RISK FACTORS AND RISK MANAGEMENT

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1 RISK FACTORS AND RISK MANAGEMENT Bangkok Bank realizes that the Bank s business operations may be subject to various risk factors. It has therefore taken prudent measures to protect itself against such risks and charted a plan to manage risks effectively. During the past few years, the Bank has regularly reviewed its organizational structure and improved its processes for managing relevant risks, with the objective of enhancing the Bank s risk management systems to be on par with international standards, and to prepare the Bank to be able to manage risks in accordance with the principles of Basel II. The Bank s Risk Management Committee plays a significant role in prescribing the risk management policy, reviewing the sufficiency of risk management policy and systems, and monitoring and maintaining the Bank s risks at an appropriate level in compliance with the Bank s risk management policy. The Bank s objectives for risk management include managing relevant risks within designated parameters while managing the business in such a way as to achieve an appropriate rate of return. In carrying out its business, the Bank is exposed to a number of risks, including: credit risk; market risk; liquidity risk; capital adequacy risk; and operational risk. The Bank s guidelines for managing relevant risks are as follows: CREDIT RISK MANAGEMENT Credit Risk. Credit risk is a risk where the borrower may not be able or willing to repay the debt owed to the Bank, or to honor other contractual commitments. Credit Risk Factors. Credit risk factors include various factors which may affect the ability of borrowers to repay loans in full as well as factors which affect the Bank s ability to resolve non-performing loans. As a result of these factors, actual losses incurred toward the end of the problem debt recovery process may also affect the Bank s capital adequacy. Significant credit risk factors are as follows: 1. Non-performing loans As of December 31, 2006, the Bank had Baht 89.1 billion in non-performing loans representing 9.2 percent of total outstanding loans, despite an ongoing reduction in the level and ratio of non-performing loans over the past several years. 2. Economic growth Low or less than expected economic growth may affect businesses and the debt repayment capacity of the Bank s customers. Factors which may affect the growth of the Thai economy include: Concern about the domestic political situation and the threat of violence. Economic slowdown in the US and other trading partners which are Thailand s major export markets. Outbreak of avian flu and subsequent damage to related businesses. Appreciation of the Baht against other currencies in the region and in those countries competing against Thailand s exports. Crude oil prices in the world market, although falling from their peak, remaining higher than previously. 3. Sensitivity of the entertainment and tourism-related businesses Problems of political uncertainty and violence may cause tourists and consumers to be concerned for their personal safety and the safety of their property, which in turn may affect the profitability and the loan repayment ability of entertainment and tourismrelated businesses. 038 Bangkok Bank Public Company Limited Annual Report 2006

2 Risk Management 4: Sensitivity of export businesses The profitability of businesses in the export sector and exportdependent businesses may decrease as a result of intensifying competition in international markets as well as exchange rate volatility. Risk Management. In managing credit risk, the Bank has set up clear processes for credit approval which include credit policy, credit scoring for customers, and the establishment of different levels of authority for credit approval depending on the type of business and, or, the size of the credit line. In considering the approval of each loan application, the Bank considers the purpose of the loan and assesses the repayment ability of the applicant, taking into account the applicant s operating cash fl ows, business feasibility, the capability of management and collateral. The Bank also reviews the levels of credit risk ratings on a regular basis. The Bank has set up a Risk Management Unit to propose and review the overall risk policy for the Bank in anticipation of, and in compliance with, new rules and stipulations including the Basel II international standards. The Unit oversees the management of relevant risks in compliance with the policy of the Risk Management Committee. The Bank has also established a Credit Management Unit, which is independent from other areas of the organization. The Unit is responsible for managing the risks related to credit extension. It does this by supervising and monitoring credit extensions in accordance with the Bank s credit policies. The Credit Management Unit comprises the Credit Policy Unit, the Credit Acceptance Unit, the Portfolio Management Unit, the Risk Asset Review Unit, the Special Asset Management Unit, and the Loan Recovery and Legal Unit. The functions of each unit are summarized on the next page: Bangkok Bank has the objective of enhancing its risk management systems to be on par with international standards and to prepare the Bank to be able to manage risks in accordance with the principles of Basel II. Annual Report 2006 Bangkok Bank Public Company Limited 039

3 The Credit Policy Unit oversees the credit policy structure, and coordinates the improvement and adjustment of the credit policy. It is also responsible for disseminating credit policy, standards and processes; monitoring and overseeing exceptional cases which are inconsistent with the credit policy; and gathering comments to be used for improving the credit policy. The Credit Acceptance Unit, a working unit independent from business units, oversees credit extensions to ensure they are in line with the credit policy and credit underwriting standards, reviews the results of customers credit ratings, promotes a good credit culture, and maintains a systematic and reliable credit extension process. The Special Asset Management Unit is responsible for managing substandard loans, and determining strategies for resolving and restructuring troubled loans. The Portfolio Management Unit is responsible for analyzing and recommending the appropriate portfolio composition; making recommendations for adjustments to the portfolio structure, the provision of reserves for losses at the loan portfolio level; developing and overseeing credit risk management tools and methodologies; constructing loan databases; as well as overseeing related management standards. The Risk Asset Review Unit is an independent working unit which is charged with reviewing loan management processes and loan quality, assessing the adequacy of loan loss reserves, and evaluating compliance with loan policy, regulations and credit underwriting standards. The Loan Recovery and Legal Unit is responsible for court filings or reconciliation, foreclosing properties and managing the Bank s foreclosed assets. In addition, while reducing non-performing loans, the Bank has continued to increase the allowance for doubtful debt. In 2006, the Bank allocated additional provisioning for non-performing loans which was higher than the provisioning requirements recently revised by the Bank of Thailand. 040 Bangkok Bank Public Company Limited Annual Report 2006

4 MARKET RISK MANAGEMENT Market Risk. Market risk is the risk that arises from fl uctuations in interest rates, exchange rates, and the price of instruments in the money and capital markets, which may affect the fi nancial performance of the Bank. Interest Rate Risk. The level of interest rates is a major factor that determines the Bank s interest income from assets and interest expenses on liabilities. The Bank is exposed to interest rate risk as interest rates for the Bank s assets and liabilities may be adjusted at different times or subject to different contractual maturities, or movements of the benchmark interest rates on assets may be inconsistent with those on liabilities, thus impacting on the Bank s net interest income. Interest Rate Risk Factors. Interest rate risk factors include: pressure from infl ation and oil prices; the monetary policy adopted by the Bank of Thailand; and market competition, particularly with regard to deposits which are the primary source of capital for the Bank thus impacting on the Bank s net interest income. Foreign Exchange Rate Risk. Foreign exchange rate risk arises when the Bank is involved in foreign currency transactions which may result in defi cits or surpluses in the Bank s foreign currency position in any currency denomination. These transactions include foreign currency exchange, investments, loans, borrowings, contractual commitments, and the use of fi nancial derivatives in foreign currencies. The Bank may incur gains or losses on transactions as a result of movements in exchange rates. Foreign Exchange Rate Risk Factors. Foreign exchange rate risk factors include the increasing volatility of foreign exchange rates, as a result of factors such as imbalances in global trade, international capital fl ows and exchange rate speculation. Risk Management. The Bank aims to manage market risk to a level which is deemed appropriate, acceptable, and in compliance with the overall risk management policy of the Bank. In general, the Bank s policy is to match foreign currency assets and liabilities. In the case of mismatches, the Bank will typically hedge the exposures in various ways, for example by engaging in cross currency and interest rate swaps, or forward contracts. The Board of Executive Directors approves appropriate foreign exchange position limits in line with the risk appetite which is determined by the Risk Management Committee and the Board of Directors. The Asset and Liability Management Committee (ALCO) is responsible for establishing guidelines for the management of assets and liabilities. ALCO is also responsible for monitoring and maintaining interest rate risks at an acceptable level with minimal fl uctuations, and in compliance with the policies set by the Risk Management Committee and the Board of Directors. ALCO operates with support from the Market Risk Unit, a working unit under the Risk Management Unit and independent from the business units, which is charged with identifying, assessing, monitoring, reporting, and controlling the Bank s market risk. The Treasury Division manages and controls day-to-day trading activities under the supervision of ALCO which in turn ensures that the level of assumed risks is maintained at, or below, the approved level. The Bank may enter into interest rate and currency derivative transactions with the purpose of hedging the Bank s interest rate and foreign exchange exposures, or to provide limited derivative services to certain selected major corporate customers as well as domestic and international fi nancial institutions. Such services include foreign currency forward transactions and cross currency and interest rate swaps. Annual Report 2006 Bangkok Bank Public Company Limited 041

5 LIQUIDITY RISK MANAGEMENT Liquidity Risk is the risk that the Bank may not be able to meet cash fl ow obligations within a stipulated timeframe. The purpose of the Bank s liquidity risk management is to maintain suitable and suffi cient funds to meet present and future liquidity obligations whilst utilizing the funds appropriately to take advantage of market opportunities as they arise. Liquidity Risk Factors. Liquidity risk factors include competition among commercial banks for larger market share in deposits, an unstable or potentially violent domestic political situation, the fl uctuation of the Baht, and implementation of government policies which may affect capital movements in and out of Thailand. Risk Management. The Bank has several sources of liquidity and manages its liquidity through domestic money and capital markets, including swap and repurchase markets, as well as through international money and capital markets, primarily in the U.S. dollar and Eurocurrency markets. The Bank seeks to minimize its liquidity costs in line with market conditions by closely managing its liquidity position on a daily and long-term basis, as well as exercising due care in using medium-term borrowings from overseas to fund foreign currency loans of domestic and overseas customers. The Bank also considers plans for raising capital in line with market conditions. CAPITAL ADEQUACY RISK MANAGEMENT Capital Adequacy Risk is a risk that the Bank may not have suffi cient capital reserves to do business or to absorb unexpected losses arising from credit, market and operational risks. Capital Adequacy Risk Factors. Commercial banks in Thailand will be required to comply with the Bank for International Settlements Basel II Accord in phases starting from the end of These requirements will affect the risk weighting of different types of assets, and necessitate maintaining suffi cient capital for market and operational risks. This in turn will have a direct effect on the Bank s capital adequacy ratio and provisioning for doubtful accounts. Risk Management. The principal objective of the Bank s capital management policy is to ensure that the Bank maintains an adequate level of capital to support growth strategies and meets regulatory requirements and market expectations. Any proposals to raise additional capital are presented to the Board of Executive Directors and the Board of Directors for ultimate approval by shareholders. In addition, the Bank constantly assesses its capital position under various scenarios in order to prepare itself suffi ciently with regard to capital planning and management. OPERATIONAL RISK MANAGEMENT Operational Risk is the risk of potential losses from a breakdown in internal processes and systems, human error, or management or operational failure arising from external causes. The objective of the operational risk management framework is to ensure that the Bank has in place appropriate policies, processes and procedures, and gathers relevant information relating to operational risks so as to avoid operational failures and minimize relevant losses; while enabling the Bank to quickly respond to and pursue new business opportunities under appropriate risk controls and monitoring. Operational Risk Factors. Signifi cant operational risk factors include: Operational processes which may have flaws or weak control systems. Inadequate staffing which may make it difficult for staff to perform their work effectively and efficiently. Technological developments which may affect the security of Bank data or information held on behalf of customers. Malfunctions in information processing systems. Potential fraud by outsiders in terms of robbery, cheating, computer hacking, document falsification, credit and debit cards fraud, etc. Catastrophic events. 042 Bangkok Bank Public Company Limited Annual Report 2006

6 Risk Management. The Bank s operational risk control includes the defi nition of risks, risk assessment, risk monitoring, and risk mitigation and control. The primary responsibility for managing such risks rests with each operating unit, through the adoption of proper internal control measures as endorsed by the Operational Risk Unit, a working unit under the Risk Management Unit. Bangkok Bank manages its operational risks through the establishment of an effective internal control system within operating units as well as performing internal audits on a regular basis. The Compliance Unit has the responsibility of coordinating with operating units and collecting information about incidents which may cause operational risks or damage as well as continuously monitoring processes to rectify such problems. The Bank is preparing itself to comply with Basel II international standards and is therefore managing operational risks in a systematic and objective manner, and quantifying operational risks to determine capital adequacy. The Bank has restructured its organization, has set up a dedicated unit for operational risk, established an operational risk management policy, determined a framework for operational risk management and is implementing the framework in operating units as well as upper levels of the organization. In order to systematically monitor and prevent operational risk, the Bank is collecting and analyzing data about potential threats to operational risk, and is determining appropriate ways and methods for calculating capital reserves in anticipation of operational risks. The Bank plans to implement the framework for operational risk management in every unit throughout the organization as part of its day-to-day business operations. The Operational Risk Unit will monitor the operations of each unit and the organization as a whole. The Bank recognizes the importance of business continuity planning and management in mitigating or avoiding negative impacts from external events such as natural catastrophes or epidemics on the Bank s business operations as well as helping to restore normal operations within an appropriate timeframe. The Bank is therefore in the process of establishing business continuity policies and plans which cover critical and crucial business functions of the Bank. The implementation of such plans also includes the allocation of adequate resources and testing and reviewing business continuity plans on a regular basis. Annual Report 2006 Bangkok Bank Public Company Limited 043