, proper authorization of transactions, accounting reconciliations, and analysis of deviations between actual and expected results. Control activities are a constant part of the bank s activities and are conducted to eliminate risks identified by the Bank through its risk identification and evaluation procedures. The activities also include safeguarding assets and other controls. Information and communication Monitoring A robust management information and communication system is required for the internal control system to function effectively. An effective system of internal control requires reliable, useful and adequate financial and operational information, as well as information about compliance with established regulations and requirements and external information about market events and conditions that is required for decisionmaking. In 2008, the Bank made important strides toward improving the relevance, timeliness and reliability of its management information, as well as further strengthening controls over confidential information. An internal communications system was implemented during 2007 (discussed in the Corporate Communications section on page 93). The Bank seeks to improve internal control in order to ensure the system s efficient functioning and taking into account the changing internal and external factors that influence the Bank. Monitoring of the internal control system is conducted on an ongoing basis by management and employees from various departments, including departments that execute banking operations and other transactions, as well as accounting and financial reporting and the Internal Audit Department. The Bank s management reports to the Board of Directors on an annual basis about the status of the internal control system, evaluates its effectiveness, discusses any shortcomings and steps taken to address them. This report also includes an evaluation of the effectiveness of the Bank s capital adequacy monitoring (based both on Basel requirements and CBR requirements) and an evaluation of internal controls for the preparation of financial reporting. An important part of the ongoing monitoring of the internal control system is the work of the Internal Audit Department, which provides an independent assessment of the adequacy of existing rules and procedures, as well as their observance. The Internal Audit Department functions independently of the bank s business and operational management and has access to all operations conducted by the Bank, including its branch offices and subsidiaries (see the Internal Audit section on page 89). The Bank s external auditors, while not a part of the system of Internal Control, nonetheless play an important role in evaluation of the system of control over the correctness of the Bank s financial reporting as well as offering recommendations regarding the system of Internal Control, based on audit results.

85 84 MDM Bank Annual report 2008 Risk Management MDM Bank s risk management system aims to identify, analyze and manage the Bank s risk exposure. All Bank operations that involve risk are conducted within established limits and restrictions, and risk compliance is constantly monitored. MDM Bank s risk management is based on three main principles: (1) limiting potential losses, (2) evaluating risks in a timely fashion, and (3) maintaining clear and effective risk governance. MDM Bank has established an efficient and reliable risk management system, combining the latest global standards with procedures established by the Bank. The system encompasses the full range of risks involved in financial operations, including: credit risk and market risks, which includes stock market, currency and interest-rate risks, as well as liquidity, operating, legal, reputational and other risks. The Bank has highly qualified team of experts in the Risk Management unit designing and developing the risk-management system. Key Developments in 2008 The launch of a capital-allocation system for risk, with the key indicators being risk adjusted return on capital (RAROC) and shareholder value added (SVA). The introduction of a social and environmental risk-assessment system into the credit process, based on International Financial Corporation (IFC) and European Bank for Reconstruction and Development (EBRD) standards. Improving the loan portfolio monitoring method specifically designed and implemented as a means to monitor industry loan portfolio risks. Also, the Bank began to assess comprehensively on a monthly basis the quality of service rendered to the Bank's small- and medium-sized business clients at its offices, from attracting new clients to working with businesses that have breached their loan contracts. This enables the Bank to efficiently and swiftly identify problem areas and to make the necessary changes to the credit process. An improved market risk assessment method, specifically in assessing repo risks and determining fair prices for third-party promissory notes. At the same time, the global financial crisis caused several changes to Risk Management s activities, the most important being the timely introduction of operational measures to minimize risks. Consequently, the Bank achieved the following: Liquidity was maintained at a sufficient level. Credit policy was changed, thereby halting simplified credit analysis and significantly raising the standard of financial solvency required for a client to receive a loan, as well as broadening credit decisions requiring direct involvement of Risk Management. Market risk limits were made more rigorous, specifically to reduce risk in currency operations, debt security, derivative instruments, margin trading and repo operations. Plans for 2009 MDM Bank s main objectives for 2009 will be to maintain liquidity and adjust risk management to reflect the new economic reality. The Bank intends to update its credit policy: to define target client groups based on their tolerance indices in crisis conditions and their credit-analysis parameters, as well as introduce measures to assess risks objectively and to enable flexibility in making changes to risk management policy. This includes creating a statistical rating

86 85 system to rate corporate clients and small- and mid-sized business; and to begin using statistical scoring cards for all retail programs. There are plans to use qualitative and new quantitative assessment models to improve objectivity and brevity when assessing operational risks. In addition to the current early warning indicators for liquidity risk, the Bank plans to design and implement analogous systems for other major financial risks. A detailed description of the financial risk management system is presented in Note 28, Financial Risk Management, as an note to the Bank s audited financial statements. Please also see Note 11, Loans and Advances to Customers, where important credit risk information is discussed in detail. Operational Risks Operational risks are direct or indirect losses caused by various factors involving processes, personnel, or the Group s technology and infrastructure. Losses can also be caused by external factors differing from credit and market as well as liquidity risks. Operational Risk Management The Bank seeks to minimize possible financial losses and damage to the Bank s reputation, as well as to ensure the optimization of general expenses, minimize superfluous managerial procedures that may limit initiative, and utilize new problem solving methods. The Bank manages operational risks by taking into account recommendations from the Central Bank of the Russian Federation and the Basel Committee on Banking Supervision, when seeking best practices and managing operational risks. The Bank accomplishes this via compilation, monitoring, operational risk minimization and continuous management. The Risk unit develops operational risk management methodology, coordinates the risk management procedure as part of the Bank unit, makes corresponding suggestions to improve operations, as well as presents reports on the Bank s level of operational risk to the Management Board. The management of each department is responsible for controlling risks assigned to it. The overall operational risk management standards of the Bank include the following: Separation of powers, specifically independent operation authorization and operation monitoring; Adherence to the requirements of the regulating authorities and legislation; Procedures to minimize operational risks; Management and procedure documentation; Periodic assessment of exposure to operational risks; Immediate reporting on losses due to operational risks; Maintenance of plans for emergency situations;

87 86 MDM Bank Annual report 2008 Professional development, specifically using training programs; Ethical business practices; All methods to minimize risk, specifically insurance, where it is efficient. Operational Risk Assessment Operational risk compilation, analysis and monitoring include the following: Collecting information on past operational losses by the Bank; Analysis of operational risks for products and processes; Compiling operational risks for new products, processes and large transactions. A risk chart is created based on an analysis of operational risks, using a quantitative rating based on key risk indicators for each of the Bank s separate and operations.. Upgraded Operational Risk Management Methods During 2008, MDM Bank implemented a capital allocation system for overall risk that includes operational risk assessment. In turn, this motivated the business unit to take measures to lower operational risks on current transactions. A tax and legal risk assessment system was also implemented, resulting in the Bank s full risk assessment increasing noticeably. There were no major problems recorded in the operational processes for the fiscal year. In 2009, the Bank plans to implement quantitative models of operational risk assessment in addition to the current qualitative models, which will result in improvements in the level of objectivity and speed when assessing these risks.

88 87 Additional Risks The Bank also manages legal, reputational, country and other risks. Legal Risk Legal risks concern possible damages to the Bank arising from internal and external legal factors. Internal risk factors include: Non-adherence to the applicable legislation; Internal documentation inconsistent with the applicable legislation, as well as the Group s inability to bring its activity and internal documents in line with changes in legislation in a timely manner; Insufficiently accurate analysis of the legal risks of new products, operations and technology. External risk factors include: An imperfect legal system; Breach of contract conditions by the Bank s clients or counter parties; The Bank s and/or its clients subsidiaries being located in jurisdictions of various governments. Legal risks are managed with the goal of reducing or eliminating possible losses, specifically in terms of courtawarded monetary funds. The Legal Department monitors legal risks, while the Tax Department monitors tax risks. Legal risks are managed according to the following principles: Standard contract forms provisionally agreed upon by all respective parties of the Bank, specifically by the units responsible for risk management that the transaction contains; Most transactions are made based on standard contract forms; Only in exceptional instances are transactions made based on non-standard contracts that the Legal Department approves; Contracts are signed only after the counter party s credentials have been verified; Utmost attention is paid to the legal risk assessment of the property put up for collateral. The pledgor has to show a full list of documents that confirm his legal property rights to the object used as collateral. Reputational Risk Reputational risks occur when people form a negative opinion of the Bank. These risks are managed according to the following main principles: The Bank fulfills all its obligations in a timely manner to clients and counterparties, and adheres to all applicable legislation and norms of business etiquette; Obligatory due diligence is conducted on counterparties and clients in accordance with the on Anti-Money- Laundering, Illegal Funds and Anti-Terrorism Acts; A system is used to prevent price manipulation on the securities market; The MDM Bank Public Relations Department monitors external information on the Bank and sets in motion steps and previously developed regulations to counter negative information and news flow.

89 88 MDM Bank Annual report 2008 Compliance Department In 2008, MDM Bank s Board of Directors developed and approved the Policy on Managing Compliance Risks for MDM Bank and its Subsidiaries. The document describes the structure of the compliance system as well as the main regulatory, reputational and financial risks. As per the document, the main principles of the compliance risks were developed, particularly recommendations to identify and prevent them. The main compliance principles are as follows: Adherence to legislation and internal rules and standards is an absolute requirement for all Bank units and employees, as well as key to the decision-making system; When fulfilling the Bank s duties, it is not only necessary to adhere to the legislation and requirements of the regulatory bodies, but also to assess how the Bank s decisions and actions correspond to its values, and to take into consideration the interests of all its shareholders; MDM Bank is continuously improving its approach to identifying, analyzing and managing compliance risks and provides the necessary qualification level for its employees in managing these risks. To fulfill these tasks, the Compliance Control Department was formed, combining two units: the Financial Monitoring Department, the main functions of which are to develop and fulfill the internal control rules and other internal organization measures to identify and prevent money laundering and the financing of terrorism; and the Financial Market Operations Compliance Control Department, which oversees the Bank s adherence to required legislation, financial markets legal norms acts, internal rules and professional participant securities market procedures. The department s main tasks are to manage compliance risks efficiently, and to counsel the Bank s executive bodies on the laws, rules and standards in relation to compliance risk management. The department also counsels the Bank s executive bodies on training personnel on compliance risk issues, develops policies, procedures and other documents on compliance control, as well as identifies and analyzes compliance risks. The Compliance Control Department answers directly to the Chairman of MDM Bank s Management Board and presents on a regular basis the Management Board and the Board of Directors consolidated reports which identify risks and detail measures to reduce them. The Compliance Control Department s operation in accordance to the Policy on Managing Compliance Risks to MDM Bank and its Subsidiaries has enabled the Bank to minimize its risks and maintain its strong reputation.

90 Internal Audit 89 The Internal Audit Department s main goal is to provide for the efficient operation of the Bank s units by internally auditing activities and presenting independent and objective recommendations on improving the quality of the internal control system, risk management and corporate governance. The department s employees are on the staff of the Bank s Head Office, although the department is an independent structure answering functionally to the Board of Directors Audit and Risk Committee, which independently assesses the operations of the internal auditors. Additionally, for administrative purposes the department reports to the Chairman of the Management Board to ensure efficient reporting on the internal control system to the Bank s senior management. The Internal Audit Department interacts with the Bank s external auditor, and, when necessary, informs it on all current events for the Bank s activity. The department s director reports on a monthly basis to the Audit and Risk Committee and prepares a report for the Board of Directors twice yearly. The department s director also participates in weekly management meetings and is part of the Bank s Main Management Council. Key Developments in 2008 In 2008, thirty-six people worked in the Internal Audit Department, including four IT audit specialists. All of the department s employees are highly qualified specialists with significant experience working in large global auditing firms or similar departments in other large banks. Three of the employees are qualified as Certified Information Systems Auditors (CISA). Four of the department s employees are part of the Bank s Revisiory Commission. One of the department s most important activities in 2008 was auditing the Bank s regional branch offices. Consequently, the Network Audit Department and the Local Regional Auditors Department were set up as part of the department s structure to ensure timely and regular audits, and to monitor implementation of the auditors recommendations. Every regional bank has at least one employee in the Internal Audit Department, whose specialists in the regions operate in accordance to the approved annual plan, assess the efficiency of the internal control system at the branches, and participate in unscheduled reviews. They answer to the Department s director and provide independent and objective spot-audits. In 2008, the department developed, introduced and began using use the E-DVA automated report and control system. This system offers a combined database that, from the audits, contains all the department s recommendations and comments to the responsible party in the Bank, which can be ranked according to importance, as well as their completion status. All relevant departments in the Bank s have access to the E-DVA system and report online on completing the audit recommendations. The E-DVA system allows for the following: Saving all audit recommendations; Constant control over their completion by the responsible employees of the Bank; Drawing up analytical reports to assess risks according to the type of the Bank s activities; Operations planning and assessment of work efficiency of the Internal Audit Department; Assessing the efficiency of eliminating previous deficiencies in operations by the Bank s structure units.

91 90 MDM Bank Annual report 2008 The Department also updated a previously developed risk assessment method which is used to assess risks yearly and to plan the Department s activities. The allocation of audited units was revised and supplemented and the list of factors was updated and is used to assess inherent risk. The Compliance Control Department s director and those responsible for corresponding business processes were included in the main expert group to assess control risk. The Internal Audit Department s review plan for 2009 was developed taking a risk-informed approach. The Bank s main risk areas are reviewed on a yearly basis. The annual plan incorporates the possibility to conduct spot audits if the Bank s management is requested to do so. At the end of 2008, the Internal Audit Department reviewed the strategy and action plan for the fourth quarter of The changes will allow for the following: Maximum rational use of the department s resources; Maximum relevance of the audit remarks; Timely assessment of risks that arise during a period of financial crisis; Reduction in expenses for audits. Plans for 2009 The department plans to regularly review in 2009 the audit recommendation fulfillment and to follow their enactment continuously via the E-DVA system. The department plans to initiate a new automated audit format.

92 Human Resources 91 MDM Bank Employees 1,400 1,200 1, ,500 4,000 3,500 3,000 2,500 2,000 1,500 1, Under Above Male Female Head Office Regional Network A concerted effort was made in 2008 to implement the plans that fell under the Bank s comprehensive employee strategy, approved at the end of Systematic integration of professional operations in the Bank s business strategy became the main focus in conducting a number of planned events, which transformed the Bank s Human Resources Department from its original role as an administrative service unit to a full HR partner for all of the Bank s business units. The HR Department s main task is creating an environment for the Bank s employees that engenders real participation from each employee in the business. In 2008, the following tasks were prioritized: introducing an incentive system; ensuring efficiency in personal and team operations; improving professional qualifications; and developing personnel. A new regulatory framework was approved in MDM Bank in 2008, which incorporated the best global HR practices and took into account business strategy priorities, as well as the specifics of the Bank s operating model. An instrument that allowed for the analysis of the Bank s employees functional responsibilities was developed, thereby enabling systemization of information on the activities of units and individual employees, and by extension the use of the organization s professional potential most efficiently. The personnel records were fully automated during the past year, with all of MDM Bank s affiliates switching to a new IT platform that optimizes documentation management and significantly saves work time for HR specialists. Hiring personnel The banking specialist job market in 2008 remained highly competitive. The HR Department constantly monitored the job market to allow MDM Bank to maintain its position as one of the most attractive employers in the Russian banking sector. Systematic work on strengthening the Bank s recruiting team and improving

93 92 MDM Bank Annual report 2008 the search process in order to attract highly qualified candidates produced excellent results in In the third and fourth quarters, 96% of the vacancies in the Main Office and affiliates were filled by the HR Department itself, without using external recruiting firms. MDM Bank staff numbers increased in 2008 to 6,563, with practically all of the new employees joining the Bank s regional offices as a result of the Bank actively implementing in its regional network the development strategy during the last year. The Bank s professional and intellectual potential is highlighted by the fact 5,348 employees have a university education and 366 employees combine work and study in various university programs. Training and development The employee management development program begun in 2007 was successfully concluded in The Bank s senior management last year took the INSEAD course specially designed for MDM Bank. Based on this, they organized and conducted workshops during which the Bank s full management team was introduced to global best practices in the banking business and shared their ideas on improving the Bank s management system. During the development process for the Bank s structured unit managers, training focused on developing skills for efficient internal and external communication. At Head Office and in the Bank s regional branches, 250 mid-level managers participated in specialized training sessions. In 2008, in-house training and personnel development courses were initiated, with focus shifting from external training to in-house courses. This optimized training costs while simultaneously ensuring that the Bank s employees had the chance to take training programs that were in full compliance with their daily business tasks and geared toward developing skills necessary for efficient work in a dynamically changing market. Today, training managers work in all the Bank s regional branches. Training sessions on sales received high marks from participants and significantly helped in working with client managers. The business trainers value in quickly responding to business demands was successfully demonstrated at the end of 2008, when the global financial crisis required adjustments in all of the Bank s units, and clarification for current and potential clients regarding the financial situation and the actions taken by the Bank to protect the interests of its investors and depositors. The Everyone to the Front Lines for Victory and Crisis or New Possibilities? training sessions resolved the Bank s important employee incentive support tasks. From April to December 2008, 2,662 MDM Bank employees attended internal corporate training sessions developed by the Training and Development Department in conjunction with the business units. Meanwhile, 887 employees attended external training sessions. Outlook for 2009 The process of creating a unified bank presents the HR Department with new and exacting tasks. The most important goals are rethinking and reorganizing the Bank s organizational structure, developing optimal principles to involve employees in business decisions by using internal personnel rotation, as well as forming the Bank s strategic employee reserve and a unified value system within the bank. There are also plans to improve the HR processes, increase employees professional qualifications at all levels, strengthen corporate culture and increase staff loyalty.

94 Corporate Communications 93 MDM Bank s information policy has established a systematic and comprehensive approach to transparency that quickly improved the quality of communications with target audiences. In 2008, Corporate Communications, which included the Investor Relations Division, the Corporate Social Responsibility Division, the Public Relations Department and the Internal Communications Division, encompassed the full spectrum of the Bank s communications. As a result of the work of the Investor Relations Division, which is responsible for the quality, efficiency and availability of information, the Bank remains one of the leaders in the Russian banking system in terms of information transparency. The Bank s 2007 Annual Report set a new standard and placed first among other annual reports in several competitions. The Public Relations Department structured the Bank s crisis communication and prepared recommendations for the Bank s managers on how to communicate with target audiences. A new section was created on the MDM Bank website, simplifying the search process for necessary information about the Bank, its products and services and the situation on the financial markets. The Corporate Social Responsibility Division in 2008 concentrated its efforts on implementing priorities approved in the Bank s Corporate and Social Responsibility (CSR) strategy, such as education and musical events. Three major long-term programs were launched during the year: Culture, under the name World of Divine Melodies; Education, under the name World of Young Business People; and Financial Literacy. The Bank s initiatives were in demand in the regions, as attested by the following figures: The 12 best teachers, who were selected through an open competition, from seven leading regional partner higher education institutions took part in an exchange program at the Stockholm University School of Business and received grants to develop modern academic curricula; Forty-nine of the best students at partner institutions of higher learning received scholarships from MDM Bank; More than 2,000 people participated in free seminars on financial literacy organized by the Bank; More than 18,000 classical music lovers attended concerts organized as part of the World of Divine Melodies programs. Detailed information on programs conducted as part of the Bank s CSR activities is included in MDM Bank s first Corporate Social Responsibility Report for At the beginning of 2008, the Internal Communications Division polled MDM Bank employees to research the quality of corporate culture and the internal communications channels. More than 2,500 employees from 80 of the Bank s structural units participated in the poll, with the results used to assess the efficiency of the information channels, the methods and instruments for internal communications, as well as to find out employee opinions on how to improve the current channels, methods and instruments. The poll results also helped define the main areas for internal communications development for The internal communications system operated successfully, and enabled the following: The exchange process between units, various management levels and employees, as well as various regions, was structured as part of strategic sessions; Employees were efficiently informed on strategic and operation decisions;

95 94 MDM Bank Annual report 2008 The Bank s hotline, and message board provided and fostered feedback from employees. A corporate culture was engendered and the Bank s philosophy, based on its Mission, Vision and Values, was introduced. During the year, two consultative organs operated under the Management Board the Main Management Council (MMC) and the Extended Management Council (EMC). At the weekly MMC meetings, the directors of the Bank s main business units discussed and resolved issues. EMC meetings were convened on a quarterly basis to discuss important events and key management decisions. Professional training aimed at improving the communication skills of the Bank s senior managers increased the efficiency of the external and internal information companies. Beginning in Moscow, training then spread to all of the Bank s regional branches, with 171 of the Bank s managers of various levels and speakers receiving training. In June 2008, work began on updating the corporate intranet site based on better software that offers new possibilities to integrate employees in the united information media. These possibilities are particularly as follows: Information support for business and corporate communication; Work space for each unit, group and employee; Knowledge-gathering and management system; Information protection. Plans for 2009 In 2009, the Bank plans to continue improving the information disclosure system and supporting information transparency for all the main target audiences. The intranet site will be completely updated, which will present users with considerably more convenient instruments to communicate internally. The new version is set for launch in May MDM Bank is also planning to approve a Code of Corporate Ethics and, with the assistance of various means of communication, to report its basic standards to every employee.

96 Consolidated Financial Statements For the Year Ended 31 December 2008 Together with Independent Auditors Report

97 96 Contents Independent Auditor s Report Consolidated Balance Sheet Consolidated Income Statement Consolidated Cash Flow Statement Consolidated Statement of Changes in Equity Notes to the Consolidated Financial Statements 1. Organisation of the Group and its Principal Activities 2. Operating Environment of the Group 3. Basis of Preparation 4. Significant Accounting Policies 5. Cash and Cash Equivalents 6. Due from Other Banks 7. Trading Securities 8. Derivative Financial Instruments 9. Available-for-Sale Financial Assets 10. Investment Securities Held to Maturity 11. Loans and Advances to Customers 12. Property, Plant and Equipment and Intangible Assets 13. Other Assets 14. Due to Central Banks 15. Due to Other Banks 16. Customer Accounts 17. Debt Securities in Issue 18. Subordinated Debt 19. Other Liabilities 20. Share Capital 21. Interest Income and Expense 22. Gains less Losses from Foreign Exchange 23. Fee and Commission Income and Expense 24. Other Operating Income 25. Operating Expenses 26. Income Taxes 27. Analysis by Segment 28. Financial Risk Management 29. Contingent Liabilities and Commitments 30. Fair Value of Financial Instruments 31. Related Party Transactions 32. Principal Subsidiaries 33. Subsequent Events

98 97 CJSC Ernst & Young Vneshaudit Sadovnicheskaya Nab., 77, bld. 1 Moscow, , Russia Tel: +7 (495) (495) Fax: +7 (495) Independent Auditor s Report To the Shareholders and Board of Directors of MDM Bank We have audited the accompanying consolidated financial statements of MDM Bank and its subsidiaries (the Group ), which comprise the consolidated balance sheet as at 31 December 2008, and the consolidated income statement, consolidated statement of changes in equity and consolidated cash flow statement for the year then ended, and a summary of significant accounting policies and other explanatory notes. Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatements, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances. Auditor s Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Group as at 31 December 2008, and its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards. 9 April 2009

99 98 MDM Bank Consolidated Balance Sheet as at 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Note 31 December December 2007 Assets Cash and cash equivalents Mandatory cash balances with central banks Due from other banks Trading securities: - owned by the Group pledged under sale and repurchase agreements Derivative financial instruments Available-for-sale financial assets 9 - owned by the Group pledged under sale and repurchase agreements Investment securities held to maturity Loans and advances to customers Property, plant and equipment and intangible assets Other assets Total assets Liabilities Due to central bank Due to other banks Derivative financial instruments Customer accounts Debt securities in issue Subordinated debt Deferred tax liability Other liabilities Total liabilities Equity Share capital Share premium Revaluation of premises Revaluation of available-for-sale financial assets (1 566) 21 Cumulative translation reserve Retained earnings Total equity Total liabilities and equity The consolidated financial statements are approved for issue by the Management Board of MDM Bank and signed on its behalf on 9 April Igor Kim Chairman of the Management Board Vadim Sorokin Chief Financial Officer The notes on pages 102 to 186 form an integral part of these consolidated financial statements.

100 MDM Bank Consolidated Income Statement for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 99 Note Year ended 31 December 2008 Year ended 31 December 2007 Interest income Interest expense 21 (15 985) (14 213) Net interest income Loan impairment losses 11 (6 616) (2 083) Net interest income after loan impairment losses (Losses)/gains arising from trading securities, net (997) 309 Gains/(losses) arising from trading in precious metals, net 504 (22) Gains from foreign exchange, net Gains/(losses) from interest-based derivative financial instruments, net 520 (520) Gains from early redemption of debt Fee and commission income Fee and commission expense 23 (883) (634) Other assets impairment losses 13 (518) (3) Impairment of investment securities held to maturity 10 (371) - Other provisions 13 (330) - Other operating income Operating income Operating expenses 25 (9 366) (8 622) Gain on disposal of premises Profit before taxation Income tax expense 26 (1 333) (2 111) Profit for the year Igor Kim Chairman of the Management Board Vadim Sorokin Chief Financial Officer The notes on pages 102 to 186 form an integral part of these consolidated financial statements.

101 100 MDM Bank Consolidated Cash Flow Statement for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Note Year ended 31 December 2008 Year ended 31 December 2007 Cash flows from operating activities Interest received Interest paid (14 669) (13 701) (Losses)/gains from trading in securities (181) 767 Losses net of gains from interest-based derivative financial instruments (348) (310) Gains/(losses) from trading in precious metals 160 (768) Realised gains/(losses) from trading in foreign currencies (26) Commissions received Commissions paid (861) (635) Other operating income received Operating expenses paid (9 104) (8 572) Income tax paid (1 488) (2 003) Cash flows from operating activities before changes in operating assets and liabilities Changes in operating assets and liabilities Net decrease/(increase) in mandatory cash balances with central banks (1 481) Net increase in due from other banks (1 007) (15 114) Net (increase) / decrease in trading securities (525) Net decrease in other financial assets at fair value through profit or loss Net increase in available-for-sale assets (390) (263) Net decrease in investment securities held to maturity Net decrease/(increase) in loans and advances to customers (20 255) Net increase in due to central banks Net (decrease)/increase in due to other banks (21 058) Net (decrease)/increase in customer accounts (20 578) Net (decrease)/increase in promissory notes issued and deposit certificates (12 483) Net increase in other assets less other liabilities (39) (423) Net cash (used in)/from operating activities (2 908) Cash flows from investing activities Purchase of property, plant and equipment (1 626) (797) Proceeds from sale of property, plant and equipment Net cash (used in)/from investing activities (1 617) 359 Cash flows from financing activities Loan participation notes and bonds issued Loan participation notes repaid/repurchased (11 836) (28 378) Subordinated debt repaid/repurchased (95) - Share capital issued Net cash used in financing activities (10 753) (1 897) Effect of exchange rate changes on cash and cash equivalents (2 842) Net increase in cash and cash equivalents (6 163) Cash and cash equivalents at the beginning of the year Cash and cash equivalents at the end of the year Igor Kim Chairman of the Management Board Vadim Sorokin Chief Financial Officer The notes on pages 102 to 186 form an integral part of these consolidated financial statements.

102 MDM Bank Consolidated Statement of Changes in Equity for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 101 Share capital Share premium Revaluation of premises Revaluation of availablefor-sale financial assets Cumulative translation reserve Retained earnings Total equity Balance as at 1 January (21) Revaluation of premises, net of deferred tax (Note 12) Revaluation of available-for-sale financial assets, net of deferred tax (Note 9) Currency translation differences Total recognised income directly in equity for the year ended 31 December Profit for the year ended 31 December Total income recognised for the year ended 31 December Disposal of premises (Note 12) - - (280) Share capital issued Balance as at 31 December Currency translation differences Revaluation of available-for-sale financial assets, net of deferred tax (Note 9) (1587) - - (1587) Effect of change in income tax rate Total income and expense recognised directly in equity for the year ended 31 December (1 587) (1 128) Profit for the year ended 31 December Total income and expense recognised for the year ended 31 December (1 587) Balance as at 31 December (1 566) Igor Kim Chairman of the Management Board Vadim Sorokin Chief Financial Officer The notes on pages 102 to 186 form an integral part of these consolidated financial statements.

103 102 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 1. Organisation of the Group and its Principal Activities These consolidated financial statements include the financial statements of MDM Bank (Open Joint Stock Company) ( the Bank ) and its subsidiaries. MDM Bank and its subsidiaries are hereinafter collectively referred to as the Group. As at 31 December 2008, the Group operated two banks, one in the Russian Federation and one in Latvia, securities trading and asset management companies and leasing companies. MDM Bank, the parent company and the lead operating entity of the Group, has been registered in the Russian Federation to carry out banking activities since The Bank operates under a general banking license issued by the Central Bank of the Russian Federation ( the CBR ). The Bank also has broker and dealer licenses issued by the Russian Federal Financial Markets Service. The Bank participates in the state deposit insurance system, which was introduced by the Federal Law #177-FZ Deposits of individuals insurance in Russian Federation dated 23 December The State Deposit Insurance Agency guarantees repayment of 100% of individual deposits up to RUR 700 thousand per individual in case of the withdrawal of a licence of a bank or the CBR imposed moratorium on payments. The Group operates in two major business areas: Corporate and investment banking and Retail banking. The Group also has a Central treasury, which undertakes the Group s funding and certain centralised risk management activities. Refer to Note 27. The activities of the Group are conducted principally in Russia, although the Group also conducts operations on international markets. The Bank s registered address is: Kotelnicheskaya emb. 33 bld. 1, Moscow, Russian Federation. As at 31 December 2008 the Group has 35 branches (31 December 2007: 35). All branches are located within the Russian Federation. The Group also operates a number of sub-branches in the Russian Federation and cash exchange offices and a network of retail micro offices in Moscow. As at 31 December 2008, the total number of points of sale of MDM Bank s network was 199 (31 December 2007: 164). As at 31 December 2008 and 31 December 2007, the Bank s parent company is ZAO Banking Holding MDM (Russia). ZAO Banking Holding MDM is a 100% subsidiary of MDM Holding SE, a European company based in Cyprus. As at 31 December 2008 and 31 December 2007, Mr. Sergey Popov was the majority beneficial shareholder of the Group with approximately 77% beneficial interest, Olivant Limited had a 9.5% beneficial interest, Mr. Martin Andersson had an 8.5% beneficial interest and the International Financial Corporation (the IFC ) had a 5.0% direct interest. In addition, Olivant Limited has an option to purchase a further 4.75% interest. Refer to Note 31 for information on related party transactions. On 3 December 2008 the shareholders of MDM Bank and URSA Bank (a large privately-owned Russian bank based in Siberia and the Urals) announced their intent to combine their equity stakes. A detailed integration plan will be developed simultaneously with the legal merger of the two banks. The integration of the two banks is expected to be complete within months. Prior to the legal merger, both banks will continue to function independently. Completion of the transaction remains subject to obtaining the necessary approvals and consents, including those from the Central Bank of the Russian Federation and the Federal Antimonopoly Service. For the purposes of these consolidated financial statements, key management personnel of the Group, collectively, is referred to as management.

104 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Operating Environment of the Group The Russian Federation displays certain characteristics of an emerging market, including relatively high inflation. The tax, currency and customs legislation within the Russian Federation is subject to varying interpretations and frequent changes. Furthermore, the need for further developments in the bankruptcy laws, the absence of formalised procedures for the registration and enforcement of collateral, and other legal and fiscal impediments contribute to the challenges faced by banks currently operating in the Russian Federation. The future economic direction of the Russian Federation is largely dependent upon the effectiveness of economic, financial and monetary measures undertaken by the Government, together with tax, legal, regulatory, and political developments. Recent volatility in global and Russian financial markets The ongoing global liquidity crisis which commenced in the middle of 2007 has resulted in, among other things, a lower level of capital market funding, lower liquidity levels across the banking sector, and, at times, higher interbank lending rates and very high volatility in stock and currency markets. The uncertainties in the global financial markets have also led to bank failures and bank rescues in the United States of America, Western Europe, Russia and elsewhere. Since September 2008 several medium-sized Russian banks have been acquired by state-controlled banks and companies due to their liquidity problems. The full extent of the impact of the ongoing financial crisis is proving to be difficult to anticipate or completely guard against. Despite strong economic growth in recent years, the financial situation in the Russian market significantly deteriorated during 2008, particularly in the fourth quarter. As a result of global volatility in financial and commodity markets, among other factors, there has been a significant decline in the Russian stock market since mid Since September 2008, there has been increased volatility in currency markets and the Russian Rouble (RUR) has depreciated significantly against some major currencies. The official US Dollar (USD) exchange rate of the Central Bank of the Russian Federation increased from RUR at 1 October 2008 to RUR at 31 December 2008 and RUR at 31 March Due to increased market volatility, one-day MosPrime rate fluctuated between 4.75% p.a. and 22.67% p.a. during the fourth quarter. International reserves of the Russian Federation decreased from USD 557 billion at 30 September 2008 to USD 427 billion at 31 December The commodities market was also impacted by the latest events on the financial markets. The price of Urals oil for barrel decreased from USD as at 30 September 2008 to USD as at 31 December A number of measures have been undertaken to support the Russian financial markets, including the following: In October 2008 the CBR reduced the mandatory reserves ratio to 0.5%; The guarantee repayment of individual deposits under the state deposit insurance scheme was raised to RUR 700 thousand per individual in case of the withdrawal of a licence of a bank or the CBR-imposed moratorium on payments; The list of assets which can be pledged under repurchase agreements with the CBR was significantly extended; Vnesheconombank (VEB) was appointed to re-finance foreign debt of the largest companies and banks; The largest Russian banks meeting certain criteria have been entitled to participate in Ministry of Finance and CBR deposit auctions, where each bank was allocated a limit of non-collaterised borrowings it might receive; CBR implemented a loss compensation scheme for interbank lending to allow the largest banks support the medium-sized banks. The volume of wholesale financing has significantly reduced since August Such circumstances may affect the ability of the Group to obtain new borrowings and re-finance its existing borrowings at terms and conditions similar to those applied to earlier transactions.

105 104 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Borrowers of the Group may be affected by the lower liquidity situation which could in turn impact their ability to repay the amounts owed. Deteriorating operating conditions for borrowers may also have an impact on management s cash flow forecasts and assessment of the impairment of financial and non-financial assets. To the extent that information is available, management has properly reflected revised estimates of expected future cash flows in its impairment assessments. The amount of provision for impaired loans is based on management s appraisals of these assets at the balance sheet date after taking into consideration the cash flows that may result from foreclosure less costs for obtaining and selling the collateral. The market in Russia for many types of collateral, especially real estate, has been severely affected by the recent volatility in global financial markets resulting in there being a low level of liquidity for certain types of assets. As a result, the actual realisable value on foreclosure may differ from the value ascribed in estimating allowances for impairment. The fair values of quoted investments in active markets are based on current bid prices (financial assets) or offer prices (financial liabilities). If there is no active market for a financial instrument, the Group establishes fair value using valuation techniques. These include the use of recent arm s length transactions, discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants. The valuation models reflect current market conditions at the measurement date which may not be representative of market conditions either before or after the measurement date. As at the balance sheet date management has reviewed its models to ensure they appropriately reflect current market conditions, including the relative liquidity of the market and credit spreads. As a result of the recent volatility in financial markets there are no longer regularly occurring transactions on an arm s length basis for some debt available-for-sale financial assets and, as such, in the opinion of management many financial instruments are no longer being quoted on an active market in accordance with IAS 39.AG71. Hence fair value as at 31 December 2008 of these instruments has been determined using a valuation technique. The objective of the valuation technique is to establish what the transaction price would have been on the reporting date in an arm s length exchange motivated by normal business considerations. Determining fair value requires consideration of current market conditions, including the relative liquidity of the market and current credit spreads. The valuation techniques used by management to determine fair value in the absence of an active market include discounted cash flow analysis, taking into consideration market spreads for similar financial instruments quoted in an active market. Management is unable to reliably determine the effects on the banking sector the Group s future financial position of any further deterioration in the liquidity of the financial markets and the increased volatility in the currency and equity markets. Management believes it is taking all the necessary measures to support the sustainability and growth of the Group s business in the current circumstances. 3. Basis of Preparation (a) Statement of compliance These consolidated financial statements have been prepared in accordance with the requirements of International Financial Reporting Standards ( IFRS ). (b) Basis of measurement These consolidated financial statements are prepared on the historical cost basis except that financial instruments held for trading, other financial instruments held at fair value through profit or loss, derivative financial instruments and available-for-sale financial instruments are stated at fair value, and certain class of property, plant and equipment are stated at revalued amounts. (c) Presentation currency These consolidated financial statements are presented in Russian Roubles ( RUR ). Amounts in Russian Roubles have been rounded to the nearest million. (d) Use of estimates and judgements The preparation of financial statements in accordance with IFRS requires management to make judgements, estimates and assumptions that affect the application of policies and the reported amounts of assets and

106 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 105 liabilities, income and expense. The estimates and associated assumptions are based on historical experience and various other factors, that are believed to be reasonable under the circumstances, the results of which form the basis of making the judgements about carrying values of assets and liabilities that are not readily apparent from other sources. Although these estimates are based on management s best knowledge of current events and actions, actual results ultimately may differ from these estimates. The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognised in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods if the revision affects both current and future periods. Information about significant areas of estimation uncertainty and critical judgments made by management in the application of IFRSs that have a significant effect on the amounts recognised in these consolidated financial statements are described in the following notes: Note 2 Operating environment of the Group in respect of loan impairment allowance and valuation of available-for-sale financial assets. Note 4 (l) Significant accounting policies and Note 11 (a) Loans and advances to customers in respect of loan impairment allowance. Note 8 Derivative financial instruments in respect of valuation of complex derivative products. Note 12 Property, plant and equipment and intangible assets in respect of valuation of premises. Note 29 (b) Contingent liabilities and commitments in respect of tax contingencies. 4. Significant Accounting Policies The following significant accounting policies have been applied in the preparation of these financial statements. The accounting policies have been consistently applied and they are consistent with those used in the consolidated financial statements for the year ended 31 December Changes in accounting policies as a result of revised accounting standards are described below in this Note. (a) Subsidiaries Subsidiaries are those companies and other entities (including special purpose entities) in which the Group, directly or indirectly, has an interest of more than one half of the voting rights or otherwise has power to govern the financial and operating policies so as to obtain benefits from their activities. The existence and effect of potential voting rights that are presently exercisable or presently convertible are considered when assessing whether the Group controls another entity. Subsidiaries are consolidated from the date on which control is transferred to the Group (acquisition date) and are removed from consolidation from the date that control ceases. Special purpose entities ( SPEs ) are entities which are created to accomplish a narrow and well-defined objective, such as the securitisation of particular assets, or the execution of a specific borrowing transaction. The financial statements of SPEs are included in the consolidated financial statements when the substance of the relationship between the Group and the SPE indicates that the SPE is controlled by the Group, even if the Group does not have any direct or indirect shareholdings in the entity. Intra-group transactions, balances and unrealised gains on transactions between the Group companies are eliminated. Unrealised losses are also eliminated, but only to the extent that there is no evidence of impairment. Where necessary, accounting policies of subsidiaries have been changed to ensure consistency with the policies adopted by the Group. (b) Functional currency Functional currency for each Group company has been determined as the currency of the primary economic environment in which the company operates. The Russian Rouble ( RUR ) has been selected as the functional currency for the Bank, Group companies domiciled in the Russian Federation and certain Group companies domiciled outside of the Russian Federation, where it reflects the economic substance of the underlying events and circumstances. For other Group companies the currencies of the respective countries in which these companies are domiciled have been selected as their functional currencies.

107 106 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) The results and financial position of each foreign entity of the Group (the functional currency of none of which is a currency of a hyperinflationary economy) are translated into the presentation currency as follows: assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that balance sheet; (i) income and expenses for each income statement are translated at average exchange rates (unless this average is not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the dates of the transactions); and (ii) all resulting exchange differences are recognised as a separate component of equity as cumulative translation reserve. When a foreign subsidiary is disposed of through sale, liquidation, repayment of share capital or abandonment of all, or part of, that entity, the exchange differences deferred in equity are reclassified to profit or loss. (c) Foreign currency translation Transactions in foreign currencies are translated to the functional currency of the relevant Group entity at the foreign exchange rate at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated to the functional currency at the foreign exchange rates at the respective balance sheet date. The foreign currency gain or loss on monetary assets and liabilities is the difference between amortised cost in the functional currency at the beginning of the period, adjusted for interest accrued using the effective interest rate and payments during the period, and the amortised cost in foreign currency translated at the exchange rate at the end of the period. Non-monetary items that are measured at historical cost in a foreign currency are translated using the exchange rates as at the dates of the initial transactions. Non-monetary items measured at fair value in a foreign currency are translated using the exchange rates at the date when the fair value was determined. Foreign exchange differences arising on translation are recognised in the consolidated income statement, except for differences arising on translation on availablefor-sale equity instruments, which are recognised directly in equity. As at 31 December 2008 the principal rates of exchange used for translating foreign currency balances were RUR to USD 1 and RUR to EUR 1 for US Dollar and Euro, respectively (31 December 2007: RUR to USD 1 and RUR to 1 EUR for US Dollar and Euro, respectively). (d) Accounting for the effects of hyperinflation In periods prior to 1 January 2003 the Russian Federation experienced relatively high levels of inflation and was considered to be a hyperinflationary economy as defined by International Financial Reporting Standard IAS 29 Financial Reporting in Hyperinflationary Economies. The characteristics of the economic environment of the Russian Federation indicated that hyperinflation had ceased effective from 1 January Restatement procedures of IAS 29 are therefore only applied to nonmonetary assets acquired or revalued and non-monetary liabilities incurred or assumed prior to that date. For these balances, the amounts expressed in the measuring unit current as at 31 December 2002 are the basis for the carrying amounts in these consolidated financial statements. The restatement was calculated using the conversion factors derived from the Russian Federation Consumer Price Index ( CPI ), published by the Russian Statistics Agency. (e) Financial assets and liabilities (i) Classification of financial instruments Financial instruments at fair value through profit or loss include financial assets or liabilities held for trading and financial instruments designated at fair value through profit or loss at initial recognition. A financial instrument is classified as held for trading if it is acquired principally for the purpose of selling it in the near term or it is a part of a portfolio for which there is evidence of a recent actual pattern of short-term profit-taking, or it is a derivative (except for a derivative that is a financial guarantee contract or a designated and effective hedging instrument).

108 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 107 The Group designates financial assets and liabilities at fair value through profit or loss where either: - a group of financial assets, liabilities or both is managed and their performance is evaluated on a fair value basis in accordance with a documented risk management or investment strategy; - the designation eliminates or significantly reduces a measurement or recognition inconsistency ( an accounting mismatch ) which would otherwise arise; or - the financial instrument represents a hybrid (combined) contract that contains an embedded derivative that significantly modifies the cash flows that would otherwise be required under the contract. Financial assets and liabilities at fair value through profit or loss are not reclassified subsequent to initial recognition. Financial instruments at fair value through profit or loss include trading securities, other financial assets at fair value through profit or loss, derivative financial instruments and trading liabilities. Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market, other than those that the Group intends to sell immediately or in the near term, which are classified as held for trading, or those which the Group designates at initial recognition as at fair value through profit or loss or available-for-sale financial assets. Loans and receivables include cash and cash equivalents, due from other banks, including central banks, loans and advances to customers, and other receivables. Held to maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Group s management has the positive intention and ability to hold to maturity. Available-for-sale financial assets are non-derivative financial assets that are designated as available for sale and are not classified as loans and receivables, held to maturity investments or financial instruments at fair value through profit or loss. Available-for-sale financial assets may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices. Promissory notes purchased are included in trading securities or in loans and advances to customers or in due from other banks, depending on their substance and are subsequently remeasured and accounted for in accordance with the accounting policies applicable for these classes of assets. Financial liabilities, which are not financial liabilities at fair value through profit or loss or financial guarantee contracts, include debt securities in issue, due to other banks, customer accounts, subordinated debt and other payables. Debt securities in issue include promissory notes, certificates of deposit, loan participation notes and bonds issued by the Group. Management determines the appropriate classification of financial instruments at the time of the initial recognition. (ii) Amortised cost measurement principles Amortised cost is the amount at which the financial instrument was recognised at initial recognition less any principal repayments, plus accrued interest, and for financial assets less any write-down for incurred impairment losses. Accrued interest includes amortisation of transaction costs deferred at initial recognition and of any premium or discount to maturity amount using the effective interest method. Accrued interest income and accrued interest expense, including both accrued coupon and amortised discount or premium (including fees deferred at origination, if any), are not presented separately and are included in the carrying values of related balance sheet items. Transaction costs are incremental costs that are directly attributable to the acquisition, issue or disposal of a financial instrument. An incremental cost is one that would not have been incurred if the transaction had not taken place. Transaction costs include fees and commissions paid to agents (including employees acting as selling agents), advisors, brokers and dealers, levies by regulatory agencies and securities exchanges, and transfer taxes and duties. Transaction costs do not include debt premiums or discounts, financing costs or internal administrative or holding costs. The effective interest method is a method of allocating interest income or interest expense over the relevant period so as to achieve a constant periodic rate of interest (effective interest rate) on the carrying amount. The effective

109 108 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) interest rate is the rate that exactly discounts estimated future cash payments or receipts (excluding future credit losses, except that future credit losses are not considered when estimating those cash receipts) through the expected life of the financial instrument or a shorter period, if appropriate, to the net carrying amount of the financial instrument. The effective interest rate discounts cash flows of variable interest instruments to the next interest repricing date except for the premium or discount which reflects the credit spread over the floating rate specified in the instrument, or other variables that are not reset to market rates. Such premiums or discounts are amortised over the whole expected life of the instrument. The present value calculation includes all fees paid or received between parties to the contract that are an integral part of the effective interest rate (refer to income and expense recognition policy). (iii) Fair value measurement principles Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm s length transaction. Fair value is the current bid price for financial assets and current offer price for financial liabilities which are quoted in an active market. For assets and liabilities with offsetting market risks, the Group may use mid-market prices as a basis for establishing fair values for the offsetting risk positions and apply the bid or offer price to the net open position as appropriate. A financial instrument is regarded as quoted in an active market if quoted prices are readily and regularly available from an exchange or other institution and those prices represent actual and regularly occurring market transactions on an arm s length basis. Where an active market price is not available, fair value is determined using valuation techniques with a maximum use of market inputs. Such valuation techniques include reference to recent arm s length market transactions, current market prices of substantially similar instruments, discounted cash flow and option pricing models and other techniques commonly used by market participants to price the instrument. Where discounted cash flow techniques are used, estimated future cash flows are based on management s best estimates and the discount rate is a market-based rate at the balance sheet date for an instrument with similar terms and conditions. Where pricing models are used, inputs are based on market-based measures at the balance sheet date. The fair value of a financial liability with a demand feature, such as a demand deposit, is not less than the amount payable on demand, discounted from the first date that the amount could be redeemed by the counterparty. (iv) Initial recognition Trading securities, derivatives and other financial assets and liabilities at fair value through profit or loss are initially recorded at fair value. All other financial instruments are initially recorded at fair value plus transaction costs. Fair value at initial recognition is best evidenced by the transaction price. A gain or loss on initial recognition is only recorded if there is a difference between fair value and transaction price which can be evidenced by other observable current market transactions in the same instrument or by a valuation technique whose inputs include only data from observable markets. Where an initial gain or loss is not based entirely on observable market data, it is deferred and recognised over the life of the asset or liability on an appropriate basis, or when prices become observable, or on disposal of the financial asset or liability. Where the transaction price in a non-active market is different to the fair value from other observable current market transactions in the same instrument or based on a valuation technique whose variables include only data from observable markets, the Group immediately recognises the difference between the transaction price and fair value (a Day 1 profit) in the income statement. In cases where use is made of data which is not observable, the difference between the transaction price and model value is only recognised when in the income statement when the inputs become observable, or when the instrument is derecognised. All purchases and sales of financial assets that require delivery within the time frame established by regulation or market convention ( regular way purchases and sales) are recorded at trade date, which is the date that the Group commits to deliver a financial asset. All other purchases and sales are recognised on the settlement date with the change in value between the commitment date and settlement date not recognised for assets carried at cost or amortised cost; recognised in profit or loss for trading securities, derivatives and

110 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 109 other financial assets at fair value through profit or loss; and recognised in equity for assets classified as available for sale. (v) Subsequent measurement Subsequent to initial recognition, financial assets are measured at their fair values, without any deduction for transaction costs that may be incurred on sale or other disposal, except for: - loans and receivables and held to maturity investments, which are measured at amortised cost using the effective interest method; - investments in equity instruments that do not have a quoted market price in an active market and whose fair value cannot be reliably measured, which are measured at cost. Financial liabilities at fair value through profit or loss are measured at their fair value. Financial liabilities, other than financial liabilities at fair value through profit or loss and financial liabilities that arise when a transfer of a financial asset carried at fair value does not qualify for derecognition, are measured at amortised cost subsequent to initial recognition. Financial assets or liabilities originated at interest rates different from market rates are re-measured at origination to their fair value, being future cash flows discounted at market interest rates for similar instruments. The difference between the fair value and the nominal value at origination is credited or charged to the consolidated income statement as gains or losses on origination of financial instruments at rates different from market rates. Subsequently, the carrying amount of such assets or liabilities is adjusted for amortisation of the gains/losses on origination and the related income/expense is recorded as interest income/expense within the consolidated income statement as part of the effective interest rate. (vi) Gains and losses on subsequent measurement All gains and losses arising from changes in the fair value of financial assets and liabilities at fair value through profit or loss are included in the consolidated income statement in the period in which they arise. Interest earned on trading securities and other securities at fair value through profit or loss calculated using the effective interest method is presented in the consolidated income statement as interest income. Dividends are included in dividend income within other operating income when the Group s right to receive the dividend payment is established and it is probable that the dividends will be collected. All other elements of the changes in the fair value and gains or losses on derecognition are recorded in profit or loss as gains less losses from trading in securities or gains less losses from other financial assets at fair value through profit or loss in the period in which they arise. Interest income on available-for-sale debt securities is calculated using the effective interest method and recognised in profit or loss. Foreign exchange gains or losses on available-for-sale debt security investments are recognised in the consolidated income statement. Dividends on available-for-sale equity instruments are recognised in profit or loss when the Group s right to receive payment is established and it is probable that the dividends will be collected. All other elements of changes in the fair value are deferred in equity until the investment is derecognised or impaired, at which time the cumulative gain or loss is removed from equity to profit or loss. The Group uses the last in first out ( LIFO ) method for measurement of gains or losses to be recognised in profit or loss.

111 110 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) (vii) Derecognition Financial assets A financial asset (or, where applicable a part of a financial asset or part of a group of similar financial assets) is derecognised where: - the rights to receive cash flows from the asset have expired; - the Group has transferred its rights to receive cash flows from the asset, or retained the right to receive cash flows from the asset, but has assumed an obligation to pay them in full without material delay to a third party under a pass-through arrangement; and - the Group either (a) has transferred substantially all the risks and rewards of the asset, or (b) has neither transferred nor retained substantially all the risks and rewards of the asset, but has transferred control of the asset. Where the Group has transferred its rights to receive cash flows from an asset and has neither transferred nor retained substantially all the risks and rewards of the asset nor transferred control of the asset, the asset is recognised to the extent of the Group s continuing involvement in the asset. Continuing involvement that takes the form of a guarantee over the transferred asset is measured at the lower of the original carrying amount of the asset and the maximum amount of consideration that the Group could be required to repay. Where continuing involvement takes the form of a written and/or purchased option (including a cash-settled option or similar provision) on the transferred asset, the extent of the Group s continuing involvement is the amount of the transferred asset that the Group may repurchase, except that in the case of a written put option (including a cash-settled option or similar provision) on an asset measured at fair value, the extent of the Group s continuing involvement is limited to the lower of the fair value of the transferred asset and the option exercise price. The Group also derecognises certain financial assets determined to be uncollectible when they are written off against provision for impairment. Refer to impairment of financial assets policy below. Securitisation As part of its operational activities, the Group securitises financial assets, generally through the transfer of these assets to special purpose entities that issue debt securities to investors. The transferred assets may qualify for derecognition in full or in part. Interests in the securitised financial assets may be retained by the Group and are primarily classified as loans to customers. Gains or losses on securitisations are based on the carrying amount of the financial assets derecognised and the retained interest, based on their relative fair values at the date of transfer. Financial liabilities A financial liability is derecognised when the obligation under the liability is discharged or cancelled or expires. Where an existing financial liability is replaced by another from the same lender on substantially different terms, or the terms of an existing liability are substantially modified, such an exchange or modification is treated as a derecognition of the original liability and the recognition of a new liability, and the difference in the respective carrying amounts is recognised in the consolidated income statement. If the Group purchases its own debt, it is removed from the consolidated balance sheet and the difference between the carrying amount of the liability and the consideration paid is included in gains or losses arising from early redemption of debt. (viii) Offsetting Financial assets and liabilities are set off and the net amount reported in the consolidated balance sheet only when there is a legally enforceable right to set off the amounts, and there is an intention either to settle on a net basis, or to realise the asset and settle the liability simultaneously. Income and expenses are presented on a net basis only where either the Group has set off the related assets and liabilities as described above, or for gains and losses arising from a group of similar transactions such as the Group s trading activity.

112 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 111 (ix) Impairment of financial assets The Group assesses at each balance sheet date whether there is any objective evidence that a financial asset or a group of financial assets is impaired. A financial asset or a group of financial assets is deemed to be impaired if, and only if, there is objective evidence of impairment as a result of one or more events that has occurred after the initial recognition of the asset (an incurred loss event ) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or the group of financial assets that can be reliably estimated. Objective evidence that financial assets are impaired can include significant financial difficulty, default or delinquency by a borrower, breach of loan covenants or conditions, restructuring of a loan or advance by the Group on terms that the Group would not otherwise consider, indications that a borrower or issuer will enter bankruptcy, the disappearance of an active market for a security, deterioration in the value of collateral, or other observable data relating to a group of assets such as adverse changes in the payment status of borrowers in the group, or economic conditions that correlate with defaults in the group. Financial assets carried at amortised cost For amounts due from other banks, loans to customers, including net investment in finance leases, and other financial assets carried at amortised cost, the Group initially assesses individually whether objective evidence of impairment exists individually for financial assets that are individually significant, and individually or collectively for financial assets that are not individually significant. If the Group determines that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, it includes the asset in a group of financial assets with similar credit risks characteristics and collectively assesses them for impairment. Assets that are individually assessed for impairment and for which an impairment loss is, or continues to be, recognised are not included in a collective assessment of impairment. If there is objective evidence that an impairment loss has been incurred, the amount of the loss is measured as the difference between the assets carrying amount and the present value of estimated future cash flows (excluding future expected credit losses that have not yet been incurred). The carrying amount of the asset is reduced through the use of an allowance account and the amount of the loss is recognised in the consolidated income statement. Interest income continues to be accrued on the reduced carrying amount based on the original effective interest rate of the asset. Changes in impairment provisions attributable to time value are reflected as a component of interest income. The present value of the estimated future cash flows is discounted at the financial asset s original effective interest rate. If a loan has a variable interest rate, the discount rate for measuring any impairment loss is the current effective interest rate. The calculation of the present value of the estimated future cash flows of a collateralised financial asset reflects the cash flows that may result from foreclosure less costs for obtaining and selling the collateral, whether or not foreclosure is probable. Each asset individually assessed for impairment is assessed on its merits, and the workout strategy and estimate of cash flows considered recoverable are independently verified by the Risk Department. The accuracy of the allowances depends on how accurately future cash flows are estimated for specific counterparty allowances and how accurately the model assumptions and parameters used in determining collective allowances predict future cash flows from loans collectively assessed for impairment. In some cases the observable data required to estimate the amount of impairment loss on a loan may be limited or no longer fully relevant to current circumstances. This may be the case when a borrower is in financial difficulties and there is limited available historical data relating to similar borrowers. In such cases, the Group uses its experience and judgement to estimate the amount of any impairment loss. The assumptions used for estimating both the amount and timing of future cash flows are reviewed regularly to reduce any differences between loss estimates and actual loss experience. For the purposes of a collective evaluation of impairment, financial assets are grouped on the basis of similar credit risk characteristics. Those characteristics are relevant to the estimation of future cash flows for groups of such assets by being indicative of the debtors ability to pay all amounts due according to the contractual terms of the assets being evaluated. In assessing collective impairment the Group uses statistical modelling of historical trends of the probability of default, timing of recoveries and the amount of loss incurred, adjusted for management s judgement as to whether current economic and credit conditions are such that the actual

113 112 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) losses are likely to be greater or less than suggested by historical modelling. Default rates, loss rates and the expected timing of future recoveries are regularly benchmarked against actual outcomes to ensure they remain appropriate. The estimated period between a loss occurring and its identification is determined by management for each identified portfolio. In general, the periods used vary between 3 and 12 months. When a loan is uncollectible, it is written off against the related allowance for loan impairment. Such loans are written off after all the necessary procedures have been completed and the amount of the loss has been determined. Subsequent recoveries of amounts previously written off are credited to the provision for loan impairment in the consolidated income statement. Held-to-maturity financial investments. For held-to-maturity investments the Group assesses individually whether there is objective evidence of impairment. If there is objective evidence that an impairment loss has been incurred, the amount of the loss is measured as the difference between the asset s carrying amount and the present value of estimated future cash flows. The carrying amount of the asset is reduced and the amount of the loss is recognised in the consolidated income statement. If, in a subsequent year, the amount of the estimated impairment loss decreases because of an event occurring after the impairment was recognised, any amounts formerly charged are credited to the consolidated income statement. Available-for-sale financial assets. For available-for-sale financial assets, the Group assesses at each balance sheet date whether there is objective evidence that an investment or a group of investments is impaired. In the case of equity investments classified as available-for-sale, objective evidence would include a significant or prolonged decline in the fair value of the investment below its cost. Where there is evidence of impairment, the cumulative loss measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that investment previously recognised in the consolidated income statement is removed from equity and recognised in the consolidated income statement. Impairment losses on equity investments are not reversed through the consolidated income statement; increases in their fair value after impairment are recognised directly in equity. In the case of debt instruments classified as available-for-sale, impairment is assessed based on the same criteria as financial assets carried at amortised cost. Future interest income is based on the reduced carrying amount and is accrued using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss. The interest income is recorded in the consolidated income statement. If, in a subsequent year, the fair value of a debt instrument increases and the increase can be objectively related to an event occurring after the impairment loss was recognised in the consolidated income statement, the impairment loss is reversed through the consolidated income statement. Renegotiated loans. Where possible, the Group seeks to restructure loans rather than to take possession of collateral. This may involve extending the payment arrangements and the agreement of new loan conditions. Once the terms have been renegotiated, the loan is no longer considered past due. Management continuously reviews renegotiated loans so that all criteria are met and that future payments are likely to occur. The loans continue to be subject to an individual or collective impairment assessment, calculated using the loan s original effective interest rate. (x) Cash and cash equivalents Cash and cash equivalents are items, which can be converted into cash within a day. All short-term interbank placements, excluding overnight deposits, are included in due from banks. Amounts which relate to funds that are of restricted nature are excluded from cash and cash equivalents. Cash and cash equivalents are carried at amortised cost in the balance sheet. (xi) Mandatory balances with central banks Mandatory balances with central banks represent mandatory reserve deposits that are not available to finance the Group s day-to-day operations and hence are not considered as part of cash and cash equivalents in the consolidated balance sheet and consolidated cash flow statement.

114 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 113 (xii) Sale and repurchase agreements Where the Group sells/purchases financial asset and simultaneously enters into an agreement to repurchase/ resell the asset at a fixed price on a future date, the arrangement is accounted for as a secured financing transaction. Assets sold subject to sale and repurchase ( repo ) agreements are continued to be recognised in the financial statements. They are reclassified as pledged assets when the transferee has the right by contract or custom to sell or repledge the collateral. The counterparty liability is included in amounts due to other banks or to customers, as appropriate. Assets purchased under agreements to resell ( reverse repo ) are not recognised in the Group s financial statements, and corresponding amounts are recorded as due from banks or loans and advances to customers as appropriate. The differences between the sale and repurchase prices are treated as interest and accrued over the life of the repo/reverse repo agreement using the effective interest method. If assets purchased under agreement to resell are sold to third parties, the obligation to return securities is recorded as a trading liability and measured at fair value. (xiii) Derivative financial instruments Derivative financial instruments include swap, forward, futures, spot transactions and options in interest rate, foreign exchange, precious metals and stock markets, and any combinations of these instruments. Derivatives are initially recognised at fair value on the date on which a derivative contract is entered into and are subsequently remeasured at fair value. All derivatives are carried as assets when their fair value is positive and as liabilities when their fair value is negative. Changes in the fair value of derivatives are recognised immediately in the consolidated income statement. Derivatives may be embedded in another contractual arrangement (a host contract ). An embedded derivative is separated from the host contract and it is accounted for as a derivative if, and only if the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host contract, a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and the combined instrument is not measured at fair value with changes in fair value recognised in the consolidated income statement. Derivatives embedded in financial assets or financial liabilities at fair value through profit or loss are not separated. Although the Group enters into derivative instruments for risk hedging purposes, the Group does not have a formal hedging strategy that would qualify for hedge accounting. (f) Precious metals Precious metals are stated at fair value. The net realizable value of precious metals is estimated based on quoted market prices. The cost of precious metals is assigned using the first-in, first-out cost formula. Precious metals are recorded within other assets. Precious metals lent to counterparties are retained in the consolidated financial statements. Precious metals borrowed are recognised in the consolidated financial statements as customer accounts or due to banks, as appropriate. The obligation to return them is recorded in the balance sheet at the carrying value of the precious metals borrowed and related accrued interest. If the borrowed precious metals are sold to third parties, the obligation to return the borrowed precious metals is recorded in the balance sheet at its fair value. (g) Property, plant and equipment Property, plant and equipment are stated at cost, restated to the equivalent purchasing power of the Russian Rouble at 31 December 2002 for assets acquired prior to 1 January 2003, or revalued amounts, as described

115 114 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) below, less accumulated depreciation and impairment losses. Historical cost includes expenditure that is directly attributable to the acquisition of the assets. Where an item of property, plant and equipment comprises major components having different useful lives, they are accounted for as separate items of property and equipment. Subsequent expenditure incurred to replace a component of an item of property, plant and equipment that is accounted for separately, is capitalised with the carrying amount of the component being written off. Other subsequent expenditure is capitalised if future economic benefits will arise from the expenditure. All other expenditure, including repairs and maintenance expenditure, is recognised in the consolidated income statement when incurred. Premises of the Group are subject to revaluation on a regular basis. The frequency of revaluation depends upon the movements in the fair values of the premises being revalued. A revaluation increase for an item of premises is recognised directly in equity except to the extent that it reverses a previous revaluation decrease recognised in the consolidated income statement, in which case it is recognised in the consolidated income statement. A revaluation decrease for an item of premises is recognised in the consolidated income statement except to the extent that it reverses a previous revaluation increase recognised directly in equity, in which case it is recognised directly in equity. The revaluation reserve for premises included in equity is transferred directly to retained earnings on the retirement or disposal of the asset. Construction in progress is carried at cost less impairment losses. Upon completion, assets are transferred to property, plant and equipment at their carrying value. Construction in progress is not depreciated until the asset is available for use. Gains and losses on disposal of property, plant and equipment are determined by comparing proceeds with carrying amount and are recorded in the consolidated income statement. (h) Intangible assets All of the Group s intangible assets have a definite useful life and primarily include capitalised computer software. They are stated at cost less accumulated amortisation and impairment losses. Acquired computer software licenses are capitalised on the basis of the costs incurred to acquire and bring to use the specific software. Expenditure on research activities is recognised as an expense in the period in which it is incurred. Subsequent expenditure on intangible assets is capitalised only when it increases the future economic benefits embodied in the specific asset to which it relates. All other costs associated with computer software, e.g. its maintenance, are expensed when incurred. Capitalised computer software is amortised on a straight line basis over expected useful lives. (i) Depreciation and amortisation Depreciation/amortisation commences when the asset is available for use or, in respect of internally constructed assets, from the time an asset is completed and ready for use. Depreciation/amortisation is applied on a straight-line basis over the estimated useful lives of the assets. The estimated useful lives are as follows: years Premises 40 Fixtures and fittings 6 10 Office, computer and other equipment 4 6 Intangible assets 5 7 The assets residual values and useful lives are reviewed annually, and adjusted if appropriate. (j) Impairment The carrying amounts of the Group s assets, other than deferred tax assets, are reviewed at each balance sheet date to determine whether there is any indication of impairment. If any such indication exists, the assets

116 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 115 recoverable amounts are estimated. For intangible assets that are not yet available for use, the recoverable amount is estimated at each annual balance sheet date. An impairment loss is recognised whenever the carrying amount of an asset or its cash-generating unit exceeds its recoverable amount. Impairment losses are recognised in the consolidated income statement unless the asset is recorded at a revalued amount in which case it is treated as a revaluation decrease. Recoverable amount The recoverable amount of an asset is the greater of its fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. For an asset that does not generate largely independent cash inflows, the recoverable amount is determined for the cash-generating unit to which the asset belongs. In respect of other assets, an impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortisation, if no impairment loss had been recognised. (k) Provisions Provisions are recognised if, as a result of past events, the Group has a present legal or constructive obligation, that can be estimated reliably, and it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation. Provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and, where appropriate, the risks specific to the liability. Where there are a number of similar obligations, the likelihood that an outflow will be required in settlement is determined by considering the class of obligations as a whole. A provision for restructuring is recognised when the Group has approved a detailed and formal restructuring plan, and the restructuring either has commenced or has been announced publicly. Future operating costs are not provided for. A provision for onerous contracts is recognised when the expected benefits to be derived by the Group from the contract are lower than the unavoidable costs of meeting its obligations under the contract. The provision is measured at the present value of the lower of the expected cost of terminating the contract and the expected net cost of continuing with the contract. Before a provision is established, the Group recognises any impairment loss on the assets associated with that contract. (l) Credit related commitments In the normal course of business, the Group enters into credit related commitments, comprising undrawn loan commitments, letters of credit and guarantees, and provides other forms of credit insurance. Financial guarantees are contracts that require the Group to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due in accordance with the terms of a debt instrument. A financial guarantee liability is recognised initially at fair value net of associated transaction costs, and is measured subsequently at the higher of the amount initially recognised less cumulative amortisation or the amount of provision for losses under the guarantee. Provisions for losses under financial guarantees and other credit related commitments are recognised when losses are considered probable and can be measured reliably.

117 116 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Any increase in the liability relating to financial guarantees is taken to the consolidated income statement. The premium received is recognised in the consolidated income statement on a straight-line basis over the life of the guarantee. Financial guarantee liabilities and provisions for other credit related commitments are included within other liabilities. (m) Income taxes Income tax on the profit or loss for the period comprises current and deferred tax. Income tax is recognised in the consolidated income statement except to the extent that it relates to items recognised directly in equity, in which case it is recognised in equity. Taxation has been provided for in the consolidated financial statements in accordance with applicable legislation currently in force in the respective countries in which the Group operates. Current tax expense is the expected tax payable on the taxable income for the period, using tax rates enacted or substantively enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years. Taxes, other than on income, are recorded within operating expenses. Deferred tax is provided using the balance sheet liability method, providing for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. The following temporary differences are not provided for: the initial recognition of assets or liabilities that affects neither accounting nor taxable profit; and differences relating to investments in subsidiaries where the parent company is able to control the timing of the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future. The amount of deferred tax provided is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities, using tax rates enacted or substantively enacted at the balance sheet date. A deferred tax asset is recognised only to the extent that it is probable that future taxable profits will be available against which the asset can be utilised. Deferred tax assets are reduced to the extent that it is no longer probable that the related tax benefit will be realised. The tax effects of income tax losses available for carry forward are recognised as an asset when it is probable that future taxable profits will be available against which these losses can be utilised. Deferred tax assets and liabilities are netted only within the individual entities of the Group. (n) Income and expense recognition (i) Interest income and expense Interest income and expense are recorded in the consolidated income statement for all debt instruments on an accrual basis using the effective interest method. This method defers, as part of interest income or expense, all fees paid or received between the parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums or discounts. Fees integral to the effective interest rate include origination fees received or paid by the entity relating to the creation or acquisition of a financial asset or issuance of a financial liability, for example fees for evaluating creditworthiness, evaluating and recording guarantees or collateral, negotiating the terms of the instrument and for processing transaction documents. Commitment fees received by the Group to originate loans at market interest rates are integral to the effective interest rate if it is probable that the Group will enter into a specific lending arrangement and does not expect to sell the resulting loan shortly after origination. The Group does not designate loan commitments as financial liabilities at fair value through profit or loss. (ii) Fee and commission income and expense Other fees, commissions and other income and expense items are generally recognised on an accrual basis when the service has been provided. Loan origination fees for loans which are probable of being drawn down (and are not expected to be sold shortly after recognition), are deferred (together with related incremental

118 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 117 costs) and recorded as an adjustment to the effective interest rate on the loan. Where a loan commitment is not expected to result in the draw-down of a loan, loan commitment fees are recognized on a straightline basis over the commitment period. Fees for provision of credit related commitments and other forms of financial insurance are recognised over the term of the related contract. Commissions and fees arising from negotiating, or participating in the negotiation of a transaction for a third party, such as the acquisition of loans, shares or other securities or the purchase or sale of businesses, which are earned on execution of the underlying transaction are recorded on its completion. Portfolio and other management advisory and service fees are recognised based on the applicable service contracts, usually on a time-proportion basis. Asset management fees related to investment funds are recorded rateably over the period the service is provided. The same principle is applied for wealth management, financial planning and custody services that are continuously provided over an extended period of time. Performance linked fees are recognised when the performance criteria are fulfilled. (iii) Other income and expenses Dividend income is recognised within other operating income in the consolidated income statement on the date that the dividend is declared. Non-interest expenses are recognised at the time the products are received or the services are provided, unless the expenses result from a constructive obligation, against which a liability and related expense are recognised in the consolidated financial statements. (o) Pension costs Companies within the Group which operate in the Russian Federation contribute to the Russian Federation state pension schemes, social insurance and employment funds in respect of their employees. The contributions to these funds are expensed as incurred and included within staff costs in the consolidated income statement. The Group has no further payment obligation once the contribution has been paid. (p) Leases (i) Finance leases where the Group is a lessor Where the Group is a lessor in a lease which transfers substantially all the risks and rewards incidental to ownership to the lessee, the assets leased out are presented as a finance lease receivable and carried at the present value of the future lease payments. The inception of the lease is the earlier of the date of the lease agreement and the date of commitment by the parties to the principal provisions of the lease. For purposes of this definition, a commitment should be in writing, signed by the parties with interest in the transaction, and should specifically set forth the principal terms of the transaction. At the inception of the lease the amounts to be recognised at the commencement of the lease term are determined. The commencement of the lease term is the date from which the lessee is entitled to exercise its right to use the leased asset. However, if the property covered by the lease has yet to be constructed, installed or has not been acquired by the Group, the commencement of the lease is deemed to be the date when construction and installation of the property is completed or the property is acquired by the Group. On commencement of the lease term, when the Group enters into a finance lease as a lessor, the present value of the lease payments ( net investment in leases ) is recorded as part of loans and advances to customers. The difference between the gross receivable and the present value of the receivable is unearned finance income. Finance income is recognised over the term of the lease using the effective interest method, which reflects a constant periodic rate of return. Any advance payments made by the lessee prior to commencement of the lease are recorded as a reduction in the net investment in lease. Finance income from leases is recognised as part of interest income on loans and advances to customers. Impairment losses are recognised in profit or loss when incurred as a result of one or more events ( loss events ) that occurred after the initial recognition of the net investment in leases. The Group uses the same principal criteria to determine that there is objective evidence that an impairment loss has occurred as for loans carried at amortised costs disclosed earlier in this note. Impairment losses are recognised through an allowance account to write down the receivables net carrying amount to the present value of expected

119 118 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) cash flows (which exclude future credit losses that have not been incurred) discounted at the interest rates implicit in the finance leases. The estimated future cash flows reflect the cash flows that may result from obtaining and selling the assets subject to the lease. (ii) Operating leases Where the Group is the lessee in a lease agreement and the lessor does not transfer substantially all of the risks and rewards incidental to ownership of the asset, the arrangement is accounted for as an operating lease. The leased asset is not recognised in the Group s consolidated balance sheet, and lease expenses are recognised in the consolidated income statement on a straight-line basis over the period of the lease. When an operating lease is terminated before the lease period has expired, any payment required to be made to the lessor by way of penalty is recognised as an expense in the period in which termination takes place. Where the Group is the lessor in a lease agreement and does not transfer substantially all of the risks and rewards incidental to ownership of the asset, the arrangement is accounted for as an operating lease. The leased asset is recognised in the Group s consolidated balance sheet, and depreciation and lease income are recognised in the consolidated income statement on a straight-line basis over the period of the lease. (q) Fiduciary assets The Group provides custody, asset management and other fiduciary services that result in holding or placing of assets on behalf of third parties. These assets and income arising thereon are excluded from these consolidated financial statements as they are not assets of the Group. Commissions received from such business are shown as fees and commissions received in the consolidated income statement. (r) Segment reporting The Group presents segment information by operating segments. A segment is a distinguishable component of the Group about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Refer to section (s) below. (s) Changes in accounting policies The accounting policies applied by the Group in these consolidated financial statements are consistent with those applied by the Group in the consolidated financial statements for the year ended 31 December 2007, except for changes resulting from the amendments to IFRS. IFRS 8 Operating Segments. As at 1 January 2008, the Group has early adopted IFRS 8 Operating Segments which is effective for annual periods beginning on or after 1 January 2009 (earlier application is permitted). IFRS 8 specifies how an entity should report information about its operating segments and sets out requirements for related disclosures about products and services, geographical areas and major customers. Operating segments are components of an entity about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Financial information is required to be reported on the same basis as is used internally for evaluating operating segment performance and deciding how to allocate resources to operating segments. IFRS 8 Operating Segments replaces IAS 14 Segment Reporting. As a result, the Group has presented information in Note 27 Analysis by Segment in these consolidated financial statements based on the measures of segment profit and loss, segment assets and other segment items reported to the chief operating decision maker of the Group (represented by the Management Board of MDM Bank and Chairman of the Management Board). The Group has also presented a reconciliation of the total of above measure of reportable segments profit and loss to the Group s profit and loss before tax as reported in the consolidated financial statements, and the total of the above measure of reportable segment assets to the total assets of the Group as reported in the consolidated financial statements.

120 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 119 Reclassification of Financial Assets - Amendments to IAS 39, Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures (issued in October 2008; effective from 1 July 2008). In October 2008, the IASB issued amendments to IAS 39 Financial Instruments: Recognition and Measurement, and IFRS 7 Financial Instruments: Disclosures. The amendments to IAS 39 permit (1) certain reclassifications of non-derivative financial assets (other than those designated under the fair value option) out of the trading category if they are no longer held for the purpose of selling or repurchasing them in the near term to either the held to maturity, loans and receivables or available for sale categories and (2) also allow the reclassification of financial assets from the available for sale category to the loans and receivables category in particular rare circumstances. Rare circumstances arise from a single event that is unusual and highly unlikely to recur in the near term. Any reclassified instruments should subsequently be reviewed for impairment using the IAS 39 impairment rules for the categories into which they are classified. The amendments to IFRS 7 introduce additional disclosure requirements if an entity has reclassified financial assets in accordance with the amendments to IAS 39. The effect of application of amendment to IAS 39 by the Group is as follows: The Group has reclassified certain debt trading securities into loans and advances to customers. The Group identified certain corporate bonds and eurobonds eligible under the amendments (i.e. fixed maturity instruments which are not quoted in an active market), for which as at 1 July 2008 it had an intent to hold them to maturity or in the foreseeable future. Under amendments to IAS 39, the reclassifications were made with effect from 1 July 2008 at fair value at that date. The above bonds are now accounted for at amortised cost in accordance with accounting policies for loans and advances to customers, including assessment for impairment. The deterioration of the global and Russian financial markets during the third quarter 2008 meets the definition of rare circumstances by Amendments to IAS 39. Therefore the Group has also made the following reclassifications effective from 1 July 2008: The Group has reclassified certain debt trading securities into investment securities held to maturity. The Group identified certain corporate bonds, eligible under the amendments, for which as at 1 July 2008 it had an intention and ability to hold them to maturity. The reclassifications were made with effect from 1 July 2008 at fair value at that date. Investment securities held to maturity are accounted for at amortised cost and are assessed for impairment in accordance with IAS 39 requirements for this category. The Group has reclassified the remaining part of its debt trading securities into available-for-sale financial assets effective from 1 July 2008, as the Group no longer holds these securities for the purpose of selling or repurchasing them in the near term. From the reclassification date, the securities are revalued at fair value directly in equity through the revaluation of available-for-sale financial assets. Assessment for impairment is performed for these securities in accordance with IAS 39 requirements for available-for-sale financial assets. The disclosures below detail the impact of the reclassifications on the consolidated financial statements of the Group: 31 December June 2008 Carrying value Fair value Carrying and fair value Trading securities reclassified to available-for-sale financial assets Trading securities reclassified to investment securities held to maturity Trading securities reclassified to loans and advances to customers

121 120 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Recognised for reclassified assets 2008 Would have been recognized if the reclassifications were not made Interest income Gains /(losses) arising from trading in securities, net 266 (2 259) Gains arising from available-for-sale financial assets, net Loan impairment losses (157) - Provision for impairment of investment securities held to maturity (371) - Total recognised in profit and loss for the year (before tax) (770) Revaluation of available-for-sale financial assets (1 953) - Total recognised in equity (before tax) (300) (770) As at the reclassification date, effective interest rates on reclassified trading assets ranged from 4% to 18% with expected recoverable cash flows of RUR million. (t) Comparative information Certain comparative information has been reclassified to conform to changes in presentation in the current year, as follows. In prior periods the Group presented information for Corporate Banking, Retail Banking, Small Business Banking, Investment Banking and Financial Markets, Private Banking and Asset Management and Central Treasury segments as reportable business segments. Starting from 1 January 2008, following a change in internal management reporting and the way how information is presented internally to the chief operating decision maker of the Group, i) Retail Banking segment now includes the Small Business Banking segment; and ii) Corporate Banking, Investment Banking and Financial Markets, Private Banking and Asset Management together are included in the Corporate and Investment Banking segment. The Group has accordingly changed comparative information presented in Note 27 Analysis by Segment. (u) New standards and interpretations not yet adopted Certain new standards and interpretations have been published that are mandatory for the Group s accounting periods beginning on or after 1 January 2009 or later periods and which the Group has not early adopted: Puttable Financial Instruments and Obligations Arising on Liquidation - IAS 32 and IAS 1 Amendment (effective from 1 January 2009). The amendment requires classification as equity of some financial instruments that meet the definition of a financial liability. The Group does not expect the amendment to affect its consolidated financial statements. IAS 1, Presentation of Financial Statements (revised September 2008; effective for annual periods beginning on or after 1 January 2009). The main change in IAS 1 is the replacement of the income statement by a statement of comprehensive income which will also include all non-owner changes in equity, such as the revaluation of available-for-sale financial assets. Alternatively, entities will be allowed to present two statements: a separate income statement and a statement of comprehensive income. The revised IAS 1 also introduces a requirement to present a statement of financial position (balance sheet) at the beginning of the earliest comparative period whenever the entity restates comparatives due to reclassifications, changes in accounting policies, or corrections of errors. The Group expects the revised IAS 1 to affect the presentation of its financial statements but to have no impact on the recognition or measurement of specific transactions and balances. IAS 23, Borrowing Costs (revised March 2008; effective for annual periods beginning on or after 1 January 2009). The revised IAS 23 was issued in March The main change to IAS 23 is the removal of the option of immediately recognising as an expense borrowing costs that relate to assets that take a substantial period of time to get ready for use or sale. An entity is, therefore, required to capitalise such borrowing costs as part of the cost of the asset. The revised standard applies prospectively to borrowing costs relating to qualifying assets for which the commencement date for capitalisation is on or after 1 January

122 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) No changes will be made for borrowing costs incurred to this date that have been expensed, and management does not expect the revised IAS 23 to affect the Group s financial statements. IAS 27, Consolidated and Separate Financial Statements (revised January 2008; effective for annual periods beginning on or after 1 July 2009). The revised IAS 27 will require an entity to attribute total comprehensive income to the owners of the parent and to the non-controlling interests (previously minority interests ) even if this results in the non-controlling interests having a deficit balance (the current standard requires the excess losses to be allocated to the owners of the parent in most cases). The revised standard specifies that changes in a parent s ownership interest in a subsidiary that do not result in the loss of control must be accounted for as equity transactions. It also specifies how an entity should measure any gain or loss arising on the loss of control of a subsidiary. At the date when control is lost, any investment retained in the former subsidiary will have to be measured at its fair value. The Group does not expect the amended standard to have a material effect on its consolidated financial statements. Vesting Conditions and Cancellations Amendment to IFRS 2, Share-based Payment (issued in January 2008; effective for annual periods beginning on or after 1 January 2009). The amendment clarifies that only service conditions and performance conditions are vesting conditions. Other features of a share-based payment are not vesting conditions. The amendment specifies that all cancellations, whether by the entity or by other parties, should receive the same accounting treatment. The Group does not expect the amendment to have a material effect on its consolidated financial statements. IFRS 3, Business Combinations (revised January 2008; effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after 1 July 2009). The revised IFRS 3 will allow entities to choose to measure non-controlling interests using the existing IFRS 3 method (proportionate share of the acquiree s identifiable net assets) or at fair value. The revised IFRS 3 is more detailed in providing guidance on the application of the purchase method to business combinations. The requirement to measure at fair value every asset and liability at each step in a step acquisition for the purposes of calculating a portion of goodwill has been removed. Instead, in a business combination achieved in stages, the acquirer will have to remeasure its previously held equity interest in the acquiree at its acquisition date fair value and recognise the resulting gain or loss, if any, in profit or loss. Acquisition-related costs will be accounted for separately from the business combination and therefore recognised as expenses rather than included in goodwill. An acquirer will have to recognise at the acquisition date a liability for any contingent purchase consideration. Changes in the value of that liability after the acquisition date will be recognised in accordance with other applicable IFRS, as appropriate, rather than by adjusting goodwill. The revised IFRS 3 brings into its scope business combinations involving only mutual entities and business combinations achieved by contract alone. The Group is currently assessing the impact of the amended standard on its consolidated financial statements. Improvements to International Financial Reporting Standards (issued in May 2008). In 2007, the International Accounting Standards Board decided to initiate an annual improvements project as a method of making necessary, but non-urgent, amendments to IFRS. The amendments issued in May 2008 consist of a mixture of substantive changes, clarifications, and changes in terminology in various standards. The substantive changes relate to the following areas: classification as held for sale under IFRS 5 in case of a loss of control over a subsidiary; possibility of presentation of financial instruments held for trading as non-current under IAS 1; accounting for sale of IAS 16 assets which were previously held for rental and classification of the related cash flows under IAS 7 as cash flows from operating activities; clarification of definition of a curtailment under IAS 19; accounting for below market interest rate government loans in accordance with IAS 20; making the definition of borrowing costs in IAS 23 consistent with the effective interest method; clarification of accounting for subsidiaries held for sale under IAS 27 and IFRS 5; reduction in the disclosure requirements relating to associates and joint ventures under IAS 28 and IAS 31; enhancement of disclosures required by IAS 36; clarification of accounting for advertising costs under IAS 38; amending the definition of the fair value through profit or loss category to be consistent with hedge accounting under IAS 39; introduction of accounting for investment properties under construction in accordance with IAS 40; and reduction in restrictions over manner of determining fair value of biological assets under IAS 41. Further amendments made to IAS 8, 10, 18, 20, 29, 34, 40, 41 and to IFRS 7 represent terminology or editorial changes only, which the IASB believes have no or minimal effect on accounting. The Group does not expect the amendments to have any material effect on its consolidated financial statements.

123 122 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Other new standards or interpretations. The Group has not early adopted the following other new standards or interpretations: IFRIC 13, Customer Loyalty Programmes (effective for annual periods beginning on or after 1 July 2008). IFRIC 15, Agreements for the Construction of Real Estate (effective for annual periods beginning on or after 1 January 2009). IFRIC 16, Hedges of a Net Investment in a Foreign Operation (effective for annual periods beginning on or after 1 October 2008). IFRIC 17, Distribution of Non-Cash Assets to Owners (effective for annual periods beginning on or after 1 July 2009, with earlier application permitted). Cost of an Investment in a Subsidiary, Jointly Controlled Entity or Associate - IFRS 1 and IAS 27 Amendment (revised May 2008; effective for annual periods beginning on or after 1 January 2009). Unless otherwise described above, the new standards and interpretations are not expected to significantly affect the Group s consolidated financial statements. 5. Cash and Cash Equivalents 31 December December 2007 Cash on hand Correspondent accounts with central banks Correspondent accounts and overnight deposits with other banks Settlement accounts with trading systems Total cash and cash equivalents Correspondent accounts and overnight deposits with other banks comprise: 31 December December 2007 Investment grade international banks Russian subsidiaries of investment grade international banks Large Russian banks Other Russian banks Other foreign banks Total correspondent accounts and overnight deposits Investment grade international banks in the table above are multinational or OECD-based banks with investment grade ratings as at 31 December 2008 and 31 December 2007, respectively. An investment grade rating is an international rating of BBB- or above by Standard & Poor s, BBB- or above by Fitch and Baa3 or above by Moody s. Large Russian banks in the table above are the banks included in the top thirty Russian banks by total assets in accordance with the local accounting standards as at 31 December 2008 and 31 December 2007, respectively. As at 31 December 2008, the Group had tree counterparties with aggregated balances on correspondent accounts and overnight deposits greater than 10% of consolidated equity at that date (31 December 2007: two counterparties). The total aggregate amount of these balances was RUR million, or 25% of total cash and cash equivalents, as at 31 December 2008 (31 December 2007: RUR million, or 68% of total cash and cash equivalents). As at 31 December 2008 and 31 December 2007 the Group had obligations under its loan participation notes, secured by the Group s diversified payment rights ( DPR ), i.e. its rights to funds being transferred to the Group s USD and EUR correspondent accounts. As at 31 December 2008, the carrying amount of these notes was RUR million (31 December 2007: RUR million). Refer to Note 17. Geographical and currency analysis of cash and cash equivalents is disclosed in Note 28.

124 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Due from Other Banks 31 December December 2007 Current interbank loans Investment grade international banks Russian subsidiaries of investment grade international banks Large Russian banks Other foreign banks Other Russian banks Total current interbank loans Reverse sale and repurchase agreements Investment grade international banks Large Russian banks Other Russian banks Total reverse sale and repurchase agreements Due from other banks Investment grade international banks in the table above are the multinational or OECD-based banks with investment grade ratings as at 31 December 2008 and 31 December 2007, respectively. Refer to Note 5. Large Russian banks in the table above are the banks included in the top thirty Russian banks by total assets in accordance with the local accounting standards as at 31 December 2008 and 31 December 2007, respectively. As at 31 December 2008, the Group had two counterparties with aggregated balances greater than 10% of consolidated equity at that date (31 December 2007: one counterparty). The total aggregate amount of these balances was RUR million, or 34% of due from other banks balances, as at 31 December 2008 (31 December 2007: RUR million, or 25% of due from other banks balances). As at 31 December 2008, these balances included receivables from a large international bank due under a reverse sale and repurchase agreement of RUR million (31 December 2007: RUR million), which were pledged as collateral for term deposits of RUR million (31 December 2007: RUR million) received by one of the Group s subsidiaries from the same bank. Refer to Note 15. Securities received as collateral under reverse sale and repurchase agreements are marketable corporate bonds and equity securities. The following table presents information about the fair value of these securities: 31 December December 2007 Held by the Group Pledged under sale and repurchase agreements (Notes 11, 15 and 16) Securities received as collateral under reverse sale and repurchase agreements Included in due from other banks as at 31 December 2008 were loans to an international bank of RUR million pledged as collateral for interest and principal repayments in respect of loan participation notes secured by diversified payment rights (31 December 2007: RUR million). Refer to Note 17. Geographical and currency analysis, effective interest rates and maturity structure of due from other banks are disclosed in Note 28.

125 124 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 7. Trading Securities 31 December December Owned by the Group Government bonds Municipal bonds issued by Russian municipalities - 2 Russian Federal loan bonds (OFZ) - 1 Corporate debt and equity securities Corporate bonds Corporate Eurobonds Promissory notes Corporate shares Total trading securities owned by the Group Pledged under sale and repurchase agreements Government bonds Russian Federal loan bonds (OFZ) Municipal bonds issued by Russian municipalities - 80 Corporate debt and equity securities Corporate bonds Corporate Eurobonds Corporate shares Total trading securities pledged under sale and repurchase agreements Total trading securities Municipal bonds are securities issued by Russian municipalities denominated in Russian Roubles. Russian Federal loan bonds (OFZ) are securities issued by the Government of the Russian Federation denominated in Russian Roubles. Corporate bonds are interest-bearing securities, issued by Russian companies. Corporate Eurobonds are interest-bearing securities, issued by Russian or foreign companies. Promissory notes are debt securities of Russian companies denominated in Russian Roubles issued at a discount to nominal value. The majority of corporate shares are shares of Russian companies traded in the Moscow Interbank Currency Exchange (MICEX) or the Russian Trading System (RTS). The following table provides details of the Group s debt trading securities as at 31 December 2007: Maturity Coupon rate per annum Yield to maturity per annum Minimum Maximum Minimum Maximum Average Municipal bonds issued by Russian municipalities October 2011 October % 9.2% 8.5% Russian Federal loan bonds (OFZ) November 2021 November % 9.0% 6.5% Corporate bonds April 2008 November % 14.1% 10.5% Corporate eurobonds April 2009 December % 11.0% 10.3% Promissory notes March 2008 July %

126 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 125 The following table provides information on the credit quality of the Group s corporate debt securities based on Standard & Poor s, Fitch and Moody s international ratings as at 31 December 2007: 31 December 2007 Corporate bonds owned by the Group Credit rating between BB+ and BBB Credit rating BB and below Not rated Total corporate bonds owned by the Group Promissory notes owned by the Group Credit rating BB and below 109 Not rated 208 Total promissory notes owned by the Group 317 Corporate bonds pledged under sale and repurchase agreements Credit rating between BB+ and BBB+ 504 Credit rating BB and below Not rated 331 Total corporate bonds pledged under sale and repurchase agreements Geographical and currency analysis, effective interest rates and maturity structure of trading securities are disclosed in Note 28. Information on related party transactions is disclosed in Note Derivative Financial Instruments The fair values of derivative instruments held by the Group are set out in the following table: 31 December December 2007 Contract/ Fair values Contract/ Fair values notional notional amount Assets Liabilities amount Assets Liabilities Foreign exchange derivative contracts - currency forwards (1 137) (421) - currency futures Precious metals derivative contracts - precious metals forwards (6) (6) Securities derivative contracts - securities forwards (25) - stock index forwards (1 175) written securities put options Other derivative contracts - cross currency interest rate swaps (54) (70) - balance guaranteed cross currency interest rate swaps (352) - commodity swaps Total recognised derivative assets/ (liabilities) (2 372) 260 (874)

127 126 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Derivative financial instruments are generally traded in an over-the-counter market with professional market counterparties on standardised contractual terms and conditions or exchange traded. The notional amounts of certain types of financial instruments provide a basis for comparison with instruments recognised on the balance sheet but do not necessarily indicate the amounts of future cash flows involved or the current fair value of the instruments and, therefore, do not indicate the Group s exposure to credit or price risks. The derivative instruments become favourable (positive fair value) or unfavourable (negative fair value) as a result of fluctuations in market rates relative to their terms. The aggregate contractual or notional amount of derivative financial instruments on hand, the extent to which instruments are favourable or unfavourable and, thus, the aggregate fair values of derivative financial assets and liabilities can fluctuate significantly over time. Currency, precious metal and securities forwards are over-the-counter contracts which establish terms and conditions of a deal which is settled at a future date. Currency futures are exchange traded contracts which establish terms and conditions of a deal which is settled at a future date. Stock index forwards are over-the-counter contracts whereby one party pays the other party the difference between a specified index as at contract date and settlement date. Written securities put options as at 31 December 2007 are put options expired in March 2008 written by the Group to a major international bank in respect of bonds issued by a Russian entity with a total nominal amount of USD 10 million, or RUR 245 million. As at 31 December 2007, the market price of the underlying bonds was significantly above the exercise price. Further, the Group had the right to terminate the options before maturity under certain conditions related to the price of the underlying bonds. Based on these facts, management of the Group estimated that, as at 31 December 2007, the fair value of the related liability was nil. Cross currency interest rate swaps are over-the-counter contracts whereby one party swaps principal and interest payments in one currency determined using a fixed or floating interest rate for principal and interest payments in other currency determined using a floating or fixed interest rate. Balance guaranteed cross currency interest rate swaps are swap agreements with major international banks, in which the Group entered as a part of its car loans securitisation transaction. Under the terms of the swap agreements all RUR or USD denominated fixed rate amounts received by the Group from car loans pledged as collateral under its loan participation notes are swapped for USD floating rate amounts which are then used for repayment of the loan participation notes. Refer to Note 17. Derivatives which are embedded in financial instruments measured at fair value through profit or loss are not included in the above table. As at 31 December 2007, these derivatives comprised derivatives embedded into credit-linked leveraged notes of RUR 226 million included within other assets (Refer to Note 13). The maximum losses of the Group in respect of these embedded derivatives were limited to the carrying value of the related financial instruments.

128 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 127 Remaining maturity, fair value and weighted average exchange rate breakdowns for forward and future currency contracts as at 31 December 2008 are set out in the following table: Contract/ notional amount Weighted average contracted exchange rates Assets Fair values Liabilities Forwards Buy USD sell RUR Less than three months Between three months and one year Buy RUR sell USD Less than three months (126) Between three months and one year (61) Buy USD sell EUR Less than three months (1) Buy EUR sell USD Less than three months (887) Buy RUR sell EUR Less than three months (27) Buy CHF sell USD Less than three months Buy USD sell CHF Less than three months (9) Buy JPY sell USD Less than three months (18) Buy USD sell JPY Less than three months Buy EUR sell LVL Less than three months (7) Other Less than three months (1) Futures Buy USD sell RUR Less than three months Between three months and one year Buy RUR sell USD Less than three months Between three months and one year Buy RUR sell EUR Less than three months Buy EUR sell RUR Less than three months Total (1 137)

129 128 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Remaining maturity, fair value and weighted average exchange rate breakdowns for forward and future currency contracts as at 31 December 2007 are set out in the following table: Contract/ notional amount Weighted average contracted exchange rates Fair values Assets Liabilities Forwards Buy USD sell RUR Less than three months (128) Between three months and one year (16) Buy RUR sell USD Less than three months (24) Between three months and one year (5) Buy USD sell EUR Less than three months (25) Buy EUR sell USD Less than three months Buy EUR sell RUR Less than three months (13) Buy USD sell CHF Less than three months (35) Buy CHF sell USD Less than three months Buy USD sell JPY Less than three months (95) Buy JPY sell USD Less than three months Buy EUR sell LVL Less than three months (78) Other Less than three months Between three months and one year (2) Futures Buy USD sell RUR Less than three months Between three months and one year Buy RUR sell USD Less than three months Between three months and one year Total (421) Geographical, currency analysis and maturity structure of derivative financial instruments are disclosed in Note 28. Information on related party transactions is disclosed in Note 31.

130 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Available-for-Sale Financial Assets 31 December December Owned by the Group Corporate debt and equity securities Corporate bonds Corporate Eurobonds Promissory notes Corporate shares Investments in mutual funds Total available-for-sale financial assets owned by the Group Pledged under sale and repurchase agreements Corporate debt and equity securities Corporate bonds Total available-for-sale financial assets pledged under sale and repurchase agreements Total available-for-sale financial assets As at 31 December 2008 and 31 December 2007, investments in mutual funds comprise the Group s share in a closed mutual investment fund aimed at investment projects in the South of Russia. The following table provides details of the Group s debt available-for-sale securities as at 31 December 2008: Maturity Coupon rate per annum Yield to maturity per annum Minimum Maximum Minimum Maximum Average Corporate bonds February 2009 October % 18.0% 43.1% Corporate Eurobonds January 2009 April % 13.5% 33.4% Promissory notes March 2009 November % The following table provides information on the credit quality of the Group s corporate debt securities based on Standard & Poor s, Fitch and Moody s international ratings as at 31 December 2008: 31 December 2008 Corporate bonds owned by the Group Credit rating BB and below Not rated Total corporate bonds owned by the Group Corporate Eurobonds owned by the Group Credit rating between BB+ and BBB+ 132 Credit rating BB and below Not rated 925 Total corporate bonds owned by the Group Promissory notes owned by the Group Credit rating between BB+ and BBB+ 754 Not rated 309 Total promissory notes owned by the Group Corporate bonds pledged under sale and repurchase agreements Credit rating between BB+ and BBB+ 130 Credit rating BB and below 249 Total corporate bonds pledged under sale and repurchase agreements 379 Geographical and currency analysis and maturity structure of available-for-sale financial assets are disclosed in Note 28.

131 130 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 10. Investment Securities Held to Maturity Included in investment securities held to maturity as at 31 December 2008, are corporate bonds issued by one Russian company denominated in Russian Rubles with a carrying value of RUR 479 million, a coupon rate of 7.75% and maturity date of 14 June As at 31 December 2008 provision for impairment in amount of RUR 371 million was recognised in respect of these bonds. 11. Loans and Advances to Customers 31 December December 2007 Loans to corporate customers Loans to individuals Investment banking loans Small business loans Net investment in finance leases Gross loans and advances to customers Less: loan impairment (12 203) (6 194) Loans and advances to customers (a) Loan impairment Movements in loan impairment by classes of loans to customers for the year ended 31 December 2008 are as follows: Loans to corporate customers Loans to individuals Investment banking loans Small business loans Net investment in finance leases Total Loan impairment as at 1 January Loan impairment losses during the year Transfer of impairment losses on terminated lease contracts to other assets (249) (249) Loans written off during the year as uncollectible (53) (4) - (26) - (83) Loans sold during the year (220) (666) - (1) - (887) Effect of foreign currency translation Loan impairment as at 31 December Movements in loan impairment by classes of loans to customers for the year ended 31 December 2007 are as follows: Loans to corporate customers Loans to individuals Investment banking loans Small business loans Net investment in finance leases Total Loan impairment as at 1 January Loan impairment losses during the year Loans written off during the year as uncollectible (81) (8) (89) Loans sold during the year (38) (163) (201) Effect of foreign currency translation (50) (39) - (7) (2) (98) Loan impairment as at 31 December Loans sold during the year ended 31 December 2008 comprised loans to corporate customers with a gross book value of RUR 297 million against which an impairment allowance of RUR 220 million was recognised, which were sold for RUR 44 million, and loans to individuals with a gross book value of RUR 769 million against which an impairment allowance of RUR 666 million was recognised, which were sold for RUR 67 million.

132 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 131 Included in loans and advances to customers, as at 31 December 2008, was interest accrued on loans individually assessed for impairment of RUR 372 million (31 December 2007: RUR 22 million). The Group has reviewed its loan portfolio as at 31 December 2008 and recognised loan impairment as follows: Gross loans Impairment Net loans Impairment to Gross loans (%) Loans to corporate customers Collectively assessed for impairment Standard loans not past due (2 106) Watch list loans not past due (682) Total collectively assessed for impairment (2 788) Individually assessed for impairment Watch list loans not past due (992) Overdue loans (2 709) Non-recoverable loans 804 (804) Total individually assessed for impairment (4 505) Total loans to corporate customers (7 293) Loans to individuals Loans to individuals collectively assessed for impairment Standard loans to finance purchase of cars (1 359) Express loans to finance purchase of cars (613) Mortgage loans (498) Credit card overdrafts (207) Other loans to individuals (182) Total loans to individuals (2 859) Investment banking loans Collectively assessed for impairment Margin loans fully secured by traded securities Reverse sale and repurchase agreements Other standard loans (215) Total collectively assessed for impairment (215) Individually assessed for impairment Non-recoverable loans 23 (23) Total individually assessed for impairment 23 (23) Total investment banking loans (238) Small business loans Collectively assessed for impairment Standard loans to legal entities not past due (362) Watch list loans to legal entities not past due (111) Loans to individual entrepreneurs (193) Total collectively assessed for impairment (666) Individually assessed for impairment Watch list loans not past due 23 (5) Overdue loans 550 (146) Non-recoverable loans 503 (503) Total individually assessed for impairment (654) Total small business loans (1 320)

133 132 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Gross loans Impairment Net loans Impairment to Gross loans (%) Net investment in finance leases Collectively assessed for impairment (46) Individually assessed for impairment (447) Total net investment in finance leases (493) Total loans and advances to customers (12 203) Management of the Group believes that receivables under reverse repurchase agreements and margin loans, which are fully collateralised by pledge of securities with fair value exceeding the loan amount as at that date, are not impaired. As at 31 December 2008 renegotiated loans to corporate customers that would otherwise be past due or impaired of RUR million are included in Group s loan portfolio (31 December 2007: RUR 572 million). Such restructuring activity is aimed at managing customer relationships and maximising collection opportunities. Express loans to finance purchase of cars are loans for which simplified credit approval procedures are used. The following table shows gross loans and advances to customers and related loan impairment, as at 31 December 2007: Gross loans Impairment Net loans Impairment to Gross loans (%) Loans to corporate customers Collectively assessed for impairment Standard loans not past due (1 345) Watch list loans not past due (527) Total collectively assessed for impairment (1 872) Individually assessed for impairment Watch list loans not past due (248) Overdue loans 15 (1) Non-recoverable loans (1 014) Total individually assessed for impairment (1 263) Total loans to corporate customers (3 135) Loans to individuals Loans to individuals collectively assessed for impairment Standard loans to finance purchase of cars (1 081) Express loans to finance purchase of cars (973) Mortgage loans (193) Credit card overdrafts (145) Other loans to individuals (68) Total loans to individuals (2 460) Investment banking loans Collectively assessed for impairment Margin loans fully secured by traded securities Reverse sale and repurchase agreements Other standard loans (23) Total investment banking loans (23)

134 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 133 Gross loans Impairment Net loans Impairment to Gross loans (%) Small business loans Collectively assessed for impairment Standard loans to legal entities not past due (205) Watch list loans to legal entities not past due 510 (15) Loans to individual entrepreneurs (11) Total collectively assessed for impairment (231) Individually assessed for impairment Overdue loans 137 (62) Non-recoverable loans 160 (160) Total individually assessed for impairment 297 (222) Total small business loans (453) Net investment in finance leases Collectively assessed for impairment (32) Individually assessed for impairment (91) Total net investment in finance leases (123) Total loans and advances to customers (6 194) The following table shows the ageing analysis of loans to individuals as at 31 December 2008: Gross loans Impairment Net loans Impairment to Gross loans (%) Standard loans to finance purchase of cars - Not past due (56) Overdue less than 30 days 681 (56) Overdue days 390 (133) Overdue days 182 (135) Overdue days 234 (212) Overdue more than 360 days 767 (767) Total loans to finance purchase of cars (1 359) Express loans to finance purchase of cars - Not past due (13) Overdue less than 30 days 165 (13) Overdue days 109 (33) Overdue days 61 (42) Overdue days 116 (104) Overdue more than 360 days 408 (408) Total express loans to finance purchase of cars (613) Mortgage loans - Not past due (42) Overdue less than 30 days 389 (48) Overdue days 216 (83) Overdue days 77 (62) Overdue days 125 (118) Overdue more than 360 days 145 (145) Total mortgage loans (498)

135 134 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Gross loans Impairment Net loans Impairment to Gross loans (%) Credit card overdrafts - Not past due (12) Overdue less than 30 days 75 (11) Overdue days 54 (26) Overdue days 30 (23) Overdue days 58 (51) Overdue more than 360 days 84 (84) Total credit card overdrafts (207) Other loans to individuals - Not past due (26) Overdue less than 30 days 151 (29) Overdue days 44 (26) Overdue days 27 (24) Overdue days 30 (29) Overdue more than 360 days 48 (48) Total other loans to individuals (182) Total loans to individuals (2 859) The following table shows the ageing analysis of loans to individuals as at 31 December 2007: Gross loans Impairment Net loans Impairment to Gross loans (%) Standard loans to finance purchase of cars - Not past due (70) Overdue less than 30 days 519 (44) Overdue days 207 (87) Overdue days 156 (120) Overdue days 276 (258) Overdue more than 360 days 502 (502) Total loans to finance purchase of cars (1 081) Express loans to finance purchase of cars - Not past due (39) Overdue less than 30 days 301 (29) Overdue days 167 (70) Overdue days 147 (104) Overdue days 301 (263) Overdue more than 360 days 468 (468) Total express loans to finance purchase of cars (973) Mortgage loans - Not past due (31) Overdue less than 30 days 161 (19) Overdue days 67 (29) Overdue days 82 (57) Overdue days 53 (47) Overdue more than 360 days 10 (10) Total mortgage loans (193)

136 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 135 Gross loans Impairment Net loans Impairment to Gross loans (%) Credit card overdrafts - Not past due (6) Overdue less than 30 days 52 (6) Overdue days 42 (14) Overdue days 23 (15) Overdue days 34 (30) Overdue more than 360 days 74 (74) Total credit card overdrafts (145) Other loans to individuals - Not past due (9) Overdue less than 30 days 26 (2) Overdue days 13 (3) Overdue days 8 (4) Overdue days 12 (10) Overdue more than 360 days 40 (40) Total other loans to individuals (68) Total loans to individuals (2 460) The table below shows the ageing analysis of loans to corporate customers which were individually assessed for impairment, as at 31 December 2008: Impairment to Gross loans Impairment Net loans Gross loans (%) Watch list loans not past due (992) Overdue loans - Overdue less than 30 days (170) Overdue from 30 to 90 days (1 792) Overdue from 90 to 180 days 942 (214) Overdue from 180 to 360 days 918 (509) Overdue more than 360 days 43 (24) Total overdue loans (2 709) Non-recoverable loans - Overdue less than 360 days 147 (147) Overdue more than 360 days 657 (657) Total non-recoverable loans 804 (804) Total loans to corporate customers individually assessed for impairment (4 505)

137 136 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) The table below shows the ageing analysis of loans to corporate customers which were individually assessed for impairment, as at 31 December 2007: Gross loans Impairment Net loans Impairment to Gross loans (%) Watch list loans not past due (248) Overdue loans - Overdue less than 30 days 15 (1) Total overdue loans 15 (1) Non-recoverable loans - Overdue less than 360 days 113 (113) Overdue more than 360 days 901 (901) Total non-recoverable loans (1 014) Total loans to corporate customers individually assessed for impairment (1 263) The table below shows the ageing analysis of small business loans which were individually assessed for impairment, as at 31 December 2008: Gross loans Impairment Net loans Impairment to gross loans (%) Watch list loans not past due 23 (5) Overdue loans - Overdue less than 30 days 149 (19) Overdue days 229 (67) Overdue days 73 (28) Overdue days 94 (31) Overdue more than 360 days 5 (1) Total overdue loans 550 (146) Non-recoverable loans - Overdue less than 360 days 350 (350) Overdue more than 360 days 153 (153) Total non-recoverable loans 503 (503) Total small business loans individually assessed for impairment (654) The table below shows the ageing analysis of small business loans which were individually assessed for impairment, as at 31 December 2007: Gross loans Impairment Net loans Impairment to gross loans (%) Overdue loans - Overdue less than 30 days 54 (4) Overdue days 16 (9) Overdue days 35 (21) Overdue days 32 (28) Total overdue loans 137 (62) Non-recoverable loans - Overdue less than 360 days 128 (128) Overdue more than 360 days 32 (32) Total non-recoverable loans 160 (160) Total small business loans individually assessed for impairment 297 (222)

138 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 137 The table below shows the ageing analysis of finance lease contracts which were individually assessed for impairment, as at 31 December 2008: Impairment to Gross loans Impairment Net loans Gross loans (%) Watch list contracts not past due 83 (24) Overdue finance lease contracts - Overdue less than 30 days 293 (31) Overdue days 283 (29) Overdue days 256 (125) Overdue days 367 (193) Overdue more than 360 days 103 (45) Total overdue finance lease contracts (423) Total finance lease contracts assessed for impairment (447) The table below shows the ageing analysis of finance lease contracts which were individually assessed for impairment, as at 31 December 2007: Gross loans Impairment Net loans Impairment to Gross loans (%) Overdue financial lease contracts - Overdue less than 30 days (33) Overdue days 357 (58) Total overdue finance lease contracts (91) Total financial lease contracts individually assessed for impairment (91) Non-performing loans comprise loans with principal or/and interest overdue by more than 90 days and other loans classified as non-performing by management. A loan is usually classified as non-performing by management if it is not probable that it will be recovered through means other than repossession and subsequent realization of collateral. The amounts of non-performing loans as at 31 December 2008 and 31 December 2007 are as follows: 31 December December 2007 Loans to corporate customers Loans to individuals Investment banking loans 23 - Small business loans Net investment in finance leases Total non-performing loans The loan portfolio as at 31 December 2008 included overdue loans totalling RUR million (31 December 2007: RUR million).

139 138 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) (b) Collateral The following table provides an analysis of the loan portfolio, net of impairment, by types of collateral as at 31 December 2008: Securities Real estate Motor vehicles Other realisable collateral Other collateral No collateral Total Loans to corporate customers Loans to individuals Investment banking loans Small business loans Net investment in finance leases Total The following table provides an analysis of the loan portfolio, net of impairment, by types of collateral as at 31 December 2007: Securities Real estate Motor vehicles Other realisable collateral Other collateral No collateral Total Loans to corporate customers Loans to individuals Investment banking loans Small business loans Net investment in finance leases Total The amounts shown in the tables above represent the carrying value of the loans, and do not necessarily represent the fair value of the collateral. Other realisable collateral is collateral, which, in the opinion of the Group s management, the Group will be able to sell to reduce losses in case of a loan default. Other collateral is collateral which the Group may not be able to sell easily in the market in order to recover the loan. Such collateral may include goods in turnover, corporate or personal guarantees and it is used by the Group as a tool in the process of negotiations with the borrower in case of loan default. Loans issued to finance purchase of cars are secured by underlying cars. The majority of credit card overdrafts and other loans to individuals are not secured. Mortgage loans are secured by underlying real estate. Loans to corporate customers individually assessed for impairment with gross value of RUR million were secured by collateral with fair value of RUR million, as at 31 December 2008 (31 December 2007: loans individually assessed for impairment with gross value of RUR 71 million were secured by collateral with fair value of RUR 99 million). There was no collateral or it is impracticable to determine fair value of collateral for other overdue or impaired loans. During the year ended 31 December 2008 the Group obtained assets by taking control of collateral accepted as security with fair value of RUR 264 million (31 December 2007: assets with fair value of RUR 129 million), of which assets totalling RUR 113 million were sold by the Group in the same period (31 December 2007: assets with fair value of RUR 49 million). Securities received as collateral under reverse sale and repurchase agreements are marketable corporate bonds and equity securities. The following table presents information about the fair value of these securities: 31 December December 2007 Held by the Group Pledged under sale and repurchase agreements (Notes 6, 15 and 16) Securities received as collateral under reverse sale and repurchase agreements

140 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 139 (c) Finance leases Loans and advances to customers include finance lease receivables, which are analysed as follows: 31 December December 2007 Gross investment in finance leases, receivable: - Not later than 1 year Later than 1 year and not later than 5 years Later than 5 years - 37 Less: Unearned finance income (580) (889) Net investment in finance leases Net investment in finance leases are analysed as follows: 31 December December 2007 Net investment in finance leases, receivable: - Not later than 1 year Later than 1 year and not later than 5 years Later than 5 years - 30 Net investment in finance leases (d) Pledged loans and asset securitisation The Group has transferred a pool of loans to individuals to finance the purchase of cars to Taganka Car Loan Finance plc, an entity which is in substance controlled by the Group. Accordingly, the financial statements of Taganka Car Loan Finance plc are consolidated into these consolidated financial statements and the loans are included in the consolidated balance sheet. These loans are pledged by the Group as collateral under secured loan participation notes issued by the Group. As at 31 December 2008, the amount of loans pledged was RUR million (31 December 2007: RUR million). As at 31 December 2008, the carrying amount of the notes was RUR million (31 December 2007: RUR million). Refer to Note 17. (e) Concentration analysis As at 31 December 2008, credit exposure to ten largest borrowers (or groups of borrowers), excluding claims under reverse repurchase agreements fully secured by traded securities, totalled RUR million, or 11% of the gross loan portfolio of the Group (31 December 2007: RUR million, or 11% of the gross loan portfolio). Economic sector risk concentrations within the customer loan portfolio are as follows: 31 December December 2007 Amount % Amount % Individuals Retail trade Real estate Manufacturing Wholesale trade Construction Finance Ore Chemicals Transport Food and agriculture Oil and gas Metallurgy Communication Energy and atomic power Other Gross loans and advances to customers

141 140 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Geographical and currency analysis, effective interest rates and maturity structure of loans and advances to customers are disclosed in Note 28. Information on related party transactions is disclosed in Note Property, Plant and Equipment and Intangible Assets The reconciliation of the carrying amount of property, plant and equipment and intangible assets as at 31 December 2008 and as at 1 January 2008 is presented below: Premises Office, computer and other Fixtures and equipment fittings Total property, plant and equipment Intangible assets Total property, plant and equipment and intangible assets Net book amount as at 1 January Cost or valuation Opening balance Additions (Note 27) Disposals - (37) (22) (59) - (59) Effect of foreign currency translation Closing balance Accumulated depreciation, amortisation and impairment Opening balance Depreciation and amortisation charge (Note 27) Disposals - (30) (13) (43) - (43) Effect of foreign currency translation Closing balance Net book amount as at 31 December The reconciliation of the carrying amount of property, plant and equipment and intangible assets as at 31 December 2007 and as at 1 January 2007 is presented below: Premises Office, computer and other equipment Fixtures and fittings Total property, plant and equipment Intangible assets Total property, plant and equipment and intangible assets Net book amount as at 1 January Cost or valuation Opening balance Additions (Note 27) Disposals (654) (34) (44) (732) - (732) Elimination of accumulated depreciation of revalued assets (101) - - (101) - (101) Effect of foreign currency translation Revaluation Closing balance

142 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 141 Premises Office, computer and other equipment Fixtures and fittings Total property, plant and equipment Intangible assets Total property, plant and equipment and intangible assets Accumulated depreciation, amortisation and impairment Opening balance Depreciation and amortisation charge (Note 27) Disposals (19) (26) (8) (53) - (53) Effect of foreign currency translation Elimination of accumulated depreciation of revalued assets (101) - - (101) - (101) Closing balance Net book amount as at 31 December As at 31 December 2007 premises of the Group were revalued by management based on the results of independent appraisals performed by an independent firm of appraisers, which resulted in a revaluation increase of RUR million. As at 31 December 2008 the Group has assessed the market value of its premises and concluded that the market value is not materially different from their carrying value. Included in the net book value of premises as at 31 December 2008 was RUR million (31 December 2007: RUR million) representing the revaluation surplus. The net book value of premises that would have been recognised under the historical cost method was RUR million as at 31 December 2008 (31 December 2007: RUR million). The gross book value of fully depreciated property, plant and equipment that was still in use was RUR 347 million as at 31 December 2008 (31 December 2007: RUR 229 million). 13. Other Assets 31 December December 2007 Amounts in course of settlement Claims and repossessed collateral on terminated finance lease contracts Current income tax prepayment Trade debtors and prepayments Prepaid taxes other than income tax Precious metals Settlements on securities transactions Advances to suppliers of equipment for finance leases Deferred tax asset Credit-linked leveraged notes Other Gross other assets Less: other assets impairment (677) (5) Other assets

143 142 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Movements in other assets impairment are as follows: Year ended 31 December 2008 Year ended 31 December 2007 Other assets impairment as at 1 January 5 2 Net charge to other assets impairment during the year Transfer of loan impairment losses on terminated lease contracts Write-offs (95) - Other assets impairment as at 31 December Claims and repossessed collateral on terminated finance lease contracts represent equipment repossessed from non-performing debtors on finance lease arrangements and claims to insurance companies on agreements where the lease equipment has been destroyed or significantly damaged to the extent qualifying for termination of the leased agreement. Credit-linked leveraged notes are financial assets designated at fair value through profit or loss. Credit-linked leveraged notes as at 31 December 2007 were notes issued by a major international bank, the repayment amount of which was linked to the market price of a certain bond issued by a Russian entity. Credit-linked leveraged notes, as at 31 December 2007, comprised notes with a nominal amount of USD 9 million or RUR 221 million, a coupon rate of 17.24% and a maturity date of 20 February Specific provisions are recorded against other assets if impairment is identified. The recoverable amount of other financial assets is calculated based on discounted expected future cash flows the recoverable amount of other non-financial assets represents the higher of fair value less costs to sell and value in use. Included in other assets impairment losses for the year ended 31 December 2008 is the amount of RUR 329 million representing the write-off of capitalised expenses on new core banking system development, for which no future economic benefits are expected to be received in the foreseeable future due to the decision of the management of the Group to suspend program s development; and the amount of RUR 249 million representing provision for impairment of repossessed collateral on terminated finance lease contracts transferred from loan impairment losses at termination of the contracts; and provisions for other impaired assets in the amount of RUR 99 million. Geographical and currency analysis and maturity structure of other assets are disclosed in Note Due to Central Banks Due to central banks represent sale and repurchase agreements in the amount of RUR 317 million (31 December 2007: RUR 846 million) collaterised by the eligible available for sale financial assets with a fair value of RUR 369 and uncollaterised term deposits in the amount RUR million. As at 31 December 2008 the total limit of such uncollaterised deposits available to the Group comprised RUR million. Geographical and currency analysis and maturity structure of due to central banks are disclosed in Note Due to Other Banks 31 December December 2007 Trade finance facilities Loans from international financial institutions Term deposits from other banks Bilateral structured financing Syndicated loans Correspondent accounts and overnight deposits of other banks Sale and repurchase agreements Total due to other banks

144 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 143 As at 31 December 2008, the Group had four counterparties with aggregate balances greater than 10% of consolidated equity at the date (31 December 2007: six counterparties). The total aggregate amount of these balances was RUR million or 41% of due to other banks balances (31 December 2007: RUR million, or 38% of due to other banks balances). Included in due to other banks balances, as at 31 December 2008, were term deposits received from a large international bank of RUR million (31 December 2007: RUR million), in respect of which the Group pledged its receivable under a reverse sale and repurchase agreement from the same bank of RUR million (31 December 2007: RUR million) as collateral. Refer to Note 6. The following table presents information about assets sold under sale and repurchase agreements with other banks: 31 December December 2007 Securities received as collateral under reverse sale and repurchase agreements, fair value (Notes 6, 11 and 16) Trading securities, carrying value (Note 7 and 16) Total assets sold under sale and repurchase agreements with other banks In August 2008, the Group obtained a syndicated loan from an international financial institution in total amount of USD 535 million (equivalent to RUR million as at 31 December 2008). The loan bears a floating interest rate and is repayable in two tranches: tranche A in the amount of USD 500 million is repayable in July 2009 and tranche B in the amount of USD 35 million is repayable in March Geographical and currency analysis, effective interest rates and maturity structure of due to other banks are disclosed in Note Customer Accounts 31 December December 2007 State organisations - Current/settlement accounts Term deposits Other legal entities - Current/settlement accounts Term deposits Sale and repurchase agreements Retail customers - Current/demand accounts Term deposits Total customer accounts The following table presents information about assets sold under sale and repurchase agreements with customers: 31 December December 2007 Securities received as collateral under reverse sale and repurchase agreements, fair value (Notes 6, 11 and 15) Trading securities, carrying value (Note 7 and 15) Total assets sold under sale and repurchase agreements with customers

145 144 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Economic sector concentrations within customer accounts are as follows: 31 December December 2007 Amount % Amount % Individuals Trade Finance Manufacturing State Mining and oil Intergovernmental organisations Other Total customer accounts As at 31 December 2008, aggregate balances of the ten largest customers (or groups of customers) totalled RUR million or 35% of total customer accounts (31 December 2007: RUR million, or 43% of total customer accounts). As at 31 December 2008, the Group had three customers with aggregated accounts greater than 10% of consolidated equity at the date (31 December 2007: four customers). The total aggregate amount of these accounts was RUR million or 18% of the total customer accounts (31 December 2007: RUR million or 32% of the total customer accounts). Included in customer accounts, as at 31 December 2008, was an amount of RUR million held as collateral for irrevocable commitments under import letters of credit (31 December 2007: RUR million). Geographical and currency analysis, effective interest rates and maturity structure of customer accounts are disclosed in Note 28. Information on related party transactions is disclosed in Note Debt Securities in Issue 31 December December 2007 Unsecured loan participation notes Loan participation notes secured by diversified payment rights ( DPR ) Promissory notes Loan participation notes secured by a pool of car loans Domestic bonds Deposit certificates Total debt securities in issue Loan participation notes, bonds issued, promissory notes and deposit certificates are unconditional debt instruments issued by the Group. As at 31 December 2008 loan participation notes and bonds comprised the following issues: Carrying amount Issue date Maturity Coupon rate Russian bonds denominated in RUR October October % Tranche C (junior) loan participation notes secured by a pool of car loans: October November 2013 Libor + 3.3% Loan participation notes secured by diversified payment rights denominated in EUR November December 2011 Euribor + 2% Loan participation notes secured by diversified payment rights denominated in USD May June 2012 Libor + 2% Unsecured loan participation notes denominated in USD January January % Unsecured loan participation notes denominated in USD March March %

146 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 145 As at 31 December 2007 loan participation notes and bonds comprise the following issues: Carrying amount Issue date Maturity Coupon rate Russian bonds denominated in RUR October October % Loan participation notes secured by a pool of car loans: - tranche A (senior) October November 2013 Libor + 1% - tranche B (sub-senior) October November 2013 Libor + 1.6% - tranche C (junior) October November 2013 Libor + 3.3% Loan participation notes secured by diversified payment rights denominated in EUR November December 2011 Euribor + 2% Loan participation notes secured by diversified payment rights denominated in USD May June 2012 Libor + 2% Unsecured loan participation notes denominated in USD January January % Unsecured loan participation notes denominated in USD October October % Maturity dates in the tables above represent latest contractual dates when the last payment under the notes is due. Loan participation notes secured by diversified payment rights and loan participation notes secured by a pool of car loans have quarterly and monthly repayments, respectively. Loan participation notes secured by a pool of car loans may be repaid before contractual repayment dates in case of earlier repayment of underlying car loans. As at 31 December 2008, the expected repayment date of loan participation notes secured by a pool of car loans is 15 August 2009 for tranche C (31 December 2007: 15 March 2008, 15 November 2008 and 15 August 2009 for tranches A, B and C, respectively). In October 2007, the Group repurchased its own fixed rate RUR denominated bonds with an aggregate nominal amount of RUR million issued in October 2006 from investors at par value under the early redemption option. The bonds were reissued by the Group in October 2007 with a discount of 2.4% to par value, and a coupon rate of 8.5%. In October 2008, the Group repurchased 90.6% of these bonds with an aggregate nominal amount of RUR million from investors at par value under the early redemption option. The bonds have a maturity date in October In October 2006, the Group issued three tranches of loan participation notes totaling USD million secured by a pool of car loans with a carrying value of RUR million, as at 31 December 2008 (31 December 2007: RUR million). Total amounts of tranche A, tranche B and tranche C notes on the issue date were USD million, USD 77.4 million, and USD 54.8 million, respectively. The issue proceeds net of transaction costs amounted to USD 395 million. The notes have monthly repayments. Under the conditions of the notes, more senior tranches are repaid first. During year ended 31 December 2008, the Group fully repaid Tranches A and B of the notes. As a part of this transaction, the Group entered into balance guaranteed cross currency interest rate swap agreements with major international banks. Under conditions of the swap agreements, all RUR or USD denominated fixed rate amounts received by the Group from car loans pledged as collateral under its loan participation notes are swapped for USD floating rate amounts which are then used for repayment of the loan participation notes. Refer to Notes 8 and 11. In November 2006, the Group issued floating rate loan participation notes of USD 200 million and EUR 225 million secured by the Group s diversified payment rights, i.e. its rights to funds being transferred to the Group s USD and EUR correspondent accounts. The issue proceeds net of transaction costs amounted to USD 198 million and EUR 223 million. The principal of the notes is repaid quarterly by equal installments with a final maturity on 15 December In May 2007, the Group issued additional loan participation notes of USD 350 million secured by the Group s diversified payment rights while loan participation notes of USD 200 million issued in November 2006 were repaid. The issue proceeds net of transaction costs amounted to USD 345 million. The principal of the notes is repaid quarterly by equal installments with a final maturity on 15 June Included in due from other banks balances, as at 31 December 2008 are loans to a large

147 146 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) international bank of RUR million (31 December 2007: RUR million) pledged as collateral for interest and principal repayments in respect of these notes. Refer to Note 6. In January 2007, the Group issued fixed rate loan participation notes with an aggregate nominal amount of USD 425 million. The issue proceeds net of transaction costs amounted to USD 423 million. In March 2008, the Group issued fixed rate loan participation notes with an aggregate nominal amount of USD 53 million. The issue proceeds net of transaction costs amounted to RUR million. Geographical and currency analysis, effective interest rates and maturity structure of debt securities in issue are disclosed in Note Subordinated Debt 31 December December 2007 Subordinated loan participation notes Total subordinated debt In July 2006, the Group issued USD 200 million fixed rate subordinated unsecured notes maturing in July 2011 with a coupon rate of 9.75% per annum. The issue proceeds net of transaction costs were USD 199 million. In case of bankruptcy, the repayment of the subordinated loan participation notes shall be made after repayment in full of all other liabilities of the Bank. Geographical and currency analysis, effective interest rates and maturity structure of subordinated debt are disclosed in Note Other Liabilities 31 December December 2007 Settlements with suppliers and other creditors Accrued staff compensation expenses Taxes other than income tax payable Settlements on conversion operations Liabilities from credit related commitments Current income tax payable Other Total other liabilities Included in liabilities from credit related commitments as at 31 December 2008 was a provision for losses in respect of credit related commitments of RUR 38 million (31 December 2007: RUR 44 million). Refer to Note 29. Geographical and currency analysis, maturity structure of other liabilities are disclosed in Note Share Capital The share capital of the Bank has been contributed by shareholders in Russian Roubles. Shareholders are entitled to dividends and any capital distribution in Russian Roubles. As at 31 December 2008 and 31 December 2007, share capital of the Bank consisted of authorized, issued and fully paid ordinary shares with a fixed nominal value of 500 Russian Roubles and authorized, issued and fully paid preference shares with a fixed nominal value of 500 Russian Roubles.

148 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 147 Ordinary shares carry the right to vote at annual general and extraordinary meetings, right to receive dividends and a residual interest in the assets of the Bank after deducting all its liabilities on liquidation. All ordinary shares provide equal rights to their owners. Preference shares have no right of conversion or redemption. Preference shares carry the right to vote at annual general and extraordinary meetings in respect of issues that influence the interests of preference shareholders, including reorganisation and liquidation. Preference shares are entitled to receive the same dividends as dividends attributable to ordinary shareholders. If the dividend is not paid, preference shares carry the right to vote at annual general and extraordinary meetings until dividends are paid. Dividends are not cumulative. In the event of liquidation preference shareholders are entitled to receive declared unpaid dividends and the par value of the preference shares ( liquidation value ). Dividends payable to the Bank s shareholders are restricted to the maximum retained earnings of the Bank, which are determined in accordance with legislation in the Russian Federation. As at 31 December 2008, the Bank s reserves available for distribution amounted to RUR million (31 December 2007: RUR million). No dividends on ordinary or preference shares have been declared during the year ended 31 December 2008 and 31 December The share capital of the Bank, as at 31 December 2008 and 31 December 2007, comprised the following: Nominal value Inflation adjustment Total share capital Ordinary shares Preference shares Total share capital Interest Income and Expense Year ended 31 December 2008 Year ended 31 December 2007 Interest income Loans and advances to customers Overnight deposits and due from other banks Investment securities available for sale Investments securities held to maturity 66 - Total interest income on financial assets not at fair value through profit or loss Trading securities Other financial assets at fair value through profit and loss 5 21 Total interest income Interest expense Customer accounts (6 628) (4 446) Due to other banks (5 758) (4 966) Debt securities in issue (3 111) (4 267) Subordinated debt (488) (534) Total interest expense (15 985) (14 213) Net interest income Included in interest income on loans to customers the year ended 31 December 2008 was RUR 724 million in respect of interest income from finance leases (31 December 2007: RUR 604 million). Information on related party transactions is disclosed in Note 31.

149 148 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 22. Gains less Losses from Foreign Exchange Year ended 31 December 2008 Year ended 31 December 2007 Gains less losses from trading in foreign currencies (609) Foreign exchange translation gains less losses (1 981) Total gains less losses from foreign exchange Information on related party transactions is disclosed in Note Fee and Commission Income and Expense Year ended 31 December 2008 Year ended 31 December 2007 Commission on settlement and trade finance transactions Commission on foreign currency transactions Commission on cash transactions Commission for business referral Commission for brokerage and other services of an investment banking nature Commission for trust and fiduciary services Other 6 7 Total fee and commission income Commission on settlement transactions (409) (297) Commission on foreign currency transactions (164) (73) Commission on cash transactions (133) (185) Commission on banking transactions (128) - Other (49) (79) Total fee and commission expense (883) (634) Net fee and commission income Information on related party transactions is disclosed in Note Other Operating Income 31 December December 2007 Gains less losses arising from available for sale financial assets Release of provision for losses on credit related commission 6 5 Gains less losses from other financial assets at fair value from profit or loss - 2 Other income Other operating income

150 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Operating Expenses Year ended 31 December 2008 Year ended 31 December 2007 Staff costs Depreciation, rent and other expenses related to property, plant and equipment Professional services Taxes other than on income Advertising and marketing Security Telecommunications Software Other Total operating expenses Information on related party transactions is disclosed in Note Income Taxes Income tax expense comprises the following: Year ended 31 December 2008 Year ended 31 December 2007 Current tax charge Deferred taxation movement due to origination and reversal of temporary differences and movement in valuation allowance 646 (306) Income tax expense As at 31 December 2008, the income tax rate applicable to the majority of the Russian entities of the Group s income was 24% (31 December 2007: 24%). As at 31 December 2008, the income tax rate applicable to income of non-russian entities of the Group ranged from 0% to 15% (31 December 2007: from 0% to 15%). Effective from 1 January 2009, the income tax rate in the Russian Federation has been reduced to 20%. Accordingly, the deferred tax balances have been reviewed as at 31 December 2008 to reflect that change. The reconciliation between the expected and the actual income tax expense is provided below: Year ended 31 December 2008 Year ended 31 December 2007 Profit before taxation Theoretical income tax expense at the applicable statutory rate Tax effect of items taxed at different tax rates 173 (164) Tax effect of items which are not deductible or assessable for taxation purposes, and other items of a non-temporary nature Previous year overpayment (53) - Unrecognised net deferred tax asset movement (2) (21) Effect of change in tax rate (93) - Income tax expense

151 150 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Movements in temporary differences for the year ended 31 December 2008: 1 January 2008 Movement charged/ (credited) to profit or loss Movement recorded directly to equity Effect of change in tax rate recorded in equity Effect of change in tax rate recorded in profit or loss 31 December 2008 Tax effect of deductible/ (taxable) temporary differences Impairment allowances and provisions (128) (36) 181 Accruals 563 (1 113) (475) Property, plant and equipment (1 019) (38) (595) Securities (2) (444) 475 (88) Tax loss carry forwards (4) 22 Other (182) (21) Gross deferred tax liability (768) (742) (872) Less unrecognised deferred tax asset (2) Net deferred tax liability (770) (740) (872) Deferred tax asset Deferred tax liability (770) (980) Movements in temporary differences for the year ended 31 December 2007: 1 January 2007 Movements charged/ (credited) to profit or loss Movement recorded directly to equity 31 December 2007 Tax effect of deductible/(taxable) temporary differences Impairment allowances and provisions (396) (128) Accruals Property, plant and equipment (699) 98 (418) (1 019) Securities 53 (49) (6) (2) Other 20 (202) - (182) Gross deferred tax liability (629) 285 (424) (768) Less unrecognised deferred tax asset (23) 21 - (2) Net deferred tax liability (652) 306 (424) (770) Deferred tax asset - - Deferred tax liability (652) (770) Deferred income taxes are calculated on all temporary differences under the liability method using the income tax rates applicable to entities of the Group. As at 31 December 2008 and 31 December 2007, the Group did not recognise a deferred tax liability in respect of its investments in subsidiaries as the Group was able to control the timing of the reversal of the temporary differences and it was not probable that the temporary differences will reverse in the foreseeable future. In the context of the Group s current structure, tax losses and current tax assets of different companies may not be offset against current tax liabilities and taxable profits of other companies and, accordingly, taxes may accrue even where there is a net consolidated tax loss. Therefore, a deferred tax asset of one company of the Group may not be offset against a deferred tax liability of another company. As at 31 December 2007, a net deferred tax asset in respect of net deductible temporary differences of RUR 2 million has not been recorded as it was not probable that the relevant entity of the Group will have sufficient taxable profit that will allow the Group to benefit from the deferred tax asset.

152 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Analysis by Segment The Group is organised into three main reportable operating segments: Corporate and investment banking includes deposit taking and lending to corporate clients, leasing, factoring, settlements, cash management, cash collection, trade finance, syndications, a forfait financing, export credit agency financing, corporate finance, debt and equity capital markets, money markets, trading and brokerage in securities, foreign exchange and precious metals, repo transactions, banknote trading, and trading in derivatives. Retail banking includes deposit taking and lending to individuals, small and medium enterprises and individual entrepreneurs, money transfer and foreign exchange services, a range of banking card products provided to individual customers, also settlements, cash management, and cash collection for small and medium enterprises. Central treasury includes treasury, which undertakes the Group s funding and centralized risk management activities through borrowings, issue of debt securities, use of derivatives for risk management and investing in liquid assets such as short-term placements. The Group evaluates performance of its operating segments on the basis of profit and loss before tax not including non-recurring gains and losses, such as results on disposal of property, plant and equipment or results from business combinations. The accounting policies of the operating segments of the Group are the same as those described in the summary of significant accounting policies (refer to Note 4), except for the following: the Group records risk charges on operating segments representing cost of credit risk associated with new operations of the segment originated in the reporting period; at the same time the Group does not include impairment losses and provisions in accordance with IFRS in determination of the segment profit and loss; the Group records an allowance for capital benefits representing internal notional interest income earned on risk-weighted capital allocated to operating segments to finance the activities of the segment. The Group has in place a procedure for allocating depreciation and amortisation expense between operating segments of the Group to determine segment profit or loss. However, the Group does not allocate net book value of certain property, plant and equipment between operating segments to determine segment assets. Such property, plant and equipment are included in Unallocated category in reconciliation of the total of segment assets to total assets of the Group. All assets and liabilities of operating segments are subject to mandatory placement/funding through the Central treasury, which results in internal funding charges related to such placement/funding. Such charges are calculated using internal rates, which are based on current market borrowing rates. Internal funding charges result for Central treasury also includes notional expense incurred by Central treasury for use of nominal amount of monetary capital of the Group for further funding of other operating segments. The capital is further allocated to each operating segment to cover risks associated with its assets. Such riskweighted capital is subject to placement in Central treasury by other segments. The result of this adjustment is presented as an allowance for capital benefit for each operating segment. The Group also has a central administrative function that manages its premises and certain corporate costs. Cost sharing agreements are used to allocate central costs to operating segments on a reasonable basis. The majority of operations, credit related commitments, capital expenditure, and revenues of the Group relate to residents of the Russian Federation. Segment breakdown of assets and liabilities of the Group is set out below: 31 December December 2007 Assets Corporate and investment banking Retail banking Central treasury Unallocated assets Total assets

153 152 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 31 December December 2007 Liabilities Corporate and investment banking Retail banking Central treasury Unallocated liabilities Total liabilities Segment information for the operating segments of the Group for the year ended 31 December 2008 is set out below: Corporate and investment banking Retail banking Central treasury Unallocated Consolidated Group External interest income External interest expense (9 472) (664) (5 608) (241) (15 985) Internal funding charge 1 (4 208) (3 848) Allowance for capital benefit (2 489) - Net interest income Fee and commission income Fee and commission expense (445) (353) (83) (2) (883) Trading, other financial assets at fair value through profit or loss and foreign exchange results 820 (41) Other operating income Total operating income before impairment losses and provisions Direct operating expenses 3 (1 739) (1 629) (45) - (3 413) Impairment losses and provisions (5 418) (1 726) - (685) (7 829) Reversal of accounting impairment losses and provisions (7 144) - Risk charges 5 (3 911) (670) Segment result before central overhead (2 375) Allocation of central overheads 6 (1 387) (2 326) (2) (1 754) (5 469) Investment spending (484) (484) Profit before taxation (4 613) Income tax (1 333) (1 333) Net profit for the year Refer to description of internal funding charges above. The amount included in Unallocated category represents notional income on placement of monetary capital to central treasury. 2 Refer to description of allowance of capital benefit above. The amount included in Unallocated category represents a reconciling item to the total consolidated profit of the Group. 3 Direct operating expenses represent part of total operating expenses of the Group directly attributable to operating segments. 4 Refer to description of segment accounting policies used above. Impairment losses and provisions in accordance with IFRS are not included in determination of segment profit and loss. 5 Refer to description of risk charges above. The amount included in Unallocated category represents a reconciling item to the total consolidated profit of the Group. 6 Allocation of central overheads represents part of total operating expenses of the Group incurred by the central cost centers of the Group, allocated to operating segments based on internal allocation rules. 7 Part of operating expenses of the Group representing ongoing costs of development of the distribution network, long-term venture projects and other similar costs. These costs are not internally allocated to operating segments.

154 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 153 Segment information for the operating segments of the Group for the year ended 31 December 2007 is set out below: Corporate and investment banking Retail banking Central treasury Unallocated Consolidated Group External interest income External interest expense (7 311) (312) (6 000) (590) (14 213) Internal funding charge 1 (5 564) (2 491) Allowance for capital benefit (2 165) - Net interest income (119) Fee and commission income Fee and commission expense (401) (225) (8) - (634) Trading, other financial assets at fair value through profit or loss and foreign exchange results Other operating income Total operating income before impairment losses and provisions Direct operating expenses 3 (2 450) (1 447) (73) - (3 970) Impairment losses and provisions (514) (1 564) - (3) (2 081) Reversal of accounting impairment losses and provisions (2 078) - Risk charges 5 (811) (367) Segment result before central overhead (495) Allocation of central overheads 6 (940) (1 785) (1) (1 743) (4 469) Investment spending (183) (183) Profit before taxation (2 421) Income tax (2 111) Net profit for the year Refer to description of internal funding charges above. The amount included in Unallocated category represents notional income on placement of monetary capital to central treasury. 2 Refer to description of allowance of capital benefit above. The amount included in Unallocated category represents a reconciling item to the total consolidated profit of the Group. 3 Direct operating expenses represent part of total operating expenses of the Group directly attributable to operating segments. 4 Refer to description of segment accounting policies used above. Impairment losses and provisions in accordance with IFRS are not included in determination of segment profit and loss. 5 Refer to description of risk charges above. The amount included in Unallocated category represents a reconciling item to the total consolidated profit of the Group. 6 Allocation of central overheads represents part of total operating expenses of the Group incurred by the central cost centers of the Group, allocated to operating segments based on internal allocation rules 7 Part of operating expenses of the Group representing ongoing costs of development of the distribution network, long-term venture projects and other similar costs. These costs are not internally allocated to operating segments

155 154 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Capital expenditures and depreciation and amortisation charge for the operating segments of the Group for the year ended 31 December 2008 is set out below: Corporate and investment banking Retail banking Central treasury Unallocated Consolidated Group Capital expenditures (Note 12) Depreciation and amortisation charge (Note 12) Capital expenditures and depreciation charge for the operating segments of the Group for the year ended 31 December 2007 is set out below: Corporate and investment banking Retail banking Central treasury Unallocated Consolidated Group Capital expenditures (Note 12) Depreciation and amortisation charge (Note 12) Outstanding credit related commitments for the operating segments of the Group as at 31 December 2008 and 31 December 2007 are set out below: 31 December December 2007 Corporate and investment banking Retail banking Total credit related commitments (Note 29) The majority of Group s revenues from external customers are attributed to customers domiciled in Russian Federation (including subsidiaries and affiliates of these customers registered outside Russian Federation). Revenues from external customers domiciled in foreign countries are not significant. 28. Financial Risk Management Taking risk is core to the financial business. The Group s aim is to achieve an appropriate balance between risk and return and minimize potential adverse effect of risk on the Group s financial performance. Major financial risks to which the Group is exposed include credit, market, liquidity, and other risks. (a) Risk management framework The Group s risk management policies aim to identify, analyze and manage the risks to which the Group is exposed. Risk management function within the Group is based on the following main principles: Limitation of potential losses the Group s transactions associated with risks are performed within a system of limits/restrictions on certain types of risk. Timeliness of risk assessment all new products and transactions of the Group are analyzed for associated risks. Based on the results of the risk analysis, a system of limits/restrictions and appropriate controls are implemented for this product/transaction. Risk management activities based on the assessment of changes in the external and internal risk factors, appropriate steps are taken to either accept, avoid, mitigate or pass on the risks, in order to achieve optimal risk-reward balance for the Group. Clear segregation of duties between corporate management structures and business-units ensures effective risk management and should eliminate conflicts of interests. Risk management functions are allocated in the Group in the following way. The Board of Directors of MDM Bank has overall responsibility for the oversight of risk management, the management of key risks and approving major risk management principles, policies and procedures.

156 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 155 The Audit and Risk Committee of the Board of Directors of MDM Bank is responsible for overseeing the internal control framework and assessing the adequacy of risk management and compliance policies and procedures. It meets regularly and provides recommendations to the Board of Directors of MDM Bank on development of the framework, as well as its views on the quality of risk management and compliance. The Management Board of MDM Bank is responsible for monitoring and implementation of risk mitigation measures and making sure that both the Group and the Bank operate within the established risk parameters. Credit, market and liquidity risks at both the portfolio and major transaction levels are managed and controlled by the Senior Credit Committee, Senior Committee on Counterparties and Financial Instruments and Asset and Liability Management Committee (ALCO). The Risk Department of MDM Bank is responsible for overall risk management and compliance functions, ensuring the implementation of common principles and methods for identifying, measuring, managing and reporting both financial and non-financial risks. The Risk Department develops the methodology for risk measurement and performs independent risk analysis of products and programs submitted for approval and limits on specific clients/operations, performs portfolio analysis on current products and programs, and develops a number of aggregated risk limits (i.e. industry/sector limits, limits on insurance of pledges by insurance companies etc.). Additionally, the Risk Department prepares monthly reports on risk management covering all the main risks, including credit, market, liquidity and operational risks, which are reported to the Board of Directors and the Management Board of MDM Bank. The business units of the Group manage risks within their functional duties. The Internal Audit Department of MDM Bank audits the Group s business units to check their compliance with the internal policies of the Group, reports its findings to the Board of Directors and management of the Group and proposes remedial actions for the findings. The main risk management policies and procedures currently used by the Group and details of major measures aimed at increasing the effectiveness and quality of risk management which are planned for implementation in the current financial year, are described below. (b) Credit Risk Credit risk is the risk of losses as a result of the non-performance, late or partial performance by a debtor of its contractual financial obligations to the Group. Credit risk arises principally from credit transactions, transactions with counterparties on the financial markets, purchase of debt securities and other on and off balance sheet credit exposures. For risk reporting purposes, the Group considers and consolidates all elements of credit risk exposures such as individual debtor default risk, country and industry risk. For risk management purposes, credit risk arising from positions in trading securities and other financial assets at fair value through profit or loss is managed and reported as a market risk exposure. (i) Credit risk management The Group limits concentrations of exposure to individual customers, counterparties and issuers (for securities), groups of related customers, as well as exposure by industry/sector etc. To limit potential losses arising from credit risk, all transactions involving credit risk (including sale and repurchase agreements and other transactions with collateral) are performed within established limits. The process of developing and setting limits is aimed at minimizing conflicts of interest. The application to establish a limit is originated by the relevant client managers.

157 156 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Credit risk analyses are performed either by the Credit Department or the Risk Department (in respect of limits for financial institutions: banks, funds and investment companies, etc.). The credit risk limits are then approved by the Senior Credit Committee, by the Senior Committee on Counterparties and Financial Instruments (in respect of limits for financial institutions) or by an authorized underwriter. In order to facilitate efficient decision-making, the Group has established a hierarchy of authority for approval of credit risk limits depending on the type and amount of the exposure to risk. Authority to approve corporate and retail exposures subject to credit risk operated during the major part of year ended 31 December 2008 was allocated as follows: The Senior Credit Committee approves credit risk management policies and procedures, new standard products and programs for corporate, small business and retail customers of the Group, and approves all credit risk limits above RUR 250 million. The Senior Credit Committee includes the heads of client, investment, credit, collections and retail units of the Group. The chairman of the Senior Credit Committee is the Head of the Risk Department (with the veto right). Applications for limit setting or new standard product/program approval are subject to independent assessment by the Risk Department prior to being passed on to the Senior Credit Committee. The Risk Department assesses risks and provides recommendations to the members of the Senior Credit Committee on mitigating risks identified. In order to facilitate efficient decision-making for limits approval procedure, authority to approve limits for lower amounts were delegated as follows: Authority to approve small limits within the retail lending programs approved by the Senior Credit Committee is delegated to Junior credit committees for retail lending in branches (for customers of regional branches). Such authority varies depending on standard credit products: auto loan, mortgage loan, consumer loan and credit card, etc. Authority to approve small limits (up to RUR 10 million) within the small business lending programs approved by the Senior Credit Committee is delegated to Junior credit committees for standard lending products in branches and to Small Business Lending Division (for customers of the Head Office). Authority to approve limits to corporate and small business customers within the small business lending programs approved by the Senior Credit Committee, which requires control of basic covenants, rather than detailed financial analysis is delegated to underwriters of the Credit Department. The authority is limited to RUR 30 million per customer. The underwriters are authorized by the Head of the Risk Department. Authority to approve all other credit limits to corporate, small business and retail customers within RUR 250 million is delegated to underwriters of the Risk Department. The authority to approve deals with financial institutions subject to credit risk operated during the major part of the year ended 31 December 2008 is allocated as follows: The Senior Committee on Counterparties and Financial Instruments approves credit risk management policies and procedures, for the Group s operations on financial markets, and approves all credit risk limits above USD 25 million. The Senior Committee on Counterparties and Financial Instruments includes the Chief Financial Officer of MDM Bank and the head of investment unit of the Group. The chairman of the Senior Committee on Counterparties and Financial Instruments is the Head of the Risk Department. All limits over USD 75 million must be approved by the Chairman of the Management Board of MDM Bank (who has a veto right). Applications for limit setting are subject to independent assessment by the Risk Department prior to being passed on to the Senior Committee on Counterparties and Financial Instruments. The Risk Department assesses risks and provides recommendations to the members of the Senior Committee on Counterparties and Financial Instruments on mitigating risks identified.

158 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 157 Authority to approve credit limits to financial institutions within USD 25 million is delegated to underwriters of the Risk Department. At the end of 2008 the Group undertook a number of crisis management steps on toughening the approach to decision making in the area of approval/ change of credit limits: powers of business units on decision-making are reduced significantly: amounts eligible for approval by Junior Credit Committees in regional branches were lowered and transferred at the level of Regional banks; decision-making on corporate clients is transferred to the level of the Senior Credit Committee, on financial institutions to the level of the Senior Committee on counterparties and financial instruments; approval of limits on small and medium business is transferred to the level of underwriters of the Risk Department. The above measures are aimed to improve prudence of limit approval decision in the complex current environment where previously used procedures may lead to inadequate decisions. The Group s activities may give rise to settlement risk at the time of settlement of transactions. Settlement risk is the risk of loss due to the failure of a counterparty to honor its obligations to deliver cash, securities or other assets as contractually agreed. For certain types of transactions the Group mitigates this risk by conducting settlements through settlement/clearing agents to ensure that a trade is settled only when both parties have fulfilled their contractual settlement obligations. Acceptance of settlement risk on free settlement transactions requires transaction specific and/or counterparty specific settlement limits which form part of the credit risk limits. (ii) Policies for credit risk analysis and setting credit risk limits Credit analysis is performed using approved methodologies. These methodologies include a methodology for analyzing the financial standing of debtors and a methodology for the assessment of collateral. Analysis of debtor financial standing is performed using all the information on the debtor available to the Group in accordance with methodology applied. This analysis includes assessment of current and expected debtor financial position and the current business of the debtor. Generally, the group of companies of the debtor is evaluated as a whole, provided that all members of the group accept responsibility for the loan. Analysis of the expected creditworthiness of individuals within retail lending is performed based on the current income and profile of the customer using scoring models which are based on statistical analysis of defaults by individual lending program. The Group internally assesses collateral using methodologies developed for each type of collateral. Valuations performed by third parties, including independent appraisal firms authorized by the Group, may serve as the external data used for such assessment. The Group normally accepts the following types of property as collateral: in the commercial and industrial sector, charges over business assets such as premises, equipment, stock and debtors; in the commercial real estate sector, mortgages and/or charges over the properties being financed; in the financial sector, charges over financial instruments such as debt securities and equities; in the retail sector, mortgages over residential properties, and charges over motor vehicles or other valuables. Collateral is not generally held over loans and advances to banks, except where securities are held as collateral in reverse repurchase agreements and secured lending lines. Collateral is not held against exposures to securities.

159 158 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) The Group usually requires collateral, equipment and products to be insured for any loss or damage by approved insurance companies. At the end of 2008 the Group undertook a number of crisis management steps aimed at toughening the approach to risk assessment during the crisis period: simplified procedures on limits approval were suspended, clients are considered only on the basis of the detailed analysis of their credit status. Overall minimal requirements to the financial position of clients were increased; approval of limits for lending to construction industry and several other industries which in the opinion of the Group will be most affected by the crisis were suspended; all limits on purchase of debt securities (bonds, promissory notes) to the Group s proprietary position were suspended; uncollaterised lending was suspended, discounts rates on collateral received were raised, additional procedures were performed to increase collateral on existing loans; in retail lending the Group has now suspended all products, except consumer lending: represented by high margin loans in small amounts and relatively short term with monthly annuity repayments. Significant changes were made to the client scoring techniques to exclude most clients with higher probability of default: clients are accepted only if their income is supported by documents; maximum share of annuity payment in the client s free cash flow was lowered; other potential client portrait features were amended. The Group also analyzes other risks arising from the business of the debtor or transactions being financed. Other risks include the following: Ecological/social risks are the reputation risks of the Group and credit risks arising from the debtor s noncompliance with environmental, health, safety, non-discrimination and other legal requirements regulating ecological, labor and social activities, as well as from environmental damage by third parties to the debtor s activities and property. In 2008 the Group adopted the Policy of ecological risk management. Assessment of this risk is based on the standards of International Finance Corporation and European Bank for Reconstruction and Development and is performed for all credit risk limits for corporate and small business clients. Compliance risk is the risk that the debtor will face difficulties in servicing the loan due to claims against the debtor by the regulatory authorities. Reputation risk is the risk from the possible association of the Group with the illegal activities of its customer. Generally, in order to mitigate reputation risk all the Group s customers are subject to a check by the Security Department. Legal risk is the risk of potential losses due to weaknesses in the legal framework or insufficient analysis of legal issues during preparation of credit documentation. The main principles for setting limits include: the financial position of the debtor (current and expected) should allow the debtor to repay outstanding loans on a timely basis, without the Group having to realize collateral (which is an important but secondary factor in limit setting); the intended use of lending products within a limit should be consistent with the business of the debtor; sources of repayment of lending products should be identifiable and their existence should be validated; other risks identified should be acceptable. Risk-Adjusted Return on Capital (RAROC) is the a key measure for evaluation of risk-reward of the considered limit. (iii) Credit risk measurement The quantitative assessment of credit risk is based on the expected loss model, as recommended by the Basel Committee on Banking Regulations and Supervisory Practices (the Basel Committee ). The expected loss model can be contrasted with impairment allowances required under International Accounting Standard 39 Financial Instruments: Recognition and Measurement ( IAS 39 ), which are based on losses that have been incurred as at the balance sheet date (the incurred loss model ) rather than expected losses. The expected loss model calculates expected losses for various credit exposures based on the probability of default (PD), exposure at default (EAD) and loss given default (LGD).

160 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 159 The Group assesses the probability of default of individual counterparties using internal rating tools tailored to the various categories of debtor, industry/sector and different standard credit products/programs. They have been developed internally and combine statistical analysis with credit and risk department officer judgment and are validated, where appropriate, by comparison with externally available data. The exposure at default is the expected amount of the exposure at the time of default. Loss given default is estimated based on the historical recovery rate and typically varies by type of counterparty, type and availability of collateral or other credit risk mitigation tools. Information on the credit quality of the Group s loan portfolio and impairment allowances recorded under IAS 39 is presented in Note 11. (iv) Policies for providing credit products within established limits When providing credit products within established limits the Group implements a set of procedures to mitigate the risk of conflict of interests and operating risks: A client relationship unit initiates the issue of a credit product within the established limit. The supporting unit (middle-office) prepares credit documentation and monitors compliance with the terms of the limit. The Operations Department executes the transaction and records it in the Group s accounting systems. (v) Principles for credit risk monitoring Credit risk monitoring comprises two components: Monitoring of established limits The Group regularly monitors the payment discipline of debtors, availability and value of collateral, financial standing of debtors, their ecological/social risks and compliance with other covenants established under the limits. Corporate clients and small business clients are usually monitored by supporting units (middle-office) of the Group. Financial institutions are monitored by the Risk Department. Based on the monitoring results, the Credit Department performs regular assessment of the credit exposures for any indications of individual impairment. If necessary, the Group implements steps to mitigate credit risk. These may include revision of limit terms, request for additional collateral etc. In certain cases recovery of the loan is delegated to the special department responsible for collection of bad debts. Portfolio-based monitoring Apart from monitoring individual risk limits, the Risk Department also periodically assesses credit risk for the loan portfolio as a whole and for individual standard programs and products. Such analysis includes analysis of the default rates for portfolios, adequacy of impairment losses recognized, level of industry and geographical concentration, and portfolio diversification. If negative trends are identified, the Risk Department analyzes the trends and initiates required changes to the credit policies and methodology of the Group. (vi) Allowance for loan losses The Group establishes an allowance for loan losses that represents its estimate of losses incurred in its loan portfolio.

161 160 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) The Group writes off a loan balance against related allowances for loan losses when the Group s Senior Credit Committee determines that the loans are uncollectible and when all necessary steps to collect the loan are completed. For smaller balance standardized loans, write off decisions are generally based on a product specific past due status. Generally, overdue loans are written off when overdue more than one year or if the debtor is declared bankrupt. (vii) Maximum exposure to credit risk The Group s maximum exposure to on balance sheet credit risk is generally reflected in the carrying amounts of financial assets on the balance sheet. The impact of possible netting of assets and liabilities to reduce potential credit exposure is not significant. Credit risk for off balance sheet financial instruments 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 procedures and methodologies, as defined by the Group s credit policy, for approving credit related commitments (undrawn loan commitments, letters of credit and guarantees) as it does for on balance sheet credit obligations (loans). The Group s maximum exposure to off balance sheet credit risk is reflected in Note 29 Contingent liabilities and commitments. For analysis of concentration of credit risk in respect of loans and advances to customers refer to Note 11 Loans and advances to customers. (viii) Changes in the credit risk management process The Group constantly takes steps to improve its risk management systems in line with international best practices. During the year ended 31 December 2008 the Group: Improved the limits approval procedure, by implementation of the underwriting system as described in section (i) of this Note. Implemented system of capital at risk allocation integrated with the credit risk management system. Expected and actual RAROC (Risk-Adjusted Return on Capital) is now considered as one of the key riskreward measures. Established the procedure for ecological/social risks evaluation as part of credit approval process based on standards of International Finance Corporation and European Bank for Reconstruction and Development. Improved methods of monitoring the loan portfolio. In particular, the Group has developed and introduced procedures of monitoring sector risks of the loan portfolio. The procedures now allow to carry out more prudent industry risk limit policy. Additionally, the Group has introduced monthly assessment of the quality of small and medium business lending procedures of the Bank s branches, including sales and selection of new customers and work with customers that breached lending limits. The above monitoring procedures identify problem areas on a more timely and accurate basis and to take relevant corrective actions to the lending procedures. In 2009 the major objective of the Group will be to adjust its credit risk management policy and procedures to the new economic environment: Definition of target groups of clients, based on their sustainability in the crisis environment, and key indicators for their credit analysis; Optimization of the product range for all types of clients; Introduction of decision making systems which allow more accurate risk assessment, identification of potential crisis areas in advance and to change risk management policies flexibly: statistical rating and scoring models, increased frequency of stress-testing of the loan portfolio, system of Early Warning Indicators etc.; Development of restructuring programs for current loans of good retail clients of the Group (those which have not committed any significant defaults) who have temporary financial difficulties, but overall assessment shows that those clients will be able to service and repay their debt at mutually acceptable terms.

162 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 161 (c) Market risk Market risk is the risk that movements in market prices, including foreign exchange rates, interest rates, credit spreads and equity prices will have an adverse affect on the Group s income or the value of its financial instruments. Market risk comprises interest rate risk, currency risk and other price risks. Market risk arises from open positions in interest rate, currency and equity financial instruments, which are subject to general and specific market movements and changes in the level of volatility of market prices. (i) Market risk management The objective of market risk management is to manage and keep market risk exposures within acceptable parameters, whilst optimizing the return on risk. Market risk management is based on proper allocation of risk management functions with the objective to limit potential losses. Market risk is managed through the system of limits, which includes position limits, loss limits, and limits on certain deal parameters. The system of limits sets the acceptable risk level at any point of time, including intra-day positions. Compliance with limits is controlled on a daily basis. The Asset and Liability Committee (ALCO) is responsible for managing the Group s market risk. The committee approves market risk limits based on recommendations of the market risk unit of Risk Department. The limit structure corresponds to the volume and structure of the Group s operations in the financial markets. Use of new types of financial instruments is permitted only after approval by ALCO which includes the following procedures: The front-office unit initiates the procedure of setting the required limits, including market risk limits. The Risk Department performs a detailed analysis of a proposed transaction, develops market risk assessment procedures, establishes appropriate risk limits and develops required control procedures. The Risk Department submits recommendations to ALCO on acceptability of the proposed transaction, risk limits and control procedures. (ii) Quantitative assessment of market risk To obtain an accurate assessment of market risk, the Group revalues its positions to current market prices on a daily basis and calculates volatilities of the risk factors. Results of such calculations are incorporated into the quantitative assessment of market risks for its trading positions using the Value-at-Risk ( VaR ) methodology. VaR is a technique that estimates the potential losses that could occur on risk positions as a result of movements in market rates and prices over a specified time horizon and to a given level of confidence. The VaR model used by the Group is based upon a 99 percent confidence level and assumes a 10-day holding period. The Group applies a linear VaR model. Potential movements in market prices are determined with reference to market data for at least the last 12 months. Back-testing of the model is performed at least once every six months. A summary of the VaR estimates in respect of foreign currency risk and securities price risk for the Group s portfolio of trading securities and liquid available-for-sale financial instruments (liquid instruments are defined as those which the Group will be able to liquidate within 10 days) as at 31 December 2008 and 31 December 2007 is as follows: 31 December December 2007 Foreign exchange risk Fixed income securities price risk Equity securities price risk

163 162 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Although VaR is a valuable tool in measuring market risk exposures, it has a number of limitations, especially in less liquid markets, which include the majority of the debt and equity instruments traded in Russia: The use of historical data as a basis for determining future events may not encompass all possible scenarios. A 10-day holding period assumes that all positions can be liquidated or hedged within that period. This is considered to be a realistic assumption in almost all cases but may not be the case in situations in which there is severe market illiquidity for a prolonged period. The use of a 99% confidence level does not take into account losses that may occur beyond this level. There is a one percent probability that the loss could exceed the VaR. As VaR is only calculated on an end-of-day basis, it does not necessarily reflect exposures that may arise on positions during the trading day. Due to the above limitations of the VaR methodology the Group additionally performs stress-testing of the risk positions using scenarios of unfavourable changes of the major risk factors. Further, the limitations of the VaR methodology are recognized by supplementing VaR limits with limits of open positions for financial instruments and risk exposures and limits of sensitivity to risk factors. In addition, the Group performs scenario stress-testing for trading positions on a monthly basis to model the possible financial impact of exceptional market scenarios on individual trading portfolios and the Group s overall position. (iii) Price risk Price risk is the risk that movements in market prices resulting from factors associated with issuers of financial instruments (specific risk) and general changes in the market prices of financial instruments (general risk) will have an adverse affect on the Group s income or the value of its financial instruments. Price risk for financial instruments held within the Group s trading portfolios is managed by setting limits on investments in financial instruments taking into account their liquidity, setting stop-loss limits for trading portfolios, and maintaining a diversified structure of portfolios. Positions in securities are monitored centrally across the Group. (iv) Currency risk Currency risk is the risk that movements in foreign exchange rates will have an adverse affect on the Group s income or the value of its portfolios of financial instruments. Currency risk mainly results from open foreign currency positions. All transactions with currency risk exposure are performed within limits on open foreign currency positions. Such limits are established taking into consideration expected future movements in foreign exchange rates which are based on historical volatilities, scenario modeling and expert estimates. Traders manage currency risk in respect of the Group s trading foreign currency positions which are opened within the limits established by the ALCO. The Treasury Department manages currency risk in respect of the currency mismatch between non-trading assets and liabilities (structural foreign currency position). The Group s target is to maintain a risk neutral structural foreign currency position. Transactions are generally performed in three major currencies: the Russian rouble, US dollar and Euro. For the purposes of currency risk management the Group applies a system of controls over overall open foreign currency positions, and trading positions which are monitored on real-time basis.

164 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 163 As at 31 December 2008, the Group has the following positions in different currencies: RUR USD EUR Other currencies Assets Cash and cash equivalents Mandatory cash balances with central banks Due from other banks Trading securities - owned by the Group pledged under sale and repurchase agreements Derivative financial instruments Available-for-sale financial assets - owned by the Group pledged under sale and repurchase agreements Investment securities held to maturity Loans and advances to customers Property, plant and equipment and intangible assets Other assets Total assets Total Liabilities Due to central bank Due to other banks Derivative financial instruments Customer accounts Debt securities in issue Subordinated debt Deferred tax liability Other liabilities Total liabilities Net balance sheet position (6 401) (869) Off balance sheet net notional position (4 564) (248) (1 880) - Net position (1 117) Credit related commitments Currency classification of monetary assets and liabilities is based on the currency in which they are denominated. Investments in equities have been attributed to the currency of the country where the issuer of the equity instrument is resident (predominantly, the Russian Rouble and the Russian Federation, respectively). Currency classification of tangible assets (precious metals, property, plant and equipment) and prepayments has been based on the functional currency used to record them. The Group has extended loans and advances denominated in foreign currencies. Depending on the revenue stream of the borrower, the possible appreciation of the currencies in which loans and advances have been extended against the Russian Rouble may adversely affect the borrower s repayment ability and therefore increase the likelihood of future loan losses.

165 164 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) As at 31 December 2007, the Group had the following positions in different currencies: RUR USD EUR Other currencies Total Assets Cash and cash equivalents Mandatory cash balances with central banks Due from other banks Trading securities - owned by the Group pledged under sale and repurchase agreements Derivative financial instruments Available-for-sale financial assets Loans and advances to customers Property, plant and equipment and intangible assets Other assets Total assets Liabilities Due to central bank Due to other banks Derivative financial instruments Customer accounts Debt securities in issue Subordinated debt Deferred tax liability Other liabilities Total liabilities Net balance sheet position (13 048) Off balance sheet net notional position (9 228) (1 721) (998) - Net position (1 101) (398) Credit related commitments (v) Interest rate risk Interest rate risk is the risk that movements in interest rates will have an adverse affect on the Group s revenue or the value of its portfolios of financial instruments. The Group is exposed to the effects of fluctuations in the prevailing levels of market interest rates on its financial position and cash flows. Interest margins may increase as a result of such changes but may also reduce or create losses in the event that unexpected movements arise. Management of interest rate risk is performed through analysis of the structure of assets and liabilities by repricing dates (gap-analysis). Dynamic modeling of balance sheet structure is performed for different scenarios of movement in interest rates. Apart from gap-analysis the Group assesses the duration of its assets and liabilities. Interest rate risk is measured for the Group as a whole on a consolidated basis. The impact of changes in interest rates on the Group s profit before tax is assessed as a key measure of interest rate risk. All new products and transactions of the Group are evaluated from the interest rate risk perspective prior to starting these transactions.

166 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 165 ALCO is responsible for the Group s asset and liability management. ALCO delegates day-to-day management of the interest rate mismatch to the Treasury Department. The Risk Department independently monitors compliance with limits established to control interest rate risk. The table below summarises the effective average interest rate, by major currencies, for major monetary financial instruments. The analysis has been prepared on the basis of weighted average interest rates for the various financial instruments using period-end effective interest rates. 31 December 2008 % 31 December 2007 % EUR and other currencies RUR USD EUR and other currencies RUR USD Assets Due from other banks: - Current interbank loans Reverse sale and repurchase agreements Trading securities: - Municipal bonds issued by Russian municipalities Russian Federal loan bonds (OFZ) Corporate bonds Corporate Eurobonds Promissory notes Other financial assets at fair value through profit or loss Loans and advances to customers: - Loans to corporate customers Loans to individuals Investment banking loans Small business loans Net investment in finance lease Liabilities Due to central banks Due to other banks: - Bilateral structured financing Syndicated loans Trade finance facilities Loans from international financial institutions Term deposits from other banks Sale and repurchase agreements Customer accounts: - Term deposits Sale and repurchase agreements Debt securities in issue: - Unsecured loan participation notes Loan participation notes secured by diversified payments rights Loan participation notes secured by a pool of car loans Promissory notes Bonds Deposit certificates Subordinated debt

167 166 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) The table below summarises the Group s exposure to interest rate risks as at 31 December Included in the tables are the assets and liabilities at carrying amounts, categorised by the earlier of contractual repricing or maturity dates. Less than 1 month From 1 to 6 months From 6 to 12 months From 1 to 3 years More than 3 years Non interest bearing Total Assets Cash and cash equivalents Mandatory cash balances with central banks Due from other banks Trading securities - owned by the Group pledged under sale and repurchase agreements Derivative financial instruments Available-for-sale financial assets - owned by the Group pledged under sale and repurchase agreements Investment securities held to maturity Loans and advances to customers Property, plant and equipment and intangible assets Other assets Total assets Liabilities Due to central banks Due to other banks Derivative financial instruments Customer accounts Debt securities in issue Subordinated debt Deferred tax liability Other liabilities Total liabilities Interest rate sensitivity gap (51 574) Off balance sheet net notional position (516) (929) (2 221) Interest rate sensitivity gap, including interest-based derivative financial instruments (51 546)

168 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 167 The Group s exposure to interest rate risks as at 31 December 2007 is set out below: Less than 1 month From 1 to 6 months From 6 to 12 months From 1 to 3 years More than 3 years Non interest bearing Assets Cash and cash equivalents Mandatory cash balances with central banks Due from other banks Trading securities - owned by the Group pledged under sale and repurchase agreements Derivative financial instruments Available-for-sale financial assets Loans and advances to customers Property, plant and equipment and intangible assets Other assets Total assets Total Liabilities Due to central bank Due to other banks Derivative financial instruments Customer accounts Debt securities in issue Subordinated debt Deferred tax liability Other liabilities Total liabilities Interest rate sensitivity gap (7 153) (15 635) Off balance sheet net notional position (816) (380) (4 668) (536) Interest rate sensitivity gap, including interest-based derivative financial instruments (7 969) (16 015) Loan participation notes secured by a pool of car loans have been presented in the above tables based on the maturity of car loans pledged under the notes. The management of interest rate risk by monitoring the interest rate gap is supplemented by monitoring the sensitivity of the Group s profit before tax to various interest rate scenarios. An analysis of sensitivity of the Group s profit before tax for the period to changes in the market interest rate based on a simplified scenario of a 100 basis point (bp) parallel fall or rise in all yield curves (assuming no asymmetrical movement in yield curves and a constant balance sheet position) is as follows: 31 December December 2007 RUR million RUR Other currencies Total RUR Other currencies Total 100 bp parallel increase bp parallel decrease (123) (252) (375) (199) (115) (314)

169 168 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) (vi) Changes in the market risk management process In 2008 the Group improved its market risk assessment methodology, including assessment of risks related to securities purchased under reverse sale and repurchase agreements, and fair value measurement technique for promissory notes purchased. At the end of 2008 the Group tightened its market risk limit system in respect to change in market risk level, in order to reduce risks for currency, fixed income, derivatives, margin trading operation risk. In 2009 the Group is planning to implement Early Warning Indicators system in its market risk management framework. (d) Liquidity risk Liquidity risk is the risk that the Group will encounter difficulty in meeting obligations from its financial liabilities. The Group is exposed to daily calls on its available cash resources from overnight deposits, current accounts, maturing deposits, loan drawdowns, guarantees and from margin and other calls on cashsettled derivative instruments. The Group does not maintain cash resources to meet all of these needs as experience shows that a minimum level of reinvestment of maturing funds can be predicted with a high level of certainty. Liquidity risk exists when the maturities of assets and liabilities do not match. The matching and/or controlled mismatching of the maturities and interest rates of assets and liabilities is fundamental to the management of financial institutions, including the Group. It is unusual for financial institutions to ever be completely matched since business transacted is often of an uncertain term and of different types. An unmatched position potentially enhances profitability, but can also increase the risk of losses. (i) Liquidity risk management The Group s approach to management of liquidity is to ensure that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or taking risk of damage to the Group s reputation. The Group seeks to actively support a diversified and stable funding base comprising debt securities in issue, long-term and short-term loans from other banks, core corporate and retail customer deposits, accompanied by holding diversified portfolios of highly liquid assets, in order to be able to respond quickly and smoothly to unforeseen liquidity requirements. The liquidity management policy of the Group requires: projecting cash flows by major currencies and considering the level of liquid assets necessary in relation thereto; maintaining a diverse range of funding sources; managing the concentration and profile of funding; maintaining debt financing plans; maintaining a portfolio of highly marketable assets that can easily be liquidated as protection against any interruption to cash flows; maintaining liquidity and funding contingency plans; monitoring balance sheet liquidity ratios against regulatory requirements. The Treasury Department receives information from business units regarding the liquidity profile of their financial assets and liabilities and details of other projected cash flows arising from projected future business. The Treasury Department then provides for an adequate portfolio of short-term liquid assets to be maintained, largely made up of short-term liquid trading securities, loans to banks and other inter-bank facilities, to ensure that sufficient liquidity is maintained within the Group as a whole. The daily liquidity position is monitored and regular liquidity stress testing under a variety of scenarios covering both normal and more severe market conditions is performed by the Treasury Department. Under the normal market conditions, liquidity reports covering the liquidity position of the Group are presented to senior management on a weekly basis. Decisions on the Group s liquidity management are made by the ALCO and implemented by the Treasury Department.

170 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 169 (ii) Liquidity risk measurement 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. The tables below show the carrying amounts of assets and liabilities of the Group by their remaining contractual maturity, with the exception of loan participation notes secured by a pool of car loans, which have been presented based on their expected repayment dates (refer to Note 17), and trading securities owned by the Group, which are shown in the category Demand and less than 1 month based on the fact that management believes that all of these trading securities could be liquidated within one month in the normal course of business. The position as at 31 December 2008 is set out below: 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 Mandatory cash balances with central banks Due from other banks Trading securities - owned by the Group pledged under sale and repurchase agreements Derivative financial instruments Available-for-sale financial assets - owned by the Group pledged under sale and repurchase agreements Investments securities held to maturity Loans and advances to customers Property, plant and equipment and intangible assets Other assets Total assets Liabilities Due to central banks Due to other banks Derivative financial instruments Customer accounts Debt securities in issue Subordinated debt Deferred tax liability Other liabilities Total liabilities Net liquidity gap (12 912) (14 470) (2 555) Cumulative liquidity gap

171 170 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) The position as at 31 December 2007 is set out below: 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 Mandatory cash balances with central banks Due from other banks Trading securities - owned by the Group pledged under sale and repurchase agreements Derivative financial instruments Available-for-sale financial assets Loans and advances to customers Property, plant and equipment and intangible assets Other assets Total assets Liabilities Due to central bank Due to other banks Derivative financial instruments Customer accounts Debt securities in issue Subordinated debt Deferred tax liability Other liabilities Total liabilities Net liquidity gap (6 148) (19 456) (1 191) Cumulative liquidity gap The following table shows the contractual maturities of trading securities of the Group: 31 December December 2007 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 trading securities Management believes that in spite of a substantial portion of customer accounts being on demand (customer current/settlement accounts), diversification of these funds by number and type of depositors, and the past experience of the Group indicates that these deposits provide a long-term and stable source of funding for the Group. The following table shows the undiscounted cash flows on the Group s financial liabilities and unrecognized loan commitments on the basis of their earliest possible contractual maturity. The gross nominal (inflow)/ outflow disclosed in the table is the contractual, undiscounted cash flow on the financial liability or commitment. Loan participation notes secured by a pool of car loans have been presented based on their

172 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 171 expected repayment dates (refer to Note 16). The Group s expected cash flows on these financial liabilities and unrecognized loan commitments vary significantly from this analysis. The position of the Group as at 31 December 2008 was as follows: Demand and less than 1 month From1 to 6 month From 6 to 12 months From 1 to 3 years More than 3 years Total gross nominal (inflow)/ outflow Carrying amount Non-derivative liabilities Due to central bank Due to other banks Customer accounts Debt securities in issue Subordinated debt Other financial liabilities Gross settled derivative financial instruments - Inflow (84 133) (5 769) (1 006) (944) (82) (91 934) (674) - Outflow Total Credit related commitments The position of the Group as at 31 December 2007 was as follows: Demand and less than 1 month From 1 to 6 month From 6 to 12 months From 1 to 3 years More than 3 years Total gross nominal (inflow)/ outflow Carrying amount Non-derivative liabilities Due to other banks Customer accounts Debt securities in issue Subordinated debt Other financial liabilities Gross settled derivative financial instruments - Inflow (57 680) (10 648) (3 850) (1 750) (168) (74 096) (260) - Outflow Total Credit related commitments The Bank also calculates mandatory liquidity ratios on a daily basis in accordance with the requirement of the CBR. These ratios include: Instant liquidity ratio (N2), which is calculated as the ratio of highly-liquid assets to liabilities payable on demand. Current liquidity ratio (N3), which is calculated as the ratio of liquid assets to liabilities maturing within 30 calendar days. Long-term liquidity ratio (N4), which is calculated as the ratio of assets maturing after one year to capital and liabilities maturing after one year.

173 172 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) MDM Bank was in compliance with the above ratios during the year ended 31 December 2008 and year ended 31 December The following table presents the mandatory liquidity ratios for MDM Bank calculated as at 31 December 2008 and 31 December 2007: Requirement 31 December December 2007 Instant liquidity ratio (N2) Minimum 15% 120.9% 124.8% Current liquidity ratio (N3) Minimum 50% 132.4% 118.9% Long-term liquidity ratio (N4). Maximum 120% 72.1% 71.2% (iii) Changes in the liquidity risk management processes To improve the liquidity risk management system, at the end of 2007 the Bank introduced a system of early warning indicators. The system of early warning indicators is aimed at identifying an increase in liquidity risk at the early stages. The system is based on day-to-day monitoring of a number of the Bank s balance sheet ratios, market indicators of financial market conditions as well as other external available data. (e) Country risks Country risk is the risk of losses as a result of foreign counterparties failing to meet their obligations due to economical, political and social changes in the respective country. The majority of the operations of the Group are located in Russia. The Group accepts other country risk only after performing a separate analysis. The majority of the operations of the Group are located in Russia. The geographical analysis of the Group s assets and liabilities as at 31 December 2008 is set out below: Russia OECD countries Non-OECD countries Total Assets Cash and cash equivalents Mandatory cash balances with central banks Due from other banks Trading securities - owned by the Group pledged under sale and repurchase agreements - Derivative financial instruments Available-for-sale financial assets - owned by the Group pledged under sale and repurchase agreements Investments securities held to maturity Loans and advances to customers Property, plant and equipment and intangible assets Other assets Total assets Liabilities Due to central banks Due to other banks Derivative financial instruments Customer accounts Debt securities in issue Subordinated debt Deferred tax liability Other liabilities Total liabilities Net position (66 454) (2 946)

174 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 173 The geographical analysis of the Group s assets and liabilities as at 31 December 2007 is set out below: Russia OECD countries Non-OECD countries Total Assets Cash and cash equivalents Mandatory cash balances with central banks Due from other banks Trading securities - owned by the Group pledged under sale and repurchase agreements Derivative financial instruments Available-for-sale financial assets Loans and advances to customers Property, plant and equipment and intangible assets Other assets Total assets Liabilities Due to central bank Due to other banks Derivative financial instruments Customer accounts Debt securities in issue Subordinated debt Deferred tax liability Other liabilities Total liabilities Net position (65 694) (29 866) The majority of credit related commitments, as at 31 December 2008 and 31 December 2007, are related to residents of the Russian Federation. The geographical classification of financial assets, liabilities and credit related commitments has been based on the country in which the counterparty is located. The classification of tangible assets (precious metals, property, plant and equipment) has been based on the country in which they are physically held. As at 31 December 2008, loans and advances to customers of RUR million (31 December 2007: RUR million), included in the above tables as being with Russian counterparties, have been granted to subsidiaries and affiliates of these Russian counterparties located outside of the Russian Federation. (f) Capital management (i) Capital management policy The Group s policy is to maintain a strong capital base so as to maintain investor, creditor and market confidence and to sustain future development of its business. The Central Bank of Russia sets and monitors regulatory capital requirements for MDM Bank, the lead operating entity of the Group. The Central Bank of Latvia sets and monitors capital requirements for Latvian Trade Bank. Under the current capital requirements set by the CBR banks have to maintain a ratio of capital to risk weighted assets ( statutory capital adequacy ratio ) above the prescribed minimum level. As at 31 December 2008, this minimum level is 10% (31 December 2007: 10%).

175 174 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) MDM Bank was in compliance with the statutory capital adequacy ratio during the year ended 31 December 2008 and 31 December As at 31 December 2008, the statutory capital of MDM Bank on a standalone basis was RUR million (31 December 2007: RUR million). The statutory adequacy capital ratio of MDM Bank as at 31 December 2008 was 14.6% (31 December 2007: 14.4%). The Group and the Bank also are subject to minimum capital requirements established by covenants under liabilities incurred by the Bank or the Group, including capital adequacy levels calculated in accordance with the requirements of the Basle Accord, as defined in the International Convergence of Capital Measurement and Capital Standards (updated April 1998) and Amendment to the Capital Accord to incorporate market risks (updated November 2005), commonly known as Basel I. As at 31 December 2008 and 31 December 2007, such minimum capital requirements for total capital ratio was 12%. The following table shows the composition of the Group s capital position calculated in accordance with the requirements of the Basle Accord, as at 31 December 2008 and 31 December 2007: 31 December December 2007 Tier 1 capital Share capital Share premium Cumulative translation reserves Retained earnings Total tier 1 capital Tier 2 capital Asset revaluation reserve Subordinated debt (unamortised portion) Total tier 2 capital Total capital Risk-weighted assets Banking book Trading book Total risk weighted assets Total capital expressed as a percentage of risk-weighted assets ( total capital ratio ) Total tier 1 capital expressed as a percentage of riskweighted assets ( tier 1 capital ratio ) The risk-weighted assets are measured by means of a hierarchy of risk weights classified according to the nature of and reflecting an estimate of credit, market and other risks associated with each asset and counterparty, taking into account any eligible collateral or guarantees. A similar treatment is adopted for off-balance sheet exposure, with some adjustments to reflect the more contingent nature of the potential losses. The Group and the Bank have complied with all externally imposed capital requirements as at 31 December 2008 and 31 December The management of the Group believes that a 10% tier I capital ratio and a 12% total capital ratio, calculated in accordance with the requirements of the Basle Accord, are the appropriate minimum capitalization levels for the Group and MDM Bank. The allocation of capital between specific operations and activities is, to a large extent, driven by optimization of the return achieved on the capital allocated. Although maximization of return on risk-adjusted capital is the principal basis used in determining how capital is allocated within the Group to particular operations or activities, it is not the sole basis used for decision making. Account is also taken of synergies with other operations and activities, the availability of management and other resources and the fit of the activity with

176 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 175 the Group s longer term strategic objectives. The Group s policies in respect of capital management and allocation are regularly reviewed by the Board of Directors of MDM Bank through approval and review of annual budgets, including those for various business segments of the Group. (ii) Changes in the capital management policy In the end of 2007 the Group established a policy of allocation of capital by individual transactions and activities. This policy includes: the methodology of calculation of capital at risk allocated to individual transactions and activities; the methodology of calculation of capital used for each segment of the Group s business; the methodology of calculation of RAROC and shareholder value added (SVA). Target returns on allocated capital and of the SVA amounts were set for the Group and individual business units within the Group in 2008 budgets. 29. Contingent Liabilities and Commitments (a) Legal proceedings In the ordinary course of business, the Group is subject to legal actions and complaints. Management believes that the ultimate liability, if any, arising from such actions or complaints, will not have a material adverse effect on the financial condition or the results of future operations of the Group. (b) Tax legislation The Group operates in a number of tax jurisdictions. In the normal course of business, management must interpret and apply existing legislation to transactions with third parties and its own activities. Current Russian tax legislation is principally based on the form in which transactions are documented and the underlying accounting treatment as prescribed by Russian Accounting Rules. The interpretation of Russian tax legislation by the tax authorities and court practice, which are constantly changing, in the future may focus less on the form and more on the substance of a transaction. Recent events within the Russian Federation suggest that the tax authorities are taking a more assertive position in their interpretation and enforcement of tax legislation. Tax years remain open to normal audit by the Russian tax authorities for three years; during such time any change in interpretation or practice, even if there is no change in Russian tax legislation, could be applied retroactively. The interpretation and practice in other jurisdictions in which the Group operates are also changing, sometimes with retroactive effect. In management s opinion, the Group is in substantial compliance with the tax and other laws governing its operations in Russia and in other tax jurisdictions. However, a risk remains that the relevant authorities could take different positions with regard to interpretative issues or that court practice could develop adversely to positions taken by the Group and the effect on the financial position of the Group, should the authorities succeed in asserting their positions, could be significant. In August 2008, MDM Bank received the final results of the tax audit for from the Federal Tax Service of the Ministry of Finance. In accordance with the resolution, the tax authorities have assessed additional taxes against MDM Bank of approximately RUR 194 million and fines and penalties at a maximum of RUR 63 million. The Bank filed a complaint in arbitration to overrule the tax inspectors claim. The final hearing on the issue took place on 20 February 2009 in St. Petersburg Arbitration Court and the complaint of the Bank was upheld by the Court, while the inspectors claim was overruled. The tax authorities are entitled to take an appeal on this ruling due to Federal Tax Service internal requirements regardless of the arbitration perspectives. Accordingly, the Group has not recorded provisions in respect of the above contingencies in these consolidated financial statements. (c) Capital commitments As at 31 December 2008, the Group had capital commitments mainly in respect of the development of its branch network and system enhancements, totalling approximately RUR 132 million (31 December 2007: RUR 315 million).

177 176 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) (d) Operating lease commitments Where the Group is the lessee, the future minimum lease payments under non-cancellable operating leases are as follows: 31 December December 2007 Not later than 1 year Later than 1 year and not later than 5 years Later than 5 years Total operating lease commitments During the year ended 31 December 2008 RUR 869 million was recognised as an expense in the consolidated income statement in respect of operating leases (31 December 2007: RUR 486 million). (e) Credit related commitments Credit related commitments comprise letters of credit, guarantees and undrawn loan commitments. The contractual amount of these commitments represents the value at risk should amounts under the contract be fully drawn upon. Guarantees and standby letters of credit carry the same credit risk as loans. Documentary and commercial letters of credit which are written undertakings by the Group on behalf of a customer authorising a third party to draw drafts on the Group up to a stipulated amount under specific terms and conditions are collateralised by the underlying shipments of goods to which they relate and therefore carry less risk than a direct loan. The primary purpose of undrawn loan commitments is to ensure that funds are available to a customer as required. With respect to credit risk on commitments to extend credit, the Group is potentially exposed to loss in an amount equal to the total unused commitments. However, the likely amount of such potential loss is less than the total unused commitments, as most commitments to extend credit are contingent upon customers maintaining specific credit standards. Outstanding credit related commitments are as follows: 31 December December 2007 Letters of credit Undrawn loan commitments Guarantees issued Total credit related commitments The Group creates provisions for losses on a collective and individual basis for its credit related commitments. Movements in provision for losses on credit related commitments are as follows: Year ended 31 December 2008 Year ended 31 December 2007 Provision for losses on credit related commitments as at 1 January Effect of foreign currency translation 3 (1) Provision during the year (9) (5) Provision for losses on credit related commitments as at 31 December (Note 19) The total outstanding contractual amount of guarantees, letters of credit and undrawn loan commitments does not necessarily represent future cash requirements, as these commitments may expire or terminate without being funded. Currency analysis of credit related commitments is disclosed in Note 28. Information on related party transactions is disclosed in Note 31.

178 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 177 (f) Fiduciary assets The Group provides custody services to its customers, whereby it holds securities on behalf of customers and receives fee income for providing these services. These securities are not assets of the Group and are not recognised in the consolidated balance sheet. The Group also provides asset management services to individuals, trusts, retirement benefit plans and other institutions, whereby it holds or invests funds received at the discretion of the customer. The Group receives fee income for providing these services. Assets for which the Group provides asset management services to its customers are not assets of the Group and are not recognised in the consolidated balance sheet. The Group is not exposed to any credit risk relating to such placements, as it does not guarantee these investments. As at 31 December 2008, total assets for which the Group provides asset management services to its customers were RUR million including mutual funds of RUR 180 million and discretionally managed portfolios of RUR 868 million (31 December 2007: RUR million including mutual funds of RUR 304 million and discretionally managed portfolios of RUR million). 30. Fair Value of Financial Instruments The Group has performed an assessment of its financial instruments, as required by IFRS 7 Financial Instruments: Disclosures. The estimated fair value of cash and cash equivalents, which is comprised of cash, correspondent accounts with central banks, correspondent accounts, overnight deposits with other banks and other floating rate placements is their carrying value. The estimated fair value of mandatory cash balances with central banks represents the amount proportionate to the discounted amount of estimated future cash flows on due to other banks, customer accounts and debt securities in issue to which these mandatory cash balances relate. The estimated fair value of fixed rate balances due from other banks, including central banks, is calculated based on discounted expected future principal and interest cash flows. The estimated fair value of quoted trading securities, derivative financial instruments and other financial assets at fair value through profit or loss and available-for-sale financial assets is based on quoted market prices at the balance sheet date without any deduction for transaction costs. For securities and derivative financial instruments not traded in an active market, the fair value is estimated by using valuation techniques, which include the use of recent arm s length transactions, discounted cash flow analysis and other valuation techniques commonly used by market participants. The estimated fair value of loans and advances to customers represents the discounted amount of estimated future cash flows expected to be received. The estimated fair value of due to other banks and customer accounts balances, which are payable on demand, is their carrying value. The estimated fair value of due to other banks and customer accounts balances, which are not payable on demand, and other borrowed funds, which are not quoted in an active market, is calculated based on discounted expected future principal and interest cash flows. The estimated fair value of debt securities in issue and subordinated debt is based on quoted market prices at the balance sheet date without any deduction for transaction costs. The estimated fair value of all other financial instruments represents the discounted amount of estimated future cash flows expected to be received or paid. Where discounted cash flow techniques are used, estimated future cash flows are based on management s best estimates and the discount rate is a market-based rate for a similar instrument at the balance sheet date.

179 178 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) The estimates of fair value are intended to approximate the amount for which a financial instrument could be exchanged between knowledgeable, willing parties in an arm s length transaction. However given the uncertainties and the use of subjective judgment, the fair value should not be interpreted as being realisable in an immediate sale of the assets or settlement of liabilities. The following table summarises the fair values of major financial assets and liabilities: 31 December December 2007 Carrying value Fair value Carrying value Fair value Cash and cash equivalents Mandatory cash balances with central banks Due from other banks Trading securities: - owned by the Group pledged under sale and repurchase agreements Derivative financial instruments Available-for-sale financial assets: - owned by the Group pledged under sale and repurchase agreements Investment securities held to maturity Loans and advances to customers: - Loans to corporate customers Loans to individuals Investment banking loans Small business loans Net investment in finance lease Due to central bank (35 575) (35 558) (846) (846) Due to other banks - Correspondent accounts and overnight deposits of other banks (3 421) (3 421) (6 039) (6 039) - Bilateral structured financing (9 073) (8 977) (7 042) (7 042) - Syndicated loans (8 281) (8 063) (24 839) (24 906) - Trade finance facilities (31 569) (31 931) (29 116) (29 008) - Loans from international financial institutions (29 396) (28 783) (11 515) (11 273) - Term deposits from other banks (15 634) (15 699) (15 648) (15 680) - Sale and repurchase agreements - - (7 317) (7 395) Derivative financial instruments (2 372) (2 372) (874) (874) Customer accounts: - State organisations Current/settlement accounts (4) (4) (1) (1) Term deposits (10 600) (10 584) (4 016) (4 021) - Other legal entities Current/settlement accounts (31 587) (31 587) (30 867) (30 867) Term deposits (42 451) (42 486) (68 426) (68 416) Sale and repurchase agreements - - (1 316) (1 316)

180 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) December December 2007 Carrying value Fair value Carrying value Fair value - Retail customers Current/demand accounts (5 067) (5 067) (5 412) (5 412) Term deposits (25 362) (25 377) (14 094) (14 069) Debt securities in issue: - Unsecured loan participation notes (11 808) (9 946) (11 043) (10 825) - Loan participation notes secured by diversified payment rights ( DPR ) (9 791) (9 861) (14 133) (14 239) - Promissory notes (5 370) (5 329) (9 771) (9 708) - Loan participation notes secured by a pool of car loans (1 282) (1 288) (4 153) (4 161) - Bonds (422) (427) (6 007) (6 122) - Deposit certificates (27) (25) (1 524) (1 527) Subordinated debt (5 966) (5 990) (5 066) (5 099) The following table shows an analysis of financial instruments recorded at fair value, between those whose fair value is based on quoted market prices, those involving valuation techniques where all the model inputs are observable in the market, and those where the valuation techniques involve the use of non-market observable inputs as at 31 December 2008: Valuation techniques based on market observable inputs Valuation techniques based on non-market observable inputs Quoted market price Total Financial assets Trading securities - owned by the Group pledged under sale and repurchase agreements Derivative financial instruments Available-for-sale financial assets - owned by the Group pledged under sale and repurchase agreements Financial liabilities Derivative financial instruments

181 180 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) The following table shows an analysis of financial instruments recorded at fair value, between those whose fair value is based on quoted market prices, those involving valuation techniques where all the model inputs are observable in the market, and those where the valuation techniques involve the use of non-market observable inputs as at 31 December 2007: Quoted market price Valuation techniques based on market observable inputs Valuation techniques based on non-market observable inputs Total Financial assets Trading securities - owned by the Group pledged under sale and repurchase agreements Derivative financial instruments Other financial assets at fair value through profit or loss Available-for-sale financial assets Financial liabilities Derivative financial instruments Related Party Transactions For the purposes of these consolidated financial statements, parties are considered to be related if one party has the ability to control the other party or exercise significant influence over the other party in making financial or operational decisions as defined by International Financial Reporting Standard IAS 24 Related Party Disclosures. In considering each possible related party relationship, attention is directed to the substance of the relationship, not merely the legal form. Related parties comprise immediate and indirect parent companies and ultimate beneficiaries of the Group, directors and key management personnel, and other related parties. Other related parties are entities, which are under common control with the Group, and entities, which are significantly influenced by the Group s beneficiaries, directors and key management personnel. As at 31 December 2008, these primarily consisted of Joint Stock Company Siberian Coal Energy Company (SUEK) (coal and energy), holding companies for SUEK, and other fellow subsidiaries. Joint Stock Company Mineral and Chemical Company EuroChem (mineral fertilizers) was a related party until May Banking transactions are entered into in the normal course of business with the related parties. These include settlements, loans, deposit taking, trade finance, securities and foreign currency transactions. These transaction are priced mainly on normal market terms. The following table shows credit exposure of the Group to related parties as at 31 December 2008 and 31 December 2007: 31 December December 2007 Amount % of Total assets Amount % of Total assets Total credit balance sheet exposure (net of impairment) Total credit on and off balance sheet exposure (net of impairment)

182 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 181 The outstanding balances as at 31 December 2008 with related parties are as follows: (a) Beneficiaries (b) Directors and key management (c) Immediate and indirect parent companies of the Bank SUEK (d) Other related parties Companies controlled by key management Other Total Assets Due from other banks Trading securities - Corporate shares Available-for-sale financial assets - Corporate bonds Loans and advances to customers (gross) Loan impairment - (1) (1) Total assets Total Liabilities Due to other banks Customer accounts - Current accounts Term deposits Total liabilities The results of transactions with related parties for the year ended 31 December 2008 are as follows: (a) Beneficiaries (b) Directors and key management (c) Immediate and indirect parent companies of the Bank SUEK (d) Other related parties Companies controlled my key management Other Total Interest income on amount due from other banks Interest income on loans and advances to customers Loan impairment reversal - (1) Interest expense on customer accounts (146) (26) - (160) - (2) (162) (334) Results from trading in foreign currencies Operating expenses - (726) (64) Fee and commission income/(expenses) Total

183 182 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) The outstanding balances as at 31 December 2007 with related parties are as follows: (a) Beneficiaries (b) Directors and key management (c) Immediate and indirect parent companies of the Bank (d) Other related parties SUEK Other Total Total Assets Trading securities - Corporate shares Loans and advances to customers (gross) Loan impairment (2) - (2) (2) Total assets Liabilities Customer accounts - Current accounts Term deposits Total liabilities The results of transactions with related parties for the year ended 31 December 2007 are as follows: (a) Beneficiaries (b) Directors and key management (c) Immediate and indirect parent companies of the Bank (d) Other related parties SUEK Other Total Total Interest income on loans and advances to customers Interest income received from securities issued by related parties Loan impairment reversal Interest expense on customer accounts (14) (11) (47) (2) (244) (246) (318) Net trading gain from trading in securities issued by related parties Results from trading in foreign currencies - - (3) Net fee and commission income Operating expenses - (934) - (81) - (81) (1 015) (a) Transactions with beneficiaries of the Group As at 1 December 2008 and 31 December 2007 term deposits from beneficiaries had remaining maturities less than one year. The table below summarises information about average effective interest rates and outstanding balances of term deposits from beneficiaries: 31 December December 2007 RUR USD EUR Total RUR USD EUR Total Outstanding balances Average effective interest rate, %

184 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 183 The table below summarises information about average balances of term deposits of beneficiaries of the Group: Year ended 31 December 2008 Year ended 31 December 2007 RUR USD EUR (b) Transactions with the members of the board of directors and key management personnel The total remuneration of the members of the Board of Directors of MDM Bank, including discretionary compensation, amounted to RUR 91 million for the year ended 31 December 2008 (31 December 2007: RUR 86 million). MDM Bank s Board of Directors was composed of 7 members, as at 31 December 2008 (31 December 2007: 7 members), all of them non-executive. The Board has elected three Board Committees: Audit and Risk Committee, Strategy Committee, and Nomination and Remuneration Committee. Boards stand for re-election every year under Russian law. Key management personnel comprise members of the Management Board of MDM Bank, heads of core business units and the Chief accountant of MDM Bank. As at 31 December 2008, key management personnel comprised of 10 persons (31 December 2007: 11 persons). The total remuneration of key management personnel, including discretionary compensation, is as follows: Year ended 31 December 2008 Year ended 31 December 2007 Salary and bonuses Contributions to the Russian Federation State pension fund 1 1 Termination benefits Total remuneration of key management personnel The Group does not provide post-employment, share-based or other long-term benefits to the directors and key management personnel. The table below summarises information about average effective interest rates and outstanding balances of term deposits from the directors and key management personnel: 31 December December 2007 RUR USD EUR Total RUR USD EUR Total Outstanding balances Average effective interest rate, % The table below summarises information about the remaining maturity of deposits from the directors and key management personnel: 31 December December 2007 Term deposits due to customers Up to one year remaining maturity From 1 to 5 years remaining maturity

185 184 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) (c) Transactions with immediate and indirect parent companies of the Bank The table below summarises information about average balances with immediate and indirect parent companies of the Bank and entities controlled by these companies: Year ended 31 December 2008 Year ended 31 December 2007 Term deposits due to customers RUR USD 46 1 EUR 34 1 (d) Transactions with other related parties The table below summarises information about average effective interest rates and outstanding balances with other related parties: 31 December December 2007 RUR USD EUR Total RUR USD EUR Total Due from other banks Outstanding balance Average effective interest rate, % Corporate shares Outstanding balance Corporate bonds Outstanding balance Coupon rate, % Loans and advances to customers Outstanding balance Average yield to maturity, % Current accounts Term deposits due to customers Outstanding balance Average effective interest rate, % Due to other banks Outstanding balance Average effective interest rate, % Balances on current accounts of other related parties are on terms similar to those for third parties.

186 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) 185 The table below summarises information about average balances with other related parties: Year ended 31 December 2008 Year ended 31 December 2007 Corporate bonds RUR 2 - Corporate shares RUR 7 7 Loans and advances to customers RUR Term deposits due to customers RUR USD Credit related commitments RUR - - Due to other banks RUR 70 - USD EUR 98 - The table below summarises information about the remaining maturity of balances with other related parties: 31 December December 2007 Loans and advances to customers Up to one year remaining maturity Term deposits Up to one year remaining maturity Principal Subsidiaries Included in the table below is the list of the principal subsidiaries of the Group, as at 31 December 2008 and 31 December Voting rights/ equity owned, % Voting rights/ equity owned, % Name Jurisdiction 31 December December 2007 Banking Latvian Trade Bank Latvia Securities trading MDM Investments Limited Cyprus MCM Russian Investments Limited Cyprus Asset management MDM Asset Management Russia Leasing LeasingPromHold Russia MDM Leasing Russia Special purpose entities for financing transactions MDM International Funding plc Ireland Taganka Car Loan Finance plc Ireland MDM DPR Finance Company S.A. Luxemburg MDM ECP Limited Ireland

187 186 MDM Bank Notes to the Consolidated Financial Statements for the Year Ended 31 December 2008 (expressed in millions of Russian Roubles refer to Note 3) Latvian Trade Bank is a commercial bank licensed by the Central Bank of Latvia to perform banking operations. MDM Investments Limited is a company licensed by the Cyprus Securities and Exchange Commission specializing in securities brokerage, trading on its own account and asset management. MCM Russian Investments Limited is a company that specializes in trading in securities on its own account and providing margin loans to customers of MDM Investments Limited. MDM Asset Management is a company licensed by the Russian Federal Financial Markets Service to manage third-party assets and collective investment schemes. LeasingPromHold is a company specializing in provision of leasing services to corporate customers of the Group. MDM International Funding plc, Taganka Car Loan Finance plc, MDM DPR Finance Company S.A. and MDM ECP Limited are special purpose entities used for financing transactions in international capital markets such as loan participation note issues, asset securitisations, future flows (DPR) securitisations etc. These SPEs are controlled by the Group through the predetermination of the activities of SPEs, having rights to obtain the majority of benefits of the SPEs, and retaining the majority of the residual risks and rewards related to the SPEs. 33. Subsequent Events In April 2009 the Group acquired 84% of the share capital of OAO Moskvichka. The company s main asset is premises in Moscow with a fair value of RUR 839 million. The purchase consideration paid by the Group was RUR 702 million.

188 187 Contact Details Head Office Address: 33/1 Kotelnicheskaya Embankment, Moscow, , Russia Call Center (24 hours): +7(495) fax (general): +7(495) Small business Lending: +7(800) Cardholder Support Center (24 hours): +7(495) Telex MDMD RU S.W.I.F.T. MOBW RU MM Bloomberg MDMG Reuters MBWM, MDMM, MDMB X-400 C: USSR, A: SOVMAIL SPRINT MDMBANK/CUSTOMERS Website: Settlements Ms. Tatyana Berezhnova, Head of Interbank Transactions Tel.: +7(495) Investor Relations Mr. Sam VanDerlip Head of Investor Relations Tel.: +7(495) Fax: +7(495) Public Relations Mr. Pavel Nefedov Head of Public Relations Tel.: +7(495) Fax: +7(495)

189 188 MDM Bank Annual report 2008 Principal Correspondent Accounts RUR USD EUR CHF GBP SEK NOK DKK JPY BYR UAH Account No OPERU of MosKovsky GTU of the Bank of Russia Account No BANK OF NEW YORK, One Wall Street, 8th Floor, New York, NY, USA, S.W.I.F.T: IRVTUS3N Account No DEUTSCHE BANK AG 12, Taunusanlage Frankfurt/Main, Germany, S.W.I.F.T: DEUTDEFF Account No Z UBS AG P.O. Box 8098, Zurich, Switzerland, Global Services Financial Institutions, S.W.I.F.T: UBSWCHZH80A Account Nо GBP 000 LDN DEUTSCHE BANK AG Winchester House 1, Great Winchester Street, London, EC2N 2DB U.K., SORT CODE , S.W.I.F.T : DEUTGB2L Account No SVENSKA HANDELSBANKEN Blasiehomstorg 11, Stockholm, Sweden, S.W.I.F.T: HANDSESS Account No DNB NOR BANK ASA, (formerly DEN NORSKE BANK ASA) Stranden 21, 0250 Oslo, Norway, S.W.I.F.T: DNBANOKK Account No DEN DANSKE BANK Holmens kanal 2-12, DK-092, Copenhagen K, Denmark, S.W.I.F.T: DABADKKK Account No BANK OF TOKYO MITSUBISHI 7-1 Marunouchi 2-Chome, Chiyoda-ku, Tokyo, 100, Japan, S.W.I.F.T: BOTKJPJT Account No BELVNESHECONOMBANK Myasnikov Str., 32, Minsk, Belarus, МFО 226, S.W.I.F.T: BELBBY2X Account No. LV16LATC LATVIJAS TIRDZNIECIBAS BANKA 4 Trijadibas iela, LV-1048 Riga, Latvia, S.W.I.F.T: LATCLV22

190 Licences 189 MDM Bank Activity General Banking License Issuing body Central Bank of Russia Number and date 2361 of Activity Precious Metals Operations Issuing body Central Bank of Russia Number and date 2361 of Activity Gold Export Issuing body Ministry of Economic Development and Trade of Russia Number and date LG of Activity Silver Export Issuing body Ministry of Economic Development and Trade of Russia Number and date: LG of Activity Exchange Broker Issuing body Federal Securities Market Commission of Russia Number and date 861 of Activity Issuing body Custody Operations (professional securities market participant) Federal Securities Market Commission of Russia Number and date of Activity Issuing body Brokerage Operations (professional securities market participant) Federal Securities Market Commission of Russia Number and date of Activity Issuing body Dealing Operations (professional securities market participant) Federal Securities Market Commission of Russia Number and date of Activity Issuing body Asset Management Operations (professional securities market participant) Federal Securities Market Commission of Russia Number and date of

191 190 MDM Bank Annual report 2008 MDM Bank has been a member of the deposit insurance system since 15 December MDM Asset Management Activity Issuing body: Managing investment funds, mutual funds and private pension funds Federal Securities Market Commission of Russia Number and date: , issued on 24 January 2001 Activity Issuing body: Securities Management Federal Financial Markets Service Number and date: , issued on 17 July 2008 Latvian Trade Bank Activity Issuing body: Number and date: Credit Institution Financial and Capital Market Commission of the Republic of Latvia /82 of 4 December 1991 (over-issued on 10 January 2004 as a result of over-registration in the company registry of the Republic of Latvia) MDM Investments Limited Activity Issuing body: 1) Broker and Depository 2) Securities Management 3) Financial Consulting Securities and Exchange Commission Number and date: SIF/038/04, issued on

192 Memberships 191 Association of Russian Banks, Moscow Moscow Interbank Currency Exchange (MICEX) ZAO, Moscow MICEX Stock Exchange ZAO, Moscow National Association of Stock Market Participants (SRO), Moscow St. Petersburg Stock Exchange ZAO, St. Petersburg Moscow Stock Exchange, Moscow Russian Trading System (RTS), Moscow National Stock Association (SRO), Moscow National Currency Association, Moscow Moscow International Currency Association, Moscow Association of Russian Regional Banks, Moscow ROSSWIFT, Moscow US-Russia Business Council, Washington, DC, U.S.A. National Council for Corporate Governance The Bank has adopted and fully observes in its operations the principles and norms of professional ethics developed by the associations, exchanges and partnerships of which it is a member.

193 192 MDM Bank Annual report 2008 Annual Report 2008 This Report is available in Russian and English. In the event of any discrepancy between the texts of the Russian and English versions, the text in the Russian version shall prevail. Detailed information on related-party transactions is provided in Annex 1 to this Report, which is available in PDF format on the Bank s website at The Bank was not involved in any major transactions in 2008, as defined by the Russian Law On Joint-Stock Companies. Annex 1 shall be viewed as an integral part of this Annual Report. Design and special photography Agey Tomesh