NEDBANK GROUP LIMITED

Transcription

1 NEDBANK GROUP LIMITED AND NEDBANK LIMITED PILLAR 3 Basel III Public Disclosure Report for the half year endedd 30 June 2013

2 Contents EXECUTIVE SUMMARY... 3 GROUP STRUCTURE AND BASIS OF PILLAR 3 DISCLOSURE RISK CULTURE RISK APPETITE STRESS AND SCENARIO TESTING RISK GOVERNANCE ICAAP OVERVIEW CAPITAL MANAGEMENT LEVERAGE RISK MANAGEMENT RISK UNIVERSE CREDIT RISK COUNTERPARTY CREDIT RISK SECURITISATION RISK MARKET RISKS Trading market risk Equity risk ASSET AND LIABILITY MANAGEMENT Liquidity risk Interest rate risk in the banking book Foreign currency translation risk Net interest margin INSURANCE RISK OPERATIONAL RISK BUSINESS RISK ACCOUNTING AND TAXATION RISKS TECHNOLOGY RISK REPUTATIONAL, STRATEGIC, SOCIAL AND ENVIRONMENTAL AND TRANSFORMATION RISKS HUMAN RESOURCES (OR PEOPLE) AND TRANSFORMATION RISKS CONCENTRATION AND OFF BALANCE SHEET RISKS ANNEXURE A: COMPOSITION OF CAPITAL DISCLOSURE ANNEXURE B: CAPITAL INSTRUMENTS MAIN FEATURES DISCLOSURE ANNEXURE C: ABBREVIATIONS ANNEXURE D: GLOSSARY OF RISK TERMS AND DEFINITIONS Nedbank Group Limited and Nedbank Limited Pillar 3 June

3 EXECUTIVE SUMMARY ˈIn a tougher economic environment Nedbank Group delivered a solid performance in the first six months of Strong NIR growth and disciplined expensee management resulted in the NIR to expense ratio target of over 85% being exceeded for the first time and the return on equity increasing. The group benefited from its portfolio of diverse businesses and strong performances in the t wholesale and wealth businesses resulted in overall headline earnings growth of 13,3%. Despite the more challenging economic environment and increasing consumer creditt stress that has led to higher retail banking impairments, Nedbank Group is targeting, for the full year, growth in dilutedd headline earnings per sharee to meet its medium to long g term target. Mike Brown Chief Executive CONTINUED BUILDING AFRICA S MOST ADMIRED BANK BY DELVERING SUSTAINABILITYY TO ALL STAKEHOLDERS Nedbank Group Limited and Nedbank Limited Pillar 3 June

4 RISK AND BALANCE SHEET MANAGEMENT HIGHLIGHTS Nedbank has maintained its focus on excellence in risk management, and actively managing and maintaining a strong, robust balance sheet, particularly important in view of the tough macro environment that continues to be challenging, volatile and uncertain, and which has helped enable the group to deliver another solid financial performance in the first six months of Portfolio tilt forms part of the four key strategic focus areas of Nedbank Group, and is a carefully structured, integrated and holistic component of the group s 'manage for value' emphasis, involving balance sheet structuring and optimisation, strategic portfolio management and client value management. The key objectives of portfolio tilt are as follows: Target an optimal balance sheet shape and mix. Maximise economic profit (EP) by emphasising and optimising EP rich activities. Optimise the strategic impact of Basel III. Promote sustainable profitability through economic cycles and reduce earnings volatility risk. Optimise the risk versus return profile of the group, while operating within the group s Risk Appetite Framework. Allocate/use scarce resources (eg capital, term liquidity, IT innovation spend and expenses) optimally, while also investing for the future to grow the franchise (eg Rest of Africa). Effective risk management, using best practice risk management as an enabler. BALANCE SHEET HIGHLIGHTS Nedbank Group % change 1 Jun 2013 Rm Jun ,5 Rm Dec Rm Cash and securities 1, Net advances 11, All other 15, Home Loans 3 (3,5) Personal Loans 3 (10,7) Other assets 2 1, Total assets 9, Total equity 8, Deposits 10, Long term debt instruments (25,4) Other liabilities 2 21, Total equity and liabilities 9, Change reflects December 2012 to June 2013 (annualised). 2 Other assets and other liabilities key items in 'Other assets' include derivative financial instruments, investment securities, property and equipment, long term employee benefit assets and intangible assets. Key items in 'Other liabilities' include derivative financial instruments, long term employee benefit liabilities, investment contract liabilities and insurance contract liabilities. 3 Home Loans and Personal Loans represent specific business units within Nedbank Retail. These exclude Home Loans and Personal Loans in the Nedbank Retail Relationship Banking business unit restated to reflect the adoption of IAS 19 Employee Benefits (2011). 5 Clients indebtedness for acceptances and liabilities for acceptances have been reclassified as loans and advances and amounts owed to depositors respectively in order to achieve improved comparability with the majority of the group s SA banking peers. These items were previously separately disclosed in the group s statement of financial position. Nedbank Group Limited and Nedbank Limited Pillar 3 June

5 Cash and securities Strong levels of cash and securities were maintained, including surplus liquid assets of R25,0bn in line with preparation for compliance with the liquidity coverage ratio (LCR) under Basel III from As part of the group s interest rate risk strategy, higher levels of unhedged fixed rate short dated securities were accumulated within cash and securities versus government bonds. Advances While Personal Loans and Home Loans advances declined by 10,7% and 3,5% respectively in line with the planned slowdown in both advances portfolios, growth in other advances of 15,5% (annualised), underpinned by wholesale banking, saw net loans and advances growing by 11,5% (annualised) to R557,3bn (December 2012: R527,2bn). Nedbank Group experienced good growth in gross advances as follows: Leases and instalment debtors 10,2% Overdrafts 14,6% Overnight loans 25,4% Term loans (excluding personal loans) 19,0% Card 19,7% Gross new advances payouts increased 20,3% to R83bn (June 2012: R69bn) These were offset by Retail banking net advances that grew by a modest 2,5% (annualised), reflecting the difficult consumer environment, selective origination in home loans and personal loans in line with the portfolio tilt strategy, rolloff of the backbook and early repayments. Continued consumer stress, further proactive strengthening of balance sheet impairments in Personal Loans and a client specific charge in Business Banking led to an increase in the group s impairments to R3 325m (June 2012: R2 702m) and in the credit loss ratio (CLR) to 1,31% (June 2012: 1,11%). Total group defaulted advances decreased year on year to R20 176m (June 2012: R21 838m) from ongoing improvements in the residential and commercial mortgage books. Defaulted advances were up 9,4% (annualised) on the 2012 year end (December 2012: R19 273m) from increases in Personal Loans and the Wholesale businesses. The coverage ratio for total and specific impairments increased to 58,8% (June 2012: 52,9%) and 40,9% (June 2012: 39,0%) respectively. Portfolio coverage on the performing book continued to strengthen to 0,7% (June 2012: 0,6%). SOUND ASSET QUALITY, GOOD ADVANCES GROWTH AND PAYOUTS 7,1% 5,7% 6,8% 5,6% 4,9% 5,4% 15,6% 11,7% Dec 10 Jun 11 Dec 11 Jun 12 Dec 12 Jun 13 Gross loans and advances excluding Home Loans and Personal Loans 1, 2 Gross loans and advances 2 Asset payouts (Rm) ENHANCED GROSS LOANS AND ADVANCES MIX 32,4 23,9 Home Loans 16,6 17,3 Commercial mortgages 2,1 3,9 Personal Loans December 2009 June ,0 MFC 10,7 1 Home Loans and Personal Loans represent specific business units within Nedbank Retail. These exclude Home Loans and Personal Loans in the Nedbank Retail Relationship Banking business unit. 2 All growth percentages are per December year on year, with the exception of June 2013, which is the annualised percentage change on December Nedbank Group Limited and Nedbank Limited Pillar 3 June

6 DECLINING NON PERFORMING LOAN RATIOS, EXCEPT PERSONAL LOANS Defaulted advances as a % of gross advances 14,6% 12,9% 13,4% INCREASING BALANCE SHEET COVERAGE RATIOS, EXCEPT WHOLESALE 90,0% 10,1% 5,9% 2,5% ,9% 6,2% 3,5% 2,1% 9,4% ,8% 68,2% 58,8% 41,5% 42,3% 36,4% 41,9% 36,2% 19,8% Dec 09 Dec 10 Dec 11 Jun 12 Dec 12 Jun 13 Home Loans Nedbank Group Personal Loans Wholesale 1 Retail Defaulted advances excluding Personal Loans Personal Loans defaulted advances 1 Wholesale includes Nedbank Capital, Nedbank Corporate and Nedbank Business Banking Dec 09 Dec 10 Dec 11 Jun 12 Dec 12 Jun 13 Home Loans coverage ratio (%) Total coverage ratio (%) Personal Loans coverage ratio (%) Wholesale total coverage ratio (%) Retail total coverage ratio (%) Specific impairments (Rm) Portfolio impairments (Rm) NEDBANK RETAIL PORTFOLIO IMPAIRMENTS 1 Rbn Nedbank Retail Personal Loans 1,7 1,3 0,9 0,7 0,3 0,4 0,5 0,1 0,0 0,1 0,2 0,1 0,1 0,3 0,6 0, H1 2,3 2,4 Coverage ratio performing book (%) 0,1 0,1 0,4 0,6 0,5 0,8 1 1,2 1, to 2009 numbers exclude MFC. Equity The growth in ordinary shareholders equity is aligned with the continued solid growth in headline earnings and that, together with strong balance sheet management, resulted in all capital adequacy ratios remaining well above the Basel III (2019) minimum regulatory capital requirements and well within the group s new Basel III internal target ranges. This has facilitated the group increasing the interim dividend to 390 cents per share ahead of HEPS growth of 12,4%. R1,8bn of new style, fully loss absorbent Basel III compliant Tier 2 subordinated debt capital was successfully issued during July 2013 to replace the R1,8bn Basel II Tier 2 that matures in September Deposits, funding and liquidity and long term debt Nedbank Group remains well funded with a strong liquidity position underpinned by a well diversified and lengthened funding profile, a surplus liquid asset buffer of R25,0bn in anticipation of the Basel III LCR, a strong loans to deposits ratio consistently below 100% and low reliance on interbank and foreign currency funding. The average long term funding ratio for the 2013 second quarter at 28,0% (December 2012: 26,0%) was supported by, inter alia, growth in the Retail Savings Bond to R7,7bn. The attractiveness of the Nedbank franchise as a capital markets issuer was again recently demonstrated, in that, in addition to the R1,8bn new style Basel III Tier 2 issue mentioned above, a R2,0bn five year commercial mortgage securitisation in March 2013 and R3,2bn of three year senior unsecured debt in July 2013 were successfully issued. In total, over the past four months, R7bn of long term debt has been issued at competitive pricing by Nedbank. Deposits grew by a strong 10,2% (annualised) to R579bn (December 2012: R551bn), maintaining a strong loan to deposit ratio of 96,3% (December 2012: 95,7%). Nedbank Group Limited and Nedbank Limited Pillar 3 June

7 ENHANCED FUNDING AND LIQUIDITY PROFILE, UNDERPINNED BY COMPETITIVE CAPITAL MARKETS ISSUANCE 95,9% 21,1% 20,1 96,9% 24,0% 26,1 21,0 96,3% 95,2% 95,6% 95,7% 28,0% 27,0% 26,0% 25,0% 33,7 29,4 30,1 30,3 26,8 27,9 26,5 15,4 Loan to deposit ratio Three month average longterm funding ratio Growth in deposits for the period ending (Rm) Capital market issuance (Rm) 2,5 Dec 09 Dec 10 Dec 11 Jun 12 Dec 12 Jun 13 Net interest margin Net interest income (NII) grew 6,9% to R10 309m (June 2012: R9 642m), supported by growth in average interest earning banking assets of 6,1%. NIM has continued to improve in a challenging macroeconomic environment, on the back of the group s portfolio tilt strategy and strong margin management. NIM improved by 4bps from 3,54% in June 2012 to 3,58% in June 2013 and by 5bps from 3,53% in December Margin gains were underpinned by mix enhancements, sound risk adjusted pricing of new advances and backbook advances runoff, offset to a degree by lower endowment margin as a result of lower interest rates following the interest rate cut in July The improvement in the marginal cost of funds is due to a small decrease in rates and deposit mix enhancements. Liability pricing improved due to the increase in mix contribution from current accounts in Corporate and Business Banking and strong growth in call, term and fixed deposits as a result of the increased focus on deposit strategies, allowing a reduced reliance on wholesale deposits. It is pleasing to highlight that all business clusters, with the exception of Nedbank Wealth (who experienced a squeeze across most advances categories as a result of very low interest rates in their offshore related business and increasingly competitive markets), have grown NIM. Jun 2013 Jun Dec bps Rm bps Rm bps Rm Interest earning banking assets (year to date average) Opening NIM Growth in banking assets Improved asset mix and pricing Cost of enhancing liquidity risk (Basel III) (12) (4) (248) (6) (330) Impact due to interest rate change (2) (123) 13 (3) (162) Reduction in marginal cost of funds Improved liability mix (2) (94) Lower reliance on long term debt 1 57 (1) (26) (1) (37) Other (15) 1 46 (1) (64) Closing NIM Prior year s numbers restated to align with current period. NIM breakdown by business Bps (Increase Decrease ) Jun 2013 Jun 2012 Dec 2012 Nedbank Group Nedbank Capital Nedbank Corporate Nedbank Business Banking Nedbank Retail Nedbank Wealth Central Management, including Rest of Africa Nedbank Group Limited and Nedbank Limited Pillar 3 June

8 STRENGTHENING NIM TRENDS DESPITE LOWER INTEREST RATES AND CONTINUING TOUGH MACRO ENVIRONMENT SINCE % 3,60 11,9 3,58 12,5 3,55 3,53 11,5 3,50 9,9 3,48 10,5 Nedbank Group 3,45 3,40 3,39 3,36 9,0 8,5 8,5 9,5 8,5 Prime (RHS) 3,35 Dec 09 Dec 10 Dec 11 Dec 12 Jun 13 7, NIM has been adjusted for the reclassification of acceptances. Capital adequacy The Common Equity Tier 1 (CET1) capital ratio increased to 11,8% (December 2012: 11,6% pro forma Basel III), above the midpoint of Nedbank s new internal Basel III target range of 10,5% 12,5% as the group continues to build capital reserves in anticipation of exercising its subscription and topup rights in Ecobank Transnational Incorporated (ETI). STRONG COMMON EQUITY TIER 1 RATIO RWA 2 : Total Assets (%) 50% 50% 51% 54% 53% 54% Basel III target range CET1: 10,5% 12,5% Basel II.5 target range CET1: 7,5% 9,0% 9,9% 10,1% 11,0% 10,6% 11,4% 11,8% CET1 CAR 1 (%) Dec 09 Basel II Dec 10 Basel II Dec 11 Basel II Jun 12 Basel II.5 Dec 12 Basel II.5 Jun 13 Basel III 1 Capital adequacy ratio. 2 Risk weighted assets. Nedbank Group s revised target CAR ranges for CET1 under Basel III are 10,5% 12,5% (Basel II.5: 7,5% 9,0%), Total Tier 1: 11,5% 13,0% and total: 14,0% 15,0%. The revised CET1 range is set based on the final, fully phased in 2019 Basel III minimum SARB regulatory requirements, and constitutes a full through the cycle (TTC) target range. Total Tier 1 and total ranges have been set based on the phased in 2015 Basel III minimum SARB regulatory requirements. Nedbank Group Limited and Nedbank Limited Pillar 3 June

9 Nedbank Group Basel II.5 SARB minimum REGULATORY CAPITAL ADEQUACY RATIOS Basel III SARB minimum 5 Basel II.5 internal target old ranges Basel III internal target new ranges 4 Jun 2013 Basel III Jun 2012 Basel III 1 Jun 2012 Basel II.5 Dec 2012 Basel III 1 Dec 2012 Basel II.5 Including unappropriated profits CET1 (%) 5,25 4,50 7,5 9,0 10,5 12,5 11,8 10,6 10,6 11,6 11,4 Total Tier 1 (%) 7,00 6,00 8,5 10,0 11,5 13,0 13,0 12,1 12,1 13,1 12,9 Total (%) 9,50 9,50 11,5 13,0 14,0 15,0 14,8 14,7 14,4 15,1 14,9 Surplus CET1 capital 2, 3 (Rm) Total RWA (Rm) Total RWA : total assets (%) > Dividend cover (times) 1,75 2,25 2,18 2,23 2,18 Excluding unappropriated profits CET1 (%) 5,25 4,50 11,3 10,3 11,2 Total Tier 1 (%) 7,00 6,00 12,5 11,8 12,7 Total (%) 9,50 9,50 14,4 14,2 14,7 Nedbank Limited Including unappropriated profits CET1 (%) 5,25 4,50 7,5 9,0 9,5 11,5 10,1 10,0 10,5 10,6 11,2 Total Tier 1 (%) 7,00 6,00 8,5 10,0 10,5 12,0 11,6 11,6 12,2 12,3 12,9 Total (%) 9,50 9,50 11,5 13,0 13,0 14,0 13,6 14,6 15,0 14,8 15,3 Surplus CET1 capital 2, 3 (Rm) Total RWA (Rm) Total RWA : total assets (%) > Excluding unappropriated profits CET1 (%) 5,25 4,50 9,7 10,2 11,1 Total Tier 1 (%) 7,00 6,00 11,2 11,9 12,8 Total (%) 9,50 9,50 13,3 14,8 15,2 1 Pro forma Basel III. 2 Based on a 2019 end state Basel III minimum capital requirements for pro forma Basel III. 3 Excluding any specific Pillar 2B addon and countercyclical buffer (CCB). 4 Nedbank s internal TTC target ranges are based on final minimum regulatory requirements of 2019 for CET1 and 2015 for the Total Tier 1 and total capital ratios. 5 The SARB minimum ratios are for 2013 and increase in line with Basel III phasing over Economic capital is the group s comprehensive internal measurement of risk and capital requirements, and forms the basis of the group s annual Internal Capital Adequacy Assessment Process (ICAAP) and allocation of risk based capital to the business clusters. This includes a best practice Stress and Scenario Testing Framework and process to confirm the robustness of the group s capital adequacy position and capital buffers, as well as the forward capital projections and related capital planning activities. Management and the board of directors are satisfied that the capital levels [both regulatory capital and Nedbank s internal capital assessment (economic capital)] are conservative and appropriate, and both Nedbank Group and Nedbank Limited are strongly capitalised relative to their business activities, strategy, risk appetite, risk profile and the external environment in which the group operates, and their liquidity profiles remain sound. ECONOMIC CAPITAL AND NEDBANK S ICAAP Available financial resources (AFR) : economic capital 1 ratio (%) Surplus AFR over minimum economic capital requirements 1 (Rm) Economic capital requirements include the 10% capital buffer determined by the surplus ICAAP. Jun 2013 Jun 2012 Dec 2012 Solvency II and SAM (for South Africa) Solvency Assessment and Management (SAM) is the Financial Services Board s (FSB's) new economic risk based solvency regime for SA insurers, which closely follows international regulatory trends, in particular Solvency II. SAM affects the Nedbank Wealth cluster within Nedbank Group and implementation, which is set for 1 January 2016 (previously 2015), is on track, with the impact on the group s existing solvency or capital levels expected to be immaterial. Leverage SA banks, including Nedbank, compare favourably to most international banks on leverage. SA s banking system as a whole is less risky than banking sectors elsewhere. As a consequence, deleveraging, which is continuing among most international banks after the global financial crisis, is not a factor in South Africa. Nedbank Group s gearing or daily average accounting based leverage ratio remains at a prudent level of 12,6 times [December 2012: 13,2 times (restated to reflect the adoption of IAS 19 Employee Benefits, 2011)]. Nedbank Group Limited and Nedbank Limited Pillar 3 June

10 Nedbank Group s leverage ratio under Basel III, which includes off balance sheet exposure, is 16,3 times (or 6,13%) at 30 June 2013 (quarterly average: 16,5 times or 6,08%) against an internal risk appetite target of less than 20 times (or > 5%), and well below the Basel III limit in accordance with the revised SA regulations of 25 times (or > 4%), which is more prudent than Basel III at 33,3 times (or > 3%). The Basel Committee on Banking Supervision (Basel Committee) published a consultative document in June 2013 entitled 'Revised Basel III Leverage Ratio Framework and disclosure requirements'. Revisions to this framework relate primarily to the exposure measure of the leverage ratio. This is anticipated to impact Nedbank Group only through the inclusion of collateral on derivatives. Currently this represents approximately 0,1% of the total exposure measure and is therefore not expected to have a material impact on the leverage ratio. External credit ratings Nedbank engages three credit rating agencies, whose ratings are summarised below. FITCH RATINGS Nedbank Group Limited Nedbank Limited Sovereign rating South Africa August 2013 August 2013 August 2013 Support 2 Foreign currency Short term F3 F3 F3 Long term BBB BBB BBB Outlook Stable Stable Stable Local currency Long term BBB BBB BBB+ Outlook Stable Stable Stable National scale Short term F1+(zaf) F1+(zaf) Long term AA(zaf) AA(zaf) Outlook Stable Stable Viability rating bbb Country rating A MOODY'S INVESTOR SERVICE RATINGS Nedbank Limited Sovereign rating South Africa June 2013 June 2013 Foreign currency deposit ratings Long term Baa1 Baa1/A2 Short term P 2 Outlook Negative Negative Local currency deposit ratings Long term A3 Baa1/Baa1 Short term P 2 Outlook Negative Negative National scale Long term deposits Aa2.za Short term deposits P 1.za Bank financial strength rating C Outlook Stable STANDARD & POOR S RATINGS Nedbank Limited Sovereign rating South Africa January 2013 January 2013 Foreign currency counterparty credit rating Long term BBB BBB Short term A 2 A 2 Outlook Negative Negative Local currency counterparty credit rating Long term BBB A Short term A 2 A 2 Outlook Negative Negative South Africa national scale Long term zaaa Short term zaa 1 Nedbank Group Limited and Nedbank Limited Pillar 3 June

11 RISK MANAGEMENT HIGHLIGHTS Liquidity risk Nedbank Group remains well funded with a strong liquidity position, underpinned by a further lengthening of the funding profile, a large surplus liquid asset buffer, a strong loan to deposit ratio, low reliance on interbank and foreign currency funding, and a reduction in capital market issuance during the first half of 2013 as part of the group s capital planning. On 6 January 2013 the Basel Committee announced final revisions to, and confirmed the implementation of, the liquidity coverage ratio (LCR). The LCR will be phased in between 2015 and o Previously 100% compliance was required from 2015, whereas now the minimum LCR requirement will be phased in starting at 60% in 2015, and increasing by 10% each year to 100% in The definition of 'high quality liquid assets (HQLA)' has been widened and 'Level 2' assets now include a new '2B' subcategory. The definitions of net cash outflows have been relaxed. The Basel Committee will continue to do further work in terms of the role of central bank liquidity facilities in jurisdictions where there are insufficient HQLAs available for purposes of the LCR. In May 2012 the SARB, as per Guidance Note 05/2012, announced that it would provide a committed liquidity facility (CLF) for an amount up to 40% of the LCR requirements. The Basel Committee has, however, announced that work to revise the net stable funding ratio (NSFR) will commence in 2013 and span a period of up to 24 months. Across the globe market participants are expecting fundamental changes to the NSFR. Nedbank s strong liquidity and funding position is illustrated by the following: Based on the current level of qualifying HQLA, Nedbank is well positioned to meet the minimum LCR requirement of 60% in 2015 excluding any use of the SARB s CLF. Assuming targeted access to the currently available CLF, Nedbank is well positioned to exceed the 100% requirement of Nedbank has maintained significant sources of quick liquidity amounting to R102,7bn, representing 14,4% of total assets, which is underpinned by R25,0bn of surplus statutory liquid assets, ie an excess over and above the prudential statutory liquid asset requirement. The three month average long term funding ratio increased to 28% in June 2013, compared with 26% in December The loan to deposit ratio remains consistently below 100%, at 96,3%. LIQUIDITY AND FUNDING PROFILE Total sources of quick liquidity (Rm) Surplus statutory liquid assets (Rm) Statutory liquid assets and cash reserves (ie SARB prudential minimum) (Rm) Other sources of quick liquidity 1 (Rm) Total sources of quick liquidity as a % of total assets (%) 14,4 16,9 15,4 Long term funding ratio (three month average) (%) 28,0 27,0 26,0 Senior unsecured debt (Rm) Retail Savings Bond 2 (Rm) Green Retail Savings Bond 2 (Rm) Reliance on NCDs 3 (%) 14,4 16,1 14,0 Capital market issuance (Rm) Loan to deposit ratio (%) 96,3 95,6 95,7 Basel III pro forma liquidity ratios LCR (effective date 2015 to 2019) including targeted access to the CLF 4 (%) Pro forma compliant Pro forma compliant Pro forma compliant NSFR (effective date 2018) 5 (%) WIP 6 WIP 6 WIP 6 1 This includes corporate bonds, listed equities and other marketable securities. 2 These represent Nedbank s Retail Savings Bonds with tenures of two, three and five years. During 2012 Nedbank launched the Green Retail Savings Bond, the proceeds of which are earmarked for renewable energy projects. 3 As a % of total deposits. 4 A 60% minimum LCR is required from 2015, increasing 10% per annum to 100% by Finalisation of the NSFR by the Basel Committee is still 12 to 24 months away. Globally it is expected that the ratio will be significantly revised and that a pragmatic approach will ultimately be followed. 6 WIP = work in progress. Jun 2013 Jun 2012 Dec 2012 Nedbank Group Limited and Nedbank Limited Pillar 3 June

12 Asset quality and credit risk Nedbank s asset mix and quality continued to improve in 2013 in line with the group s Portfolio Tilt strategy, as discussed above, and strong credit risk management. SUMMARY OF NEDBANK GROUP S ASSET QUALITY PROFILE % Jun 2013 Jun 2012 Dec 2012 Return on assets (improved) 1,15 1,07 1,13 Return on RoRWA 4 (improved) 2,1 2,0 2,1 Interest margin (improved) 3,58 3,54 3,53 Non performing loans to gross loans and advances (improved) 3,54 4,14 3,58 Total wholesale 1 2,13 2,43 1,99 Nedbank Retail 6,15 7,01 6,27 Home Loans 2 6,87 8,72 7,38 Personal Loans 13,38 10,62 11,74 Properties in possession (improved) 0,11 0,13 0,11 Total impairments to gross loans and advances (improved year on year) 2,08 2,20 2,02 Portfolio impairments (decreased) 0,63 0,58 0,64 Total wholesale 1 0,28 0,30 0,29 Nedbank Retail 1,21 0,95 1,13 Home Loans 2 0,74 0,65 0,68 Personal Loans 3,54 1,84 2,83 Specific impairments (improved) 1,45 1,62 1,38 Total wholesale 1 0,62 0,80 0,55 Nedbank Retail 2,98 3,04 2,84 Home Loans 2 2,15 2,54 2,24 Personal loans 8,50 6,41 6,97 Total impairments coverage ratio 3 (coverage strengthened) 58,8 52,9 56,4 Total portfolio impairments coverage ratio performing advances (stable) 0,7 0,6 0,7 Total wholesale 1 0,3 0,3 0,3 Nedbank Retail 1,3 1,0 1,2 Home Loans 2 0,8 0,7 0,7 Personal Loans 4,1 2,1 3,2 Total specific coverage ratio defaulted advances (strengthened) 40,9 39,0 38,6 Total wholesale 1 29,3 32,8 27,4 Nedbank Retail 48,5 43,4 45,2 Home Loans 2 31,2 29,1 30,3 Personal Loans 63,5 60,3 59,4 1 Wholesale includes Nedbank Capital, Nedbank Corporate and Nedbank Business Banking. 2 Home Loans as discussed here represents a specific business unit within Nedbank Retail, and excludes the Nedbank Relationship Banking and Business Banking business units. 3 Total impairments as a percentage of total defaulted advances. 4 RoRWA = Return on risk weighted assets. The non performing to gross loans and advances ratio decreased to 3,54% (June 2012: 4,14%), driven by ongoing improvements in the residential and commercial mortgage books, despite increased defaults experienced in the personal loans book. The total and specific impairment coverage ratio increased to 58,8% (June 2012: 52,9%) and 40,9% (June 2012: 39,0%). Both portfolio and specific coverage ratios in the Nedbank Retail portfolio increased to 1,3% and 48,5% respectively (June 2012: 1,0% and 43,4%). Total impairments to gross loans and advances decreased to 2,08% (June 2012: 2,20%), driven by both lower specific impairments. Wholesale specific coverage levels have decreased overall to 29,3% (June 2012: 32,8%), mainly due to the commercial lending portfolio where there were a number of partial writeoffs as well as reductions in defaulted advances in Nedbank Capital as a direct result of resolutions. Continued consumer stress, further proactive strengthening of balance sheet impairments in Personal Loans and a single client charge in Business Banking led to an increase in the group s impairments to R3 325m (June 2012: R2 702m) and in the CLR to 1,31% (June 2012: 1,11%). The CLR is comprised of a specific charge of 1,24% and a portfolio charge of 0,07% (June 2012: specific: 1,00% and portfolio: 0,11%). However, quality remains sound in the rest of the book. Nedbank Group Limited and Nedbank Limited Pillar 3 June

13 Summary of credit risk profile % ,17 1,52 0,52 0,47 0,35 0,24 Dec 09 CREDIT LOSS RATIO TREND 2,67 1,98 2,01 1,36 1,23 1,06 1,27 1,13 1,05 0,61 0,40 0,53 0,34 0,19 0,29 0,15 0,25 0,24 Dec 10 Dec 11 Dec 12 Jun 13 1 TTC = through the cycle. 2 Nedbank Retail CLR restated due to the Imperial Bank integration in Nedbank Corporate restated due to the migration of Nedbank Africa to Central Management as welll as the Imperial Book integration in ,56 1,31 1,02 0,77 0,30 0,24 Nedbank Retail 2 1,50 2,20 Nedbank Group 0,60 1,00 Nedbank Business Banking TTC 1 target ranges (%) 0,55 0,75 Nedbank Capital 0,10 0,55 Nedbank Corporate 3 0,20 0,35 Nedbank Wealth 0,20 0,40 % OF AVERAGE BANKING ADVANCES In Nedbank Corporate the CLR was maintained within its TTC target range, and both Nedbank Capital and Nedbank Wealth reported lower impairments. The Business Banking CLR was affected by thee aforementioned client specific impairmentt charge and is likely to revert to the TTC target range by year end (excluding the client specific impairment charge, the Business Banking CLR was 0,43% at a 30 June 2013). The deterioration in Nedbank Retail s CLR reflects consumer stress and the outcome of the prudent impairment methodologies and early risk mitigation actions taken in Personal Loans. In line with the group s Portfolio Tilt strategy, the asset mix of the group and especially within Nedbank Retail has changed materially since The table below illustrates the impact of the 2009 asset mix on the June CLR. IMPACT OF NEDBANK RETAIL ADVANCES MIX CHANGE, BUSINESS BANKING CLIENT SPECIFIC CHARGE AND PERSONAL LOANS ON THE GROUP S AND NEDBANK RETAIL S CLR % Home Loans Jun ,4 Retail advances mix Dec ,7 Dec ,9 Dec ,5 Actual Jun 2013 CLR Credit loss ratio Nedbank Group 1,31 Nedbank Retail 2,56 Nedbank Business Banking 1,02 Vehicle Finance 29,6 28,5 26,8 21,8 Illustrative Jun 2013 CLR based on 2009 Retail portfolio mix 0,90 1,58 1,02 Personal Loans Card 11,0 5,4 11,3 5,1 9,0 4,5 4,5 4,2 Illustrative excluding Business Banking once off charge 1,23 2,56 0,43 Other Total 12,6 100,0 12,4 100,0 12,8 15,0 100,0 100,0 Illustrative with Personal Loans at the top end of its CLR target range 1,03 1,86 1,02 Based on the 2009 Nedbank Retail asset mix, the June 2013 Nedbank Retail CLR would have been 98bps lower at 1,,58% rather than the reported 2,56% %. At a Nedbank Group level this translates into a 41bps improvement to 0,90% rather than the reportedd 1,31%. These mix changes suggest the need to review these TTC target ranges for Retail and thee group, which is anticipated to be done during the second half of Based on the effect of Personal Loans being at the upperr end of its TTC target range,, the Retail CLRR would have been b 70bps lower at 1,86%. This translates to a 28bps improvement at a group level. Adjusting for the effects of the client specific impairmentt charge of R182m in Business Banking, thee CLR decreasedd to 0,43% from the reported 1,02% %, a 59bps and 8bps improvement at a Business Banking and group level respectively. Nedbank Group Limited and Nedbank Limited Pillar 3 June

14 Market risks Other than interest rate risk in the banking book (IRRBB), the group does not have significant risk appetite for, or exposure to, market risk. Nedbank s IRRBB is positioned for an upward interest rate cycle, but has been reduced to protect against downside risk in the short term. The focus of the trading businesses is to continue to develop the flow model by leveraging the deal flow from clients. Proprietary trading has been significantly scaled down. Equity risk in the banking book, or investment risk, is low relative to the rest of the balance sheet. All transactions with hedge funds are executed from a specialist unit with a primary focus on risk mitigation. SUMMARY OF MARKET RISK PROFILE Nedbank Group Jun 2013 Jun 2012 Dec 2012 IRRBB (high) Net interest income (NII) sensitivity to 1% decline in interest rates (equal and opposite positive NII impact for an increase in interest rates) (Rm) (938) 1 (903) 1 (813) 1 NII sensitivity to 2% decline in interest rates (equal and opposite positive NII impact for an increase in interest rates) (Rm) (1 901) (1 810) (1 665) % of ordinary shareholders equity (board limit: 2,25%) (%) 1,67 1,77 1,51 Trading market risk (low) % of group minimum economic capital requirement (%) 1,3 1,3 1,3 Total value at risk (VaR) (99%, one day VaR) exposure (average) (Rm) 7,0 17,8 14,7 Total stressed VaR exposure (99%, one day VaR at period end) (Rm) 12, ,1 Equity risk in the banking book (low) Total equity portfolio (Rm) % of total assets (%) 0,7 0,7 0,7 % of group minimum economic capital requirement (%) 3,4 4,5 3,9 Foreign currency translation (FCT) risk (low) Impact on group s total regulatory capital ratio for 10% change in the value of the rand (%) 0,1 0,1 0,1 1 Positioned for an upward interest rate cycle. BASEL III OVERVIEW Nedbank successfully implemented Basel III with effect from 1 January 2013 and remains well positioned. Strong capital ratios, well above minimum regulatory requirements and within new Basel III target ranges on day one. Liquidity coverage ratio (LCR) pro forma compliant. Net stable funding ration (NSFR) still work in progress and most likely to be changed significantly over next two years. No issue with the leverage ratio. Strategic impact of Basel III has been proactively managed and planned for at Nedbank since o Using Portfolio Tilt as one of Nedbank s four key strategic focus areas. Additional international regulatory reforms not anticipated to materially impact SA banks. Unlike Basel II implemented in 2008 as a 'big bang', Basel III is being phased in/implemented over several years from 2013 to 2019, and as such there are significant work in progress items as summarised on the next page. Nedbank Group Limited and Nedbank Limited Pillar 3 June

15 SUMMARY OVERVIEW OF BASEL III AND TIMELINES Key component Capital Tier 1 and Tier 2 definitions and minimum ratios Basel I 1988 Basel II 2008 Basel II Basel III Improved quality and definition of capital Higher risk weighted assets (RWA) requirements Higher minimum ratios New capital buffers Fully loss absorbency capital instruments Leverage Leverage ratio Liquidity LCR Risk and the three pillars Pillar 1 credit risk Pillar 1 market risk (revised 1998) = implementation/phasing in 1 Advanced Internal Ratings based. Pillar 1 credit risk (comprehensively revised) AIRB 1 credit risk 6% scaling factor (South Africa) Pillar 1 equity risk Pillar 1 securitisation revisions Pillar 1 securitisation risk Pillar 1 operational risk Pillar 2 Internal Capital Adequacy Assessment Process (ICAAP) Pillar 1 market risk trading book revisions Pillar 2 enhancements (risk management and governance) NSFR subject to change Liquidity risk management standards and disclosure Pillar 1 counterparty credit risk and centralised clearing counterparties Securitisation framework review (version 2) Trading book review (version 2) Recovery and resolution plan Pillar 3 enhancements to disclosure 60% 70% 80% 90% 100% Pillar 3 disclosure Other items 100% SUMMARY OF BASEL III WORK IN PROGRESS ITEMS There are significant work in progress items for Basel III as summarised below: NSFR Balancing risk sensitivity, simplicity and comparability Potentially increasing RWA levels LCR disclosure Recovery and resolution plans Revisions to leverage ratio Centralised clearing counterparties Non internal model (NIM) method for counterparty credit risk Large exposure rules/concentration risk Forward looking impairments (IFRS 9) Fundamental review of the trading book Fundamental review of securitisation framework Fundamental revision to the Operational Risk Framework Interest rate risk in the banking book Enhancing the risk disclosures of banks (Pillar 3) Peer reviews of Basel III implementation G SIFIs and DSIFIs Nedbank Group Limited and Nedbank Limited Pillar 3 June

16 OTHER REGULATORY CHANGE National Credit Act (NCA) Provisions of this act together with relevant awareness, are well embedded within Nedbank following a successful NCA programme. The Department of Trade and Industry (dti) has issued an NCA Draft Amendment Bill for comment following the issue of a draft policy review document. Nedbank has submitted comments to the dti on the bill and will also form part of the broader industry feedback via The Banking Association of South Africa (BASA). Consumer Protection Act (CPA) Meeting the requirements of the CPA are a business as usual practice within the organisation. In addition to conforming to the compliance requirements as stipulated in the act, the group fully adopts its spirit and intention, with client satisfaction receiving enhanced focus. Financial Intelligence Centre Act (FICA) Nedbank has a designated Money Laundering Unit, as well as an independent money laundering control officer appointed in terms of section 43 (b) (ii) of FICA. This remains a constant focus for the group, in light of the increasing requirements of the Financial Intelligence Centre. Companies Act The new Companies Act has been successfully implemented within the group. Compliance with requirements of the act occurs on a businessas usual basis. Nedbank remains constantly vigilant in respect of new developments and provisions. Foreign Account Tax Compliance Act (FATCA) A formal programme is currently underway to ensure compliance with the US Internal Revenue Service (US IRS) regulation released in January The financial services industry awaits the signing of an intergovernmental agreement between South Africa and the US IRS, anticipated to be concluded during October Nedbank Group remains well positioned to meet the requirements of the act. Protection of Personal Information (POPI) The POPI Bill is yet to be signed into law. The bill in its current form provides for a one year implementation phase in from the date of promulgation. Nedbank has embarked on a formal programme to ensure compliance, which is designed to align the conditions of the draft bill with those of the UK Data Protection Act 9 (as required by Old Mutual plc). Bribery/Corruption Nedbank is committed to combatting bribery and corruption within the group. The requirements of the Prevention and Combating of Corrupt Activities Act (PRECCA) as well as the UK Bribery Act are successfully embedded within the organisation. Banks Act The Banks Act Amendment Bill seeks to align terminology with the new Companies Act and Basel III. Nedbank is compliant with the provisions and well positioned to meet the future capital and liquidity requirements. The various circulars, directives and consultative papers from the SARB are tracked to ensure ongoing compliance. Tax Laws General Amendment Bill With many of the provisions of the bill anticipated to be effective from March 2014, the bill is likely to be promulgated in October Nedbank is currently collating feedback on the bill and will accordingly provide this to the SA Revenue Services through BASA. Treating Customers Fairly (TCF) The Financial Regulatory Reform Steering Committee (FRRSC), comprising National Treasury, the Financial Services Board (FSB) and SARB, is in the process of consultation on the implementation of a 'twin peaks' model of financial regulation in South Africa. The model will result in a 'split' in the regulatory and supervisory authority between the FSB and SARB, which in effect will give the SARB authority over prudential matters and FSB a mandate over market conduct matters. TCF is a key driver of that market conduct mandate. Although not yet implemented, the FSB has published outcomes for its TCF programme and commenced with the drafting of regulatory and supervisory frameworks. Nedbank has actively participated in all consultation processes and requests. In conclusion, Nedbank is well positioned to meet all the necessary regulatory requirements specified. Nedbank Group Limited and Nedbank Limited Pillar 3 June

17 GROUP STRUCTURE AND BASIS OF PILLAR 3 DISCLOSURE The group s comprehensive Pillar 3 and public disclosure is in line with Regulation 43 of the regulations relating to banks in South Africa based on Basel III. Set out below are the key subsidiary companies of the Nedbank Group. Consistent with the principle of proportionality (or materiality) contained in the regulations, this Pillar 3 report covers Nedbank Group Limited and Nedbank Limited. The other banking subsidiary companies are not in themselves material enough to warrant individual Pillar 3 reporting. All subsidiary companies and legal entities are consolidated into the Nedbank Group Limited ICAAP and Pillar 3 reporting as explained in the 'consolidated supervision' section below, again in compliance with the regulations. B: Banks F: Financial entities H: Holding Companies I: Insurance entities S: Securities entities T: Trusts Note: All subsidiaries are wholly owned unless otherwise stated. CONSOLIDATED SUPERVISION Consolidation of all entities for accounting purposes is in accordance with the International Financial Reporting Standards (IFRS) and for regulatory purposes is in accordance with the requirements of Basel III, the Banks Act and accompanying regulations. There are some differences in the basis of consolidation for accounting and regulatory purposes. These include the exclusion of certain accounting reserves (eg the profits not formally appropriated by Board of Directors by way of resolution to constitute retained earnings, for Group Banking entities or controlling company). The deduction of the investments in insurance entities is limited to the amount in excess of 10% of the qualifying Common Equity Tier 1 of the group. Refer to the table, 'Summary of regulatory qualifying capital and reserves' on page 53 for differences in the basis of consolidation for accounting and regulatory purposes. The definition of capital includes foreign currency translation (FCT) reserve, share based payment (SBP) reserve and available for sale (AFS) reserve as Common Equity Tier 1 capital under Basel III from 1 January Nedbank Group Limited and Nedbank Limited Pillar 3 June

18 The following is a summary of the treatment followed for Basel III consolidation. Type of entity Banking, securities and other financial entities 1,2 Insurance entities Commercial entities 20% Treat as equity investment. Apply 100% risk weight (SA) or 300%/400% risk weight (IRB 3 market based Simple Risk Weight Approach). As above. Minority interest Other significant shareholder Proportionately consolidate. Percentage holding 20% and 50% 20% and 50% No other significant shareholder Apply deduction method. Risk Weight at 250% up to 10% of the bank or controlling company's CET1 capital. Deduct the amount in excess of 10% of CET1 against the corresponding component of capital Treat as equity investment. Apply 100% risk weight (SA) or 300%/400% risk weight (IRB 3 market based Simple Risk Weight Approach). Aggregate of investment 10% of the bank or controlling company's CET1 Risk Weight at the appropriate risk weighting based on nature of holding of instrument and measurement approach. Risk Weight at 250% up to 10% of the bank or controlling company's CET1 capital. Deduct the amount in excess of 10% of CET1 against the corresponding component of capital. Standardised Individual Investment up to 15% of CET1, AT1 and T2 is to be risk weighted at no less than 100%. Individual Investment in excess of 15% of CET1, AT1 and T2 is to be risk weighted at 1 250%. Aggregate of Investment > 60% of CET1, AT1 and T2 the excess above 60% is to be risk weighted at 1 250%. Majority/controlling interest Aggregate of Investment > 10% of the bank or controlling company's CET1 Risk weight at the appropriate risk weighting based on nature of holding of instrument and measurement approach up to 10% of the bank or controlling company's CET1 deduct the amount in excess of 10% of CET1 against the corresponding component of capital. > 50% Full consolidation OR Financial entities with specific limitations will have a to apply the deduction method. Risk weight at 250% up to 10% of the bank or controlling company's CET1 capital. Deduct the amount in excess of 10% of CET1 against the corresponding component of capital. Advanced approach Individual Investment up to 15% of CET1, AT1 and T2 is to be riskweighted in accordance with one of the available equity risk approaches [Market based approach simple risk weight or Internal Model; or PD/LGD (probability of default/loss given default) approach]. Individual Investment in excess of 15% of CET1, AT1 and T2 is to be risk weighted at 1 250% or RWE equivalent. 1 Includes regulated and unregulated entities 2 Types of activities that financial entities might be involved in include financial leasing, issuing credit cards, portfolio management, investment advisory, custodial and safekeeping services and other similar activities that are ancillary to the business of banking. 3 IRB = Internal Ratings based. Nedbank Group Limited and Nedbank Limited Pillar 3 June

19 CAPITAL TREATMENT OF INVESTMENTS IN BANKING, FINANCIAL, SECURITIES FIRMS, INSURANCE AND COMMERCIAL ENTITIES 1 Entities to which the deduction method is applied should apply the provisions of Reg 38(5)(a)(i)(M), ie limited recognition is allowed (up to a specified threshold) after which any amounts above the specified thresholds will be deducted against capital. 2 Banks may use either the aggregation of the full consolidation method for investments for which consolidation is required. CAPITAL TREATMENT OF INVESTMENTS IN BANKING, FINANCIAL, SECURITIES FIRMS, INSURANCE AND COMMERCIAL ENTITIES For the Nedbank Group, the following Basel III consolidation approaches are followed: The banking, securities and other financial entities are fully consolidated. The insurance entities are fully deducted. All commercial entities are treated as set out above. Nedbank Group Limited and Nedbank Limited Pillar 3 June

20 BASEL III RWA CALCULATION APPROACHES The following approaches have been adopted by Nedbank Group for the calculation of RWA. Risk Type Nedbank Limited Solo 3 Local subsidiaries Nedbank Limited Foreign subsidiaries Foreign subsidiaries Nedbank Group Limited Trusts and securities entities Other insurance entities Credit risk AIRB / TSA 1 AIRB TSA TSA TSA N/A Counterparty credit risk CEM N/A CEM 4 N/A N/A N/A Securitisation risk AIRB TSA TSA TSA TSA N/A Market risk IMA TSA TSA TSA TSA N/A Equity risk SRWA SRWA SRWA SRWA SRWA N/A Operational risk 2 AMA/TSA AMA TSA TSA AMA N/A Other assets AIRB AIRB TSA TSA TSA N/A 1 SARB approval received to use the AIRB approach for MFC (ex Imperial Bank) in July The remaining portion of the legacy Imperial Bank book (ie in Property Finance and Nedbank Business Banking) remains on TSA. 2 The AMA coverage is 90%, TSA 10%. The TSA portion in Nedbank Solo is insignificant/immaterial. 3 Approaches followed by Nedbank Limited solo also apply to Nedbank London branch. 4 CEM is applicable for London branch only; all other foreign subsidiaries are not applicable. Abbreviations: AIRB = Advanced Internal Ratings Based CEM = Current Exposure Method IMA = Internal Model Approach (based on stressed VaR) AMA = Advanced Measurement Approach SRWA = Simple Risk Weight Approach TSA = The Standardised Approach RISK CULTURE Nedbank Group has a strong risk culture and follows best practice enterprisewide risk management, which aligns strategy, policies, people, processes, technology and business intelligence in order to evaluate, manage and optimise the opportunities, threats and uncertainties the group may face in its ongoing efforts to maximise sustainable shareholder value within the group s defined risk appetite. Nedbank s approach to risk embraces risk management as a core competency that allows the business to optimise risk taking, is objective and transparent and ensures that the business prices for risk appropriately, linking risk to return. VISION NEDBANK GROUP S STRATEGIC FRAMEWORK INCORPORATES RISK MANAGEMENT Building Africa s most admired bank by our staff, clients, shareholders, regulators and communities DEEP GREEN ASPIRATIONS Great place to work Great place to bank Most respected and aspirational brand Great place to invest Great at collaboration Leading transformation Highly involved in the community and environment Worldclass at managing risk Community of leaders Living our values In Nedbank, to be 'Worldclass at managing risk' means that: ˈUnderstanding, measuring and managing risk are central to everything we do. We have engrained risk management in our business. We understand that banking at Nedbank is about managing risk, not avoiding it. Our risk management methodologies are worldclass.ˈ Nedbank has three core objectives in managing risk: 'Managing Risk as a THREAT' To minimise and protect against downside risk, protect against material unforeseen losses and maximise long run sustainability. 'Managing Risk as an UNCERTAINTY' To eliminate excessive earnings volatility and minimise material negative surprises. 'Managing Risk as an OPPORTUNITY' To maximise financial and share price performance upside via application of superior business intelligence, managing for value including strategic portfolio management and client value management, optimising business opportunities, risk appetite, funding, capital and the balance sheet shape and mix. Nedbank Group Limited and Nedbank Limited Pillar 3 June

21 Nedbank also strictly applies three lines of defence in its risk governance, underpinned by a best practice Enterprisewide Risk Management Framework (ERMF). First line The board and management of Nedbank Group are responsible for the implementation and management of risk. Second line Group Risk and Enterprise Governance and Compliance perform a policy setting and monitoring role to ensure implementation of risk management principles and adherence to regulation and legislation. Third line Group internal audit, external auditors and independent actuaries provide additional assurance on the effectiveness of risk management in the organisation. The three lines of defence governance model is covered in more detail on page 35. Consistent with Nedbank Group s risk philosophy and strong risk culture engrained in the group s ERMF is the culture with respect to capital management, and Nedbank s capital management framework. The group's strong risk culture is evident in its proactive and comprehensive response to the global financial crisis. The group strategy is continuously refined by anticipating changing global and local events. Nedbank conducts scenario planning exercises to identify appropriate courses of action. Over the past few years, specifically around risk and balance sheet management, a more conservative approach was implemented, including an intensified focus on: Increasing capital adequacy levels Risk and capital optimisation (including risk weighted assets) Growing deposits and liquidity Risk based pricing of loans and advances Proactive risk management Excellence in collections Proactive margin management Refining credit and credit risk parameters Selectively growing assets in businesses Disciplined cost management Managing down positions in riskier lines of business Excellence in data and building superior business intelligence. Economic capital is embedded in the organisation and the way the business is managed. This is summarised below. ECONOMIC CAPITAL USE ACROSS NEDBANK Economic capital adequacy Risk based capital allocation across the group s businesses Key component of risk appetite Active capital management and Internal Capital Adequacy Process (ICAAP) Effective reporting of risk (Pillar 3) GROUP LEVEL PORTFOLIO LEVEL Concentration risk management Risk diversification Risk portfolio management and optimisation Limit setting Portfolio Tilt Strategic and capital planning Risk/return economic value appraisal of different business units and monolines Economic Profit target setting Risk based strategic planning Risk appetite optimisation Internal Capital Adequacy Process (ICAAP) Risk based pricing Consideration of economic return on individual loan applications and products Client value management Prioritisation of utilisation of client limits Economic capital is a sophisticated, consistent measurement and comparison of risk across business units, risk types and individual products or transactions. This enables a focus on both downside risk (risk protection) and upside potential (earnings growth). Nedbank assesses the internal requirements for capital using its proprietary economic capital methodology shown previously, which models and assigns economic capital within 14 quantifiable risk categories, as summarised on page 43. All of Nedbank s quantifiable risks, as measured by its economic capital, are then allocated back to the businesses in the form of an economic capital allocation to where the assets or risk positions reside or originate. Economic capital not only facilitates a 'like for like' measurement and comparison of risk across businesses but, by incorporating it into performance measurement, the performance of each business can be measured and compared on an absolute basis using EP and a relative percentage return basis, namely return on risk adjusted capital (RORAC) or ROE by comparing these measures against the group s cost of capital. Nedbank Group Limited and Nedbank Limited Pillar 3 June

22 ECONOMIC PROFIT IS NEDBANK S PRIMARY FINANCIAL PERFORMANCE METRIC AS IT ALIGNS CLOSEST WITH SHAREHOLDER VALUE CREATION AND INCORPORATES RISK (VIA ECONOMIC CAPITAL ALLOCATION) EP is a combination of familiar metrics that enables trade off between: Risk and return Growth and profitability Shareholder value creation Strong correlation of total shareholder return (TSR) with economic profit growth Indicator for TSR 1 Compare (%) ROE versus TSR R = 19 ROE versus TSR R = 15 EP versus TSR R = 18 EP versus TSR R = 49 1 Source: Oliver Wyman analysis based on US banks with market values over $1bn for five year period ending EP = CAPITAL X (RORAC cost of capital) Robust measure of risk, based on Basel III Economic ROE Shareholder requirements Currently EP and RORAC are used interchangeably as the primary measure for performance measurement within Nedbank Group. In the calculation of RORAC, which equates to Nedbank s internal measure of ROE, the capital is calculated on a risk adjusted basis (economic capital), however, the return is not risk adjusted as IFRS earnings are used. This is shown in the diagram below. The RAROC measure is calculated using both risk adjusted return and capital, and is also reported internally as a secondary performance measure. In order to derive the risk adjusted earnings, impairments are replaced with expected loss. Impairments represent an accounting charge that is cyclical in nature and volatile over the economic cycle, whereas the expected loss charge is a through the economic cycle measure that is more aligned to long run business profitability and sound management decision making. Globally, following the financial crisis, there has been a move towards using through the cycle (TTC) risk measures of return that provide a longer term view and appropriate incentivisation of reward. R % EP = IFRS EARNINGS (OR RISK ADJUSTED PROFIT) HURDLE RATE X ECONOMIC CAPITAL Value is created if EP > 0. EP is a core metric for shareholder value add. If capital is unconstrained, all business with EP > 0 should be grown subject to established hurdle ranges. No information on the marginal percentage return on economic capital that RORAC or RAROC provides. RORAC OR RAROC = [IFRS EARNINGS FOR RORAC (INTERNAL ROE) (OR RISK ADJUSTED PROFIT FOR RAROC) + CAPITAL BENEFIT] ECONOMIC CAPITAL Value is created if RAROC OR RORAC > hurdle rate. If capital is scarce, businesses with the highest RORAC or RAROC (ie highest marginal return per rand of economic capital) should be prioritised. No information on magnitude of value being created for shareholders which EP provides. Economic capital, EP and RORAC as well as other important metrics, such as return on assets (ROA), credit loss ratio, non interest revenue (NIR) to expenses and the efficiency ratio, are included in performance scorecards across the group. The primary performance indicator is EP driven off risk based economic capital. Risk based remuneration practices Economic capital and EP are comprehensively in use across the group, embedded within businesses on a day to day basis, and in performance measurement and reward schemes as discussed above. This risk adjusted performance measurement has been applied across the group for some years now and helps ensure that excessive risk taking is mitigated and managed appropriately within the group. To align the group's current short term Incentive scheme (STI scheme) with the shareholder value drivers, the STI scheme has been designed to appropriately incentivise a combination of profitable returns, risk and growth. It is driven from an economic profit and headline earnings basis, using risk based economic capital allocation as discussed above. Risk is thus an integral component of capital allocation and performance measurement (and reward) in Nedbank. The global financial crisis also precipitated a number of initiatives aimed at improving the governance and management of remuneration. The recommendations, guidance and practice notes are primarily aimed at the remuneration of senior managers and those whose activities could have a material impact on the risk profile of the organisation, but the underlying principles and statements of good practice can be applied to most incentive arrangements for the majority of staff members. The group's remuneration practices and public disclosures are compliant with the evolving principles, practices and governance codes released for the SA financial services industry. For this detail please refer to the group s Remuneration Report within the Integrated Report which can be found at Nedbank Group continues to monitor the evolving governance environment, to ensure appropriate compliance of the group s risk adjusted remuneration practices with the relevant regulatory and/or statutory requirements. Nedbank Group Limited and Nedbank Limited Pillar 3 June

23 Risk Appetite Framework A comprehensive Risk Appetite Framework was first approved by the board of directors in 2006 and subsequently has been significantly enhanced, which is an integral component of the group s ERMF and embedded in strategy and business plans. Detail of the enhancements is discussed in the risk appetite section that follows from page 25. Stress and Scenario Testing Framework A comprehensive Stress and Scenario Testing Framework was also originally implemented in 2006 as described from page 31, and this has also been further enhanced. Stress testing has been an integral part of the group's ICAAP since 2008 and has contributed to the proactive risk management that has facilitated the group's resilience through the global financial crisis and the local recession in Enterprisewide Risk Management Framework (ERMF) The backbone of the group's strong risk management culture and risk governance has been, and continues to be, the group's ERMF, first developed and rolled out in Enterprisewide risk management is a structured and disciplined approach to risk management. It aligns strategy, processes, people, technology and knowledge, with the purpose of evaluating and managing the opportunities, threats and uncertainties the group faces as it strives to create shareholder value. It involves integrating risk and capital management effectively across the group's risk universe, business units and operating divisions, geographical locations and legal entities. Capital Management Framework NEDBANK S CAPITAL MANAGEMENT FRAMEWORK 1 MMFTP = Matched maturity funds transfer pricing. 2 AJTP = Activity justified transfer pricing. Nedbank's comprehensive Capital Management Framework is designed to meet its key external stakeholders needs, both those focused more on the adequacy of the group s capital in relation to its risk profile (or risk versus solvency) and those focused more on the return or profitability of the group relative to the risk assumed (or risk versus return). The challenge for management and the board is to achieve an optimal balance between these two important dimensions. Nedbank Group Limited and Nedbank Limited Pillar 3 June

24 Liquidity Risk Management Framework NEDBANK S LIQUIDITY RISK MANAGEMENT FRAMEWORK Contractual mismatch Business as usual mismatch Stressed mismatch Available sources of stress funding Liquidity Risk Contingency Plan (LRCP) For dealing with more protracted liquidity scenarios Funding strategy Formulated on the basis of the liquidity risk metrics and policy Liquidity policies Structural and daily liquidity risk management Liquidity risk metrics Calibrated to meet board approved appetite Liquidity risk management objective Stress Funding Requirement Stress Funding Sources Stress liquidity gap Liquidity buffer management Risk appetite setting Minimum survival horizon in days Cost / profitability Internal Liquidity Adequacy Assessment Process (ILAAP) Ongoing assessment of liquidity self sufficiency through stress testing and scenario analysis Review and assessment of all components making up and/or supporting the Liquidity Risk Management Framework Embedded within the Liquidity Risk Management Framework is Nedbank Group's Internal Liquidity Adequacy Assessment Process (ILAAP). The ILAAP involves an ongoing and rigorous assessment of Nedbank Group's liquidity self sufficiency under a continuum of stress liquidity scenarios, taking cognisance of the board approved risk appetite. The ILAAP also involves an ongoing review and assessment of all components that collectively make up and/or support the Liquidity Risk Management Framework. The objective of this review and assessment process is to ensure that the framework remains sound in terms of measuring, monitoring, managing and mitigating liquidity risk, taking cognisance of best practise and regulatory developments. In conclusion, the group's risk culture, risk profile and overall balance sheet management systems have been duly tested and proven effective during the recent global financial crisis. Nedbank Group Limited and Nedbank Limited Pillar 3 June

25 RISK APPETITE Risk appetite is an articulation and allocation of the risk capacity or quantum of risk Nedbank Group is willing to accept in pursuit of its strategy, duly set and monitored by Group Exco and the board, and integrated into our strategy, business, risk and capital plans. Nedbank Group measures and expresses risk appetite qualitatively and in terms of quantitative risk metrics. The quantitative metrics include earnings at risk (EaR) (or earnings volatility) and, related to this, the chance of experiencing a loss, the chance of regulatory insolvency and economic capital adequacy. Earnings volatility is the level of potential deviation from expected financial performance that the group is prepared to sustain at relevant points on its risk profile. It is established with reference to the strategic objectives and business plans of the group, including the achievement of financial targets, payment of dividends, funding of capital growth and maintenance of target capital ratios. Together with total RWA to total assets and the Basel III leverage ratio, these comprise the group s core risk appetite metrics. In addition, a large variety of other risk appetite metrics with targets, triggers, mandates and guidelines are in place for all the financial risks [eg credit, market and asset and liability management (ALM) and concentration risks]. In 2009 the group sought to enhance the extent, focus and reporting of the key financial risk appetite metrics, and the cascade from group level down to cluster, business unit and monoline level. Accordingly an enhanced suite of base case [through the cycle (TTC) and point in time (PIT)] risk appetite metrics was established and incorporated into the business plans at both group and business cluster levels. In 2010 the risk appetite metrics and targets were enhanced to include short term and long term insurance, insurance investment and asset management risk profiles. In 2011 the risk appetite metrics and targets were further enhanced to include operational and tax risk profiles of the group. Credit risk and investment risk appetite metrics and targets, as relevant to the approved business activities, have been cascaded down from group level for each business cluster, major business unit and the monolines in Nedbank Retail. The relevant operational risk appetite metrics have also been cascaded down to the business cluster level. Stressed (extreme event) risk appetite limits for the PIT risk appetite metrics, and linked to Nedbank Group s stress and scenario testing programme, were then also introduced in In 2012 risk appetite metrics for the Rest of Africa were implemented in terms of economic capital consumption and return targets for the various businesses. Two sets of targets were established, one set for the medium term (end 2015) and one for the long term (end 2020). Concentration risk appetite targets were introduced in 2011, both in areas where Nedbank Group is materially exposed to concentration risk, as well as areas of under concentration, and so to identify potential growth. The targets were agreed by senior management and approved by the board in 2011, in line with the Basel II.5 regulations and the board s responsibilities. The concentration risk appetite metrics and target ranges were further enhanced in Further detail is contained in the section 'Concentration and off balance sheet risks'. Qualitatively, the group also expresses risk appetite in terms of policies, processes, procedures, statements and controls meant to limit risks that may or may not be quantifiable. Policies, processes and procedures relating to governance, effective risk management, adequate capital and internal control have board and senior management oversight and are governed by the three lines of defence (refer to page 35 for details on Nedbank s three lines of defence). A key component of the Enterprisewide Risk Management Framework (ERMF) is a comprehensive set of board approved risk policies and procedures, which are updated annually. The coordination and maintenance of this formal process rests with the head of Enterprisewide Risk Management, who reports directly to the Chief Risk Officer. Nedbank Group s risk appetite is defined across five broad categories as set out in the board approved Risk Appetite Framework, namely: Core risk appetite metrics: EaR Chance of a loss Chance of regulatory insolvency Available financial resources (AFR): economic capital (A solvency target) Total RWA: total assets Leverage ratio During 2011 Nedbank Group revised the EaR and chance of a loss metrics from 100% to 80% and from 1 in 10 to 1 in 15 respectively, adding further conservatism to these core risk appetite metrics. Specific risk type limit setting (which clarify across the group s businesses the mandate levels that are of an appropriate scale relative to the risk and reward of the underlying activities so as to minimise concentrations and other risks that could lead to unexpected losses of a disproportionate scale). Stakeholder targets (such as performance targets, regulatory capital targets and target debt rating for economic capital adequacy, economic capital allocations to business clusters, dividend policy, target credit impairment ratios, derisking the balance sheet of non core assets). Policies, procedures and controls. Zero tolerance statements. Nedbank Group Limited and Nedbank Limited Pillar 3 June

26 NEDBANK GROUP CORE RISK APPETITE METRICS Group metrics Definition Measurement methodology Current targets Target achieved Earnings at risk (EaR) Percentage pretax earnings potentially lost over a one year period Measured as a ratio of earnings volatility as a 1 in 10 chance event (ie 90% confidence level) and pretax earnings EaR less than 80% Chance of experiencing a loss Event in which Nedbank Group experiences an annual loss Compares expected profit over the next year with economic loss at different confidence intervals expressed as a 1 in N chance event of experiencing a loss Better than 1 in 15 years Chance of regulatory insolvency Event in which losses would result in Nedbank Group being undercapitalised relative to the minimum total regulatory capital ratio Compares the capital buffer above minimum required regulatory capital with economic loss at different confidence intervals and expressed as a 1 in N chance event of regulatory insolvency Better than 1 in 50 years Economic capital adequacy Nedbank Group adequately capitalised on an economic basis to its current international foreign currency target debt rating Measured by the ratio of AFR and required economic capital at an A international foreign currency debt rating Greater than an A rating plus 10% buffer Total RWA to total assets The average risk profile (risk weight) of Nedbank Group s assets Measured as the ratio of total RWA and total assets 50% 59% Leverage ratio The extent to which Nedbank Group is leveraged in terms of assets, including offbalance sheet assets, per unit of qualifying Tier 1 regulatory capital Measured as the ratio of total assets, including off balance sheet assets, to qualifying Tier 1 regulatory capital (aligns with Basel III) Less than 20 times Nedbank Group s Risk Appetite Framework and modelling of the group level metrics are integrated with the economic capital model and the ERMF. The two measures, EaR and economic capital, are methodologically very similar and differing primarily in the confidence level used. Both economic capital and EaR are calculated at granular levels and are key components of Nedbank Group s Risk Appetite Framework and Risk Adjusted Performance Measurement system (ie for RORAC, EP measures). Nedbank Group has a cascading system of risk limits at all levels of the group and for all financial risks, which is a core component of the implementation of the Risk Appetite Framework. The size of the various limits is a direct reflection of the board s risk appetite, given the business cycle, market environment, business plans and strategy, and capital planning. NEDBANK S SUITE OF RISK APPETITE METRICS GROUP TARGET CREDIT RISK PROFILE Credit loss ratio (%) 0,60 1,0 Credit RWA : Loans and advances (%) Credit property exposure : Loans and advances (%) < 45 Nedbank owned properties : Loans and advances (%) < 0,1 Average PD (%) performing book (TTC) < 3 Average LGD (%) performing book (TTC) Average expected loss (EL) (%) performing book (TTC) 0,6 0,7 Defaulted exposure at default (EAD) : Total EAD (%) < 3 EAD: Exposure (%) < 120 COUNTERPARTY CREDIT RISK (CCR) (DERIVATIVES) PROFILE CCR EAD : Total EAD (%) < 2 CCR economic capital : Total economic capital (%) < 0,5 SECURITISATION RISK PROFILE Securitisation RWA : Total RWA (%) < 5 TRADING MARKET RISK PROFILE VaR (99%, three day) < 127 Stress trigger (Rm) < 846 Trading economic capital : Total economic capital (%) < 3 EQUITY (INVESTMENT) RISK PROFILE Exposure : Total assets < 2 Equity investment economic capital : Total economic capital (%) < 7 ALM RISK PROFILE LIQUIDITY Short term (0 to 31 days) funding : Total funding (%) < 58 (+5 tolerable deviation) Cumulative Short and Medium term (0 to 180 days) funding : Total funding (%) < 75 (+5 tolerable deviation) Long term (> 180 days) funding : Total funding (%) > 25 ( 5 tolerable deviation) Contractual maturity mismatch (0 to 31 days) : Total funding (%) < 38 (+5 tolerable deviation) Liquidity stress event (minimum survival period) : Days > 21 Net interbank reliance : Total funding (%) < 1,5 (+1 tolerable deviation) Nedbank Group Limited and Nedbank Limited Pillar 3 June

27 GROUP TARGET ALM RISK PROFILE Interest rate risk in the banking book Nedbank Group NII sensitivity (100bps parallel shift in interest rates) : Equity (%) < 2,25 Nedbank Group NII sensitivity (100bps parallel shift in interest rates) : 12 months NII (%) < 7,5 Nedbank Group NII sensitivity (100bps parallel shift in interest rates) : Interest earning assets (bps) < 25 Nedbank Group NII sensitivity (25bps shift in call rates) : Equity (%) < 1 Nedbank Limited Economic value of equity sensitivity (100bps parallel shift in interest rates) : Equity (%) < 2,25 Nedbank Limited MTM Sensitivity : 25bps shift between Bond and Swap curves (Rm) 1 < 165 Nedbank Limited MTM Sensitivity : 100bps parallel shift (Rm) 1 < 82 ALM RISK PROFILE Foreign currency translation risk Currency equity : Total equity (%) < 5 LONG TERM INSURANCE RISK PROFILE Net claims ratio 2 < 50 Capital adequacy requirement cover 3 > max of economic capital or 1,5*regulatory capital Max loss per client after re insurance (Rk) 550 SHORT TERM INSURANCE RISK PROFILE Net claims ratio 2 < 75 Capital adequacy requirement cover 4 > max of economic capital or 1,3* regulatory capital ASSET MANAGEMENT RISK PROFILE Asset management economic capital : Total Nedbank Wealth economic capital (%) < 25 INSURANCE INVESTMENT RISK PROFILE Equity exposure : Total investment from premium received (%) < 10 OPERATIONAL RISK PROFILE Total operational risk loss : gross operating income (GOI) (%) < 1,3 Internal fraud loss : GOI (%) < 0,1 External fraud loss : GOI (%) < 0,6 Client, products and business practices : GOI (%) < 0,2 Operational risk VaR : GOI (%) < 15 CORE RISK APPETITE METRICS Earnings at risk < 80 Chance of a loss (1 in N years) > 15 Chance of regulatory insolvency (1 in N years) > 50 AFR : economic capital (A solvency target) (%) > 110 Total RWA : Total assets (%) Leverage ratio (Basel III basis) < 20 times 1 Applicable to liquid asset, senior unsecured debt and subordinated debt portfolio. 2 Percentage of gross premium, net of re insurance. 3 Long term insurance capital adequacy ratio (CAR) cover 1 times is the statutory requirement. 4 Short term insurance CAR cover 1,25 times is the statutory requirement. Nedbank Group has cultivated and embedded a prudent and conservative risk appetite, focused on the basics and core activities of banking. This is illustrated by reference to the following: Conservative and value based credit underwriting practices that have culminated in a high quality, well collateralised wholesale book and an emphasis on selective, value based origination in the retail book. Reasonable credit concentration risk levels: Large individual or single name exposure risk is low as shown on page 158. Geographic exposure risk is high (93% of the group's loans and advances originate in South Africa), however this concentration has been positive for Nedbank Group during the global international crisis, and reflects focus on an area of core competence. Industry exposure risk is reasonably well diversified as shown in the concentration risk section on page 159. Nedbank Group s property exposure is high, similar to the other big four SA banks. The sovereign debt crisis in the Eurozone remains unresolved. Nedbank Group s exposure to banks in the PIIGS countries is R489m as at 30 June The extent of the total Eurozone exposure is low, being only 1,82% (June 2012: 1,59%) of balance sheet credit exposure. Counterparty credit risk is almost exclusively restricted to non complex banking transactions. There is continued emphasis on the use of credit mitigation strategies, such as netting and collateralisation of exposures. Credit derivative activities have been materially restricted to single name trades of SA exposures and are biased towards providing risk mitigation. A strong, well diversified funding deposit base and a low reliance on offshore funding. Additionally, Nedbank Group's reliance on its top ten depositors is not unduly concentrated. Low level of securitisation exposure at approximately 0,7% of total RWA. Nedbank Group Limited and Nedbank Limited Pillar 3 June

28 Low leverage ratio under Basel III, which includes off balance sheet exposure, at 16,3 times against a group internal target of < 20 times, and well below the Basel III limit in accordance with the revised SA regulations of 25 times, which is more prudent than Basel III at 33,3 times. Relatively low risk of assets and liabilities exposed to the volatility of International Financial Reporting Standards (IFRS) fair value mark tomarket (MTM) when considered with the associated derivative hedges. Banking Book In terms of International Accounting Standard (IAS) 39, an entity has the option to designate a financial instrument at fair value provided that certain criteria are met. When a fixed rate deal is transacted, it gives rise to interest rate risk, which is hedged with an interest rate swap derivative that needs to be carried at fair value. In order to eliminate any accounting mismatch, the underlying fixed rate deal is designated fair value through profit and loss, fair valued and disclosed in non interest revenue (NIR). The volatility that is in the income statement on the designated fair value line is a result of the accounting mismatch described above where underlying fixed rate deals are not designated fair value through profit and loss, basis risk and because IAS 39 requires an entity to fair value its own credit at fair value through profit and loss designated financial liabilities. This process is controlled and monitored by the Group ALCO and Executive Risk Committee (Group ALCO). Nedbank Group also carries all its investment securities, both listed and unlisted, at fair value. There are no material hedges in place for these investment securities and they are designated as at fair value through profit and loss. Trading book The trading book is fair valued and the impact taken through the income statement. The trading portfolio has limited exposure to the credit derivatives market. This, coupled with the group s conservative risk appetite, has restricted losses incurred in the portfolio during the current period. Low trading market risk in relation to total bank operations (economic capital held is only 1,3% of the minimum economic capital requirement for Nedbank Group and is conservatively based on limits rather than utilisation, plus a 10% capital buffer). Although proprietary trading activities are small, they play an essential role in facilitating client trades and creating liquidity in the market. The risk appetite within the trading business has remained largely unchanged over the past two years. Trading activities have focused on the domestic market with a bias towards local interest rate and forex products. The overall performance of the trading business has been relatively sound, an indication that the impacts from the credit crunch and difficult equity markets were successfully navigated, and the group s risk systems are sound. Interest rate risk in the banking book (IRRBB) is appropriate for the size of the Nedbank Group balance sheet, in line with other peer group banks that manage IRRBB on a similar basis. Low equity (investment) risk, including private equity but excluding investment property exposures. The total equity risk exposure, including the private equity business and excluding investment property, is R4,7bn, comprising only 0,7% of total assets. Further, within this a wide range of individual investments exist and many are linked to a wider client relationship. Low foreign currency translation risk to the rand's volatility, which is in line with Nedbank Group's appropriate offshore capital structure (shown in the table on page 141) and strong SA focus. Well diversified earnings streams. Most of the group's earnings are generated by traditional vanilla annuity based income products in wholesale and retail banking, and specialised finance (kindly refer to page 18b in Nedbank Group s Analyst Booklet, June 2013). Well diversified subordinated debt and Additional Tier 1 maturity profile. As a result of Nedbank s strong total Basel II.5 and Basel III capital positions, Nedbank continued to redeem maturing Tier 2 debt during 2012, totalling R1,8bn, comprising the NED 7, NED 10, NED 12A and NED 12B notes that were not replaced with new issues. This was in line with the group s capital planning. Comprehensive stress and scenario testing to confirm the adequacy and robustness of the group s capital ratios and accompanying capital buffers. Individual risk appetite targets, as relevant to the approved business activities, have been approved and cascaded down from group level for each business cluster, major business unit and the monolines in Nedbank Retail. Additionally, individual limits for credit loss ratios in a stressed macroeconomic environment has been approved and cascaded down. In conclusion, Nedbank Group has a strong risk culture and a conservative risk appetite, which is well formalised, managed and monitored on an ongoing basis, bearing the board's ultimate approval and oversight. Nedbank Group Limited and Nedbank Limited Pillar 3 June

29 STRESS AND SCENARIO TESTING STRESS TESTING Nedbank Group has a comprehensive Stress and Scenario Testing Framework which is used, inter alia, to stress its base case projections in order to assess the adequacy of Nedbank Group s capital levels, capital buffers and target ratios. The framework has been in place, and continuously enhanced since 2006 and is an integral part of the group s Internal Capital Adequacy Assessment Process (ICAAP) under Basel III, strategy and business plans. The group s stress and scenario testing recognises and estimates the potential volatility of the capital requirements and base case (expected) three year business plan projections, including the key assumptions and sensitivities contained therein, which themselves are subject to fluctuation. Stress and scenario testing are performed and reported quarterly or more regularly if called upon. Nedbank s approach to comprehensively cover stress and scenario testing, both for regulatory and economic capital purposes, comprises several levels, including macroeconomic stress testing, reverse stress testing (ie what would 'break the bank ), benchmarking to the latest and previously relevant international stress testing exercises, procyclicality tests (ie the extent to which Nedbank s capital levels fluctuate through economic cycles), cluster and business unit level stress testing, and ad hoc additional stress scenarios. The impact of the stress scenarios on Nedbank s impairments, earnings, liquidity position, capital adequacy ratios and capital buffers is considered. The macroeconomic stress testing scenarios include a continuum of stress levels from mild to high stress levels, a 1 in 25 year stress event and, finally, both severe inflationary and severe deflationary stressed environments. The additional stress scenarios cover a wide variety of important topics pertinent to South Africa at this time, including a possible further SA credit ratings downgrade, a triple dip recession in Europe, a focus on stressed impairments at the group, cluster and business unit levels, a systemic liquidity crisis, political events, a property price crash (similar to the Spain and Irish property price crashes), stress testing of Personal Loans portfolio, credit concentration risk, and a major operational risk event (internationally there have been numerous examples of fines for money laundering and fraud). Given the industry and Nedbank s increased focus on the Personal Loans portfolio during the past 18 months, and more recently the identified higher levels of consumer indebtedness and stress, stress testing of the Personal Loans portfolio is comprehensively incorporated in Nedbank s stress testing process and ICAAP. Although Nedbank started growing the Personal Loans portfolio strongly towards the end of 2009, Nedbank s market share and growth have been intentionally steadily decreasing since 2010 in line with the group s updated risk appetite and portfolio tilt strategy. The 2013 stress and scenario testing ICAAP results confirm that the capital levels and capital buffers at Nedbank, both current and projected to 2015 (both regulatory capital and our internal capital assessment, economic capital), remain appropriate. We believe both Nedbank Group and Nedbank Limited are strongly capitalised relative to their business activities, strategy, risk appetite, risk profile and the difficult external macro environment in which the group operates. RISK RELATING TO PROCYCLICALITY Procyclicality is the extent to which the buffer between available capital and required capital levels (regulatory and economic) changes as a direct result of changes in the economic cycle, and would decrease in a downturn economic cycle. Nedbank Group explicitly addresses the issue of procyclicality by an effective capital management process, of which an integral part is the holistic stress testing of required and available capital under various macroeconomic stress scenarios. The following points explain procyclicality and how it is addressed in Nedbank Group: Dynamic enterprisewide risk management is tasked to identify and respond to changing economic conditions (eg tightening of credit lending policies). Sophisticated stress and scenario testing is integrated with active capital management that includes the careful determination of capital buffers. Nedbank employs advanced credit rating models that are used for risk management, pricing, forward looking planning, etc and therefore are appropriately procyclical [ie probability of default (PD) increase during times of macroeconomic stress]. Credit rating models are, however, calibrated based on long term historic average default rates (ie through the cycle) of at least five years for retail and seven years for wholesale. The actual level of PDs in any given year represents a hybrid between cycle neutral average and point in time default rates. The credit rating models that are calibrated to long term average default rates are thus much less procyclical than point in time rating models that are used for IAS accounting purposes. Due to the fact that PDs are hybrids between cycle neutral and point in time default rates, both Basel III credit RWA as well as credit economic capital figures are procyclical. This is considered in Pillar 1 stress testing as well as the groupwide macroeconomic factor model Nedbank Group Limited and Nedbank Limited Pillar 3 June

30 (MEFM) stress testing. The MEFM explicitly models increases in PDs over time for different macroeconomic stress scenarios (mild, severe inflationary, etc), differentiated by credit subportfolio. Nedbank applies a downturn adjustment to all its loss given defaults (LGDs) used for regulatory capital requirements. Through the cycle LGDs, which are utilised for economic capital requirements, are stressed for worsening economic conditions but not adjusted for improved conditions. The MEFM explicitly models increases in through the cycle LGDs over time for different macroeconomic stress scenarios differentiated by credit subportfolio. Similarly, the MEFM forecasts the decline in available capital levels due to increased credit impairments in a macroeconomic downturn. The excess of available capital over required capital is called the 'capital buffer'. Capital buffers are employed to ensure that capital adequacy is maintained through economic cycles. Changes in the capital buffers are explicitly modelled for each macroeconomic stress scenario and under consideration of appropriate capital actions. The MEFM is forward looking over the next three years, and is run and reported to Group ALCO and the board quarterly. This ensures that management can act timeously as the macroeconomic environment changes. The points discussed above are illustrated in the diagram below: PROCYCLICAL ˈHYBRIDˈ PD IN THE ECONOMIC CYCLE AND IMPACT ON CAPITAL ADEQUACY Rate Available capital Buffer Required capital Actual default rate PD Stress scenario Base case Positive scenario Central tendency Capital (R) Illustrative Time Recent macro environment Stress testing the impacts of procyclicality is performed both for regulatory capital purposes and for economic capital purposes in setting and assessing the adequacy of the economic capital buffer. Specific risk (Pillar 1) stress tests are performed on individual major risk types in addition to ongoing monitoring and reporting to assess the maximum potential for unexpected losses and so the impact on capital levels. APPROACH TO MACROECONOMIC STRESS AND SCENARIO TESTING Stress and scenario testing capabilities were significantly enhanced as far back as 2006 with the group s building of a proprietary MEFM and completion of a comprehensive Stress and Scenario Testing Framework. The Stress and Scenario Testing Framework and process were further enhanced during 2009 to 2012 to assist in proactively derisking the bank in appropriate segments in view of the global financial crisis. The main objective of the group s stress testing is to assess the effect of possible unexpected events on Nedbank Group's base case projections, including the capital requirements, resources and adequacy of capital buffers for both regulatory capital and the ICAAP. In addition, stress testing is an important tool for analysing Nedbank Group's risk profile and setting risk appetite. Nedbank's strategy and approach to cover stress and scenario testing, both for regulatory and economic capital purposes, comprehensively considers the group s: Risk profile (through stress testing of the capital requirements covering all quantifiable risk types) Capital profile (through stress testing of qualifying capital and available financial resources) Earnings (growth) profile (through stress testing of impairments, NII, NIR and headline earnings) Return metrics (eg ROE, utilising the three points above) Risk appetite (eg through stress testing of earnings at risk and credit risk appetite metrics at the group, cluster, business unit and retail monoline level) Liquidity profile (showing the link between stress scenario results to possible liquidity stress events) Incorporation of the effects from Basel III regulations in the forecasted results. Nedbank Group Limited and Nedbank Limited Pillar 3 June

31 A high level depiction of the framework is provided in the figure below. OVERVIEW OF NEDBANK S STRESS AND SCENARIO TESTING FRAMEWORK The framework and process are adhered to in order to stress the base case projections, and so assess and ultimately conclude on the adequacy of Nedbank Group's capital buffers and target capital adequacy ratios. The group's strategic planning process, rolling forecasts and integrated capital planning include three year projections of expected (base case) financial performance, regulatory (Basel III) and economic capital risk parameters and capital requirements, which are compared with projected available financial resources and the board approved risk appetite metrics. The three year projections and base case capital planning are derived from the group's three year business plans, which are updated quarterly during the year. The groupwide MEFM is utilised to stress test regulatory (Basel III) capital, economic capital, expected losses as well as available financial resources of the expected (base case) three year projections for Nedbank Group and Nedbank Limited for different macroeconomic stress events. Regression based models are maintained for credit and business risks as these risk types are the most important (as measured by materiality), and credit risk in particular has proven links to the macroeconomic cycle. During 2012, initial work was performed on moving from a backward looking historical volatility approach to a forward looking profit and loss simulation based approach on business risk drivers, as well as a more granular split of the profit and loss and, hence, achieving a strong link between the model and strategy. The results of this work were inconclusive and the lack of adequate historical data compromised the results. The business risk economic capital model will be reviewed over the next 15 months, with the intention of adapting a revised or enhanced methodology or approach in the 2014 business planning cycle, covering the forecast period. Structural models are maintained for interest rate risk in the banking book and investment and property risks, as these risks are structurally dependent on, and driven by, specific macroeconomic factors. Linked models are maintained for operational and transfer risks, consistent with the Capital Adequacy Projection Model (CAPM). The chosen macroeconomic factors have undergone extensive data and validation processes, and proved to be the key drivers and best predictors contributing to losses due to the different risk types. Diversification between risk types is included within the model in exactly the same way as for economic capital. Diversification benefits between risk types are determined by utilising Nedbank specific correlations and the MEFM. Nedbank Group Limited and Nedbank Limited Pillar 3 June

32 NEDBANK GROUP S STRESS TESTING PROCESS AND GOVERNANCE 1 GRCMC = Group Risk and Capital Management Committee (board committee). GCC = Group Credit Committee. DCC = Divisional Credit Committee. 2 Gross domestic product. The key factors influencing economic capital buffer size may include: Procyclicality (economic cycles) Abnormal constraints arising in the market impacting capital raising and/or liquidity (funding) Earnings volatility levels Concentration risks Accounting impacts on available capital (eg IFRS) Foreign capital deployment Strategic acquisitions (if applicable) As highlighted above, Nedbank Group's economic capital buffer level is set, tested and validated using its MEFM and comprehensive Stress and Scenario Testing Framework. Using the MEFM, an economic capital buffer of 10% above the minimum economic capital requirements has been set and approved. The target minimum available financial resources (AFR) to cover the economic capital requirements will therefore be at least the minimum economic capital requirement plus 10%. This is continuously monitored against the actual AFR to assess the surplus/deficit as illustrated on the following page. Nedbank Group Limited and Nedbank Limited Pillar 3 June

33 AVAILABLE FINANCIAL RESOURCES TO ASSESS THE SURPLUS/DEFICIT Surplus/ deficit + = VS Minimum economic capital requirements Target capital buffer Target minimum requirement Actual AFR Nedbank s approach to comprehensively cover stress and scenario testing, both for regulatory and economic capital (ICAAP) purposes, comprises nine main levels, namely: Level 1 Macroeconomic stress testing [ie quarterly business as usual scenarios provided by the Group Economic Unit and reviewed by the committees as mentioned above] Mild stress (at least a 1 in 4 year event scenario) High stress (at least a 1 in 10 year event scenario) Severe inflationary stress (extreme scenario) Severe deflationary stress (extreme scenario) Positive stress (a positive scenario, better than the expected macroeconomic scenario) Level 2 1 in 25 stress scenario It is a requirement of the SARB, that a severe stress scenario of at least a 1 in 25 year stress event be considered in the ICAAP. The severe inflationary and severe deflationary scenarios included in the business as usual macroeconomic scenarios considered above, are far more severe than a 1 in 25 year stress event. Therefore, a separate 1 in 25 year stress event is included to represent a scenario that is more plausible than the extreme events portrayed by the severe inflationary and severe deflationary scenarios. The results of the 1 in 25 year event stress scenario are then more realistic in terms of what can be expected in a severe scenario. Level 3 Impairments, incorporating credit risk management actions A focus on impairments in a high stress and a 1 in 25 year stress scenario, and where plausible credit risk management actions are taken into consideration, the effect of more granular modelling where applicable, and expert judgment to take specific portfolio characteristics into account, that are not captured by the top down macroeconomic factor model, into account. Level 4 Personal Loans stress testing As discussed above there is an increased focus on personal loans. Therefore stress testing of the Personal Loans portfolio is comprehensively considered. Level 5 Additional stress scenarios The additional stress scenarios cover a wide variety of important topics pertinent to South Africa at this time, including a possible further SA credit ratings downgrade, a triple dip recession in Europe, a systemic liquidity crisis, a material negative charge in fundingmix, a financial markets shutdown, political events, a property price crash (similar to the Spain and Irish property price crashes), credit concentration risk and a major operational risk event (internationally there have been numerous examples of fines for money laundering and fraud). Level 6 Reverse stress testing (ie 'what would break the bank') Level 7 Benchmarking to the latest and previously relevant international stress testing exercises Level 8 Procyclicality tests (ie the extent to which Nedbank s capital levels fluctuate through economic cycles) Level 9 Cluster and business unit level stress testing Nedbank Group Limited and Nedbank Limited Pillar 3 June

34 There is a focus to link different risk types in the stress scenarios, ie a market risk event (property price crash) may lead to a credit risk event (increase in impairments) and eventually to a possible liquidity crisis, depending on the severity of the losses. Pillar 1 stress testing is performed by each business unit which is approved by the business cluster s DCC. Stressed Advanced Internal Ratings Based (AIRB) credit parameters results, provided by the groupwide (Pillar 2) Macroeconomic Factor Model, are approved by the business units and reported to the board s GCC annually. The overall Pillar 2 stress test results and effects on regulatory capital, economic capital, available capital resources and therefore capital adequacy ratios (CARs) are reported to the Group ALCO and the board s GRCMC on a regular basis (at least quarterly). The results and impacts are provided on both a pre and post management intervention basis. Management intervention may, for example, include the reduction in expenses and project spend, reducing asset growth and cutting dividends. The results of the stress testing scenarios form part of the Nedbank Group ICAAP, which is submitted to the board of directors and then the SARB. The forward looking capability of the stress testing model ensures that management action can be taken in advance when necessary. Nedbank Group s conclusion is that, following the proactive response to the global financial crisis and significant strengthening of capital ratios over the past three years, the group is strongly capitalised relative to its business activities, strategy, risk appetite, risk profile and the external environment in which the group operates. RISK GOVERNANCE The business of banking is fundamentally about managing risk. Nedbank Group actively strives to attain world class risk and balance sheet management as integrated core competencies critical to the success and sustainability of its business. Nedbank Group sees strong risk governance applied pragmatically and consistently as the foundation for successful risk and capital management. The strong focus on risk governance is based on the concept of three lines of defence, which is the backbone of the group's Enterprisewide Risk Management Framework (ERMF). The ERMF places a strong emphasis on accountability, responsibility, independence, reporting, communication, and transparency, both internally and with regard to key external stakeholders. AT THE HEART OF THE GROUP S BUSINESS AND MANAGEMENT PROCESSES ARE INTEGRATED WORLDCLASS RISK AND BALANCE SHEET MANAGEMENT FRAMEWORKS ERMF Sub frameworks (examples) Group Credit Risk Management Framework Group Market Risk Management Framework Group Operational Risk Management Framework Group Liquidity Risk Management Framework Capital Management Framework Solvency and Capital Management Policy Economic Capital Framework Stress and Scenario Testing Framework Internal Capital Adequacy Assessment Process (ICAAP) Internal Liquidity Adequacy Assessment Process (ILAAP) Risk Appetite Framework Risk adjusted Performance Measurement Framework Nedbank Group Limited and Nedbank Limited Pillar 3 June

35 The three lines of defence of Nedbank s ERMF, as well as the principle responsibilities that extend across the group, function as follows: NEDBANK S THREE LINES OF DEFENCE 1 ST Line Of Defence Focused and informed involvement by the board and Group Exco, accountability and responsibility of business management and Group Finance, all supported by appropriate internal control, risk management and governance structures and processes. Strategy, Performance and Risk Management 2 nd Line of Defence 3 rd Line of Defence Independent risk oversight and monitoring by the Group Risk and Enterprise Governance and Compliance Divisions Policy, Validation and Oversight Independent assurance provided by Internal and External Audit Independent Assurance Nedbank Group Board of Directors Board Committees Chief Executive (CE) Group Chief Risk Officer (CRO) Group Risk Monitoring Division Group Internal Audit External Auditors Nedbank Corporate Nedbank Capital Nedbank Wealth Group Executive Committee Executive Committees Group Finance Chief Operating Officer Rest of Africa: Investments, Alliances and Strategy Subsidiaries Balance Sheet Management Group Human Resources Group Technology Retail and Business Banking Nedbank Retail Business Banking The Chief Risk Officer, who reports directly to the Chief Executive, provides: strategic risk management leadership group independent risk oversight key support to various risk committees interacts closely with the business units is responsible for championing effective enterprise wide risk management and control Independent model validation Group Chief Governance and Compliance Officer Independent Actuaries Group Marketing, Communications and Corporate Affairs Group Strategic Planning Group Enterprise Governance and Compliance Cluster Risk Officer BU Risk Officers Head Governance and Compliance BU Compliance Officers Cluster Risk Officer Risk Officers Head Governance and Compliance Compliance Officers Cluster Risk Officer BU Risk Officer Head Governance and Compliance BU Compliance Officer Cluster Risk Officers BU Risk Officers Heads Governance and Compliance BU Compliance Officers Cluster Risk Officer BU Risk Officers Head Governance and Compliance BU Compliance Officers Cluster Risk Officer BU Risk Officers Head Governance and Compliance BU Compliance Officers * CLUSTER GOVERNANCE & COMPLIANCE (Reg 49 Banks Act 94 of 1990) Line management within the clusters are accountable and responsible for implementation of governance and compliance requirements. The cluster governance and compliance functions shall support line management and be responsible for continuously monitoring compliance by establishing a line of communication with management, requiring line management to monitor compliance as part of their normal operational duties, requiring regulatory requirements to be incorporated into operational procedure manuals and making recommendations in order to ensure that there is compliance. The group Chief Governance and Compliance Officer, who reports directly to the Chief Executive, provides continuous strategic compliance risk management leadership, independent compliance risk monitoring (of compliance monitoring in the first line), sets the group governance and compliance framework and works closely with the cluster governance and compliance functions on compliance and governance matters. Nedbank Group Limited and Nedbank Limited Pillar 3 June

36 The 17 key risks that comprise Nedbank Group's risk universe and their materiality are reassessed, reviewed and challenged on a regular basis. The ERMF specifically allocates the 17 key risks (which individually also include various subrisks) at each of three levels to: Board committees. Executive management committees (at Group Exco level and those within business clusters). Individual functions, roles and responsibilities (at group level and across all business clusters, as relevant). In these various committees the 17 key risks are contained in formal terms of reference (or charters) and linked to the agendas of meetings. Comprehensive reporting on the universe of risks thus occurs at least quarterly, where their status, materiality and effective management are assessed, reviewed and challenged. This process originates in the business clusters, proceeds based on materiality up to the group executive level and then to the non executive board level. The process is overlaid by the group's three lines of defence governance model set out on the previous page, so that the assessment, review and challenge are not only the responsibility of management and the board, but also of Group Risk, Group Compliance, Group Internal Audit and the external auditors in the second and third lines of defence. Within this recurring enterprisewide risk management process, and additionally via the strategic/business planning process, new and/or emerging risks are identified, captured and addressed within the ERMF and its associated process. A residual heat map is used and supports the iterative reassessment of the 17 key risks. Escalation criteria have been formalised and significant risk issues and/or limit breaches are raised and included in the key issues control log, which is a key feature of the ERMF and risk reporting across Nedbank Group. The process of corporate governance, including the risk management process, as contemplated in regulation 39 of the Banks Act, is assessed annually against the existing internal control environment. Similarly, an assessment of whether the bank can continue as a going concern, as required in terms of regulation 40, is carried out with due regard to governance, risk management and long term planning of the banking group. The ERMF, fully embedded in business and central functions across Nedbank Group, is supplemented by individual frameworks such as those for credit risk, market risk, liquidity risk, operational risk and capital risk, as well as a comprehensive set of risk policies and limits. These also include the role of the board, which includes setting and monitoring the group's risk appetite (which includes risk limits) and oversight of the ERMF, duly assisted by its board committees. At executive management level the Group Exco is also assisted with its risk, strategic, operational and asset, liability and capital management responsibilities by 6 subcommittees and the Group Operations Committee (Opcom), Taxation, Property and Procurement Committees and the Black Economic Empowerment (BEE) forum. Nedbank Group has also developed individual risk frameworks for the effective management of social, environmental and transformation risks. These frameworks serve as best practice guidelines for the management of risks associated with these pillars of sustainability within the organisation, offering clear governance structures (eg committees, charters and policies) to deal with the group s sustainability objectives. The ERMF thus facilitates effective challenge and debate at executive management and board levels, and strong interaction across the group between the businesses and central group services. This includes an ongoing process of risk identification, review and assessment, including formal documentation of this, which is subjected to review by external auditors. A formal process is in place to review, at least annually, the full set of risk policies, limits and various frameworks that comprise the ERMF. An overview of Nedbank Group's ERMF, including the 17 key risks that comprise the group's risk universe and the risk governance structures, is provided on the following page. Further details on the group's governance and various key committees are contained in the Nedbank Group Integrated Report 2012 under the section Governance and Ethics. Nedbank Group Limited and Nedbank Limited Pillar 3 June

37 OVERVIEW OF NEDBANK GROUP S ENTERPRISEWIDE RISK MANAGEMENT FRAMEWORK (ERMF) Nedbank Group Limited and Nedbank Limited Pillar 3 June

38 ICAAP OVERVIEW In line with the four key principles contained in Pillar 2 of Basel III, the SA regulations relating to banks sett out, in regulation 39, the Internal Capital Adequacy Assessment Process (ICAAP) requirementss of banks and related Supervisory Review and Evaluation Process (SREP) requirements of the SARB. A summary of this is depicted d below. In addition, the SARB provided further guidance in the form of Position Paper 230 ('Implementatio on of the Basel II frameworkk Pillar 2 requirements, with specific reference to the Internal Capital Adequacy Assessment Process'), and specifies 12 'ICAAP principles'. SUMMARY OF THE ICAAP AND SREP REQUIREMENTS ICAAP is primarily concerned with Nedbank s comprehensive approach, measurement and management of risk and capital from an internal perspective, that is, over and above the minimumm regulatory rules and requirements of Basel II, II.5 and noww III. ICAAP has been completed in South Africa since 2008, 2 followingg Basel II implementation. It is approved by the board and then submitted to the SARB for review. To this end it is important to highlight that Nedbank Group has seven levels of capital and other components to be measured and managed simultaneously: Regulatory capital (risk sensitive but is a global, universal standard with some limitations/restrictions). Economic capital (risk sensitive using regulatory capital as the core foundation but is more economic based and tailored internally and for the local environment, with less limitations/ restrictions, and used for Nedbank's ICAAP). Rating agencies capital (their expectations off capital levels). Buffer capital ( level of capital buffers to carryy above minimum requirements). Actual book or statutory capital (based on greater of regulatory capital and economic capital requirements). Qualifying capital and reserves (to cover regulatory capital requirements).. Available Financial Resources (AFR) (to coverr economic capital requirements). Thesee different levels illustrate the delicate and challenging balancing act involved in effectivee capital management. Nedbank Group Limited and Nedbank Limited Pillar 3 June

39 SUMMARY BACKGROUND TO THE DIFFERENT CAPITAL LEVELS TO BE MANAGED A separate ICAAP is required for each material banking legal entity and for the consolidated Nedbank Group. Size and materiality play a major role in the extent of each bank's ICAAP. Nedbank Group's ICAAP is embedded within the group's Capital Management Framework. Nedbank Group's ICAAP blueprint, on the next page, sets out its ICAAP building blocks and overall process, and the various frameworks underpinning this. This process is repeated regularly, which facilitates the continuous assessment, management and monitoring of Nedbank Group's capital adequacy in relation to its risk profile. Nedbank Group Limited and Nedbank Limited Pillar 3 June

40 NEDBANK GROUP S ICAAP BLUEPRINT The foundations of Nedbank Group's ICAAP, Capital Management Framework and ERMF are a strong and rigorous governance structure and process as discussed earlier. The ERMF is actively maintained, updated and regularly reported on up to board level, coordinated by the ERMF Division in Group Risk. This same governance process is followed for Nedbank Group and each banking legal entity ICAAP and involves key participants from the business, finance, risk, capital management and internal audit areas, as well as the relevant executive committees, board committees and the board. Further details of the group s capital management are covered from the following page. The ultimate responsibility for the ICAAP rests with the board of directors. The risk and capital management responsibilities of the board and Group Exco are incorporated in their respective terms of reference (charters) contained in the ERMF. They are assisted in this regard, and in overseeing the group's capital risk (defined in the ERMF), by the board's GRCMC and the Group ALCO and Executive Risk Committee (Group ALCO) respectively. Group ALCO, in turn, is assisted by the BSM cluster. Nedbank Group Limited and Nedbank Limited Pillar 3 June

41 CAPITAL MANAGEMENT Nedbank Group's Capital Management Framework reflects the integration of risk, capital, strategy and performance measurement, including incentives, across the group. This contributes significantly to successful enterprisewide risk management. The board approved 'Solvency and Capital Management' policy document requires Nedbank Group and its banking subsidiaries (including Nedbank Limited, Nedbank Private Wealth Limited, Nedbank Namibia, Nedbank Swaziland, Nedbank Lesotho, MBCA Bank Limited and Nedbank Malawi) to be capitalised at the higher of regulatory capital or economic capital. A bank is required to hold capital primarily so as to be able to cope with or absorb significant unexpected losses in any particular year. From this follow the two key aspects of capital management: The banking group needs to ensure that the overall capital level is in line with a number of factors, such as the expectations of the rating agencies, the internal assessment of the level of risk being taken, the requirements of the regulators, and, not least of all, the returns expected by shareholders. The bank needs to ensure that the actual capital level is not only in line with this assessment, but takes full advantage of the range of capital instruments and capital management activities (eg dividend policy and share buy backs) to optimise the financial efficiency of the capital base. Sound capital management encompasses both of these aspects, critically supported by long run capital planning. The Balance Sheet Management (BSM) cluster is mandated to champion the successful development and implementation of the Capital Management Framework and the Internal Capital Adequacy Assessment Process (ICAAP) across the group. The capital management responsibilities (incorporating ICAAP) of the board and Group Executive Committee (Exco) are incorporated in their respective terms of reference (charters) contained in the Enterprisewide Risk Management Framework (ERMF). The Group Asset and Liability Committee and Executive Risk Committee (Group ALCO), in turn, is coordinated by the BSM cluster. NEDBANK S FOUR KEY FUNCTIONS FOR SUCCESSFUL CAPITAL MANAGEMENT Capital investment Capital structuring Capital allocation Risk and capital optimisation CAPITAL INVESTMENT This involves managing the financial resources raised through the issue of capital and the internal generation of capital (ie retention of profits). This is integrated into the overall ALCO process of Nedbank Group. The group's Macroeconomic Factor Model (MEFM) provides further rigour behind Group ALCO's decisions on the extent of hedging, if at all, the group's capital against interest rate changes and hence the impact on endowment income. This is done by modelling the relationship between changes in credit extension volumes, impairment levels and the group's endowment income when the economic cycle changes and the extent to which there is a natural hedge between them. CAPITAL STRUCTURING This is the process of managing the amount of regulatory, economic and statutory capital available and ensuring it is consistent with the group s current and planned (over at least three years) levels of activity, risk appetite and required/desired level of capital adequacy (including its target debt rating), using as a tool the group s Strategic Capital Plan (SCP). The BSM cluster is responsible for the SCP. This is a dynamic plan and process which sets out all capital actions for which board approval is ultimately required. This plan is updated and reviewed regularly (monthly by Group ALCO and at least quarterly by the board's Group Risk and Capital Management Committee and the full board itself). A key sophisticated planning tool enabling the SCP is the group's Capital Adequacy Projection Model (CAPM). CAPM is fully integrated with the group s three year business and strategic plans, together with economic capital, Basel III, International Financial Reporting Standards (IFRS) and other important parameters and financial data. CAPM projects Basel III and economic capital requirements for the current year and as well as the next three years. This also covers capital requirements, available financial resources (AFR), capital buffers, target capital ratios, earnings, impairments, dividend plan, any constraints or limits, risk appetite metrics and details of proposed capital actions and contingencies. Each quarter the group updates its financial forecasts and projected risk parameters, and so updates the projections in the SCP. This also takes into account any actual change in the business environment and/or the group's risk profile, as well as any capital actions (or proposed revisions to previous capital plans, including any new constraints). This ensures that Nedbank Group's capital management is forward looking and proactive, and is driven off sophisticated and comprehensive long run capital planning. Nedbank Group Limited and Nedbank Limited Pillar 3 June

42 The above process provides 'base case (or expected) projections'. The base case is then stressed by using various macroeconomic scenarios (ie Pillar 2 stress testing), in addition to risk specific stress testing (ie additional scenarios, reverse stress testing and Pillar 1 stress testing). The outcome of this stress and scenario testing is the key factor in assessing and deciding on Nedbank Group's capital buffers another key component of the SCP. CAPITAL ALLOCATION The BSM cluster is also responsible for managing the efficient employment of capital across Nedbank Group's businesses, using risk based economic capital allocation, strategic portfolio management and risk adjusted performance measurement (RAPM) (primarily driven by economic profit and 'manage for value' principles). The group is capitalised at the higher of regulatory capital and economic capital, currently being regulatory capital. The capital allocation process to business clusters is then as follows: SOURCES OF REGULATORY CAPITAL Tier 1 capital Shareholders' equity (Common Equity Tier 1) CAPITAL ALLOCATION TO BUSINESS CLUSTERS FOR PERFORMANCE MEASUREMENT Allocated as capital using: Bottom up risk based economic capital measurement. Capital impairment for goodwill, intangible assets and the excess of downturn expected loss over provisions. Regulatory capital addons. Any shortfall versus group ordinary shareholders equity is addressed via the allocation of a capital buffer to the businesses [capped at an equivalent 11% (2011: 10%) of the group Common Equity Tier 1 capital ratio]. Preference shares and hybrid debt capital (Additional Tier 1) Allocated as part of funding costs, impacting businesses' earnings. Tier 2 capital Subordinated debt Allocated as part of funding costs, impacting businesses' earnings. Economic capital Economic capital is a sophisticated, consistent measurement and comparison of risk across business units, risk types and individual products or transactions. This enables a focus on both downside risk (risk protection) and upside potential (earnings growth) and shareholder value add. Nedbank Group assesses the internal requirements for capital using its proprietary economic capital methodology, which models and assigns economic capital within 14 quantifiable risk categories (in the graphic on the following page, property and investment risk are treated as separate risks). Nedbank Group regularly enhances its economic capital methodology and benchmarks the output to external reference points. The total average economic capital required by the group, as determined by the quantitative risk models and after incorporating the group s estimated portfolio effects is supplemented by a capital buffer of 10% to cater for any residual cyclicality and stressed scenarios. The total requirement is then compared with available financial resources (AFR). The 10% capital buffer was deemed appropriate, based on the group s comprehensive Stress and Scenario Testing Framework and Risk Appetite Framework. Nedbank s economic capital and ICAAP methodology was reviewed also taking cognisance of regulatory developments as a result of the onset of Basel III from 1 January Nedbank Group Limited and Nedbank Limited Pillar 3 June

43 SUMMARY OF NEDBANK S CURRENT ECONOMIC CAPITAL MODEL AND TARGET CAPITAL ADEQUACY USED FOR ICAAP CREDIT RISKS Banking book credit risk Credit concentration risk Counterparty credit risk Securitisation risk Incorporates the current exposure Nedbank s credit portfolio model method for exposure at default (EAD), Basel III Advanced Internal Ratingsincorporates concentration risk and probability of default (PD) and loss Basel III AIRB credit methodology Based (AIRB) credit methodology intrarisk diversification for both large given default (LGD) from the Basel III integrated with sophisticated integrated with sophisticated credit exposures and industry/sector credit methodology, which are all credit portfolio modelling. portfolio management modelling. concentration. integrated with sophisticated credit portfolio modelling. + TRANSFER RISK (closely related to credit risk but arises due to sovereign default and so separately modelled and quantified) Similar to AIRB credit methodology, but dependent on the probability and extent of a transfer event (ie sovereign default), with no interrisk diversification recognised. + MARKET RISKS Interest rate risk in the banking book Trading (position) risk Equity (investment) risk Property risk FX translation risks (IRRBB) Value at risk (VaR) scaled to one year using VaR limits (board approved) with no intrarisk diversification recognised. Simulation modelling of net interest income; economic value of equity also used % and 400% risk weightings in line with Basel III equity risk. PD/LGD approach for property finance. Multiple of exposure, based on rand volatility measures. Operational risk Business risk Insurance underwriting risk Other assets Advanced Measurement Approach Earnings at risk methodology Earnings at risk methodology 100% risk weighting (AMA) = MINIMUM ECONOMIC CAPITAL REQUIREMENT (after interrisk diversification benefits) + CAPITAL BUFFER (10% buffer for procyclicality, stressed scenarios, etc) = TOTAL ECONOMIC CAPITAL REQUIREMENT Measurement period/time horizon: one year (same as Basel III) Confidence interval (solvency standard): 99,93% (A) (ie more prudent than Basel III at 99,90%) versus AVAILABLE FINANCIAL RESOURCES (AFR) AFR Comprises: Tier A = Common Equity Tier 1 regulatory capital and qualifying reserves Tier B = Includes Basel II perpetual preference shares and hybrid debt subject to grandfathering under Basel III and new style Basel III compliant perpetual preference shares, hybrid debt capital and subordinated debt. Note: There are 14 quantifiable risk categories. Property and equity (investment) risk are treated as separate risks. The economic capital results are shown from page 57. Credit risk capital The Advanced Internal Ratings based (AIRB) approach is used for Nedbank Limited and The Standardised Approach (TSA) for all other subsidiaries for regulatory capital purposes. For the purpose of estimating internal economic capital, conservative AIRB credit benchmarks are applied for all the subsidiaries that are utilising TSA. The group's credit risk economic capital (or credit value at risk) is more sophisticated than the AIRB approach and is calculated using credit portfolio modelling based on the volatility of unexpected loss. This estimated unexpected loss is measured from the key AIRB approach credit risk parameters [probability of default (PD), exposure at default (EAD), loss given default (LGD)] as well as taking portfolio concentrations and intra risk diversification into account. It is important to recognise that the group's economic capital goes further than Basel III in explicitly recognising credit concentration risks (eg single large name, industry sector). CREDIT RISK CAPITAL Nedbank Group's credit portfolio model aggregates standalone credit risks into an overall group credit portfolio view, then takes concentration risks and diversification effects into account. Nedbank Group Limited and Nedbank Limited Pillar 3 June

44 Counterparty credit risk capital Nedbank Group applies the Basel III Current Exposure Method (CEM) for counterparty credit risk (CCR) for both regulatory capital and economic capital (ICAAP). In terms of active management of CCR there is continued emphasis on the use of credit mitigation strategies, such as netting and collateralisation of exposures. These strategies have been particularly effective in situations where there have been high PDs. Economic capital calculations currently utilise the Basel III CEM EAD results as input in the determination of credit economic capital. Having received Internal Model Approach (IMA) approval as of January 2011, Nedbank in its endeavour to achieve best practice, will consider the Internal Model Method (IMM) Approach. This is being considered within the group s Basel III programme, however this is not a short term objective. It is noted however that utilising the CEM in the quantification of CCR is more conservative than the IMM approach. Credit Value Adjustment capital charges was taken into account for regulatory capital with the implementation of Basel III. From 2014, a proposal to include this capital charge into credit economic capital may be to directly include the regulatory capital charge and allocate this on a suitable measure. Securitisation risk capital As with credit derivatives, Nedbank Group does not have significant exposure to securitisation. Nedbank Group has used securitisation primarily as a funding diversification tool. The credit exposures that Nedbank Group measures in terms of securitisation use a combination of the ratings based approach and standard formula approach (both AIRB approaches) for regulatory capital purposes. From an economic capital (ICAAP) point of view, Internal Ratings based (IRB) credit risk parameters are used. As is evident from the low level of exposure, the risk of underestimation of the Pillar 1 securitisation risk charge is considered immaterial. The Regulations Relating to Banks were amended, effective 1 January 2012, to incorporate the revised market risk and securitisation proposals as per Basel II.5. These revisions incorporate, inter alia, higher risk weightings for resecuritised exposures and do not have a material impact on Nedbank s securitisation exposures. Transfer risk capital Transfer risk is the risk that a government will be unable or unwilling to make 'hard currency' available by imposing currency controls, which limit the ability of otherwise healthy borrowers within the country from servicing their foreign currency debt, causing a transfer event. Transfer events usually only impact facilities repayable in 'hard currency' made to clients in foreign countries, but they also affect any loan denominated in a currency other than the local currency of the borrower, since the borrower needs to obtain foreign currency to repay the debt. It covers losses suffered when a client, because of circumstances in its country of domicile, is unable to obtain the foreign currency needed to meet its obligations. Transfer risk is not separately identified by Basel III for Pillar 1 regulatory capital. It is potentially a significant risk type and so is included in Nedbank Group s economic capital model. However, given that very little credit risk currently originates from outside South Africa, transfer risk economic capital is not a significant amount for the group at present. Transfer risk is treated separately from counterparty risk because it is wholly caused by a sovereign s actions and, fundamentally, it is independent of the counterparty. Transfer events and sovereign defaults are closely related, as both are driven by the credit quality of the sovereign. However, while transfer events are often coincidental with sovereign defaults, they are not synonymous. Governments may default rather than restrict access to 'hard currency' so as to maintain cross border trade. Alternatively governments may impose currency restrictions to prevent capital flight and hence retain 'hard currency' to meet debt payments. In general transfer risk is modelled similarly to credit (issuer and counterparty) risk, but it is dependent on the following: The probability of a country declaring a transfer event (probability of transfer event). The percentage of the exposure that will be lost in the event of a transfer event (loss given transfer event). The exposure in the event of a transfer event (exposure at transfer event). The methodology also takes into account the correlation of transfer risk events occurring between countries. A refined transfer risk methodology and model was implemented in Trading market risk capital The Internal Models Approach (IMA), implemented on 1 January 2011, is currently used for regulatory capital measurement. Nedbank has used the VaR trading limit methodology for internal measurement of economic capital since Basel II implementation. This resulted in a more conservative standalone trading economic capital when compared to IMA capital under Basel II. The implementation of the IMA stressed VaR add on under Basel II.5, since 1 January 2012, resulted in the regulatory trading risk capital being more closely aligned to the more conservative standalone trading risk economic capital being used by Nedbank. Nedbank Group Limited and Nedbank Limited Pillar 3 June

45 The economic capital and regulatory capital requirements for trading market risk are not materially different under Basel II.5. However, extra conservatism is introduced in the ICAAP by using the total approved VaR limit rather than the actual VaR limit utilisation. The VaR limit is set per market risk type and also per legal entity. The economic capital requirements are also calculated for each market risk type and legal entity. Applying further conservatism, the trading risk per market risk type and legal entity is all added up without applying any diversification benefits when deriving the required group economic capital. For the regulatory capital charge Nedbank Limited obtained approval to use the IMA which is based on the VaR utilisation multiplied by a factor. The factor is determined by the SARB and is based on their review of the market risk environment. The regulatory capital charge based on the IMA does allow for diversification between different market risk types while no diversification benefit is applied for economic capital requirements. Nedbank has implemented the Basel III requirements regarding the trading book and started reporting the CVA charge from 1 January 2013, although the SARB assigned a 0% weight on ZAR derivatives for a period of 12 months due to the pending decision of a centralised countparty exchange in South Africa. A consultation paper on the fundamental review of the trading book, which was released by the Basel Committee during the course of 2012 for commentary, represents a regulatory push towards reevaluating the current treatment of regulatory capital requirements and risk management as well as aiming to harmonise the standards among banks globally. A number of proposals are tabled that, among other aspects, seek to develop regulatory capital requirements that are more risk sensitive in nature as well as decrease the effect of diversification in internal models, something which has proven to be problematic during periods of stress. Nedbank is engaged in this process of review of the regulatory standards and in this regard will continue to participate in ensuring a sound and sustainable environment develops through this initiative. Interest rate risk in the banking book (IRRBB) capital IRRBB is the risk a bank faces due to interest rate repricing mismatches (ie fixed rate versus floating rate assets or liabilities) and maturity mismatches between its assets and liabilities, as well as the non repricing elements of its balance sheet including equity, certain transactional deposit accounts and working capital. The repricing mismatch between the two sides of the balance sheet makes the bank vulnerable to changes in interest rates, a risk against which the bank therefore needs to hold capital. IRRBB is not separately identified by Basel III for Pillar 1 regulatory capital, and so Nedbank captures this under Pillar 2 in the ICAAP. Nedbank Group s IRRBB economic capital methodology is based on simulation modelling of the bank s net interest income (NII) exposure to changes in interest rates as represented by a stochastic interest rate shock. Economic value of equity exposure is also used as a secondary measure. The stochastic interest rate shock is quantified based on the volatility, derived from a one year log return of the past five years of money market data, applied to current interest rates. The IRRBB economic capital is defined as the difference between the 99,93% probability NII and the probability weighted mean NII of stochastic modelling. Property risk capital Property risk is the risk a bank faces due to the fluctuation of property values. In the case of Nedbank Group this includes the capital to be held against properties in possession as well as its fixed property. Property risk is included under 'Other Assets' for regulatory capital and so attracts a 100% risk weighting. Nedbank Group's economic capital calculations for property risk are far more conservative than the 100% risk weight for regulatory capital, being aligned to the treatment under the Simple Risk Weight Approach applied under Basel III for unlisted equity risk, namely a 400% risk weighting. Equity risk capital Equity risk is the risk of decline in the net realisable value of investment assets arising from adverse movements in market prices or factors specific to any investment itself (eg reputation, quality of management). Note that these investments are long term as opposed to the holding of short term positions that are covered under trading risk. The calculation of economic capital in Nedbank Group for equity (investment) risk is similar to property risk above. However, the two risks have been separated as both are material to the group and therefore deserve separate focus and quantification. The calculations of economic capital for equity (investment) risk are based on the same principles as for Basel III, namely the Simple Risk Weight Approach is used for the bulk of the portfolio, the exception being in the Property Finance Division. In line with moving to a bottom up approach, the Property Finance book investment risk economic capital is modelled using a PD/LGD approach. The risk weight multipliers are currently set at 30% (300% x 10%) for listed equities and 40% (400% x 10%) for unlisted equities. These multipliers are applied to the investment exposures to derive the standalone economic capital figures. Nedbank Group Limited and Nedbank Limited Pillar 3 June

46 Foreign currency translation risk capital Foreign currency translation risk (FCTR) is the risk that the bank's exposures to foreign capital will lose value as a result of shifts in the exchange rate. As Nedbank Group is a rand reporting entity, its risk is in a strengthening of the rand. The current methodology at Nedbank Group uses a simple VaR methodology scaled to a one year, 99,93% confidence interval to calculate standalone economic capital for FCTR, based on exchange rate volatility. FCTR is not required for Basel III Pillar 1 regulatory capital. The VaR used is based on 10 year historical monthly exchange rate information. The VaR parameters are updated annually. In accordance with the SARB circular 2/2012 FCT (foreign currency translation), SBP (Share based Payments) and AFS (Available for sale) reserves qualify as regulatory capital under Basel III effective from 1 January The inclusion of FCT in qualifying regulatory capital reserves results in an additional supply of Common Equity Tier 1 capital of R957m for the group at 30 June The quantification and inclusion of FCTR economic capital in the group s ICAAP is conservative. With the inclusion of FCT reserves in qualifying regulatory capital in 2013, the inclusion of this risk type in Nedbank s ICAAP will be revisited in Business risk capital Business risk is the risk caused by uncertainty in profits due to changes in the competitive environment that damage the franchise or operational economics of a business. In other words, it is the risk the bank faces due to fluctuations in earnings, readily observable and driven mainly by volumes, margins and fees. In the extreme, business risk can be seen as the risk of being unable to cover one's cost base should all or most of an entity's earnings fall away. Business risk is also associated with losses due to external factors such as the market situation or government regulations. This quantified risk category also essentially addresses Nedbank Group's strategic risk. The fluctuations in earnings captured here are those not attributable to the influence of other risk types. Business risk thus closes the circle and, together with the other risks defined in Nedbank Group's risk taxonomy, provides for a complete coverage of the quantifiable economic risks Nedbank Group faces. Business risk is not specified for Basel III Pillar 1 regulatory capital. It is, however, measured in Nedbank Group s economic capital model, using an earnings volatility (or earnings at risk) methodology. This methodology is currently being revised to incorporate a more forward looking approach. This revised approach is planned to be implemented in The major driver or input used in the current earnings at risk methodology is a time series of historical profit and loss, cleansed of the effects of other risk types. The volatility of this time series of historical profits and losses becomes the basis for the measurement of capital. The methodology is based on internal Nedbank Group data, which allows for analysis to understand more about earnings at risk across business units within the bank as more historical data is accumulated. Economic capital for business risk increases with increasing volatility of income streams, but can be offset by variable cost structures that may exist within a business unit. In other words, a business unit would be penalised for high volatility in income, but would receive credit for the ability to reduce costs when faced with declining incomes. Operational risk capital Nedbank Group was granted approval in December 2010 from the SARB for the use of the Advanced Measurement Approach (AMA) with diversification, and calculates its operational risk regulatory and economic capital requirements using partial and hybrid AMA. Partial use refers to a bank, controlling company or banking group using AMA for some parts of its operations, and The Standardised Approach for the remainder of its operations. Hybrid AMA refers to the attribution of group operational risk capital to legal entities by means of an allocation mechanism. The AMA Operational Risk Management Framework was approved by the board's Group Risk and Capital Management Committee. The AMA methodologies contained therein have been rolled out and embedded in the businesses, including for the purposes of the ICAAP. Nedbank use a more conservative confidence interval approach of 99,93% for economic capital when compared to the 99,90% confidence interval required for regulatory capital. Insurance underwriting risk capital Insurance underwriting risk can be defined as the risk that the underwriting process permits clients to enter risk pools with a higher level of risk than priced for, resulting in a loss to the business unit or group. It also takes into account the fact that the underwriting experience is worse than expected due to changing trends in experience or once off worse case shocks. Actuarial and statistical methodologies are used to price insurance risk (eg morbidity, mortality, theft), while underwriters align clients with this pricing basis and respond to any anti selection by placing clients in substandard risk pools, pricing this risk with an additional risk premium, excluding certain claim events or causes, or excluding clients from entering pools at all. Nedbank Group's economic capital methodology is based on modelling the bank's losses due to changes in claims as represented by a 'worse case' stochastic liability shock, which is defined as a 7 in event. The liability shock is quantified based on the volatility derived Nedbank Group Limited and Nedbank Limited Pillar 3 June

47 from the past five years of claims data, with sophisticated catastrophe modelling used in addition to this. The insurance economic capital is defined as the losses that result from the liability shock. Insurance risk economic capital is calculated in line with the methodology requirements of the Solvency Assessment and Management (SAM) regime (the local version of Solvency II) but at a higher internal statistical confidence level of 99,93%. It is calculated for both life products, long term and short term insurance products, and non life products. The insurance risk methodology will be reviewed during 2013 to ensure that there is closer alignment between economic capital requirements between ICAAP and Solvency II or SAM for banking and non banking entities. The SAM regime is expected to be in force from 1 January 2016 with parallel runs occurring from The insurance businesses are well on track with the SAM implementation programme. Other assets risk capital For economic capital (ICAAP) purposes the same approach as for regulatory capital requirements is followed, namely 100% risk weighting in line with Regulation 23 and the BA200 return. Inter risk diversification Risk diversification is the basic premise of any prudent risk management strategy, and it is included in Nedbank Group's economic capital (ICAAP) measurement in the form of inter risk diversification benefits. A McKinsey 2011 study of European banks highlighted that 80% of these banks include inter risk diversification in their Economic Capital Framework, supporting Nedbank s inclusion of inter risk diversification in its Economic Capital Framework. The group s inter risk diversification benefit at Nedbank Group is allocated back (in the capital allocation) to the business units rather than being held at the centre. Diversification benefits are allocated on a continuous basis. The continuous approach allocates economic capital to business units according to the contribution of the business unit to the total group capital requirement. Smallest and/or least uncorrelated business units benefit most from diversification. Allocation of capital allows business units to benefit from being part of a larger, well diversified group and they can therefore price products more appropriately and competitively. Enhancements to the group s inter risk diversification matrix are work in progress, namely the move from a basic variance covariance methodology to an advanced approach, which is based on joint loss simulation using copulas. These enhancements are scheduled for ICAAP implementation in Qualitative risks that cannot be mitigated by capital Nedbank Group's Economic Capital Framework is in line with best international practice. Not all risks can be mitigated by holding capital against them, although Nedbank Group has mapped all 17 key risk categories in its Enterprisewide Risk Management Framework (ERMF) to the group's Economic Capital Framework, with two exceptions being reputational risk and liquidity risk. By its nature, reputational risk is difficult to quantify and almost impossible to capitalise. This risk in essence arises when one or more of the other 17 key risks fail and so is indirectly captured therein. However, within the Operational Risk Framework the impact of events will include the cost of reputational risk. Reputational risk is managed within Nedbank Group's ERMF discussed earlier. Within Nedbank Group's BSM cluster a dedicated funding and liquidity function is responsible for the strategic management of funding and liquidity across the group. The group's daily liquidity requirements are managed by an experienced Centralised Funding Desk (CFD) within Group Treasury. Within the context of the board approved Liquidity Risk Management Framework, BSM and the CFD are responsible for proactively managing liquidity risk at an operational, tactical and strategic level. CAPITAL OPTIMISATION (INCLUDING RISK OPTIMISATION) Capital optimisation in Nedbank Group is about seeking an optimal level of capital by optimising the risk profile of the balance sheet through risk portfolio and economic value based management principles, risk based strategic planning, capital allocation and sound management of the capital buffers. This is achieved by integrating risk based capital into the group's strategy and aligning this with management's performance measurement, through established governance and management structures, the formal strategic planning process, performance scorecards and as set out in the group's Risk adjusted Performance Measurement Framework. Aside from helping to optimise financial performance and shareholder value creation, the group's enhanced 'managing for value' capabilities will have a positive influence on the group's ability to operate in a much more capital and liquidity constrained market environment, including on its strategic decisions about where and to what extent it chooses to allocate the group's capital. Nedbank Group Limited and Nedbank Limited Pillar 3 June

48 REGULATORY CAPITAL Capital adequacy is strong relative to Nedbank s business activities, strategy, risk profile and the external environment in which it operates. Nedbank Group 18% 1 22,0 16% 14% 12% 11,4% 11,6% 10% 8% 7,5% 9,0% 6% 5,25% 4% 1 28,1 11,8% 10,5% 12,5% STRONG CAPITAL RATIOS 4, WELL WITHIN BASEL III TARGET RANGES 1,2 1, ,2 1,2 21,1 27,1 19,3 20, ,9% 14,8% 15,1% 14,0% 15,0% 12,9% 13,0% 13,1% 11,5% 13,0% 11,5% 13,0% 8,5% 10,0% 9,5% 9,5% 7,0% 6,0% 4,5% December 2012 (Basel II.5) June 2013 (Basel III) December 2012 pro forma Basel III Basel II.5 regulatory minima Basel III regulatory minima Basel II.5 internal target range 2% 0% Common Equity Tier 1 Tier 1 Total Basel III internal target range 3 Nedbank Limited 18% 18,6 18,8 16% 14% 12% 11,2% 10,1% 10% 8% 6% 5,25% 4% 2% 1 10,6% 7,5% 9,0% 1 9,5% 11,5% STRONG CAPITAL RATIOS 4, WELL WITHIN BASEL III TARGET RANGES 18, ,6 1,2 1,2 1 18,2 15,3% 14,8% 12,9% 11,6% 11,5% 13,0% 12,3% 10,5% 12,0% 8,5% 10,0% 9,5% 7,0% 6,0% 4,5% 1,2 3 13,9 1,2 13,6% 13,0% 14,0% 9,5% December 2012 (Basel II.5) June 2013 (Basel III) December 2012 pro forma Basel III Basel II.5 regulatory minima Basel III regulatory minima Basel II.5 internal target range Basel III internal target range 3 0% Common Equity Tier 1 Tier 1 Total 1 Surplus (Rbn) above regulatory minima. 2 Based on the minimum Basel II.5 South African Reserve Bank (SARB) requirement (9,5%). 3 Basel III range based on 2019 SARB end state minimum requirements for Common Equity Tier 1 (CET1) and 2015 end state minimum requirements for Total Tier1 and total. 4 Including unappropriated profits. % 14 HISTORICAL TREND OF INCREASING COMMON EQUITY TIER ,9 1,6 (1,7 ) 1,2 11,0 (0,5) 0,4 (0,8 ) 10,5 2,2 (0,9) (0,3) 0,5 (0,3 ) 0,5 11,4 11,6 11, Basel II Basel II.5 Basel II.5 Basel III Basel III Basel II RWA optimisation RWA growth Organic earnings net of dividends 2011 Basel II Basel II.5 implementation 2011 Basel II.5 pro forma RWA optimisation RWA growth Organic earnings Ordinary dividend paid 2012 Basel II.5 Basel III additional RWA requirement Basel III additonal qualifying capital 2012 Basel III pro forma RWA Growth Organic earnings June 2013 Basel III The graph above demonstrates Nedbank s track record of consistent strong organic capital generation from solid earnings growth and returns, RWA optimisation and strategic portfolio management within the group s key strategic focus area of Portfolio Tilt. Nedbank Group Limited and Nedbank Limited Pillar 3 June

49 Nedbank Group The graph above demonstrates Nedbank s strong capital position that is well within the group s new Basel III capital target ranges. Nedbank Group s CET1 ratio increased to 11,8% (December 2012: 11,4% Basel II.5; 11,6% pro forma Basel III) on the back of the successful implementation of Basel III, aided by sound organic earnings growth during H after taking into account the 2012 final dividend paid in April Basel III resulted in an overall net increase in the capital supply available for Nedbank Group, with a 50bps net improvement in the CET1 ratio. This was mainly the result of: The inclusion of foreign currency translation (FCT), available for sale (AFS), share based payments (SBP) and property revaluation (PR) reserves (ie R3,7bn in additional qualifying CET1 and Tier 1 capital and R3,1bn in total capital) that previously did not qualify under Basel II.5. The less punitive treatment of 'capital held in insurance entities' as per Regulation 38(5)(b)(i) (ie R656m less CET1 and R656m less Tier 2 deductions) where the related investment is risk weighted at 250% [ie R2,2bn additional risk weighted assets (RWA)] up to a maximum of 10% of CET1 with only the excess deducted, compared to a full deduction from qualifying capital supply under Basel II.5. The above was offset partially by: The new capital deduction of 'defined benefit pension fund assets, net of related deferred tax liabilities' (ie R1,3bn additional CET1 deduction). The 'excess of downturn expected loss over provisions' being deducted 100% from CET1 capital (R468m additional CET1 deduction), as opposed to 50% against CET1 and 50% against Tier 2 (R468m less Tier 2 deduction) under Basel II.5. Deferred tax assets now risk weighted at 250% (ie R1,3bn additional RWA), up to a maximum of 10% of CET1, with the excess being deducted from qualifying capital supply. Additional risk weighted asset requirements for significant financial institutions (R845m) and the credit valuation charge (CVA) for counterparty credit risk (R474m). The Total Tier 1 ratio was 13,0% (December 2012: 12,9% Basel II.5; 13,1% pro forma Basel III) and was impacted by: The grandfathering of preference shares evenly over 10 years as per Regulation 38(13) effective 1 January 2013, resulting in a R347m reduction in Additional Tier 1 capital. The derecognition of surplus Tier 1 capital attributable to minority shareholders as per Regulation 38(16), an immaterial R20m reduction in Additional Tier 1 capital. The total capital adequacy ratio (CAR) was 14,8% (December 2012: 14,9% Basel II.5; 15,1% pro forma Basel III) and was impacted by: The grandfathering of existing subordinated debt capital Tier 2 instruments issued before 1 January 2013, evenly over 10 years as per Regulation 38(14), a R773m reduction in qualifying Tier 2 capital. Nedbank Group s revised target CAR ranges for CET1 under Basel III are 10,5% 12,5% (Basel II.5: 7,5% 9,0%),Total Tier 1 11,5% 13,0% and total 14,0% 15,0%. The revised CET1 range is set based on the final, fully phased in 2019 Basel III minimum SARB regulatory requirements, and constitutes a full through the cycle (TTC) target range. Total Tier 1 and total ranges have been set based on the phased in 2015 Basel III minimum SARB regulatory requirements. Under Basel III Nedbank Group s CET1 CAR of 11,8% is already above the middle of our new Basel III target range as the group continues to build capital reserves in anticipation of exercising its subscription and topup rights in Ecobank Transnational Incorporated (ETI). The Total Tier 1 and total capital ratios of 13,0% and 14,8% respectively are also well within these new Basel III ranges, operating towards the top end. Nedbank is well positioned with both high capital adequacy ratios and a high RWA density (total RWA : total assets) percentage of 54% under Basel III (December 2012: 53% under Basel II.5), and low leverage (refer page 62) compared with international levels. Total RWA increased by R27,1bn during the first half of 2013, representing 15,2% (annualised) growth, in line with total assets, which increased by 9,3% (annualised). Credit risk (including counterparty credit risk and securitisation RWA) increased by R19,9bn or 15% (annualised) due to the implementation of Basel III and advances growth of 11,7% (annualised). The increase in securitisation RWA was largely driven by the introduction of the Precinct commercial mortgage backed securitisation and growth in the Synthesis liquidity facility driven by asset growth in the programme. Nedbank Limited The implementation of Basel III had a less favourable impact on Nedbank Limited compared with Nedbank Group due to: The immaterial size of the net FCT, AFS, SBP and PR reserves held at bank level (ie only R363m in additional qualifying capital); and There being no benefit of the more favourable treatment of 'capital held in insurance entities', as insurance entities are held at group level. Nedbank Group Limited and Nedbank Limited Pillar 3 June

50 Nedbank Limited s new Basel III target ranges are set 1% lower than those of Nedbank Group as: Surplus capital is held at group level to support potential strategic actions. It is easy and efficient to distribute capital down the structure from Nedbank Group level (versus up the structure). There is a need to distinguish between bank and group capital adequacy levels to avoid over capitalisation of the bank. Nedbank Limited s CET1 is well within its new Basel III range at 10,1% (December 2012: 11,2% Basel II.5; 10,6% pro forma Basel III), and likewise the Total Tier 1 at 11,6% (December 2012: 12,9% Basel II.5; 12,3% pro forma Basel III) and the total CAR at 13,6% (December 2012: 15,3% Basel II.5; 14,8% pro forma Basel III). Nedbank Limited successfully placed R1,8bn of new style fully loss absorbent Basel III compliant subordinated debt capital during July 2013 at competitive pricing, which effectively replaces the R1,8bn Basel II Tier 2 capital that matures in September Regulatory capital adequacy ratios Nedbank Group Basel II.5 SARB minimum Basel III SARB minimum 5 Basel II.5 internal target old ranges Basel III internal target new ranges 4 Jun 2013 Basel III Jun 2012 Basel III 1 Jun 2012 Basel II.5 Dec 2012 Basel III 1 Dec 2012 Basel II.5 Including unappropriated profits CET1 (%) 5,25 4,50 7,5 9,0 10,5 12,5 11,8 10,6 10,6 11,6 11,4 Total Tier 1 (%) 7,00 6,00 8,5 10,0 11,5 13,0 13,0 12,1 12,1 13,1 12,9 Total (%) 9,50 9,50 11,5 13,0 14,0 15,0 14,8 14,7 14,4 15,1 14,9 Surplus CET1 capital 2, 3 (Rm) Total RWA (Rm) Total RWA : total assets (%) > Dividend cover (times) 1,75 2,25 2,18 2,23 2,18 Excluding unappropriated profits CET1 (%) 5,25 4,50 11,3 10,3 11,2 Total Tier 1 (%) 7,00 6,00 12,5 11,8 12,7 Total (%) 9,50 9,50 14,4 14,2 14,7 Nedbank Limited Including unappropriated profits CET1 (%) 5,25 4,50 7,5 9,0 9,5 11,5 10,1 10,0 10,5 10,6 11,2 Total Tier 1 (%) 7,00 6,00 8,5 10,0 10,5 12,0 11,6 11,6 12,2 12,3 12,9 Total (%) 9,50 9,50 11,5 13,0 13,0 14,0 13,6 14,6 15,0 14,8 15,3 Surplus CET1 capital 2, 3 (Rm) Total RWA (Rm) Total RWA : total assets (%) > Excluding unappropriated profits CET1 (%) 5,25 4,50 9,7 10,2 11,1 Total Tier 1 (%) 7,00 6,00 11,2 11,9 12,8 Total (%) 9,50 9,50 13,3 14,8 15,2 1 Pro forma Basel III. 2 Based on a 2019 end state Basel III minimum capital requirements for pro forma Basel III. 3 Excluding any specific Pillar 2B addon and countercyclical buffer (CCB). 4 Nedbank s internal TTC target ranges are based on final minimum regulatory requirements of 2019 for CET1 and 2015 for the Total Tier 1 and total capital ratios. 5 The SARB minimum ratios are for 2013 and increase in line with Basel III phasing over BASEL III 1 SARB MINIMUM CAPITAL ADEQUACY RATIOS Common Equity Tier 1 4,50 6,50 7,00 Total Tier 1 6,00 8,00 8,50 Total 9,50 10,00 10, and 2015 include a Pillar 2A addon inludes a capital conservation buffer but does not include a Pillar 2A/D SIB addon. In line with regulation 38(10) of the Banks Act, profits do not qualify as regulatory capital, unless formally appropriated by the board by way of a resolution. Accordingly, capital ratios are shown above, both including and excluding unappropriated profits. Nedbank Group Limited and Nedbank Limited Pillar 3 June

51 Nedbank Group Risk type SUMMARY OF REGULATORY CAPITAL REQUIREMENTS AND RISK WEIGHTED ASSETS Jun 2013 Basel III Rm RWA Mix (%) MRC 1 RWA Mix (%) MRC 1 RWA Mix (%) MRC 1 Credit risk Advanced Internal Ratings based Approach Corporate, Sovereign, Banks, SME Residential mortgages Qualifying revolving retail Other retail The Standardised Approach Corporate, Sovereign, Banks, SME Retail exposures Counterparty credit risk Current Exposure Method Securitisation risk Internal Ratings based Approach < < Equity risk Market based Simple Risk Weight Approach Listed (300% risk weighting) < < Unlisted (400% risk weighting) Trading market risk Internal Model Approach Operational risk Advanced Measurement Approach The Standardised Approach < Other assets 100% risk weighting Total Total MRC (9,5%) Pillar 1 MRC (8,0%) Pillar 2a MRC (1,5%) Total qualifying capital and reserves Total surplus capital over MRC Analysis of total surplus capital 2 CET Total Tier Total Total minimum required capital (MRC) is measured at 9,5% in line with SARB regulations and circular 5/ Includes unappropriated profits. In line with regulation 38(10) of the Banks Act, profits do not officially qualify as regulatory capital, unless formally appropriated by the board by way of a resolution. Accordingly, capital ratios are shown both including and excluding unappropriated profits. 3 SME = Small and Medium sized Enterprises. 4 RWA restated for the December 2012 Synthesis securitisation exposures due to a recalibration of the Supervisory Formula Approach model. Jun 2012 Basel II.5 Dec 2012 Basel II.5 Nedbank Group Limited and Nedbank Limited Pillar 3 June

52 Nedbank Limited 3 Risk type SUMMARY OF REGULATORY CAPITAL REQUIREMENTS AND RISK WEIGHTED ASSETS Jun 2013 Jun 2012 Dec 2012 Basel III Basel II.5 Basel II.5 Rm RWA Mix (%) MRC 1 RWA Mix (%) MRC 1 RWA Mix (%) MRC 1 Credit risk Advanced Internal Ratings based Approach Corporate, Sovereign, Banks, SME Residential mortgages Qualifying revolving retail Other retail The Standardised Approach Corporate, Sovereign, Banks, SME Retail exposures < Counterparty credit risk Current Exposure Method Securitisation risk Internal Ratings based Approach < < Equity risk Market based Simple Risk Weight Approach Listed (300% risk weighting) < Unlisted (400% risk weighting) Trading market risk Internal Model Approach Operational risk Advanced Measurement Approach The Standardised Approach 39 < < < 1 4 Other assets 100% risk weighting Total Total MRC (9,5%) Pillar 1 MRC (8,0%) Pillar 2a MRC (1,5%) Total qualifying capital and reserves Total surplus capital over MRC Analysis of total surplus capital 2 CET Total Tier Total Total MRC is measured at 9,5% in line with SARB regulations and circular 5/ Includes unappropriated profits. In line with regulation 38(10) of the Banks Act, profits do not officially qualify as regulatory capital, unless formally appropriated by the board by way of a resolution. Accordingly, capital ratios are shown both including and excluding unappropriated profits. 3 Nedbank Limited refers to the SA reporting entity in terms of Regulation 38 (BA700) of the SA banking regulations. 4 RWA restated for the December 2012 Synthesis securitisation exposures due to a recalibration of the Supervisory Formula Approach model. Nedbank Group Limited and Nedbank Limited Pillar 3 June

53 SUMMARY OF REGULATORY QUALIFYING CAPITAL AND RESERVES Including unappropriated profits Nedbank Group Nedbank Limited Rm Total Tier 1 capital CET1 capital Ordinary share capital and premium Jun 2013 Basel III Jun 2012 Basel II.5 Dec 2012 Basel II.5 Minority interest: ordinary shareholders Reserves Deductions (10 884) (12 969) (13 255) (6 814) (5 063) (5 521) Goodwill (5 076) (5 003) (5 041) (1 410) (1 410) (1 410) Capitalised software development costs (2 534) (2 246) (2 458) (2 506) (2 202) (2 421) Other intangibles (390) (538) (422) Excess of downturn expected loss over provisions (50% in 2012) (936) (551) (542) (1 118) (596) (626) AFS reserves (81) (126) (9) (9) FCT reserves (459) (599) (9) (9) SBP reserves (1 211) (1 334) Deferred tax assets, excluding temporary differences, net of related deferred tax liabilities (194) (281) (225) (560) (466) (463) Defined benefit pension fund assets (1 332) (1 220) Property revaluation reserves (1 359) (1 383) (962) (985) Capital held in insurance entities (50%) (794) (704) Other regulatory differences 1 (422) (446) (421) (17) Additional Tier 1 capital Preference share capital and premium Hybrid debt capital instruments Tier 2 capital Long term debt instruments Property revaluation reserves (50%) General allowance for credit impairments Deductions (1 358) (1 246) (609) (626) Capital held in insurance entities (50%) (794) (704) Excess of downturn expected loss over provisions (50%) (551) (542) (596) (626) Other regulatory differences (13) (13) Total qualifying capital and reserves Excluding unappropriated profits CET1 capital Total Tier 1 capital Total qualifying capital and reserves Funds invested in the Holsboer Trust Fund. Jun 2013 Basel III Jun 2012 Basel II.5 Dec 2012 Basel II.5 Nedbank Group Limited and Nedbank Limited Pillar 3 June

54 Reconciliation of Basel II.5 to Basel III at 30 June 2013 This reconciliation of the group and bank s capital ratios highlights the positive impact of Basel III of R1,8bn on the group s capital position and a negative impact of R2,5bn on the bank s capital position. This is mainly due to the qualification of previously disallowed reserves that now qualify and the benefit of the treatment of investments in insurance entities at the group level. Rm Nedbank Group Nedbank Limited Risk weighted assets Basel II.5 equivalent RWA Add: Basel III adjustments Significant financial entity charge Credit valuation adjustment Threshold deduction risk weighting Total Basel III RWA Qualifying capital and reserves CET1 (Basel II.5 equivalent) Add/(Deduct): Basel III adjustments (1 416) Excess of IFRS 1 provisions over downturn expected loss (468) (559) Capital held in insurance entities (50%) 656 Defined benefit pension fund assets (1 332) (1 220) Surplus attributable to minority shareholders (40) SBP, FCT, AFS and PR reserves CET1 (Basel III) Additional Tier 1 (Basel II.5 equivalent) Add/(deduct): Basel III adjustments (367) (347) Grandfathering Preference shares (347) (347) Grandfathering Hybrid Surplus attributable to minority shareholders (20) Additional Tier 1 (Basel III) Total Tier 1 (Basel II.5 equivalent) Total Tier 1 (Basel III) Tier 2 (Basel II.5 equivalent) Add/(deduct): Basel III adjustments (328) (702) Excess of IFRS 1 provisions over downturn expected loss % property revaluation reserve (679) (488) Grandfathering subordinated Tier 2 debt capital (773) (773) Capital held in insurance entities (50%) 656 Tier 2 (Basel III) Total capital (Basel II.5 equivalent) Total capital (Basel III) Total change in qualifying capital and reserves (2 465) Total change in RWA Capital adequacy ratios (including unappropriated profits) Basel III capital ratios (as reported) CET1 11,8% 10,1% Tier 1 13,0% 11,6% Total 14,8% 13,6% Basel II.5 equivalent capital ratios CET1 11,2% 10,6% Tier 1 12,6% 12,1% Total 14,5% 14,4% 1 IFRS = International Financial Reporting Standards. 2 Includes investments in insurance entities and deferred tax assets arising from temporary differences. Nedbank Group Limited and Nedbank Limited Pillar 3 June

55 Unlike Basel II implemented in 2008 and Basel II.5 implemented 2012, Basel III implementation effective from 1 January 2013 will be phased in over several years until As such there are also various aspects that remain work in progress and are still to be finalised, which could impact qualifying capital and reserves and/or RWA levels in the ensuing years. The main outstanding Basel III capital related work and focus relates to the conversion and/or replacement of the existing Additional Tier 1 and Tier 2 capital instruments in line with the new Basel III full loss absorbency and other requirements with phasing in over ten years, effective from 1 January Existing Additional Tier 1 and Tier 2 capital instruments will be phased out evenly over ten years from 1 January 2013, with the exception of hybrid debt capital in South Africa that is being phased out over three years from 1 January 2012 to 1 January 2015 as prescribed in Regulation 38(9)(a)(iv) of the Banks Act. The implications of the phase out of hybrid debt capital will only impact Nedbank after 2014, given the size of existing hybrid debt. Given Nedbank s strong Total CAR position, Basel III s strong focus on Common Equity Tier 1 capital and the group s current higher concentration on Tier 2 capital instruments, a number of maturing Tier 2 capital instruments were called and not replaced in the years leading up to Basel III implementation. The focus now is on raising new style Tier 2 instruments that qualify fully for Basel III. To this end the group successfully issued a total of R1,8bn of new style, fully loss absorbent, Basel III compliant, Tier 2 subordinated debt capital during July 2013 to replace the R1,8bn Basel II Tier 2 capital that matures in September Additional Basel III capital disclosure requirements On 30 June 2012 the Basel Committee issued a document entitled 'Composition of Capital Disclosure Requirements'. The additional requirements are included as annexures in this report: Annexure A: a breakdown of regulatory capital composition. Annexure B: containing the main features, terms and conditions of relevant capital instruments issued. Summary of regulatory capital adequacy of all banking subsidiaries The summary below provides all other banking subsidiaries' regulatory capital positions, reported based on their home country requirements. Rest of Africa Capital requirement (host country) REGULATORY CAPITAL AS % OF RWA Jun 2013 Jun 2012 Dec 2012 Total capital Total capital ratio Total capital ratio CET1 CET1 CET1 RWA ratio ratio RWA ratio RWA ratio % Rm % % Rm % % Rm % % Nedbank Namibia Limited 10, ,2 16, ,0 16, ,4 16,6 Nedbank (Swaziland) Limited 8, , , ,6 Nedbank (Lesotho) Limited 8, , , ,6 Nedbank (Malawi) Limited 10, , , ,2 MBCA Bank Limited 10, , , ,2 United Kingdom Nedbank Private Wealth (IOM) Limited 10, ,9 15, ,5 13, ,8 15,3 The capitalisation of all these banking entities is deemed adequate, all have prudent risk profiles and risk appetites, and all are managed, monitored and integrated within the group s Enterprisewide Risk Management Framework and ICAAP. Nedbank Group Limited and Nedbank Limited Pillar 3 June

56 EXTERNAL CREDIT RATINGS Nedbank engages three credit rating agencies, whose ratings are summarised below. Apart from Fitch s downgrade of all of SA banks in January 2013 on the back of the SA sovereign downgrade, there have been no changes since December FITCH RATINGS Nedbank Group Limited Nedbank Limited Sovereign rating South Africa August 2013 August 2013 August 2013 Support 2 Foreign currency Long term BBB BBB BBB Short term F3 F3 F3 Outlook Stable Stable Stable Local currency Long term BBB BBB BBB+ Outlook Stable Stable Stable National scale Long term AA(zaf) AA(zaf) Short term F1+(zaf) F1+(zaf) Outlook Stable Stable Viability rating bbb Country rating A MOODY'S INVESTOR SERVICE RATINGS Nedbank Limited Sovereign rating South Africa June 2013 June 2013 Foreign currency deposit ratings Long term Baa1 Baa1/A2 Short term P 2 Outlook Negative Negative Local currency deposit ratings Long term A3 Baa1/Baa1 Short term P 2 Outlook Negative Negative National scale Long term deposits Short term deposits Aa2.za P 1.za Bank financial strength rating C Outlook Stable STANDARD & POOR S RATINGS Nedbank Limited Sovereign rating South Africa January 2013 January 2013 Foreign currency counterparty credit rating Long term BBB BBB Short term A 2 A 2 Outlook Negative Negative Local currency counterparty credit rating Long term BBB A Short term A 2 A 2 Outlook Negative Negative South Africa national scale Long term Short term zaaa zaa 1 Nedbank Group Limited and Nedbank Limited Pillar 3 June

57 ECONOMIC CAPITAL AND ICAAP Nedbank Group STRONG ECONOMIC CAPITAL ADEQUACY 1 AND ICAAP MAINTAINED (Rm) Available Financial Resources : Economic Capital ratio 140% 140% Surplus % Tier B Surplus Tier B 3 Tier B Surplus % buffer⁴ % buffer⁴ % buffer⁴ Minimum requirement Tier A Minimum requirement Tier A Minimum requirement Tier A Required economic capital Available financial resources Required economic capital Available financial resources Required economic capital June 2012 December 2012 June 2013 Available financial resources Nedbank Limited STRONG ECONOMIC CAPITAL ADEQUACY 1 AND ICAAP MAINTAINED (Rm) Available Financial Resources : Economic Capital ratio 129% 131% 126% Surplus Tier B Tier B 3 Tier B Surplus Surplus % buffer % buffer % buffer Minimum requirement Tier A Minimum requirement Tier A Minimum requirement Tier A Required economic capital Available financial resources Required economic capital Available financial resources Required economic capital June 2012 December 2012 June 2013 Available financial resources 1 Including unappropriated profits. 2 Tier A AFR = CET1 type regulatory capital, adjusted further to take Basel III into account with effect from 1 January Tier B = Additional Tier 1 type regulatory capital. 4 10% buffer determined in accordance with the group s comprehensive stress testing and ICAAP. Nedbank Group Limited and Nedbank Limited Pillar 3 June

58 Economic capital is the group s comprehensive internal measurement of risk and related capital requirements, and forms the basis of the group s annual ICAAP and allocation of risk based capital to the business clusters. Nedbank s ICAAP confirms that both Nedbank Group and Nedbank Limited are well capitalised above their current 'A' or 99,93% target debt rating (solvency standard) in terms of the group s proprietary economic capital methodology. Nedbank Group s ICAAP reflects a surplus AFR of R15,1bn at 30 June 2013 (Nedbank Limited s surplus AFR is R8,6bn) after a 10% capital buffer is added, determined in accordance with the group s comprehensive Stress and Scenario Testing Framework, to the minimum required economic capital. In line with the implementation of Basel III from 1 January 2013 the following changes have been applied to Nedbank s AFR: Capital held in insurance entities is no longer deducted from AFR. Defined benefit pension fund assets are now deducted from AFR. The non qualifying portion, as a result of grandfathering or other disqualification requirements, for perpetual preference shares and hybrid debt capital instruments are excluded from AFR. New style, fully loss absorbent Basel III Tier 2 instruments will now qualify as Tier B AFR once issued, as they fully absorb losses on a going and gone concern basis. Further details on Nedbank s risk types and economic capital methodology are reflected from page 42. Economic capital requirement versus available financial resources Nedbank Group Jun 2013 Jun 2012 Dec 2012 Rm Mix (%) Rm Mix (%) Rm Mix (%) Credit risk Counterparty credit risk 209 < 1 69 < Securitisation risk 44 < 1 10 < 1 33 < 1 Transfer risk 12 < 1 11 < 1 6 < 1 Market risk Trading risk IRRBB Property risk Equity investment risk FCT risk 99 < 1 75 < 1 70 < 1 Business risk Operational risk Insurance risk Other assets risk Minimum economic capital requirement Add: capital buffer (10%) Total economic capital requirement Available financial resources Tier A capital Tier B capital Total surplus AFR Nedbank Group s total economic capital requirement (including a 10% buffer) increased by R1bn from June 2012 mainly due to the increase in credit economic capital in Corporate and Business Banking, partially offset by a R0,8bn decrease in operational risk economic capital due to modelling refinements and an update of the AMA scenarios, as well as a R0,3bn decrease in investment risk following the disposal of some investments. AFR increased by R2,8bn from June 2012 to June 2013 mainly due to headline earnings growth driving a R4,0bn increase in retained earnings, after the payment of a R2,1bn 2012 final dividend in April 2013, a R0,5bn increase in FCT reserves largely as a result of the year on year ZAR weakness relative to the USD and GBP, and a R0,4bn increase in share capital and premium due to employee share scheme issues. This was offset to some extent by the new deduction of defined benefit pension fund assets of R1,3bn following the implementation of Basel III, and grandfathering of preference shares resulting in a R347m decrease in Tier B capital. Nedbank Group Limited and Nedbank Limited Pillar 3 June

59 Nedbank Limited Jun 2013 Jun 2012 Dec 2012 Rm Mix (%) Rm Mix (%) Rm Mix (%) Credit risk Counterparty credit risk 200 < 1 55 < < 1 Securitisation risk 44 < 1 9 < 1 33 < 1 Transfer risk 2 < 1 1 < 1 2 < 1 Market risk Trading risk IRRBB Property risk Equity investment risk Business risk Operational risk Insurance risk < 1 < 1 Other assets risk Minimum economic capital requirement Add: capital buffer (10%) Total economic capital requirement Available financial resources Tier A capital Tier B capital Total surplus AFR Nedbank Limited s total economic capital requirement (including a 10% buffer) increased by R0,5bn from June 2012 mainly due to the increases in credit economic capital in Corporate and Business Banking, in business risk economic capital in Nedbank Capital and in IRRBB economic capital. These increases were partially offset by a R0,8bn decrease in operational risk economic capital due to modelling refinements and an update of the AMA scenarios. AFR decreased by R0,2bn from June 2012 to June 2013 mainly due to the new deduction of defined benefit pension fund assets of R1,2bn and grandfathering of preference shares following the implementation of Basel III related ICAAP changes, as well as a decrease in sharebased payments reserves. The decreases in AFR were partially offset by a R0,3bn increase in retained income on the back of strong organic earnings. Nedbank Group Limited and Nedbank Limited Pillar 3 June

60 Analysis of available financial resources Nedbank Group Rm Jun 2013 Jun 2012 Dec 2012 Tier A capital Ordinary share capital and premium Minority interest: ordinary shareholders Reserves Retained income Non distributable reserves AFS reserves FCT reserves SBP reserves Property revaluation reserves Deductions (9 948) (8 528) (8 567) Deferred tax assets, excluding temporary differences (194) (281) (225) Goodwill (5 076) (5 003) (5 041) Capitalised software development costs (2 534) (2 246) (2 458) Other intangibles (390) (538) (422) Other adjustments (422) (460) (421) Defined benefit pension fund assets (1 332) Excess of IFRS provisions over TTC expected loss Tier B capital Preference shares Hybrid debt capital instruments Total AFR Nedbank Group remains well capitalised in spite of the additional conservatism introduced to AFR qualification in 2013 through the additional deductions in line with Basel III as previously discussed. Nedbank Limited Rm Jun 2013 Jun 2012 Dec 2012 Tier A capital Ordinary share capital and premium Minority interest: ordinary shareholders Reserves Retained income Non distributable reserves AFS reserves FCT reserves SBP reserves (630) (608) (402) Property revaluation reserves Deductions (5 696) (4 108) (4 294) Deferred tax assets, excluding temporary differences (560) (466) (463) Goodwill (1 410) (1 410) (1 410) Capitalised software development costs (2 506) (2 202) (2 421) Other intangibles Other adjustments (30) Defined benefit pension fund assets (1 220) Excess of IFRS provisions over TTC expected loss Tier B capital Preference shares Hybrid debt capital instruments Total AFR Although there was a decrease in the AFR : total economic capital (including 10% buffer) ratio from 129% in June 2012 to 126%, Nedbank Limited remains well capitalised in spite of the additional conservatism introduced to AFR qualification in 2013 through the additional deductions in line with Basel III as previously discussed. Nedbank Group Limited and Nedbank Limited Pillar 3 June

61 Nedbank Capital Nedbank Corporate RISK BASED CAPITAL ALLOCATION TO THE BUSINESS CLUSTERS 1 Nedbank Business Banking Nedbank Retail Nedbank Wealth Central Management, including Rest of Africa Jun Jun Dec Jun Jun Dec Jun Jun Dec Jun Jun Dec Jun Jun Dec Jun Jun Dec Jun Jun Dec Rm Credit risk Counterparty credit risk Securitisation risk Transfer risk Market risk Trading risk IRRBB risk Property risk Investment risk FCT risk Business risk Operational risk Insurance risk Other assets risk Minimum economic capital requirement Intangible assets Excess of downturn expected loss over provisions (49) (47) (31) (21) (22) (8) (87) (83) (84) Goodwill Excess of CET1 over 11% of total RWA Allocated capital buffer Total capital allocated Summary of average year to date capital allocation at June 2013 versus June 2012 and December 2012, using average year to date capital consumption. 2 The allocated capital buffer aligns the capital allocated to business clusters and central functions with the ordinary shareholders equity of the group, taking into account a 10% capital buffer for stress testing. Nedbank Group There were no material changes in the risk based capital of the business clusters for Nedbank Group and Nedbank Limited except: Nedbank Corporate Cluster credit economic capital increased by R0,4bn year on year largely as a result of asset growth within the Corporate Banking portfolio and improvements to the modelling of LGD for leverage buyouts. Credit economic capital for Business Banking increased by R0,2bn driven by asset growth as well as some increases in the risk profile of the Corporate SME asset class. Business risk for Nedbank Capital increased due to increased income expectation from the business following the annual model update. Operational risk for Nedbank Capital decreased on the back of the enhanced AMA scenario methodology. Allocated buffer capital for central management increased on the back of growth in ordinary shareholders equity. In addition to the risk based economic capital allocation in place across Nedbank for several years now, the following other appropriate risk based economics is embedded bankwide: Funds transfer pricing. Liquidity premiums. Risk adjusted performance measurement (RAPM). Risk appetite. Risk strategy. All of the above are integrated into the group and each major business unit s strategy and business plans, as well as management s performance scorecards and remuneration. Furthermore there is a healthy qualitative overlay of experience, substance over form and common sense. COST OF EQUITY (COE) Nedbank Group revised its COE to 13,0% for 2013 (December 2012: 13,1%) following a review of the COE components, based on the Capital Asset Pricing Model (ie risk free rate, beta and equity risk premium) and in consideration of the approach followed by the group s parent company (Old Mutual plc), average investment analysts consensus and management judgment. Nedbank Group Limited and Nedbank Limited Pillar 3 June

62 LEVERAGE The Basel III leverage ratio has recently received significant attention with the US looking to use this ratio as a primary measure, proposing a minimum ratio of 5% to 6% compared with the current Basel III minimum of 3%. The leverage ratio is intended by the Basel Committee on Banking Supervision (Basel Committee) to serve as a simple, transparent, non riskbased leverage ratio to supplement the risk based capital requirements to: avoid the buildup of excessive leverage; and to capture both on and off balance sheet exposure. SA banks, including Nedbank, compare favourably to most international banks on leverage. SA s banking system generally has lower leverage than those of most other countries. As a consequence, deleveraging, which is continuing among most international banks after the global financial crisis, is not a factor in South Africa. Nedbank Group s gearing under Basel III, which includes off balance sheet exposure, is 16,3 times (or 6,13%) at 30 June 2013 (quarterly average: 16,5 times or 6,08%) against an internal risk appetite target of less than 20 times (or > 5%), and well below the Basel III limit in accordance with the revised SA regulations of 25 times (or > 4%), which is more prudent than Basel III at 33,3 times (or > 3%). The differences between the Basel III leverage ratio and the IFRS accounting leverage ratio include differences in both the capital measure and the exposure measure. In terms of the capital measure, Basel III currently utilises Total Tier 1 qualifying regulatory capital including preference shares and Tier 1 hybrid debt combined with relevant Basel III deductions such as goodwill and intangible assets, whereas the IFRS accounting leverage ratio utilises ordinary shareholders equity. The Basel Committee is also considering the use of Common Equity Tier 1 capital as well as total capital in the calculation of the ratio and will assess the appropriateness thereof during the parallel run period from 2013 to In terms of the exposure measure, the main difference between the Basel III and IFRS accounting is the inclusion of off balance sheet exposure in the Basel III measurement. The Basel Committee published a consultative document in June 2013 entitled 'Revised Basel III Leverage Ratio Framework and disclosure requirements'. Revisions to this framework relate primarily to the exposure measure of the leverage ratio. The specification of a broad scope of consolidation and the inclusion of exposures, such as insurance assets. This is not anticipated to affect the current measurement of the leverage ratio in South Africa significantly, since exposures such as insurance assets are currently included in the measurement of the leverage ratio. The exclusion of the deduction of collateral against the gross derivative exposure amount as well as clarification of the general treatment of derivatives. Currently collateral is deducted from the exposure measure for derivative transactions and this particular revision will therefore decrease the leverage ratio (and therefore increase gearing under Basel III). However, at Nedbank Group collateral associated with derivatives is approximately 0,1% of the total exposure measure and therefore is not expected to have any material impact. The additional treatment for written credit derivatives through the inclusion of the notional value in the exposure measure. The notional value referenced by written credit derivatives is, however, already included in the measurement of the leverage ratio in South Africa and is therefore not anticipated to have any impact. Further clarification on the treatment of securities financing transaction (SFTs) exposures. The current implementation of the leverage ratio in South Africa is considered consistent with the clarifications provided in the consultative paper. NEDBANK IS WELL PLACED UNDER THE BASEL III LEVERAGE RATIO Basel III maximum: 33,3 times (minimum 3%) SARB maximum: 25 times (minimum 4%) Nedbank's internal risk appetite target: < 20 times (minimum 5%) 13,3¹ 18,0 18,1 13,2¹ 16,4 16,4 12,6 16,3 16,3 (or 7,5%) (or 5,6%) (or 5,5%) (or 7,6%) (or 6,1%) (or 6,1%) (or 7,9%) (or 6,1%) (or 6,1%) Jun Dec Jun IFRS leverage ratio Basel III current leverage ratio Basel III leverage ratio (June 2013 consultative paper) restated to reflect the adoption of IAS 19 Employee Benefits (2011). Nedbank Group Limited and Nedbank Limited Pillar 3 June

63 RISK MANAGEMENT Nedbank Group's Enterprisewide Risk Management Framework (ERMF) enables the group to identify, measure, manage, price and control its material risks and risk appetite, and then relate these to capital requirements to help ensure its capital adequacy and sustainability, and so promotes sound business behaviour by then linking these with performance measurement and remuneration practices. RISK UNIVERSE Nedbank Group's risk universe is defined, actively managed and monitored in terms of the ERMF, in conjunction with the Capital Management Framework and its sub frameworks, including economic capital, as discussed earlier. A summary table of the key risk types impacting the group is provided below and highlights where the 17 key ERMF risk types map to the quantitative risk types of the economic capital [and Internal Capital Adequacy Assessment Process (ICAAP)] Framework. An overview of the key risks impacting Nedbank Group follows thereafter. Major risk categories ERMF s 17 key risk types Economic capital (ICAAP) risk types Capital risk Capital risk Is the aggregation of all risk types = Economic capital Credit risks Credit risk Credit risk Underwriting (lending) risk Integrated in 'credit risk' Collateral risk Integrated in 'credit risk' Concentration risk Integrated in 'credit concentration risk' Industry risk Integrated in 'credit risk' Issuer risk Integrated in 'credit risk' Settlement risk Integrated in 'credit risk' Counterparty credit risk Integrated in 'counterparty credit risk' Counterparty Credit risk Sub set of credit risk Counterparty credit risk Transfer (cross border) risk Sub set of credit risk Transfer risk Securitisation risk Sub set of liquidity risk Securitisation risk Liquidity risk Liquidity risk Liquidity risk mitigated through Internal Liquidity Adequacy Assessment Process (ILAAP), liquidity profile targets and limits, and the holding of surplus liquidity buffers as opposed to holding economic capital. Market risks Market risk in the trading book Trading (position) risk Market risk in the banking book Interest rate risk in the banking book Interest rate risk in the banking book Foreign currency translation risk in the banking book Foreign currency translation risk Foreign exchange transaction risk Foreign currency translation risk Investment risk Investment risk Equity risk in the banking book Equity (investment) risk Property risk Property risk Operational risks Operational risk Operational risk Accounting, taxation and valuation (instruments, assets and liabilities) risks Covered by operational risk Compliance risk Covered by operational risk People risk (non strategic component) Covered by operational risk Insurance and assurance risks Covered by insurance risk Information technology risk (non strategic component) Covered by operational risk Business risks Business risk Business risk Transformation risk Covered by business risk New business risk Covered by business risk Reputational risk N/A Social and environmental risks Covered by business risk Strategic risk Covered by business risk People risk (strategic component) Covered by business risk Information technology risk (strategic component) Covered by business risk Other risks Other assets Other assets Nedbank Group Limited and Nedbank Limited Pillar 3 June

64 CREDIT RISK Credit governance and structures Credit risk arises from lending and other financing activities that constitute the group's core business. It is the most significant risk type and accounts for 61% of the group's economic capital (ECap) requirement and 74% of regulatory capital (RegCap). The lower percentage contribution under economic capital is mainly due to the extra risk types (eg business risk) explicitly capitalised for under economic capital, as well as modelling differences between the regulatory capital and economic capital calculations [eg application of long run average or through the cycle (TTC) loss given defaults (LGDs) for economic capital versus downturn LGDs for regulatory capital and the regulatory capital specific Pillar 2A systemic risk add on for South Africa]. Nedbank Group's credit risk governance structure is reflected in the following diagram: GOVERNANCE STRUCTURE OF NEDBANK S ADVANCED INTERNAL RATINGS BASED CREDIT SYSTEM BOARD OF DIRECTORS GROUP CREDIT COMMITTEE (Board committee) LARGE EXPOSURE APPROVAL COMMITTEE (Board committee) GROUP AUDIT COMMITTEE (Board committee) DIVISIONAL CREDIT COMMITTEES Wholesale AIRB Technical Forum Retail AIRB Technical Forum BUSINESS CLUSTERS (first line of defence) Appropriate use of models developed by credit units The origination of exposures and recommending ratings in some cases BALANCE SHEET MANAGEMENT (first line of defence) Group Credit Portfolio Management Active credit portfolio management Champion Nedbank s AIRB credit strategy Analysis and output of the group s credit ECap and RegCap Calculation and consolidation of credit RegCap and ECap for the group INDEPENDENT CLUSTER CHIEF RISK OFFICERS Model and process validation (primary responsibility) Model refinement, improvement and backtesting New model development Oversight of rating process (first line of defence) BUSINESS UNIT CREDIT HEADS AND RISK FUNCTIONS CLUSTER RISK LABS (independent of business) GROUP RISK CLUSTER (second line of defence) GROUP CREDIT RISK MONITORING (GCRM) CREDIT MODELS VALIDATION UNIT (CMVU) Model and process validation (ultimate responsibility) Ensuring consistency of rating methodologies Approval of ratings (second line of defence) GROUP INTERNAL AUDIT (third line of defence) EXTERNAL AUDITORS Credit risk is managed across the group in terms of its board approved Group Credit Risk Management Framework, which encompasses a selective credit policy, mandate limits and governance structures. It is a key component of the group's ERMF, Capital Management and Risk Appetite Frameworks discussed earlier. The Group Credit Risk Management Framework, which covers the macrostructures for credit risk management, monitoring and approval mandates, includes the two Advanced Internal Ratings based (AIRB) approach technical forums and a Group Credit Ad Hoc Ratings Committee which report into the Group Credit Committee (GCC). Also included is the Large Exposure Approval Committee (LEAC) whose sole function is the approval of credit applications in excess of the threshold imposed by the Banks Act. The GCC also acts as the designated committee appointed by the board to monitor, challenge and ultimately approve all material aspects of the group's AIRB credit rating and risk estimation systems and processes. The South African Reserve Bank (SARB) requires that the GCC is chaired by a non executive director. Current membership includes three non executive directors and three executive directors. In this regard the board and the GCC are required by the banking regulations to have a general understanding of the AIRB credit system and the related reports. They also need to ensure the independence of the group's credit risk monitoring unit, Group Credit Risk Monitoring (GCRM), which includes the Credit Model Validation Unit (CMVU). Nedbank Group Limited and Nedbank Limited Pillar 3 June

65 GCRM is an independent unit within Group Risk focussed upon: Credit risk management across the group. The Group Credit Risk Management Framework. The AIRB credit system. GCRM monitors credit portfolios, risk procedures, policies and credit standards and reports to executive management, DCCs and ultimately the board's GCC on a regular basis. GCRM together with Balance Sheet Management (BSM) have overall responsibility for the ongoing championing of the Basel III AIRB methodology across the group. GCRM also ensures consistency in the rating processes, and has ultimate responsibility for independent credit model validation through the CMVU, the group s independent risk control unit, as per the banking regulations. The technical understanding required of senior management is greater than that required at board level. Management must have a detailed understanding of the AIRB credit system and the reports it generates. Management needs to ensure the effective operation of the AIRB credit system assisted by an independent credit risk control unit, namely the GCRM and CMVU. Divisional credit committees (DCCs), with chairpersons independent of the business units, exist for all major business units across the group. The DCCs are responsible for approving credit policy and credit mandate as well as reviewing business unit level credit portfolios, credit risk appetite parameters, adequacy of impairments, expected loss and credit capital levels. In each of the five business clusters, credit risk management functions operate independently of credit origination, reporting into the cluster head of risk, who in turn reports to the cluster managing executive. In line with the Basel III AIRB methodology each cluster has implemented economic capital quantification and risk adjusted performance measurement. Each cluster also has a cluster credit risk lab that is responsible for the ongoing expert design, implementation, business validation and performance of their business cluster's internal rating systems and AIRB credit models, subject to independent annual validation by the CMVU. Nedbank Group's credit policy regarding lending to related parties is documented and approved by the GCC. The policy is also subject to an annual review by the GCC. Definitions used for related parties are aligned with the definitions specified by the SA Institute of Chartered Accountants and Banking Regulations. Compliance with the policy requires appropriate processes and procedures for the approval, monitoring and reporting by business units, all of which are aligned to the new Companies Act. In addition, the policy requires that all related party loans are concluded at arm's length and hence subject to normal credit criteria applicable to all other lending. The repricing on all related party transactions requires sign off by the Group Taxation Department for advice on tax consequences arising from funding or transfer pricing issues. Nedbank Group's credit risk measurement and methodology Nedbank Group's Basel III AIRB credit methodology is fully implemented across all its major credit portfolios. Under this methodology credit risk is essentially measured by two key components, namely: Expected loss (EL), which is a 12 month estimate based on the long run annual average level of credit losses through a full credit cycle based on time series data history. Unexpected loss (UL), which is the annualised volatility of EL for credit risk. Analytically, EL and UL are defined respectively as the average and one standard deviation from that average of the distribution of potential losses inherent in the group s credit portfolio. These statistically estimated losses are determined by the key Basel III AIRB credit risk parameters, namely probability of default (PD), exposure at default (EAD), loss given default (LGD) and maturity. These, together with the relevant Basel III capital formulae per asset class, culminate in the Pillar 1 minimum regulatory capital requirements for credit risk. The International Accounting Standard (IAS) 39 requirements for credit risk also form an integral part of Nedbank Group's credit risk measurement and management. Nedbank Group assesses the adequacy of impairments, in line with International Financial Reporting Standards (IFRS), on a continuous basis. Specific impairments are created in respect of defaulted advances where there is objective evidence that all amounts due will not be collected. Portfolio impairments are created in respect of performing advances based on historical evidence and trends of losses in each component of the performing portfolio. As a result of the global financial crisis in 2008 the International Accounting Standards Board (IASB) undertook a substantial review of the suite of financial instrument standards, which included the impairment portion of the standard (ie IFRS 9 Financial Instruments: Impairment chapter). The IASB is proposing to move away from the incurred loss towards an expected loss methodology of calculating impairments. The proposed 'expected loss' approach is designed to result in earlier loss recognition compared with the 'incurred loss' approach currently in IAS 39 by taking into account future credit losses expected over the life or a fixed period of time of the financial asset measured at amortised cost. The decision of whether the EL will be determined over the entire lifetime or over a fixed period will depend on the performance of the financial asset relative to the original assessment of the financial asset (based on three categories: performance not deteriorated, credit deteriorated significantly since initial recognition and those where there is objective evidence of impairment). The latest proposals are that the recognition Nedbank Group Limited and Nedbank Limited Pillar 3 June

66 of these losses should be recognised in the impairment line with no impact on interest income. However, for financial assets where there is objective evidence of impairment, interest revenue will be based on the net recoverable amount. The proposals discussed above refer to the exposure draft issued by the IASB on 5 March 2013 (ED/2013/3 Financial Instruments: Expected Credit Losses). The comment period for the exposure draft closed on 5 July 2013 and the IASB has now entered a period of re deliberations where they will debate the merit of the comments received. At the time of writing this report, the effective date of IFRS 9 has been deferred from 1 January 2015 to an as yet undefined date. The IASB will announce an effective date only after the impairment and classification and measurement phases of IFRS 9 have been finalised. Furthermore, it remains unknown as to when the final requirements of the chapter of IFRS 9 pertaining to impairments will be finalised. The generic methodological differences between EL estimation, IAS 39 and IFRS 9 impairment are summarised in the table below: Key parameters PDs Intention of estimate Period of measurement LGDs Basel III IAS 39 IFRS 9 Average estimate of default within next 12 months. Long run historical average over whole economic cycle TTC. Best estimate of likelihood and timing of credit losses over the life of loan. Should reflect current economic conditions pointin time (PIT). Best estimate of likelihood and timing of credit losses over the full life of all financial assets or a fixed period depending on performance of the asset (including fully performing loans). Reflects current and future economic cycles to the extent relevant to the remaining life of the loan. Intention of estimate Average estimate of the discounted value of postdefault recoveries. Conservative estimate of the discounted value of postdefault recoveries. Conservative estimate of the discounted value of postdefault recoveries. Treatment of collection costs Recoveries net of direct and indirect collection costs. Recoveries net of direct cash collection costs only. Recoveries net of direct cash collection costs only. Discount rate Recoveries discounted using entity's cost of capital. Cashflows discounted using instrument's original effective interest rate. Cashflows are discounted at a discount rate which approximates the original effective interest rate. This discount rate is not changed because of impairment. Period of measurement Reflects period of high credit losses. Should reflect current economic conditions PIT. Reflects current and future economic cycles to the extent relevant to the remaining life of the loan. Length of relevant cycles is dependent on the relevant performance of the asset. Downturn LGDs required. EL Basis of exposure Based on EAD, which includes unutilised and contingent facilities. Based on actual exposure (on and off balance sheet). Based on the contractual outstanding balance at balance sheet date and expected cash flows on the outstanding balance. As shown in the table above, IAS 39 impairments are determined using PIT metrics, which are used to estimate the default expectations under the current economic cycle, whereas TTC metrics reflect a one year forward estimate based on a long term average through an economic cycle and are used for the group's regulatory and economic capital calculations. Basel III also requires banks to base their LGD estimates for regulatory capital requirements on a downturn scenario (ie downturn LGD), rather than an average TTC loss estimate. Downturn LGD thus represents what could be expected in downturn economic conditions in the trough of an economic cycle. EL is a forward looking measure, on a TTC basis (ie the long run average) of the statistically estimated credit losses on the performing portfolios for the forthcoming 12 months. For Nedbank Group's active portfolio, the portfolio impairments estimated using the PIT methodology are based on emergence periods of 12 months or less. Specific impairments are estimated for the defaulted portfolio and added to portfolio impairments, which then constitute the total impairments for the credit portfolio. In the case of the defaulted portfolio a best estimate of expected loss (BEEL) is calculated, which is in line with the specific impairment for that exposure. The BEEL or specific impairment takes the current economic and business conditions into account as well as the counterparty's current circumstances and condition of the collateral/mitigants and determine the PIT BEEL estimate. The downturn LGD (dlgd) estimation for the defaulted exposure is updated and compared with the BEEL. Normally no capital is held for defaulted exposures due to the specific impairment that should fully provide for any possible losses. If the dlgd exceeds BEEL, it is considered an unexpected loss and the difference is then the required capital for the defaulted portfolio. Nedbank Group Limited and Nedbank Limited Pillar 3 June

67 Nedbank's master credit rating scale Nedbank uses two master rating scales for measuring credit risk. The first measures borrower risk without the effect of collateral and any credit risk mitigation (ie PD only), while the second measures transaction risk (ie EL), which incorporates the effect of collateral, any other credit risk mitigation and recovery rates. All credit applications are required to carry the borrower PD rating [from the Nedbank Group Rating (NGR) master rating scale], estimate of LGD and overall transaction rating [from the Nedbank Group Transaction Rating (NTR) master rating scale]. NEDBANK'S PD MASTER RATING SCALE (NGR RATINGS) INTERNATIONAL SCALE Rating category Rating grade Geometric mean (%) PD band (%) Lower bound Upper bound (PD >) (PD ) Mapping to Standard and Poor s grades Performing NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 0,010 0,014 0,020 0,028 0,040 0,057 0,080 0,113 0,160 0,226 0,320 0,453 0,640 0,905 1,280 1,810 2,560 3,620 5,120 7,241 10,240 14,482 20,480 28,963 40,960 0,000 0,012 0,017 0,024 0,034 0,048 0,067 0,095 0,135 0,190 0,269 0,381 0,538 0,761 1,076 1,522 2,153 3,044 4,305 6,089 8,611 12,177 17,222 24,355 34,443 0,012 0,017 0,024 0,034 0,048 0,067 0,095 0,135 0,190 0,269 0,381 0,538 0,761 1,076 1,522 2,153 3,044 4,305 6,089 8,611 12,177 17,222 24,355 34,443 99,999 AAA AA+ AA AA A+ A+ to A A to A A to BBB+ BBB+ BBB+ to BBB BBB to BBB BBB BBB to BB+ BB+ to BB BB BB to BB BB to B+ B+ B+ to B B to B B to B B to CCC CCC CCC to C CCC to C Non performing (defaulted) NP 1 NP 2 NP D D D The comprehensive PD rating scale, which is mapped to default probabilities and external rating agency rating scales, enables the bank to rate all borrowers on a single scale, whether they are low risk corporate or high risk retail borrowers. The principle benefit thereof is that comparisons can be made between the riskiness of borrowers making up various portfolios. A brief explanation of the scale follows. NGR01 to NGR20 reflect a profile of credit risk starting with very low risk borrowers with a PD as low as 0,01%, to risky borrowers with a default probability as high as 8,6%. NGR21 to NGR25 represent very high risk borrowers with default probabilities greater than 8,6%. While many banks would generally not knowingly expose themselves to this degree of risk, these rating grades exist for four reasons: Being in an emerging market, there are times when local banks would be willing to take on this level of risk, while pricing appropriately. There may be times when the consequences of not lending may be more severe than lending for example, in the case of a marginal going concern with existing loans but a strong business plan. They cater for borrowers that were healthy but have migrated down the rating scale to the point of being near default. From time to time the bank may grant facilities to very risky borrowers on the basis of significant collateral offered. This particular rating scale measures only the likelihood of the borrower defaulting and does not recognise that a very high level of default risk may well have been successfully mitigated with collateral. The final rating categories represent those borrowers that have defaulted. NP1 applies to recent defaults, NP2 represents those accounts in respect of which the bank is proceeding to legal recovery of moneys owing and NP3 is for long term legal cases, exceeding a period of 12 months. Nedbank Group Limited and Nedbank Limited Pillar 3 June

68 Basel III specifically requires that AIRB banks maintain two ratings, one measuring the probability of the borrower defaulting and the second considering facility characteristics. The NTR table below reflects EL as a percentage of EAD and contains 10 rating bands the first three bands representing facilities of low risk, the next three bands being for facilities of average risk and the final four bands indicating facilities of high or very high risk. NEDBANK GROUP'S EXPECTED LOSS TRANSACTION RATING SCALE (NTR) EL as a % of EAD Rating class NTR01 NTR02 NTR03 NTR04 NTR05 NTR06 NTR07 NTR08 NTR09 NTR10 Lower bound (EL >) 0,00 0,05 0,10 0,20 0,40 0,80 1,60 3,20 6,40 12,80 Upper bound (EL ) 0,05 0,10 0,20 0,40 0,80 1,60 3,20 6,40 12,80 100,00 The NTR scale measures the total or overall credit risk (ie EL) in individual exposures, thereby allowing credit officers to consider the mitigating effect of collateral, other credit risk mitigation and recovery rates on borrower risk. This reflects the true or complete measurement of credit risk, incorporating not only PD, but importantly, also LGD. Credit risk reporting across the group is, to a large extent, based on the twin rating scales discussed above. Business units report on the distribution of their credit exposures across the various rating scales and explain any changes in such distribution, including the migration of exposures between rating grades and underlying reasons therefore. The development of credit rating models The three measures of risk that are used in an internal credit rating system are as follows: Probability of default (PD) PD measures the likelihood of a client defaulting on credit obligations within the next 12 months (as per Basel III). Exposure at default (EAD) EAD quantifies the expected exposure on a particular facility at the time of default. EAD risk measures consider the likelihood that a client would draw down against available facilities in the period leading up to default and are based on Nedbank Group s historical default experience in respect of similar clients and facilities. Loss given default (LGD) LGD is a measure of the economic loss the group expects to incur on a particular facility should the client default. LGD risk measures are based on Nedbank Group s historical recovery experience in respect of similar clients and facilities and consider the likelihood of cure, restructure and liquidation outcomes of defaults as well as type, quality, level and value of collateral held. Basel III requires that banks use downturn loss given default (dlgd) estimates in regulatory capital calculations, citing the fact that the PD and LGD correlations are not captured. dlgd is a measure defined as the losses occurring during economic 'downturn' conditions. LGD estimates are adjusted to those applicable during a downturn to meet regulatory requirements. Own estimates for dlgd are utilised for portfolios that have sufficient downturn period defaults and recovery data. For portfolios where there is a lack of downturn period defaults and recovery data, Nedbank Group utilises the scaling factor developed by the US Federal Reserve Board of Governors to convert cycle neutral LGD estimates to those applicable to downturn conditions. The conservatism of dlgd estimates is assessed with the annual model validations. The Basel III Pillar 1 models that are used to develop the key measures of PD, EAD and LGD form the cornerstone of Nedbank's internal rating and economic capital systems. Each business cluster has developed a team of specialist quantitative analysts who are responsible for creating and maintaining the PD, LGD and EAD models. A team of suitably qualified individuals within GCRM, namely the CMVU, is responsible for the independent validation of all models, while Nedbank's Internal Audit Division performs risk based audits. Nedbank Group Limited and Nedbank Limited Pillar 3 June

69 Nedbank makes use of a range of modelling approaches, as illustrated in the following diagram: MODEL TYPE An overview of the rating approaches adopted across the various asset classes is as follows: NATURE OF RATING SYSTEM Whenever possible, models are calibrated to long term default rates, thus ensuring that capital estimates meet regulatory requirements. Where suitably robust loss rates are not available, for example in the case of low default portfolios, external data sources such as external ratings are included to ensure appropriate calibration. Nedbank Group Limited and Nedbank Limited Pillar 3 June

70 The risk estimates generated from Nedbank's internal models are used across the credit process in running the business, as summarised in the following diagram: OVERVIEW OF NEDBANK S USE OF ITS ADVANCED INTERNAL RATINGS BASED APPROACH CREDIT SYSTEM Group credit policy not only incorporates the minimum requirements stipulated in the revised SA banking regulations, but also documents Nedbank Group's aspiration to best practice credit risk management. This policy is implemented across the group with detailed and documented policies and procedures, suitably adapted for use by the various business units. The policy forms the cornerstone for sound credit risk management as it provides a firm framework for credit granting as well as the subsequent monitoring of credit risk exposures. Credit risk approaches across the group During the second half of 2012 Nedbank received approval from the SARB to use the AIRB approach for the MFC portfolio from the legacy Imperial Bank book. The remaining portion of the legacy Imperial Bank (ie in Property Finance and Nedbank Business Banking), Nedbank Private Wealth (UK) and the non SA Nedbank African subsidiaries credit portfolios remain on TSA. This has resulted in 94% of the total credit extended by Nedbank Group being covered by the Basel III AIRB approach. The use of internal rating models within Nedbank subsidiaries is encouraged as it is anticipated that a number of them will migrate to the Internal Ratings based Approach once they have developed the data history required to adopt the approach for the estimation of regulatory capital. For the purpose of estimating internal economic capital, and for use in ICAAP, conservative AIRB credit benchmarks are applied for all the subsidiaries that are utilising The Standardised Approach (TSA). Nedbank Group Limited and Nedbank Limited Pillar 3 June

71 Roadmap of Nedbank's credit rating systems The following diagrams provide an overview of the group's credit risk profile by business line and major Basel III asset class at 30 June The distribution of retail exposures that are measured by way of the AIRB approach is reflected in the following diagram. Basel III AIRB credit exposure is reported on the basis of EAD. RETAIL AIRB RATING SYSTEM Rm (EAD basis at 30 June 2013) NEDBANK RETAIL CLUSTER (33,40%) (34,57%) NEDBANK WEALTH (2,90%) (2,91%) Shared services Secured lending Relationship banking Consumer banking Card 614 (0,27%) (67,69%) (14,79%) (10,71%) (6,54%) 665 (0,30%) (67,54%) (14,89%) (11,12%) (6,16%) Corporate Retail other Retail other Retail other Retail other 233 (37,95%) (38,54%) (4,61%) (89,55%) 120 (< 1%) (9,34%) 529 (2,68%) 286 (43,01%) (37,04%) (4,93%) (89,67%) 104 (< 1%) (9,02%) 520 (2,75%) Securitisation exposure 380 (61,89%) (59,14%) (78,61%) 1 (< 1%) (92,26%) 831 (4,20%) (5,57%) 377 (56,69%) (60,97%) (77,29%) 1 (< 1%) (92,62%) 799 (4,22%) (5,92%) SME retail Retail mortgages Retail mortgages Corporate SME retail Retail revolving credit Retail revolving credit Retail revolving credit Corporate Specialised lending IPRE Retail other Retail mortgages Retail revolving credit SME retail SME corporate 1 (< 1%) (2,31%) (5,37%) (10,29%) 210 (1,41%) (73,69%) 894 (4,52%) 2 (< 1%) (1,99%) (5,59%) (10,17%) 183 (1,32%) (73,37%) 894 (4,72%) SME retail SME retail SME retail Corporate (11,40%) 38 (< 1%) 820 (5,52%) 1 (< 1%) (12,19%) 39 (< 1%) 737 (5,31%) 2 (< 1%) Key: June 2013 December 2012 Business lines Basel III asset class Nedbank Group Limited and Nedbank Limited Pillar 3 June

72 The distribution of wholesale exposures that are measured by way of the AIRB approach is similarly reflected in the following diagram on the basis of EAD. WHOLESALE AIRB RATING SYSTEM Rm (EAD basis as at 30 June 2013) NEDBANK CORPORATE BUSINESS BANKING CAPITAL (30,23%) (11,81%) (11,88%) (30,72%) (11,74%) (10,77%) LONDON CENTRAL MANAGEMENT (5,49%) (4,29%) (4,77%) (4,52%) Other 1 Corporate Banking Property Finance (0,63%) (57,96%) (41,40%) (0,70%) (57,96%) (41,34%) Banks Corporate Banks Corporate Corporate SME corporate SME corporate Corporate Banks Specialised lending project finance Banks Corporate 849 (65,21%) 286 (21,97%) 34 (< 1%) (82,91%) (26,42%) (7,64%) (29,89%) (16,60%) (31,33%) (7,05%) (23,83%) 664 (2,27%) 418 (29,99%) 858 (61,55%) 61 (< 1%) (81,58%) (23,26%) (5,65%) (29,17%) (16,46%) (23,95%) (6,12%) (28,23%) Securities Firms Local government and municipalities Public sector entities Specialised lending HVCRE Specialised lending IPRE Local government and municipalities Public sector entities Public sector entities Specialised lending IPRE Public sector entities Sovereign 167 (12,83%) (6,73%) (8,37%) (6,05%) (57,60%) (1,61%) 221 (< 1%) (5,98%) 1 (< 1%) 246 (< 1%) (87,12%) 118 (8,46%) (6,25%) (10,58%) (6,83%) (62,41%) (1,58%) 176 (< 1%) (9,06%) 2 (< 1%) 513 (1,65%) (91,20%) SME retail SME corporate Banks Public sector entities Retail other Retail mortgages SME corporate Local government and municipalities Sovereign Banks 26 (< 1%) (1,94%) 416 (< 1%) (1,39%) 505 (< 1%) (9,54%) 688 (< 1%) 281 (< 1%) 710 (1,90%) (10,61%) 18 (< 1%) (1,52%) 255 (< 1%) (1,47%) 518 (< 1%) (9,73%) 527 (< 1%) 321 (< 1%) 386 (1,24%) (8,80%) Securitisation Sovereign Specialised lending IPRE SME retail Specialised lending commodities finance Securities firms Corporate 312 (< 1%) 35 (< 1%) (4,98%) (36,47%) 78 (< 1%) (73,61%) 36 (< 1%) (4,85%) (37,30%) 154 (< 1%) 21 (< 1%) (68,87%) Banks Corporate SME retail SME retail 4 (< 1%) (29,14%) 109 (< 1%) 1 (< 1%) 3 (< 1%) (33,19%) 51 (< 1%) 3 (< 1%) Securitation Sovereign (8,53%) (16,54%) (8,38%) (17,75%) Key: June 2013 December 2012 Business lines Basel III asset class 1 Includes Nedbank Corporate Shared Services and Transactional Banking units. Nedbank Group Limited and Nedbank Limited Pillar 3 June

73 The distribution of exposures, based on total credit extended, across the various subsidiaries that are utilising TSA is reflected in the diagram below. STANDARDISED RATING SYSTEM AND NON REGULATED ENTITIES Rm (total credit extended 1 basis at 30 June 2013) NON REGULATED ENTITIES TOTAL STANDARDISED APPROACH (5,80%) (5,85%) NEDBANK CENTRAL NEDBANK PRIVATE LIMITED 4 MANAGEMENT 2 WEALTH (22,87%) (44,31%) (32,81%) (27,96%) (41,41%) (30,63%) Retail mortgages Corporate Retail other Banks Corporate Sovereign Banks Retail other Retail mortgages (35,13%) 11 (< 1%) 250 (2,61%) (16,88%) (36,12%) (10,32%) (61,75%) (10,46%) (26,32%) (31,43%) 17 (< 1%) 367 (3,24%) (16,49%) (41,32%) (9,67%) (62,03%) (11,51%) (25,01%) SME retail SME corporate Local government Public sector Local government Retail other and municipalities entities and municipalities Sovereign Corporate 223 (2,33%) (59,80%) 153 (< 1%) (10,39%) 108 (< 1%) 202 (1,47%) 338 (2,98%) (62,19%) 1 (< 1%) 148 (< 1%) (6,65%) 62 (< 1%) 180 (1,45%) 1 (< 1%) Banks SME corporate Retail revolving credit Retail mortgages 2 (< 1%) 90 (< 1%) 690 (3,72%) (20,68%) 59 (< 1%) 553 (3,30%) (20,96%) 1 Total credit extended includes on balance sheet, off balance sheet (includes unutilised facilities), repurchase and resale agreements, and derivative exposure. 2 Includes Namibia, Swaziland, Lesotho, Malawi and Zimbabwe, which are on the Standardised Approach. 3 Includes the Isle of Man and Jersey. 4 The remaining portion of the legacy Imperial Bank book (ie in Property Finance and Nedbank Business Banking). Key: June 2013 December 2012 Business lines Basel III asset class Nedbank Group Limited and Nedbank Limited Pillar 3 June

74 Loans and advances Globally economic conditions in most developed markets improved during the first half of 2013, with the exception of the Eurozone. Emerging market economies continued to post moderate but slower growth, with currencies and international commodity prices experiencing pressure following the US Federal Reserve s announcement on likely future monetary policy changes. At the same time South Africa s economic growth deteriorated as weakness in production and exports persisted, leading to first quarter GDP growth of just 0,9%. Domestic financial markets were characterised by volatility and rand depreciation, reflecting lower levels of investor confidence primarily as a result of the current account and fiscal deficits, slow growth and ongoing labour tensions mainly in the mining sector. Both household credit and corporate credit demand remained subdued. Consumer stress has become increasingly evident with pressure from increased living costs and weak job prospects. In the corporate environment companies continued to postpone capacity expansion, given fragile global economies and lower growth prospects. On the upside the recovery in government s capital expenditure continued, with the bulk of the increase in expenditure devoted to housing and other social infrastructure. Net loans and advances grew 11,5% (annualised) to R557,3bn (December 2012: R527,2bn), underpinned by advances growth in wholesale banking of 16,6% (annualised). Growth in the trading advances book came largely from foreign currency placements and deposits placed under reverse repurchase agreements related to the hedging of the group s liquid asset portfolio. Excluding trading advances, which exhibited strong growth of 50,8%, net banking book advances grew by 9,2% (annualised). Nedbank Capital s net banking advances growth of 27,4% (annualised) was boosted by good drawdowns of the deal pipeline. In Nedbank Corporate, Corporate Banking recorded favourable growth in term loans of 13,4% (annualised), whereas commercial mortgages decreased 1,8% (annualised) as a result of higher levels of early settlements. Good momentum in quality client gains led to the increase in Nedbank Business Banking s net advances growth of 8,4% (annualised). Retail banking net advances grew by a modest 2,5% (annualised), reflecting the difficult consumer environment, selective origination in higher risk asset categories in line with the group s portfolio tilt strategy, rolloff of the backbook and early repayments. Growth arose from Card and MFC increasing advances 19,4% and 10,7% respectively, while personal loans and home loans advances declined 5,8% and 1,9% respectively, in line with the planned slowdown in both advances categories. The strategy of selective origination of home loans has continued. As a result thereof, together with the backbook runoff, this book continued to shrink, in line with the portfolio tilt strategy. At June 2013 home loans comprised 23,9% of the total Nedbank Group lending book, down from 26,2% in June 2012 and 31,5% in December 2009 when the portfolio tilt strategy was first implemented. The credit policy for personal loans has been tightened and collection efforts intensified. New business volumes have slowed materially and the book size has decreased slightly year to date. Application numbers have increased, but approval rates have declined from 58,7% to 36,4%. Personal loans represent only 3,9% of the overall group advances book, down from 4,3% in December 2012 and 4,0% at June Growth in advances at the centre was led by increased business activity in the Rest of Africa, consistent with the group s focus on deepening its Pan African banking relationships and expanding its presence in Africa. Total group defaulted advances decreased year on year to R20 176m (June 2012: R21 838m) from ongoing improvements in the residentialand commercial mortgage books. Defaulted advances were up 9,4% (annualised) on the 2012 year end (December 2012: R19 273m) from increases in personal loans and the wholesale businesses. Continued consumer stress, further proactive strengthening of balance sheet impairments in Personal Loans and a client specifc charge in Business Banking led to an increase in impairments to R3 325m (June 2012: R2 702m) and the credit loss ratio (CLR) to 1,31% (June 2012: 1,11%). The CLR is comprised of a specific charge of 1,24% and a portfolio charge of 0,07% (June 2012: specific: 1,00% and portfolio: 0,11%). The coverage ratio for total and specific impairments increased to 58,8% (June 2012: 52,9%) and 40,9% (June 2012: 39,0%) respectively. Portfolio coverage on the performing book continued to strengthen to 0,7% (June 2012: 0,6%). Nedbank Group Limited and Nedbank Limited Pillar 3 June

75 Rm SUMMARY OF LOANS AND ADVANCES BY BUSINESS CLUSTER Gross Total impairments Mix % Net Mix % June 2013 Nedbank Capital (427) Trading book Banking book (427) Nedbank Corporate (1 041) Total Nedbank RBB (9 971) Nedbank Business Banking (1 521) Nedbank Retail (8 450) Nedbank Wealth (135) Central Management including Rest of Africa (285) Total (11 859) June Nedbank Capital (595) Trading book Banking book (595) Nedbank Corporate (1 195) Total Nedbank RBB (9 316) Nedbank Business Banking (1 515) Nedbank Retail (7 801) Nedbank Wealth (135) Central Management including Rest of Africa (304) Total (11 545) December 2012 Nedbank Capital (419) Trading book Banking book (419) Nedbank Corporate (896) Total Nedbank RBB (9 141) Nedbank Business Banking (1 260) Nedbank Retail (7 881) Nedbank Wealth (112) Central Management including Rest of Africa (302) Total (10 870) RBB = Retail and Business Banking. 2 Clients indebtedness for acceptances and liabilities for acceptances have been reclassified as loans and advances and amounts owed to depositors respectively in order to achieve improved comparability with the majority of the group s SA banking peers. These items were previously separately disclosed in the group s statement of financial position. Nedbank Group Limited and Nedbank Limited Pillar 3 June

76 SUMMARY OF GROSS LOANS AND ADVANCES BY MAJOR BUSINESS LINE Rm % change Jun 2013 Jun Dec 2012 Nedbank Capital 35, Nedbank Corporate 8, Corporate Banking 19, Property Finance (1,0) Other (36,2) Nedbank RBB 4, Nedbank Business Banking 9, Nedbank Retail 3, MFC 13, Home Loans 1 (3,5) Card 20, Personal Loans (5,8) Relationship Banking 2 2, Other (13,9) Nedbank Wealth 23, Central Management including Rest of Africa 34, Nedbank Group 11, Home Loans represents a specific business unit within Nedbank Retail. This excludes home loans in the Nedbank Retail Relationship Banking business unit. 2 Nedbank Retail Relationship Banking includes Small Business Services and Personal Relationship Banking. 3 Clients indebtedness for acceptances and liabilities for acceptances have been reclassified as loans and advances and amounts owed to depositors respectively in order to achieve improved comparability with the majority of the group s SA banking peers. These items were previously separately disclosed in the group s statement of financial position. Rm SUMMARY OF LOANS AND ADVANCES BY PRODUCT Jun 2013 Jun Dec 2012 % change Rm Mix % Rm Mix % Rm Mix % Home loans (0,4) , , ,3 Commercial mortgages 1, , , ,2 Leases and instalment sales 10, , , ,1 Card 19, , , ,9 Overdrafts 14, , , ,5 Properties in possession 18, , , ,1 Term loans 12, , , ,5 Personal loans (4,9) , , ,3 Other term loans 19, , , ,2 Overnight loans 25, , , ,4 Other loans to clients 57, , , ,6 Preference shares and debentures 15, , , ,1 Factoring accounts 26, , , ,8 Deposits placed under reverse repurchase agreements 3, , , ,5 Trade, other bills and bankers acceptances > (100,0) 9 < 0,1 12 < 0,1 28 < 0,1 Gross loans and advances 11, , , ,0 Total impairments 18,3 (11 859) (11 545) (10 870) Net loans and advances 11, Clients indebtedness for acceptances and liabilities for acceptances have been reclassified as loans and advances and amounts owed to depositors respectively in order to achieve improved comparability with the majority of the group s SA banking peers. These items were previously separately disclosed in the group s statement of financial position. Nedbank Group Limited and Nedbank Limited Pillar 3 June

77 Balance sheet credit exposure analysis RECONCILIATION OF GROSS LOANS AND ADVANCES TO SUMMARISED BASEL III BALANCE SHEET EXPOSURE 2, BY BUSINESS CLUSTER AND ASSET CLASS Rm Nedbank Capital 1 Nedbank Corporate 1 Total Nedbank RBB Nedbank Business Banking Nedbank Retail Nedbank Wealth Central Management including Rest of Africa Total Jun 2013 Mix (%) Risk weighting Change 6 (%) Total Jun Mix (%) Total Dec 2012 Mix (%) Advanced Internal Ratings based (AIRB) Approach ,0 39,1 9, , ,5 Corporate ,8 38,3 17, , ,2 Specialised Lending High Volatility Commercial Real Estate (HVCRE) ,7 > 100 (7,6) , ,8 Specialised Lending Income Producing Real Estate (IPRE) ,7 44,9 (4,4) , ,3 Specialised Lending Commodity finance < (100) 439 0,1 150 < 0,1 Specialised Lending Project finance ,8 53,2 63, , ,6 SME Corporate ,7 49,8 24, , ,5 Public Sector Entities ,2 3,6 (20,6) , ,6 Local Governments and Municipalities ,4 12,0 14, , ,4 Sovereign ,7 2,3 2, , ,9 Banks ,9 31,3 40, , ,8 Securities firms ,2 21,9 > , ,1 Retail Mortgage ,1 30,0 (1,2) , ,2 Retail Revolving Credit ,7 55,6 14, , ,7 Retail Other ,5 63,8 5, , ,8 SME Retail ,4 43,8 9, , ,4 Securitisation Exposure ,1 33,5 > , ,1 The Standardised Approach (TSA) ,7 58,7 13, , ,6 Corporate ,7 > 100 (15,4) , ,8 SME Corporate ,8 > 100 (38,1) , ,1 Public Sector Entities < 0,1 70,9 49,5 46 < 0,1 110 < 0,1 Local Government and Municipalities < 0,1 74,4 45,3 35 < 0,1 49 < 0,1 Sovereign ,3 80,7 35, , ,3 Banks ,7 21,4 51, , ,4 Retail Mortgage ,6 40,9 12, , ,5 Retail Revolving Credit < 0,1 > ,6 285 < 0,1 Retail Other ,5 63,7 72, , ,4 SME Retail < 0,1 64,6 (68,6) , ,1 Properties in possession ,1 18, , ,1 Non regulated entities ,2 28, , ,7 Total Basel III balance sheet exposure ,0 11, , ,0 Less assets included in Basel III asset classes (46 719) (1 804) (159) (5 685) (39 335) (91 868) (89 019) (87 947) Derivatives (14 561) 2 (25) (14 584) (14 447) (15 121) Government stock and other dated securities (23 202) (4 228) (11 330) (38 760) (28 816) (33 176) Short term securities (4 286) (5 414) (15 940) (25 640) (34 769) (29 561) Call money (1 619) (46) (801) (195) (2 545) (3 328) (1 497) Deposits with monetary institutions (4 848) (1 414) (6 262) (2 214) (4 457) Remittances in transit Fair value adjustments (733) (2 261) (181) (155) (26) (3 175) (2 702) (3 278) Other assets net of fair value adjustments on assets (9) (10 527) (1 686) (2 943) (1 050) Setoff of accounts within IFRS total gross loans and advances 4 (3 611) (183) (183) (3 794) (3 424) (4 036) Total gross loans and advances Nedbank Corporate and Nedbank Capital include London branch (AIRB approach). 2 Balance sheet credit exposure includes on balance sheet, repurchase and resale agreements, and derivative exposure (refer to next page for details). 3 A portion of the legacy Imperial Bank book, excluding the MFC book that is now on the AIRB approach, Nedbank Private Wealth (UK) and the non SA banking entities in Africa, are covered by TSA. 4 Relates to the difference in the level of setoff applied under IFRS, when compared to the setoff applied to the balance sheet credit exposure under Basel III. 5 Clients indebtedness for acceptances and liabilities for acceptances have been reclassified as loans and advances and amounts owed to depositors respectively in order to achieve improved comparability with the majority of the group s SA banking peers. These items were previously separately disclosed in the group s statement of financial position. 6 Relates to June 2013 on December 2012 annualised change. Nedbank Group Limited and Nedbank Limited Pillar 3 June

78 Advanced Internal Ratings based approach for Nedbank Detailed analysis of Basel III balance sheet exposure, by business cluster and asset class During the second half of 2012 Nedbank received approval from the SARB to use the AIRB approach for the MFC portfolio from the legacy Imperial Bank book. The remaining portion of the legacy Imperial Bank (ie in Property Finance and Nedbank Business Banking), Nedbank Private Wealth (UK) and the non SA Nedbank African subsidiaries credit portfolios remain on TSA. This has resulted in 94% of the total credit extended by Nedbank Group being covered by the Basel III AIRB approach. SUMMARY OF THE COMPONENTS OF THE TOTAL BASEL III BALANCE SHEET CREDIT EXPOSURE BY BUSINESS CLUSTER AND ASSET CLASS June 2013 Rm On balance sheet exposure Off balance sheet exposure Repurchase and resale exposure Derivative exposure Total credit extended 1 Total Basel III balance sheet credit exposure 4 Exposure at default (EAD) Downturn expected loss (del) 2 BEEL 3 Nedbank Capital Corporate Specialised Lending IPRE Specialised Lending Commodity Finance Specialised Lending Project Finance SME Corporate Public Sector Entities Local Governments and Municipalities Sovereign Banks Securities Firms SME Retail Securitisation Exposure Nedbank Corporate Corporate Specialised Lending HVCRE Specialised Lending IPRE SME Corporate Public Sector Entities Local Governments and Municipalities Sovereign Securities Firms Banks SME Retail Securitisation Exposure Nedbank Business Banking Corporate Specialised Lending IPRE SME Corporate Public Sector Entities Local Governments and Municipalities Banks Retail Mortgage Retail Other SME Retail Nedbank Retail Corporate Retail Mortgage Retail Revolving Credit Retail Other SME Retail Securitisation Exposure Nedbank Wealth Corporate Specialised Lending IPRE SME Corporate Retail Mortgage Retail Revolving Credit Retail Other SME Retail Central Management including Rest of Africa Corporate Sovereign Banks Total Downturn expected loss (AIRB approach) IFRS impairment on AIRB loans and advances Excess of downturn expected loss over eligible provisions Total credit extended includes on balance sheet, off balance sheet (including unutilised facilities), repurchase and resale agreements, and derivative exposure. 2 Downturn expected loss is in relation to performing loans and advances. 3 Best estimate of expected loss (BEEL) is in relation to non performing loans and advances. 4 Balance sheet credit exposure includes on balance sheet, repurchase and resale agreements, and derivative exposure. Nedbank Group Limited and Nedbank Limited Pillar 3 June

79 SUMMARY DISTRIBUTION BY VALUE OF NEDBANK LIMITED 2 AND NEDBANK LONDON BRANCH'S AIRB KEY CREDIT RISK PARAMETERS [ANALYSIS BASED ON THE TOTAL BOOK, IE PERFORMING AND NON PERFORMING (DEFAULT) PORTFOLIOS] PD bands Exposure (EAD) EAD weighted average PD EAD weighted average dlgd del EAD weighted average risk weight June 2013 Rm % % % % NGR ,01 12,91 < 0,01 2 NGR ,03 12,00 < 0,01 3 NGR ,02 19,78 < 0,01 6 NGR ,03 31,80 0,01 9 NGR ,04 23,17 0,01 10 NGR ,06 19,88 0,01 7 NGR ,08 31,95 0,03 18 NGR ,11 24,97 0,03 13 NGR ,16 29,99 0,05 19 NGR ,23 19,90 0,04 14 NGR ,32 23,51 0,08 23 NGR ,45 26,64 0,12 38 NGR ,64 27,00 0,17 41 NGR ,91 22,02 0,20 33 NGR ,28 18,98 0,24 31 NGR ,81 23,53 0,43 42 NGR ,56 35,21 0,90 60 NGR ,62 32,48 1,18 55 NGR ,12 30,82 1,58 59 NGR ,24 32,37 2,34 71 NGR ,24 31,36 3,21 82 NGR ,48 43,58 6, NGR ,48 40,06 8,20 98 NGR ,96 34,33 9, NGR ,96 32,51 13, DEFAULT ,00 32,92 31,83 37 Sub total ,40 25,06 1,39 32 Slotting exposure Securitisation Total EAD Intercompany balances EAD net of intercompany Supervisory slotting and securitisation exposures are not reported by NGR band in the BA200 return. 2 Nedbank Limited refers to the SA reporting entity in terms of Regulation 38 (BA700) of the SA banking regulations. Results include London branch. Nedbank Group Limited and Nedbank Limited Pillar 3 June

80 ANALYSIS OF PORTFOLIOS WHOLESALE (AS AT JUNE 2013) Corporate 1 SME Corporate Public Sector Entities Local Government and Municipalities Average PD EL EAD del dlgd Exposure weighted average risk weight EL EAD del dlgd Exposure weighted average risk weight EL EAD del dlgd Exposure weighted average risk weight EL EAD del dlgd Exposure weighted average risk weight Risk Grade % Rm Rm % % % Rm Rm % % % Rm Rm % % % Rm Rm % % % Performing 1 0,00 < < 0,01 13,74 3,11 < 1 1 < 0,01 34,05 3,11 2 0,01 < < 0,01 11,79 2,94 < 1 < 1 < 0,01 12,60 1,16 1,16 3 0,02 < 1 < 1 < 0,01 10,76 1,82 < < 0,01 19,54 5,86 < 1 2 0,01 54,02 5,86 4 0, ,01 33,02 8,93 < < 0,01 17,20 3,67 < < 0,01 13,52 3,67 5 0, ,01 31,73 11,61 < 1 1 0,01 17,20 3,62 < ,01 13,52 3,62 6 0, ,01 19,53 7,26 < ,03 53,78 17,76 < ,01 17,12 13,59 < ,01 13,52 13,59 7 0, ,03 32,77 17,97 < ,01 13,52 8 0, ,03 27,08 15,00 < ,03 29,89 16,73 9 0, ,05 30,28 22,27 < ,08 49,73 58,13 < 1 2 0,03 17, , ,06 26,25 23,02 < ,05 20,55 23,76 < ,04 18, , ,07 22,30 25, ,10 31,23 32,16 < ,06 19, , ,12 27,07 45, ,09 20,89 25,25 < 1 3 0,09 19, , ,18 28,34 52, ,15 23,23 32, , ,18 19,35 42, ,19 20,59 34, , ,24 18,89 44, ,30 23,33 46,52 < ,25 19, , ,42 23,31 56, ,38 20,78 42,17 < 1 1 0,54 29, , ,68 26,40 73, ,63 24,77 54,27 < ,50 19, , ,80 22,12 67, ,87 24,05 58, , ,17 22,88 78, ,33 25,92 65, , ,98 27,34 90, ,69 23,33 77, , ,83 17,84 76, ,89 28,23 100, , ,76 53,56 241, ,19 15,12 62, , ,08 24,82 125,03 < 1 8 3,03 14,80 70, , ,33 25,32 136, ,61 22,81 108, , ,21 12,73 70, ,40 15,62 80,76 Default ,21 36,21 173, ,05 32,05 185, ,77 25,77 0,00 Total ,39 25,75 31, ,08 23,41 46, ,48 14,55 3, ,01 14,10 3,34 1 The Corporate asset class includes Corporate and Specialised Lending asset classes. Nedbank Group Limited and Nedbank Limited Pillar 3 June

81 ANALYSIS OF PORTFOLIOS WHOLESALE (AS AT JUNE 2013) CONTINUED Sovereigns Banks Securities Firms Average PD EL EAD del dlgd Exposure weighted average risk weight EL EAD del dlgd Exposure weighted average risk weight EL EAD del dlgd Exposure weighted average risk weight Risk Grade % Rm Rm % % % Rm Rm % % % Rm Rm % % % Performing 1 < < 0,01 12,60 1,72 < < 0,01 14,75 3,07 2 < < 0,01 12,60 4,91 3 0,02 < ,01 25,28 10,11 4 0,03 < ,01 30,25 23,15 5 0,04 < ,02 57,73 12, ,01 20,63 10,19 6 0, ,01 20,47 6,26 < ,01 22,99 0,00 7 0,08 < ,03 33,09 19,02 8 0,11 < ,03 27,70 15,34 < ,04 34,69 15,69 9 0,16 < ,04 25,75 20, , ,10 44,32 41, ,32 < ,16 51,12 58,17 < ,11 34,69 31, ,45 < ,06 12,64 28,69 < ,15 33,63 46, ,64 < 1 3 0,09 14,51 19, ,91 < 1 1 0,41 45,82 79, , ,63 49,23 112, , ,80 44,08 114, ,56 < ,32 12,60 40, ,44 56,24 131, , ,25 34,57 85, ,12 < 1 9 0,65 12,60 47,29 < ,96 57,86 167, , ,73 23,85 3, , , , ,96 16,83 57,52 301, ,96 Default ,40 49,40 529, ,82 77,82 0,09 Total ,02 12,75 2, ,12 24,11 18,43 < ,02 24,17 2,08 Nedbank Group Limited and Nedbank Limited Pillar 3 June

82 ANALYSIS OF PORTFOLIOS RETAIL (AS AT JUNE 2013) Retail Mortgage Retail Revolving Credit SME Retail Retail Other Nedbank AIRB 1 Total Average PD EL EAD del dlgd Exposure weighted average risk weight EL EAD del dlgd Exposure weighted average risk weight EL EAD del dlgd Exposure weighted average risk weight EL EAD del dlgd Exposure weighted average risk weight EL EAD del dlgd Exposure weighted average risk weight Risk Grade % Rm Rm % % % Rm Rm % % % Rm Rm % % % Rm Rm % % % Rm Rm % % % Performing < 0,01 12,91 2,10 2 0,01 < < 0,01 12,00 3,44 3 0,02 < < 0,01 19,78 6,02 4 0, ,01 31,80 9,08 5 0, ,01 23,17 10,37 6 0,06 < 1 1 0,01 9,13 3, ,01 19,88 6,76 7 0, ,03 31,95 17,86 8 0,11 < ,01 11,59 3,02 < ,07 59,37 3,96 < ,06 57,17 15,24 < ,03 28,61 7, ,03 24,97 12,66 9 0,16 < ,02 10,68 3, ,07 40,92 3,64 < ,08 48,45 16,31 < ,05 29,40 10, ,05 29,99 19, , ,03 11,96 5, ,13 56,54 6,66 < ,07 33,12 14,49 < ,04 17,54 7, ,04 19,90 14, , ,05 15,09 8, ,18 54,87 8,57 < ,12 37,85 20,44 < ,13 39,93 21, ,08 23,51 23, , ,07 14,78 10, ,26 58,31 12, ,14 30,28 20, ,17 38,13 25, ,12 26,64 37, , ,09 14,66 13, ,39 60,49 16, ,16 24,90 20, ,25 38,39 31, ,17 27,00 41, , ,11 12,63 14, ,53 58,74 20, ,26 28,18 27, ,39 43,62 42, ,20 22,02 32, , ,17 13,49 19, ,75 58,86 27, ,33 25,92 29, ,45 35,05 39, ,24 18,98 30, , ,30 16,42 30, ,13 62,38 37, ,52 28,92 36, ,72 39,67 49, ,43 23,53 41, , ,51 19,77 44, ,54 60,14 46, ,78 30,43 41, ,97 38,01 51, ,90 35,21 59, , ,62 17,20 47, ,22 61,20 59, ,11 30,71 43, ,39 38,32 54, ,18 32,48 55, , ,88 17,23 57, ,15 61,55 76, ,58 30,81 45, ,03 39,67 58, ,58 30,82 58, , ,12 15,42 60, ,37 60,33 92, ,38 32,82 50, ,27 45,20 69, ,34 32,37 70, , ,98 19,31 88, ,42 62,65 118, ,09 30,22 51, ,45 43,43 73, ,21 31,36 81, , ,34 23,07 119, ,85 61,12 138, ,05 34,85 67, ,83 47,17 91, ,31 43,58 102, , ,94 14,38 81, ,74 62,20 164, ,78 33,11 74, ,31 40,55 91, ,20 40,06 98, , ,64 16,01 93, ,15 62,67 185, ,34 28,81 73, ,39 46,24 117, ,94 34,33 114, , ,44 18,17 100, ,74 62,84 192, ,25 32,34 85, ,03 39,14 104, ,31 32,51 114,22 Default ,37 19,91 12, ,94 61,39 0, ,99 35,07 91, ,89 43,94 5, ,83 32,92 37,19 Total ,42 15,03 28, ,20 58,47 52, ,25 30,04 38, ,15 40,17 56, ,39 25,06 31,88 1 Results shown are for Nedbank Limited, which refers to the SA reporting entity in terms of Regulation 38 (BA700) of the SA banking regulations, the MFC portion of the legacy Imperial Bank book, and London branch. Nedbank Group Limited and Nedbank Limited Pillar 3 June

83 NEDBANK LIMITED 1 AND NEDBANK LONDON BRANCH AIRB BASEL III ON BALANCE SHEET EXPOSURE BY RESIDUAL CONTRACTUAL MATURITY 2 June 2013 Rm Less than 1 year 1 to 5 years Greater than 5 years Total on balance sheet exposure Corporate Public Sector Entities Local Governments and Municipalities Sovereign Banks Retail exposure Retail Mortgage Retail Revolving Credit Retail Other SME Retail Securitisation Exposure Total Nedbank Limited refers to the SA reporting entity in terms of Regulation 38 (BA700) of the SA banking regulations. 2 Results include the MFC portion of the legacy Imperial Bank book and London branch. 3 Includes Corporate, SME Corporate and Specialised Lending asset classes. The Standardised Approach (TSA) for Nedbank The remaining portion of the legacy Imperial Bank (ie in Property Finance and Nedbank Business Banking), Fairbairn Private Bank (UK) and the non SA Nedbank African subsidiaries credit portfolios remain on TSA, however, the group plans to move the remaining legacy Imperial Bank Business Banking and Property Finance exposures to the AIRB approach in the near future. June 2013 Rm DETAILED ANALYSIS OF BASEL III BALANCE SHEET EXPOSURE, BY BUSINESS CLUSTER AND ASSET CLASS On balance sheet exposure Off balance sheet exposure Derivative exposure Total credit extended 1 Total Basel III Balance sheet credit exposure 2 Nedbank Corporate Corporate SME Corporate Nedbank Business Banking Corporate SME Corporate Retail Mortgage Retail Other SME Retail Nedbank Retail Corporate SME Corporate Retail Mortgage SME Retail Nedbank Wealth Sovereign Banks Retail Mortgage Retail Other Central Management including Rest of Africa Corporate SME Corporate Public Sector Entities Local Governments and Municipalities Sovereign Banks Retail Mortgage Retail Revolving Credit Retail Other Total Total credit extended includes on balance sheet, off balance sheet (includes unutilised facilities), repurchase and resale agreements, and derivative exposure. 2 Balance sheet credit exposure includes on balance sheet, repurchase and resale agreements, and derivative exposure. Nedbank Group Limited and Nedbank Limited Pillar 3 June

84 The Nedbank Limited TSA Basel III on balance sheet exposure below relates to the remaining portion of the legacy Imperial Bank (ie in Property Finance and Nedbank Business Banking). NEDBANK LIMITED 1 TSA BASEL III ON BALANCE SHEET EXPOSURE BY RESIDUAL CONTRACTUAL MATURITY June 2013 Rm Less than 1 year 1 to 5 years Greater than 5 years Total on balance sheet exposure Corporate Local Governments and Municipalities Banks 2 2 Retail exposure Retail Mortgage Retail Other SME Retail Total Nedbank Limited refers to the SA reporting entity in terms of Regulation 38 (BA700) of the SA banking regulations, and the remaining portion of the legacy Imperial Bank book (ie in Property Finance and Nedbank Business Banking). 2 Includes Corporate, SME Corporate. Credit asset quality summary analysis SUMMARY OF NEDBANK S ASSET QUALITY PROFILE % Jun 2013 Jun 2012 Dec 2012 Return on assets (improved) 1,15 1,07 1,13 Return on RoRWA 4 (improved) 2,1 2,0 2,1 Interest margin (improved) 3,58 3,54 3,53 Non performing loans to gross loans and advances (improved) 3,54 4,14 3,58 Total wholesale 1 2,13 2,43 1,99 Nedbank Retail 6,15 7,01 6,27 Home Loans 2 6,87 8,72 7,38 Personal Loans 13,38 10,62 11,74 Properties in possession (improved) 0,11 0,13 0,11 Total impairments to gross loans and advances (improved year on year) 2,08 2,20 2,02 Portfolio impairments (decreased) 0,63 0,58 0,64 Total wholesale 1 0,28 0,30 0,29 Nedbank Retail 1,21 0,95 1,13 Home Loans 2 0,74 0,65 0,68 Personal Loans 3,54 1,84 2,83 Specific impairments (improved) 1,45 1,62 1,38 Total wholesale 1 0,62 0,80 0,55 Nedbank Retail 2,98 3,04 2,84 Home Loans 2 2,15 2,54 2,24 Personal loans 8,50 6,41 6,97 Total impairments coverage ratio 3 (coverage strengthened) 58,8 52,9 56,4 Total portfolio impairments coverage ratio performing advances (stable) 0,7 0,6 0,7 Total wholesale 1 0,3 0,3 0,3 Nedbank Retail 1,3 1,0 1,2 Home Loans 2 0,8 0,7 0,7 Personal Loans 4,1 2,1 3,2 Total specific coverage ratio defaulted advances (strengthened) 40,9 39,0 38,6 Total wholesale 1 29,3 32,8 27,4 Nedbank Retail 48,5 43,4 45,2 Home Loans 2 31,2 29,1 30,3 Personal Loans 63,5 60,3 59,4 1 Wholesale includes Nedbank Capital, Nedbank Corporate and Nedbank Business Banking. 2 Home Loans as discussed here represents a specific business unit within Nedbank Retail, and excludes the Nedbank Relationship Banking and Business Banking business units. 3 Total impairments as a percentage of total defaulted advances. 4 RoRWA = Return on risk weighted assets. Nedbank Group Limited and Nedbank Limited Pillar 3 June

85 The non performing to gross loans and advances ratio decreased to 3,54% (June 2012: 4,14%), driven by ongoing improvements in the residential and commercial mortgage books, despite increased defaults experienced in the personal loans book. The total and specific impairment coverage ratio increased to 58,8% (June 2012: 52,9%) and 40,9% (June 2012: 39,0%). Both specific and portfolio coverage ratios in the Nedbank Retail portfolio increased to 1,3% and 48,5% respectively (June 2012: 1,0% and 43,4%). Total impairments to gross loans and advances decreased to 2,08% (June 2012: 2,20%), driven by both lower specific impairments and growth in advances. Wholesale specific coverage levels have decreased overall to 29,3% (June 2012: 32,8%), mainly due to the commercial lending portfolio where there were a number of partial writeoffs as well as reductions in defaulted advances in Nedbank Capital as a direct result of resolutions. Summary of impairments and credit loss ratios The tables on the following pages summarise Nedbank Group s level of impairments, CLRs and defaulted portfolio. The policies, principles and definitions relating to the defaulted portfolio and impairments are well articulated in the group s credit policy and a summary of these definitions is included in Annexure B. % SUMMARY OF KEY CREDIT RISK RATIOS Nedbank Capital Nedbank Corporate Total Nedbank RBB Nedbank Business Banking Nedbank Retail Nedbank Wealth June 2013 Impairments to gross loans and advances Total impairments 0,44 0,61 3,75 2,37 4,19 0,61 2,08 Specific impairments 0,28 0,39 2,69 1,76 2,98 0,50 1,45 Portfolio impairments 0,16 0,22 1,06 0,61 1,21 0,10 0,63 Impairments charge as a percentage of NII Credit loss ratio target range 0,10 0,55 0,20 0,35 0,55 0,75 1,50 2,20 0,20 0,40 0,60 1,00 Total CLR 0,77 0,30 2,20 1,02 2,56 0,24 1,31 Specific CLR 0,81 0,29 2,03 0,94 2,37 0,25 1,24 Portfolio CLR (0,04) 0,01 0,17 0,08 0,19 (0,01) 0,07 Defaulted advances to gross loans and advances 0,98 1,91 5,74 4,46 6,15 2,41 3,54 Properties in possession to gross loans and advances 0,20 0,10 0,02 0,13 0,09 0,11 June 2012 Impairments to gross loans and advances Total impairments 0,74 0,76 3,64 2,50 3,99 0,70 2,20 Specific impairments 0,53 0,52 2,78 1,93 3,04 0,57 1,62 Portfolio impairments 0,21 0,24 0,86 0,57 0,95 0,13 0,58 Impairments charge as a percentage of NII CLR target range 0,10 0,35 1 0,20 0,35 0,55 0,75 1,50 2,20 0,20 0,40 0,60 1,00 Total CLR 1,41 0,30 1,62 0,41 2,00 0,46 1,11 Specific CLR 1,20 0,25 1,49 0,36 1,83 0,47 1,00 Portfolio CLR 0,21 0,05 0,13 0,05 0,17 (0,01) 0,11 Defaulted advances to gross loans and advances 1,34 2,18 6,46 4,65 7,01 3,25 4,14 Properties in possession to gross loans and advances 0,15 0,16 0,03 0,20 0,12 0,13 December 2012 Impairments to gross loans and advances Total impairments 0,51 0,55 3,52 2,05 3,97 0,56 2,02 Specific impairments 0,31 0,33 2,51 1,46 2,84 0,44 1,38 Portfolio impairments 0,20 0,22 1,01 0,59 1,13 0,12 0,64 Impairments charge as a percentage of NII Credit loss ratio target range 0,10 0,55 1 0,20 0,35 0,55 0,75 1,50 2,20 0,20 0,40 0,60 1,00 Total CLR 1,06 0,24 1,62 0,34 2,01 0,61 1,05 Specific CLR 0,99 0,23 1,38 0,28 1,73 0,61 0,91 Portfolio CLR 0,07 0,01 0,24 0,06 0,28 0,14 Defaulted advances to gross loans and advances 0,94 1,69 5,79 4,23 6,27 2,78 3,58 Properties in possession to gross loans and advances 0,13 0,12 0,03 0,15 0,16 0,11 1 The Nedbank Capital target range was amended in Q Total Nedbank Group Limited and Nedbank Limited Pillar 3 June

86 RECONCILIATION OF BALANCE SHEET IMPAIRMENTS BY BUSINESS CLUSTER Rm Nedbank Capital Nedbank Corporate Total Nedbank RBB Nedbank Business Banking Nedbank Retail Nedbank Wealth Central Management Jun 2013 Change (%) Jun Dec 2012 Opening balance (11,0) Specific impairments (30,1) Specific impairments excluding discounts (18) (40,3) Specific impairments for discounted cashflow losses , Portfolio impairments , Income statement impairments charge (net of recoveries) (21) (72,7) Specific impairments (64,6) Net increase/decrease in impairments for discounted cashflow losses , Portfolio impairments (10) (1) (45) 169 < (100) Recoveries < (100) Amounts written off and other transfers (212) (119) (2 415) (67) (2 348) (2) (2 748) < (100) (3 082) (6 692) Specific impairments (215) (122) (2 415) (67) (2 348) (2) (3) (2 757) < (100) (3 078) (6 689) Portfolio impairments < (100) (4) (3) Closing balance , Specific impairments , Specific impairments excluding discounts (9) , Specific impairments for discounted cashflow losses , Portfolio impairments , Total gross loans and advances , Total average gross banking book loans and advances , Total average gross loans and advances , Clients indebtedness for acceptances and liabilities for acceptances have been reclassified as loans and advances and amounts owed to depositors respectively in order to achieve improved comparability with the majority of the group s SA banking peers. These items were previously separately disclosed in the group s statement of financial position. Continued consumer stress, led to an increase in the impairments charge to R3 325m (June 2012: R2 702m). Collections processes generated post writeoff recoveries amounting to R412m (June 2012: R428m), reflecting the prudent approach of only cash accounting the recoveries on the written off book. Personal loans recoveries amounted to R130m. Retail collections processes generated an increase of 7,4% in bad debt recoveries amounting to R375m (June 2012: R349m). Retail gross advances increased 3,0% to R201,5bn (June 2012: R195,4bn), this after R2,3bn in writedowns of defaulted advances (June 2012: R2,1bn) after all collection alternatives had been exhausted. The group retained some of its central portfolio provision set aside from unknown events that may have already occurred but which will only be evident in the future, however this was reduced from R200m to R140m with R60m transferred to Nedbank Retail for the once off in duplum related model overlay charge. Nedbank Group Limited and Nedbank Limited Pillar 3 June

87 Credit loss ratio trends NEDBANK GROUP CREDIT LOSS RATIO TREND % 2,0 1,5 1,0 0,5 0,0 1,72 1,60 (0,12) 1,59 1,52 (0,08) 1,46 1,36 1,46 1,32 0,00 0,04 1,21 1,13 1,11 1,05 1,10 1,01 1,00 0,91 0,11 0,12 0,11 0,14 1,31 1,24 0,07 Group total impairments Group specific impairments Upper bound group target (1,00%) Lower bound group target (0,6%) Group portfolio impairments (0,5) Jun 09 Dec 09 Jun 10 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12 Jun 13 BUSINESS CLUSTERS 1 TOTAL CREDIT LOSS RATIO TRENDS % 3,5 3,0 3,22 3,17 2,93 2,67 2,5 2,0 2,24 1,98 2,00 2,01 2,56 Nedbank Retail (1,50 2,20) ² ³ Nedbank Business Banking (0,55 0,75)³ 1,5 1,41 1,27 1,23 1,06 1,00,79 0,86 1,02 0,80 0,77 0,62 0,47 0,52 0,53 0,61 0,41 0,46 0,5 0,60 0,32 0,40 0,40 0,29 0,29 0,41 0,34 0,30 0,36 0,19 0,35 0,24 0,26 0,24 0,24 0,15 0,25 0,30 0,24 0,0 Jun 09 Dec 09 Jun 10 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12 Jun 13 Nedbank Capital (0,10 0,55)³ Nedbank Corporate (0,20 0,35)¹ ³ Nedbank Wealth (0,20 0,40)³ 1 Nedbank Corporate restated due to the migration of Nedbank Africa to Central Management as well as the Imperial Book integration in Nedbank Retail CLR restated due to the Imperial Bank integration in Through the cycle (TTC) target range. % RETAIL BUSINESS LINES CREDIT LOSS RATIO TRENDS 16,0 14,0 14,33 Personal Loans 12,0 10,09,52 8,63 8,0 10,29 7,65 8,98 7,58 8,23 7,74 9,94 11,02 Card MFC 6,0 5,44 5,09 3,88 4,30 4,52 3,73 4,17 3,90 4,0 2,92 3,23 2,20 2,57 2,60 2,78 1,91 2,0 2,37 1,54 2,38 1,01 1,05 1,15 2,29 2,04 2,20 1,53 1,47 1,00 1,38 1,26 0,72 0,62 0,85 0,0 0,59 0,61 Jun 09 Dec 09 Jun 10 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12 Jun 13 Home loans Retail Relationship Banking Nedbank Group Limited and Nedbank Limited Pillar 3 June

88 The Nedbank Corporate the CLR was maintained within its TTC target range, and both Nedbank Capital and Nedbank Wealth reported lower impairments. The Business Banking CLR was affected by the aforementioned client specific impairment charge and is likely to revert to the TTC target range by year end (excluding the client specific impairment charge, the Business Banking CLR was 0,43% at 30 June 2013). The deterioration in Nedbank Retail s CLR reflects consumer stress and the outcome of the more conservative impairment methodologies and early risk mitigation actions taken in Personal Loans. The table below illustrates the impact of the 2009 asset mix on the June 2013 CLR. IMPACT OF NEDBANK RETAIL ADVANCES MIX CHANGE, BUSINESS BANKING CLIENT SPECIFIC CHARGE AND PERSONAL LOANS ON THE GROUP S AND NEDBANK RETAIL S CLR Retail advances mix Credit loss ratio % Jun 2013 Dec 2012 Dec 2011 Dec 2009 Nedbank Group Nedbank Retail Nedbank Business Banking Home Loans 41,4 42,7 46,9 54,5 Actual June 2013 CLR 1,31 2,56 1,02 Vehicle Finance 29,6 28,5 26,8 21,8 Illustrative June 2013 CLR based on 2009 Retail portfolio mix Personal Loans Card 11,0 5,4 11,3 5,1 9,0 4,5 4,5 4,2 Illustrative excluding Business Banking client specific charge Other 12,6 12,4 12,8 15,0 Illustrative with Personal Loans at the top Total 100,0 100,0 100,0 100,0 end of its CLR target range 0,90 1,58 1,02 1,23 2,56 0,43 1,03 1,86 1,02 Based on the 2009 Nedbank Retail asset mix, the June 2013 Nedbank Retail CLR would have been 98bps lower at 1,58% rather than the reported 2,56%. At a Nedbank Group level this translates into a 41bps improvement to 0,90% rather than the reported 1,31%. These mix changes suggest the need to review these TTC target ranges for Retail and the group, which is anticipated to be done during the second half of Based on the effect of Personal Loans being at the upper end of its TTC target range, the Retail CLR would have been 70bps lower at 1,86%. This translates to a 28bps improvement at a group level. Adjusting for the effects of the client specific impairment charge of R182m in Business Banking, the CLR decreased to 0,43% from the reported 1,02%, a 59bps and 8bps improvement at a Business Banking and group level respectively. Defaulted loans and advances and coverage ratios The specific coverage ratio is the amount of specific impairments that have been raised for total defaulted loans and advances. This is the inverse of the expected recoveries ratio. Expected recoveries are equal to defaulted loans and advances less specific impairments, as specific impairments are raised for any shortfall that would arise after all recoveries have been taken into account. Expected recoveries of defaulted loans and advances include recoveries as a result of the liquidation of security or collateral as well as recoveries as a result of a client curing or partial client repayments. Total coverage is defined as the amount of total impairments as value of defaulted advances. The absolute value of expected recoveries on or from defaulted accounts (which includes security values) will generally increase as the number of defaults increase. The expected recovery amount will in most instances be less than the total defaulted exposure, as 100% of the defaulted loan is seldom recovered. A decrease in the coverage ratio (or increase in the expected recoveries ratio) may arise as a result of the following: Expected recoveries improving due to improved market conditions and therefore lower loss given default (LGD). Higher curing levels. A change in the defaulted product mix, with a greater percentage of products that have a higher security value and therefore a lower specific impairment, such as secured products (home loans and commercial real estate). An increase in the value of collateral that is an input into the LGD calculation and would result in a decrease in the LGD and decrease in specific impairments. A change in the mix of new versus older defaults, as in most products the recoveries expected from defaulted clients decrease over time. A change in the writeoff policy, eg if the period is extended prior to writing off a deal, there will be a longer period in which recoveries can be realised. Nedbank Group Limited and Nedbank Limited Pillar 3 June

89 Rm DEFAULTED LOANS AND ADVANCES AND SPECIFIC IMPAIRMENTS DECLINING YEAR ON YEAR Nedbank Group Nedbank Capital Nedbank Corporate Nedbank Business Banking Nedbank Retail Nedbank Wealth Defaulted loans and advances Specific impairments Defaulted loans and advances Specific impairments Defaulted loans and advances Specific impairments Central Management including Rest of Africa June 2012 December 2012 June 2013 RETAIL DEFAULTED ADVANCES (RM) AND AS A % OF BOOK 14,6% 13,4% 12,9% 10,1% 6,9% 6,9% 6,5% 6,2% 3,0% 1,5% (0,8%) RETAIL SPECIFIC COVERAGE RATIOS 100,0% 93,4% 63,0% 63,5% 56,1% 60,4% 32,9% 17,9% ,6% 35,2% 41,2% 43,4% 45,2% 48,5% Dec 09 Dec 10 Dec 11 Jun 12 Dec 12 Jun 13 Home Loans Card Personal Loans MFC Retail Retail defaulted advances Dec 09 Dec 10 Dec 11 Jun 12 Dec 12 Jun 13 Card Personal Loans MFC Home Loans Retail Total group defaulted advances decreased year on year to R20 176m (June 2012: R21 838m) from ongoing improvements in the residential and commercial mortgage books. The total and specific impairment coverage ratio increased to 58,8% (June 2012: 52,9%) and 40,9% (June 2012: 39,0%). Specific coverage levels in Nedbank Retail increased to 48,5% (June 2012: 43,4%), driven by secured/unsecured defaulted portfolio mix changes. The contribution of unsecured lending (including Personal Loans and Card) to Nedbank Retail s defaulted advances increased to 29,0% (June 2012: 22,3%), with an average specific coverage of 69,4%. Home Loans specific coverage in Nedbank Retail improved to 32,9% (June 2012: 30,4%), providing protection in the rehabilitation of defaulted advances in a subdued property market and continued high levels of consumer indebtedness. While the ratio of non performing loans to gross loans and advances for the secured home loans and vehicle finance products continued to decline, consumer stress is evident in the increases in the unsecured portfolios, with personal loans increasing to 13,4% (June 2012: 10,6%). In the personal loans portfolio specific coverage continued to strengthen to 63,5% (June 2012: 60,3%). Nedbank Group Limited and Nedbank Limited Pillar 3 June

90 June 2013 SUMMARY OF DEFAULTED LOANS AND ADVANCES, SPECIFIC IMPAIRMENTS AND SPECIFIC COVERAGE RATIO, BY BUSINESS CLUSTER Defaulted loans and advances Expected recoveries Specific impairments Specific coverage ratio (%) Total coverage ratio (%) Rm as % of total Rm Rm as % of total On defaulted loans and advances Nedbank Capital 957 4, , ,6 39,1 33,4 44,8 55,1 54,0 For discounted cashflow losses Other loans and advances 957 4, , ,6 39,1 33,4 Nedbank Corporate , , ,4 23,7 19,2 32,0 34,7 32,4 Home loans 27 0, < 0, ,6 29,4 15,9 Commercial mortgages , , ,1 23,3 17,7 Leases and instalment debtors 27 0, < 0,1 7 25,9 59,1 33,3 Properties in possession 334 1, ,8 Other loans and advances 731 3, , ,3 45,7 57,1 Nedbank Business Banking , , ,5 41,6 34,4 53,2 53,8 48,5 Home loans , , ,5 28,0 24,8 Commercial mortgages 413 2, , ,3 22,1 20,1 Leases and instalment debtors 570 2, , ,4 67,2 59,3 Card 5 < 0,1 5 0, ,0 66,7 75,0 Properties in possession 15 0,1 15 Other loans and advances 808 4, , ,2 51,7 41,4 Nedbank Retail , , ,5 43,4 45,2 68,2 56,9 63,3 Home loans , , ,4 30,4 31,9 Commercial mortgages 31 0, , ,2 55,0 44,4 Leases and instalment debtors , , ,3 61,4 58,7 Card 710 3, , ,4 99,1 98,0 Personal loans , , ,5 60,3 59,4 Properties in possession 258 1, , ,6 9,6 Other loans and advances 268 1, , ,1 91,1 87,3 Nedbank Wealth 537 2, , ,9 17,8 15,9 25,0 21,5 20,2 Home loans 387 1, ,8 (40) ,3 17,3 11,9 Commercial mortgages 107 0, , ,4 15,5 26,0 Leases and instalment debtors 6 < 0,1 3 3 < 0,1 3 50,0 60,0 83,3 Properties in possession 20 0, < 0,1 3 15,0 4,3 3,2 Other loans and advances 17 0, < 0,1 3 17,6 66,7 57,1 Central Management including Rest of Africa , ,8 (9) 73 39,0 26,0 30,5 Home loans 58 0, , ,1 26,8 24,5 Commercial mortgages 1 < 0,1 1 (5) 5 Leases and instalment debtors 27 0, , ,6 34,5 55,6 Card 3 < 0,1 3 < 0,1 3 Personal loans 20 0, ,1 (2) 14 60,0 61,1 44,4 Other loans and advances 68 0, ,2 (3) 23 36,8 13,3 19,6 Group , , ,9 39,0 38,6 58,8 52,9 56,4 Home loans , , ,6 29,5 29,9 Commercial mortgages , , ,5 23,1 18,6 Leases and instalment debtors , , ,9 62,5 58,8 Card 718 3, , ,5 99,0 97,9 Personal loans , , ,5 60,3 59,3 Properties in possession 627 3, ,5 38 6,1 6,0 0,2 Other loans and advances , , ,9 49,6 45,7 December 2012 Group , , Home loans , , Commercial mortgages , , Leases and instalment debtors , , Card 618 3, , Personal loans , , Properties in possession 574 3, < 0,1 1 Other loans and advances , , Total coverage excluded for Central Management including Rest of Africa, due to R140m central provisions set aside for unknown events that may have already occurred, but which will only be evident in the future. Jun 2013 Jun 2012 Dec 2012 Jun 2013 Jun 2012 Dec 2012 Nedbank Group Limited and Nedbank Limited Pillar 3 June

91 DEFAULTED LOANS AND ADVANCES, BY BUSINESS CLUSTER AND BASEL III AIRB ASSET CLASS Rm Nedbank Capital Nedbank Corporate Total Nedbank RBB Nedbank Business Banking Nedbank Retail Nedbank Wealth Central Management 1 Jun 2013 Jun 2012 Dec 2012 AIRB approach Corporate Specialised Lending HVCRE Specialised Lending IPRE Specialised Lending PF SME Corporate Bank Sovereign Retail Mortgage Retail Revolving Credit Retail Other SME Retail TSA Corporate SME Corporate Retail Mortgage Retail Other SME Retail Other regulated entities Properties in possession Non regulated entities (2) Total defaulted loans and advances Central Management including Rest of Africa. PF = Project Finance. PROPERTIES IN POSSESSION (PiPs) Rm Nedbank Capital Nedbank Corporate Total Nedbank RBB Nedbank Business Banking Nedbank Retail Nedbank Wealth Central Management Total Nedbank Group Jun 2013 Jun 2012 Dec 2012 Opening balance Disposal/Writedowns/ Revaluations (37) (141) (1) (140) (11) (189) (72) (391) PiPs acquired Closing balance Unsold Sold awaiting transfer There has been a sustained decrease in PiPs to R627m (June 2012: R664m), with a decrease of R48m in Nedbank Retail, offset by a R114m increase in Nedbank Corporate in the commercial real estate portfolio. Nedbank Group Limited and Nedbank Limited Pillar 3 June

92 Debt counselling The analysis below is Nedbank Group s debt counselling book within the Retail Cluster, which shows both new applications in the year to date and the portfolio balance. Product 1 Number of accounts New applications Portfolio balance June 2013 June 2012 June 2013 June 2012 Exposure Rm Number of accounts Exposure Rm Number of accounts Exposure Rm Number of accounts Exposure Rm Card Personal loans Mortgages Overdrafts Vehicle and asset finance Total All products include Nedbank Retail monoline, Retail Relationship Banking and Business Banking. Overall, the portfolio continues to increase month on month, although inflows have slowed down in June. Portfolio performance is consistently above industry, with market marginally lower month on month. The rand value of secured products declined as a percentage of the total portfolio from 74% to 66% over the past 12 months. The portfolio is stable, with the majority of the matters finalised. Of all matters finalised, 56% are through court orders. Distribution and quality of Nedbank Group's credit risk profile The graphs on the following pages are derived from Nedbank Group's AIRB credit system and provide a means of comparative analysis across Nedbank's portfolios. Long run average or TTC LGDs are used for the derivation of EL for Nedbank Group in line with internal economic capital use instead of dlgds used for Basel III regulatory capital. Thereafter the Nedbank Limited AIRB portfolio is presented on an asset class basis for regulatory purposes using dlgd and thus del. The graphs provided are based on both the performing and non performing portfolios. Both the average and total performing PD, LGD and EL percentages (which include performing and non performing advances) are shown. The trends in the graphs can mainly be attributed to three factors, namely the change in the economic cycle, methodological and model enhancements, and the continued focus on data quality improvement. Nedbank Group's rating models are based on TTC PDs which means that they are built on long term historical default data. The factors that are included in the models also assess clients risk attributes, including account conduct, in order to update the PD with their current risk profile. The models are not completely cycle neutral and have some sensitivity to changes in the economy, which may result in clients being up or downgraded, and accordingly changes to PDs, LGDs and ELs. Please refer to the graphs that follow for brief explanations of some of the drivers behind the migrations and trends between the NGR bands for the individual business units and Basel III asset classes. Nedbank Group Limited and Nedbank Limited Pillar 3 June

93 10% DISTRIBUTION OF TOTAL EAD OF NEDBANK GROUP 1 EAD distribution by NGR (ie PD only) Dec 2010 Dec 2011 Dec 2012 Jun % 0% NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 2,21% (Dec 2012: 2,25%) Average performing book EAD weighted LGD 23,86% (Dec 2012: 21,88%) Average performing book EAD weighted EL 0,61% (Dec 2012: 0,63%) Average total book EAD weighted PD 4,85% (Dec 2012: 4,91%) Average total book EAD weighted LGD 24,00% (Dec 2012: 22,04%) Average total book EAD weighted EL 1,38% (Dec 2012: 1,36%) EAD % distribution by bucketed NGR bands over time (ie PD only) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 4% 3% 3% 3% 2% 1% 1% 1% 3% 4% 4% 3% 12% 12% 13% 13% 21% 21% 22% 23% 17% 16% 10% 9% 10% 16% 18% 0% 0% 22% 23% 13% 12% 9% 9% 11% 10% 10% 8% 8% Dec 2010 Dec 2011 Dec 2012 Jun 2013 NP NGR24 25 NGR21 23 NGR18 20 NGR15 17 NGR12 14 NGR09 11 NGR06 08 NGR03 05 NGR For reporting group results, AIRB benchmarks based on expert judgement are applied to Imperial Bank and the small group subsidiaries under TSA. Nedbank Limited operates fully under the AIRB approach and this accounts for 95% of total group credit exposure. A number of factors drove the shift in the Nedbank Group NGR distribution, as well as caused changes in the PD, LGD and EL estimates over the period December 2012 to June 2013: Portfolio growth as well as a weakened ZAR over H drove increased exposure, mainly in the Nedbank Capital portfolio, to large international institutions (predominantly financial institutions) in the NGR06 08 bucket. This large shift contributed to the decrease in group EAD weighted PD. Increase in exposure to low default risk products with higher relative LGDs in the corporate portfolio contributed to an increase in the group EAD weighted LGD. Growing concerns surrounding personal loans products in the broader South African banking landscape have prompted a more conservative and cautious outlook with respect to the product. The downturn LGD parameter is currently applied for economic capital purposes and has been the largest driver for the increase in EAD weighted LGD for the Nedbank Retail cluster. Increased default experience in this book, and slower growth in this book has increased the total EAD weighted PD and decreased the performing PD. Nedbank Group Limited and Nedbank Limited Pillar 3 June

94 DISTRIBUTION OF NEDBANK GROUP'S TOTAL EAD BY MAJOR BUSINESS LINE NEDBANK CORPORATE CLUSTER: CORPORATE BANKING EAD distribution by NGR (ie PD only) Dec % Dec 2011 Dec 2012 Jun % 10% 5% 0% NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 0,56% (Dec 2012: 0,58%) Average performing book EAD weighted LGD 26,37% (Dec 2012: 24,63%) Average performing book EAD weighted EL 0,13% (Dec 2012: 0,13%) Average total book EAD weighted PD 1,14% (Dec 2012: 0,74%) Average total book EAD weighted LGD 26,36% (Dec 2012: 24,62%) Average total book EAD weighted EL 0,27% (Dec 2012: 0,15%) EAD % distribution by bucketed NGR bands over time (ie PD only) 100% 90% 80% 70% 60% 2% 2% 2% 0% 1% 1% 4% 3% 3% 3% 5% 6% 8% 9% 13% 12% 12% 23% 18% 21% 18% NP NGR24 25 NGR21 23 NGR18 20 NGR % 40% 27% 22% 23% 23% NGR12 14 NGR % 20% 10% 0% 28% 27% 33% 34% 9% 7% Dec 2010 Dec 2011 Dec 2012 Jun 2013 NGR06 08 NGR03 05 NGR00 02 The majority of the Corporate Banking book mainly comprises of large deals to a relatively small number of clients with low default probabilities which remained fairly stable during the period December 2012 to June The noteworthy changes are as follows: An increase in the total book EAD weighted PD for Corporate Banking is attributable to the default of a corporate client in H Increase in exposure to low default risk products with higher relative LGDs in the corporate portfolio contributed to an increase in the group EAD weighted LGD. Since December 2012, decreased exposure to Public Sector Entities substantiated the drop in EAD distribution in the NGR00 02 bucket. Over the period December 2012 to June 2013 increased pressure particularly within the local Mining and Resources industries resulted in downgrades for some related entities driving shifts in EAD from the NGR03 05 bucket to the NGR06 08 bucket. Annual re ratings drove some improvements in the distribution from the NGR09 NGR11 to the NGR06 NGR08 buckets, as well as some rating declines from the NGR12 14 to the NGR15 17 buckets. Nedbank Group Limited and Nedbank Limited Pillar 3 June

95 NEDBANK CORPORATE CLUSTER: PROPERTY FINANCE EAD distribution by NGR (ie PD only) Dec 2010 Dec % Dec 2012 Jun % 5% 0% NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 1,26% (Dec 2012: 1,35%) Average performing book EAD weighted LGD 11,17% (Dec 2012: 12,24%) Average performing book EAD weighted EL 0,18% (Dec 2012: 0,22%) Average total book EAD weighted PD 3,63% (Dec 2012: 4,20%) Average total book EAD weighted LGD 11,47% (Dec 2012: 12,59%) Average total book EAD weighted EL 0,75% (Dec 2012: 0,91%) EAD % distribution by bucketed NGR bands over time (ie PD only) 100% 90% 3% 4% 3% 2% 1% 1% 2% 2% 6% 6% 5% 4% NP NGR % 22% 23% 24% 25% NGR % NGR % NGR % 40% 46% 44% 41% 41% NGR12 14 NGR % NGR % 10% 0% 12% 11% 13% 15% 8% 8% 8% 7% 2% 3% 3% 3% Dec 2010 Dec 2011 Dec 2012 Jun 2013 NGR03 05 NGR00 02 An improved risk profile in the Property Finance portfolio over H with portfolio growth in the lower NGR bands and updated ratings for previously unrated (NGR20) clients drove a decrease in the EAD weighted PD for the portfolio. Due to repayment of a large problem client defaulted advances decreased in the aforementioned period causing the average total book EAD weighted PD and EL to decrease. Overall improved risk profiles across property fund clients contributed to the decrease in EAD weighted LGD for Property Finance. Nedbank Group Limited and Nedbank Limited Pillar 3 June

96 NEDBANK CAPITAL CLUSTER EAD distribution by NGR (ie PD only) 30% 25% Dec 2010 Dec 2011 Dec 2012 Jun % 15% 10% 5% 0% NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 0,43% (Dec 2012: 0,55%) Average performing book EAD weighted LGD 23,21% (Dec 2012: 23,29%) Average performing book EAD weighted EL 0,10% (Dec 2012: 0,14%) Average total book EAD weighted PD 1,22% (Dec 2012: 1,30%) Average total book EAD weighted LGD 23,31% (Dec 2012: 23,40%) Average total book EAD weighted EL 0,38% (Dec 2012: 0,43%) EAD % distribution by bucketed NGR bands over time (ie PD only) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1% 1% 1% 2% 2% 1% 2% 4% 1% 4% 4% 4% 4% 10% 11% 10% 10% 13% 15% 18% 17% 16% 22% 16% 24% 27% 54% 23% 46% 1% 21% 17% Dec 2010 Dec 2011 Dec 2012 Jun 2013 NP NGR24 25 NGR21 23 NGR18 20 NGR15 17 NGR12 14 NGR09 11 NGR06 08 NGR03 05 NGR00 02 Portfolio growth as well as a weakened ZAR over H drove increased exposure, mainly in the Nedbank Capital portfolio, to large international institutions (predominantly financial institutions) in the NGR06 08 bucket. This large shift contributed to the decrease in Nedbank Capital EAD weighted PD Over the period December 2012 to June 2013, increased pressure particularly within the local Mining and Resources industries resulted in downgrades for related entities driving shifts in EAD from the NGR03 05 bucket to the NGR06 08 bucket. The decrease in the NGR00 NGR02 bucket comes from the fact that Sovereign exposure remained relatively stable over the period while the growth was in the other NGR buckets. This led to the relative decrease in this bucket s exposure. Nedbank Group Limited and Nedbank Limited Pillar 3 June

97 NEDBANK BUSINESS BANKING CLUSTER EAD distribution by NGR (ie PD only) Dec 2010 Dec % Dec 2012 Jun % 5% 0% NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 2,57% (Dec 2012: 2,45%) Average performing book EAD weighted LGD 17,52% (Dec 2012: 17,21%) Average performing book EAD weighted EL 0,47% (Dec 2012: 0,45%) Average total book EAD weighted PD 5,68% (Dec 2012: 5,37%) Average total book EAD weighted LGD 17,70% (Dec 2012: 17,43%) Average total book EAD weighted EL 1,20% (Dec 2012: 1,18%) EAD% distribution by bucketed NGR bands over time (ie PD only) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 5% 4% 2% 1% 2% 1% 1% 3% 2% 1% 3% 2% 15% 40% 22% 37% 31% 25% 21% 21% 4% 7% 7% 5% 2% 2% 2% 2% Dec 2010 Dec 2011 Dec 2012 Jun % 31% 35% 30% NP NGR24 25 NGR21 23 NGR18 20 NGR15 17 NGR12 14 NGR09 11 NGR06 08 NGR03 05 NGR00 02 The application of more conservative PD parameters in the SME segment reflects a more cautious outlook based on current market conditions. This drove the increase in portfolio EAD weighted PD for the Business Banking cluster. Nedbank Group Limited and Nedbank Limited Pillar 3 June

98 NEDBANK RETAIL CLUSTER 1 EAD distribution by NGR (ie PD only) Dec % Dec 2011 Dec % Jun % 5% 0% NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 4,69% (Dec 2012: 4,72%) Average performing book EAD weighted LGD 26,08% (Dec 2012: 25,52%) Average performing book EAD weighted EL 1,50% (Dec 2012: 1,48% %) Average total book EAD weighted PD 9,84% (Dec 2012: 9,88%) Average total book EAD weighted LGD 26,89% (Dec 2012: 25,73%) Average total book EAD weighted EL 3,12% (Dec 2012: 2,99%) EAD % distribution by bucketed NGR bands over time (ie PD only) 100% 90% 80% 70% 60% 50% 40% 30% 9% 6% 5% 6% 3% 4% 3% 4% 9% 9% 8% 7% 20% 36% 20% 36% 25% 26% 36% 36% NP NGR24 25 NGR21 23 NGR18 20 NGR15 17 NGR12 14 NGR09 11 NGR % 10% 0% 16% 20% 9% 8% 10% 10% 6% 3% 2% 2% 2% 3% 1% Dec 2010 Dec 2011 Dec 2012 Jun The figures for the Nedbank Retail cluster exclude the Nedbank Wealth cluster since NGR03 05 NGR00 02 Growing concerns surrounding personal loans products in the broader South African banking landscape have prompted a more conservative and cautious outlook with respect to the product. The downturn LGD parameter is currently applied for economic capital purposes and has been the largest driver for the increase in EAD weighted LGD for the Nedbank Retail cluster. The increased default experienced in this book has driven the increased EAD weighting for the NP bucket and the consequent decrease in performing advances have driven shifts in the distribution. The rest of the Retail book has remained relatively stable and positive with defaulted advances decreasing particularly in the homeloans portfolio due to tightened origination policies. Nedbank Group Limited and Nedbank Limited Pillar 3 June

99 CENTRAL MANAGEMENT: NEDBANK AFRICA EAD distribution by NGR (ie PD only) 30% 25% Dec 2010 Dec 2011 Dec 2012 Jun % 15% 10% 5% 0% NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 2,99% (Dec 2012: 2,93%) Average performing book EAD weighted LGD 33,33% (Dec 2012: 33,18%) Average performing book EAD weighted EL 1,03% (Dec 2012: 1,00%) Average total book EAD weighted PD 4,73% (Dec 2012: 4,38%) Average total book EAD weighted LGD 33,35% (Dec 2012: 33,25%) Average total book EAD weighted EL 1,63% (Dec 2012: 1,55%) EAD % distribution by bucketed NGR bands over time (ie PD only) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2% 2% 1% 2% 47% 46% 48% 50% 27% 31% 29% 29% 17% 16% 17% 16% 7% 5% 4% 3% Dec 2010 Dec 2011 Dec 2012 Jun 2013 NP NGR24 25 NGR21 23 NGR18 20 NGR15 17 NGR12 14 NGR09 11 NGR06 08 NGR03 05 NGR00 02 Nedbank Africa utilises TSA for regulatory purposes and as such the ratings for internal economic capital purposes are based on conservative AIRB benchmarks. Changes in the PDs and LGDs are driven by changes in portfolio mix. Nedbank Group Limited and Nedbank Limited Pillar 3 June

100 DISTRIBUTION OF TOTAL EAD OF NEDBANK LIMITED (INCLUDING NEDBANK LONDON BRANCH) EAD distribution by NGR (ie PD only) Dec 2010 Dec % Dec 2012 Jun % 0% NGR00 NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 2,10% (Dec 2012: 2,22%) Average performing book EAD weighted LGD 25,07% (Dec 2012: 25,08%) Average performing book EAD weighted del 0,66% (Dec 2012: 0,71%) Average total book EAD weighted PD 4,46% (Dec 2012: 4,71%) Average total book EAD weighted dlgd 25,26% (Dec 2012: 25,25%) Average total book EAD weighted del 1,71% (Dec 2012: 1,75%) EAD % distribution by bucketed NGR bands over time (ie PD only) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 4% 3% 2% 2% 2% 1% 1% 1% 3% 4% 3% 3% 10% 10% 12% 12% 20% 20% 21% 21% 15% 15% 9% 14% 8% 17% 19% 21% 22% 12% 12% 14% 14% 15% 10% 9% 9% 8% Dec 2010 Dec 2011 Dec 2012 Jun 2013 NP NGR NGR NGR NGR NGR NGR NGR NGR NGR From December 2012 to June 2013, the overall EAD distribution by bucketed NGR remained relatively stable. Factors which drove shifts in the Nedbank Limited NGR distribution are as follows: Portfolio growth as well as a weakened ZAR over H drove increased exposure, mainly in the Nedbank Capital portfolio, to large international institutions (predominantly financial institutions) in the NGR06 08 bucket. This large shift contributed greatly to the decrease in the Nedbank Limited EAD weighted PD. Increase in exposure to low default risk products with higher relative LGDs in the corporate portfolio contributed to an increase in the group EAD weighted LGD. Growing concerns surrounding personal loans products in the broader South African banking landscape have prompted a more conservative and cautious outlook with respect to the product. The downturn LGD parameter is currently applied for economic capital purposes and has been the largest driver for the increase in EAD weighted LGD for the Nedbank Retail cluster. Increased default experience in this book, and slower growth in this book has increased the total EAD weighted PD and decreased the performing PD. Nedbank Group Limited and Nedbank Limited Pillar 3 June

101 DISTRIBUTION OF NEDBANK LIMITED'S EAD BY SELECTED MAJOR BASEL III ASSET CLASS ASSET CLASS: CORPORATE EAD distribution by NGR (ie PD only) 20% 15% Dec 2010 Dec 2011 Dec 2012 Jun % 5% 0% NGR00 NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 0,69% (Dec 2012: 0,67%) Average performing book EAD weighted dlgd 28,27% (Dec 2012: 28,78%) Average performing book EAD weighted del 0,18% (Dec 2012: 0,18%) Average total book EAD weighted PD 1,18% (Dec 2012: 1,02%) Average total book EAD weighted dlgd 28,31% (Dec 2012: 28,83%) Average total book weighted del 0,38% (Dec 2012: 0,41%) EAD % distribution by bucketed NGR bands over time (ie PD only) 100% 90% 80% 70% 60% 50% 40% 30% 20% 1% 2% 1% 1% 1% 1% 4% 5% 5% 5% 5% 7% 6% 8% 14% 25% 32% 16% 22% 27% 14% 23% 21% 29% 14% 32% NP NGR NGR NGR NGR NGR NGR NGR NGR % 16% 21% 21% 17% NGR % 1% 2% Dec 2010 Dec 2011 Dec 2012 Jun 2013 Over the period December 2012 to June 2013 increased pressure particularly within the local Mining and Resources industries resulted in downgrades for some related entities driving shifts in EAD from the NGR03 05 bucket to the NGR06 08 bucket. Annual re ratings drove some improvements in the distribution from the NGR09 NGR11 to the NGR06 NGR08 buckets, as well as some rating declines from the NGR12 14 to the NGR15 17 buckets. Nedbank Group Limited and Nedbank Limited Pillar 3 June

102 ASSET CLASS: SPECIALISED LENDING INCOME PRODUCING REAL ESTATE EAD distribution by NGR (ie PD only) 25% Dec 2010 Dec % Dec 2012 Jun % 10% 5% 0% NGR00 NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 1,01% (Dec 2012: 1,02%) Average performing book EAD weighted dlgd 18,86% (Dec 2012: 19,16%) Average performing book EAD weighted del 0,19% (Dec 2012: 0,20%) Average total book EAD weighted PD 1,67% (Dec 2012: 1,85%) Average total book EAD weighted dlgd 18,89% (Dec 2012: 19,19%) Average total book EAD weighted del 0,29% (Dec 2012: 0,30%) EAD % distribution by bucketed NGR bands over time (ie PD only) 100% 90% 80% 70% 60% 50% 1% 1% 4% 1% 2% 1% 1% 2% 1% 31% 32% 33% 32% NP NGR NGR NGR NGR NGR % 30% 59% 60% 57% 57% NGR NGR % NGR % 0% 3% 8% 7% 3% 2% 1% 1% Dec 2010 Dec 2011 Dec 2012 Jun 2013 NGR The Property Finance commercial real estate portfolio has remained relatively stable in H with a decrease in defaulted advances driving a decrease in total book EAD weighted PD. Nedbank Group Limited and Nedbank Limited Pillar 3 June

103 ASSET CLASS: SME CORPORATE EAD distribution by NGR (ie PD only) Dec 2010 Dec % Dec 2012 Jun % 5% 0% NGR00 NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 2,31% (Dec 2012: 2,36%) Average performing book EAD weighted dlgd 23,26% (Dec 2012: 23,19%) Average performing book EAD weighted del 0,51% (Dec 2012: 0,54%) Average total book EAD weighted PD 4,07% (Dec 2012: 3,97%) Average total book EAD weighted dlgd 23,41% (Dec 2012: 23,33%) Average total book EAD weighted del 1,28% (Dec 2012: 1,04%) EAD % distribution by bucketed NGR bands over time (ie PD only) 100% 90% 80% 70% 60% 50% 40% 1% 4% 2% 1% 2% 2% 1% 1% 2% 11% 19% 16% 15% 37% 41% 46% 44% NP NGR NGR NGR NGR NGR NGR % 20% 41% 30% 29% 29% NGR NGR % 0% 3% 7% 5% 5% 1% 1% 3% Dec 2010 Dec 2011 Dec 2012 Jun 2013 NGR The downgrade of two large exposures in this asset class drove a shift in EAD from the NGR12 14 bucket to NGR15 NGR17 however portfolio growth in the NGR12 14 bucket offset the decrease in EAD in this bucket. Two new large exposures rated at NGR08 contributed to the increase in EAD weighting for the NGR06 08 bucket. Nedbank Group Limited and Nedbank Limited Pillar 3 June

104 ASSET CLASS: BANKS EAD distribution by NGR (ie PD only) 70% 60% 50% Dec 2010 Dec 2011 Dec 2012 Jun % 30% 20% 10% 0% NGR00 NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 0,28% (Dec 2012: 0,25%) Average performing book EAD weighted dlgd 24,68% (Dec 2012: 23,97%) Average performing book EAD weighted del 0,12% (Dec 2012: 0,12%) Average total book EAD weighted PD 0,28% (Dec 2012: 0,25%) Average total book EAD weighted dlgd 24,68% (Dec 2012: 23,97%) Average Total book EAD weighted del 0,12% (Dec 2012: 0,12%) EAD % distribution by bucketed NGR bands over time (ie PD only) 100% 90% 80% 70% 60% 50% 40% 2% 1% 2% 8% 7% 7% 1% 1% 2% 3% 2% 2% 45% 47% 48% 50% NP NGR NGR NGR NGR NGR NGR % 20% 51% 41% 43% 38% NGR NGR % NGR % Dec 2010 Dec 2011 Dec 2012 Jun 2013 The majority of exposure in the Banks asset class comprises significantly large deals to low NGR local and International banks. Increased interbank lending among large international banks with relatively reduced local bank exposure largely drove the shift in the distribution. Nedbank Group Limited and Nedbank Limited Pillar 3 June

105 ASSET CLASS: RETAIL MORTGAGE EAD distribution by NGR (ie PD only) 25% 20% Dec 2010 Dec 2011 Dec 2012 Jun % 10% 5% 0% NGR00 NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 3,18% (Dec 2012: 3,12%) Average performing book EAD weighted dlgd 14,77% (Dec 2012: 14,77%) Average performing book EAD weighted del 0,54% (Dec 2012: 0,54%) Average total book EAD weighted PD 7,96% (Dec 2012: 8,22%) Average total book EAD weighted dlgd 15,03% (Dec 2012: 15,06%) Average total book EAD weighted del 2,06% (Dec 2012: 2,10%) EAD % distribution by bucketed NGR bands over time (ie PD only) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 8% 7% 5% 5% 2% 2% 3% 4% 6% 5% 5% 5% 13% 13% 14% 15% 38% 42% 23% 24% 40% 41% 13% 13% 18% 17% 5% 2% 2% 2% 1% 3% 3% Dec 2010 Dec 2011 Dec 2012 Jun 2013 NP NGR NGR NGR NGR NGR NGR NGR NGR NGR In the period December 2012 to June 2013, the Retail Mortgage asset class of the Nedbank portfolio maintained a relatively stable NGR distribution. Improved total book EAD weighted PD is driven by a decrease in defaulted advances driven by improvements in the portfolio as a result of changes in credit policy in line with the group s portfolio tilt strategy. Nedbank Group Limited and Nedbank Limited Pillar 3 June

106 ASSET CLASS: RETAIL REVOLVING CREDIT EAD distribution by NGR (ie PD only) Dec 2010 Dec % Dec 2012 Jun % 0% NGR00 NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 5,74% (Dec 2012: 5,74%) Average performing book EAD weighted dlgd 58,32% (Dec 2012: 58,01%) Average performing book EAD weighted del 3,56% (Dec 2012: 3,54%) Average total book EAD weighted PD 10,24% (Dec 2012: 9,84%) Average total book EAD weighted dlgd 58,47% (Dec 2012: 58,15%) Average total book EAD weighted del 7,60% (Dec 2012: 7,31%) EAD % distribution by bucketed NGR bands over time (ie PD only) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 5% 4% 4% 5% 5% 5% 6% 9% 8% 9% 9% 11% 18% 14% 27% 20% 22% 21% 16% 23% 21% 18% 13% 5% 5% 7% 1% 1% 2% 1% Dec 2010 Dec 2011 Dec 2012 Jun % 13% 24% 23% NP NGR NGR NGR NGR NGR NGR NGR NGR NGR The implementation of a new middle market credit card rating model in January 2013 drove the shift in distribution for the Retail Revolving Credit asset class in H This initially resulted in a decrease in EAD weighted PD for the card portfolio however increased technical delinquent behaviour, largely as a result of seasonal effects (eg public holidays in March), saw an increase in EAD in the NGR21 23 and NGR24 25 buckets and offset the decrease. These technicalities are expected to abate over the remainder of Nedbank Group Limited and Nedbank Limited Pillar 3 June

107 20% 15% ASSET CLASS: RETAIL OTHER EAD distribution by NGR (ie PD only) Dec 2010 Dec 2011 Dec 2012 Jun % 5% 0% NGR00 NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 6,30% (Dec 2012: 6,55%) Average total book EAD weighted PD 12,25% (Dec 2012: 12,14%) 100% 90% 80% 70% 60% 50% 40% 44% Average performing book EAD weighted dlgd 39,91% (Dec 2012: 40,25%) Average total book EAD weighted dlgd 40,17% (Dec 2012: 40,44%) EAD % distribution by bucketed NGR bands over time (ie PD only) 10% 9% 6% 6% 5% 4% 5% 8% 14% 12% 12% 25% 34% Average performing book EAD weighted del 2,60% (Dec 2012: 2,74%) Average total book EAD weighted del 6,05% (Dec 2012: 5,84%) 38% 42% NP NGR NGR NGR NGR NGR NGR % NGR % 17% 13% 32% 30% NGR % 0% 12% 11% 4% 4% Dec 2010 Dec 2011 Dec 2012 Jun 2013 NGR Contraction of the Personal Loans portfolio in H resulted in a significant decrease in exposures rated in the NGR21 23 and NGR24 25 buckets and drove the decrease in performing EAD weighted PD for the Retail Other asset class. An increase in defaulted advances for the product, however, contributed to the increase in total book EAD weighted PD. Growth in the MFC portfolio over H contributed greatly to the increase in EAD in the NGR18 20 bucket. Nedbank Group Limited and Nedbank Limited Pillar 3 June

108 ASSET CLASS: SME RETAIL EAD distribution by NGR (ie PD only) Dec % Dec 2011 Dec 2012 Jun % 10% 5% 0% NGR00 NGR01 NGR02 NGR03 NGR04 NGR05 NGR06 NGR07 NGR08 NGR09 NGR10 NGR11 NGR12 NGR13 NGR14 NGR15 NGR16 NGR17 NGR18 NGR19 NGR20 NGR21 NGR22 NGR23 NGR24 NGR25 NP Average performing book EAD weighted PD 3,36% (Dec 2012: 3,07%) Average performing book EAD weighted dlgd 29,85% (Dec 2012: 29,20%) Average performing book EAD weighted del 1,04% (Dec 2012: 0,95%) Average total book EAD weighted PD 6,80% (Dec 2012: 6,58%) Average total book EAD weighted dlgd 30,04% (Dec 2012: 29,41%) Average total book EAD weighted del 2,65% (Dec 2012: 2,53%) EAD % distribution by bucketed NGR bands over time (ie PD only) 100% 5% 4% 4% 4% 1% 3% 1% 3% 1% 1% 3% 90% 4% NP NGR % 21% 27% 29% 31% NGR % NGR % NGR % 34% 30% 32% 35% NGR % NGR % NGR % 33% 33% 25% 23% 10% NGR NGR % 2% 2% 7% 4% Dec 2010 Dec 2011 Dec 2012 Jun 2013 EAD weighted PD for the SME Retail asset class increased over the period December 2012 to June 2013 largely due to the implementation of a new application model which had a considerable effect on the SME retail portion of the MFC portfolio. This drove a shift in the distribution causing notable increases in the NGR15 17 and NGR18 20 buckets. Nedbank Group Limited and Nedbank Limited Pillar 3 June

109 AIRB credit parameter backtesting Nedbank applies the AIRB approach for the majority of its credit portfolios. The corresponding EAD, PD and dlgd credit parameters are longrun or TTC averages and associated models are subject to annual validation, which includes a backtesting exercise in order to compare the estimates to the actual outcomes over time. The Basel III Pillar 3 disclosure regulations require banks to compare the regulatory AIRB expected loss to the actual loss over time, and to analyse the difference between estimated and realised EAD, PD and dlgd credit parameters. As the AIRB parameters are based on a TTC view (with relevant downturn adjustments), the actual outcome is not expected to align to the corresponding parameters for each point in time (PIT) period. One may rather expect that the average actual outcome over a sufficiently long time period (ie at least a full economic cycle of around ten years) is close to the corresponding TTC parameters. For a typical portfolio or asset class one would expect to observe several 'good' economic years with minimal defaults and then some years with high losses during an economic downturn. The average actual outcome over that time would be expected to align to the corresponding TTC risk parameters. The Pillar 3 credit parameter backtesting is carried out on an annual basis for the respective calendar year. This avoids unwanted fluctuations due to seasonality effects which could arise if a shorter time horizon is considered. This section provides an analysis for the four calendar years 2009, 2010, 2011 and Expected loss refers to the AIRB regulatory loss expected for the performing portfolio, and incorporates downturn conditions, as per the beginning of each respective reporting period. The actual loss and loss rate have been restated for years prior to 2012 in order to reflect the latest available loss information for accounts which defaulted during those time periods, eg if actual writeoffs exceeded or fell short of the previously assigned level of specific impairments. The estimates for the three underlying key credit parameters have been derived as follows: PD is derived as the EAD weighted average PD as per the beginning of the respective reporting period. dlgd is derived as the EAD weighted average dlgd prior to default of all transactions which defaulted in the respective reporting period. EAD is derived as the total EAD prior to default of all transactions which defaulted in the respective reporting period. Conversely, the actual loss outcomes have been derived as follows: Actual loss refers to the total IFRS specific impairments (including writeoffs) raised against the transactions which defaulted in the respective reporting period. Actual default rate is derived as the EAD weighted default rate for the respective reporting period. Actual loss rate is derived as the ratio between the actual loss and the actual EAD. Actual EAD refers to the exposure as per the date of default. It should be noted that the analysis, in line with the regulations, excludes: Any portfolio which is not yet subject to the AIRB approach as there is no regulatory expected loss measure available for the underlying exposures. This exclusion has also been applied for the MFC portfolio as it was subject to TSA until September 2012 and thereafter switched to the AIRB approach following approval received from the SARB. It will form part of the next annual update of the backtesting. All transactions which were originated and defaulted in the same calendar year as they did not contribute to the expected loss as measured. Nedbank Group Limited and Nedbank Limited Pillar 3 June

110 Actual versus downturn expected loss The table below provides a summary of the downturn expected and the actual losses per AIRB asset class for the last four years. While the regulatory del is meant to serve as a through the cycle (yet downturn from an LGD perspective) measure, the actual losses are point in time and hence most likely deviate from the del depending on the current state of the credit and economic cycle. del Actual loss Expected/ actual Expected/ actual Expected/ actual Expected/ actual AIRB exposure class Rm Rm % % % % Corporate Sovereign, Banks, PSE 2 and Local Government 11 Retail Retail Mortgage Retail Revolving Credit Retail Other SME Retail Total The actual losses have been restated based on an enhancement of the backtesting database with more enhanced writeoff information. 2 PSE = Public Sector Entities. As discussed, the AIRB parameters are based on a TTC view (with relevant downturn adjustments) and so the actual outcome is not expected to align to the corresponding estimated parameters for each single reporting period. With the global financial crisis and local recession, the 2009 actual losses were expected to exceed the expected loss given the PIT nature of the actual losses. This is clearly visible in the table above for most of the retail asset classes, whereas Nedbank s wholesale book has consistently performed well through economic cycles and so this was not be the case for the Corporate asset class. Bearing in mind that 2009 was right at the bottom of the current credit cycle and that there was only a small improvement in the economy thereafter, the relatively close alignment between expected and actual default, and loss rates, in the last three years shows that the applied AIRB credit parameters provide a sound assessment of risk from a TTC perspective. Compared to the previous annual analysis, it should be noted that this update includes post writeoff recoveries for the three unsecured retail products (current accounts, card and personal loans) which has a positive impact on actual losses for the Retail Revolving Credit and Retail Other asset classes for previous years. The seemingly unfavourable trend for the Retail Mortgage asset class is largely due to a more conservative IFRS impairment approach for new defaults which has resulted in higher reported actual losses. If the positive performance of the defaulted back book continues as observed in 2012, some of the aforementioned impairment charges may be reversed during the workout process in 2013 and beyond. Another driver of the higher actual retail mortgage losses was the subdued property market. Parameters underlying expected loss PROBABILITY OF DEFAULT (PD) AIRB exposure class % EAD weighted PD Default rate Expected/ actual Expected/ actual Expected/ actual Expected/ actual Corporate 0,97 0, Sovereign, Banks, PSE and Local Government 0,08 16 Retail 4,11 4, Retail Mortgage 3,32 4, Retail Revolving Credit 4,80 4, Retail Other 9,38 12, SME Retail 3,13 2, Total 2,07 2, The backtesting of the PD models show the general, but slow, recovery of the credit cycle since 2009 with actual default rates decreasing from 4,15% in 2009 to 2,19% in The EAD weighted PD also decreased during the observation period as more default data was available which allowed Nedbank to more accurately assess the central tendencies of the various portfolios. Nedbank Group Limited and Nedbank Limited Pillar 3 June

111 The actual default rate in the Corporate asset class consistently improved during the observation period which was largely driven by fewer defaults in the middle market segments (eg Business Banking) as well as the good performance of the commercial real estate portfolio in Property Finance. There was one technical default case in the Public Sector Entities asset class in 2010 which resulted in the spike in actual default rate, although the default was subsequently worked out with no actual loss to the group. The retail asset class showed a positive trend in default rates between 2009 and The 2012 default rate increased slightly due to the higher contribution of Personal Loans to the Retail asset class. Higher than expected default rates for the Retail Other asset class were observed for Personal Loans and for the old Nedbank Vehicle Asset Finance portfolio which is currently running down with new business originating through the MFC franchise. As credit policies for the personal loans product were further tightened during the course of 2012, the actual default rates are expected to reduce in the future is considered to be at the bottom of the current credit cycle, being at the height of the recent global financial crisis, and hence the very low expected/actual ratios, and the three years following 2009 to 2012 have revealed a small recovery. Hence, the applied PD measures are considered to provide a fair assessment from a TTC perspective. Downturn loss given default (dlgd) As mentioned above, the EAD weighted dlgd in the table below refers to the EAD weighted average dlgd prior to default of all transactions which defaulted in the respective reporting period and hence, does not refer to the EAD weighted LGD for the total portfolio. AIRB exposure class % EAD weighted dlgd Loss rate Expected/ actual Expected/ actual Expected/ actual Expected/ actual Corporate 32,3 23, Sovereign, Banks, PSE and Local Government Retail 33,0 36, Retail Mortgage 16,0 19, Retail Revolving Credit 65,2 76, Retail Other 56,8 58, SME Retail 30,3 27, Total 32,9 34, Compared to the previous year s assessment, the actual loss rate for defaults in the Corporate asset class increased following an increase in impairments for a few large default cases in the project finance and commercial real estate portfolios. The integration of post writeoff recoveries for unsecured retail products had a mitigating impact on actual loss rates both for the retail asset class and at group level. As there is a natural time lag for the realisation of post writeoff recoveries and as the actual loss does not comprise forecasts thereof, the 2011 and 2012 actual losses for the retail asset class are expected to decrease in the next assessment and bring the level of actual loss rates back to the level of expected loss rates. The actual loss rates closely align to the predicted dlgd at group level. However, the retail asset classes show varying outcomes for the different sub asset classes: The Retail Mortgage asset class revealed a significant decrease in default rates in 2011 and remained at this level in 2012 following Nedbank Retail s turnaround strategy for its Home Loans portfolio. However, the average loss rate for the new defaults increased which was largely the result of the introduction of a more conservative impairment methodology. The Retail Revolving Credit asset class experienced higher than expected loss rates in 2009 and Whereas the high 2009 loss rate was observed at the bottom of the current credit cycle, the 2012 loss rate does not yet fully benefit from post writeoff recoveries which are expected due to Nedbank s 100% provisioning of non performing card exposures and early writeoff strategy. However, the total actual loss is closely aligned to the expected loss in 2012 because of the lower than expected usage of the available facilities in the case of default (refer to the very conservative EAD estimates in the next table). The Retail Other asset class revealed a similar offsetting effect between LGD and EAD in the last four years. The composition of this asset class will be subject to a material change going forward as Nedbank implemented AIRB models for the MFC portfolio in September 2012, which is not included in this assessment. The conservative LGD estimates for the SME Retail asset class offset the aforementioned higher actual than expected default rates. Nedbank Group Limited and Nedbank Limited Pillar 3 June

112 EXPOSURE AT DEFAULT (EAD) AIRB exposure class % Expected/actual Expected/actual Expected/actual Expected/actual Corporate Sovereign, Banks, PSE and Local Government 86 Retail Retail Mortgage Retail Revolving Credit Retail Other SME Retail Total The backtesting of the EAD shows that the various EAD models being used for the regulatory capital calculations yielded especially conservative estimates in the last four years for all AIRB asset classes. The main reason for the higher expected than actual EAD relates to the amortising nature of a large portion of Nedbank s credit portfolio. As the Basel III regulations require the EAD measure to be not less than the current on balance sheet exposure, the actual EAD typically accounts for some instalments which are paid by the obligor prior to default and hence is lower than the previously estimated EAD. The decrease for Retail Other in 2012 is driven by the higher contribution of unsecured lending products to this asset class. Credit risk mitigation Credit risk mitigation refers to the actions that can be taken by a bank to manage its exposure to credit risk so as to align such exposure to its risk appetite. This action can be proactive or reactive and the level of mitigation that a bank desires may be influenced by external factors such as the economic cycle or internal factors such as a change in risk appetite. References to credit risk mitigation normally focus on the taking of collateral as well as the management of such collateral. While collateral is an essential component of credit risk mitigation there are a number of other methods used for mitigating credit risk. Nedbank Group's credit risk policy acknowledges the role to be played by credit risk mitigation in the management of credit risk but emphasises that collateral on its own is not necessarily a justification for lending. The primary consideration for any lending opportunity should rather be the borrower's financial position and ability to repay the facility from its own resources and cashflow. TSA for credit risk allows for the use of certain categories of collateral to be used to reduce exposures prior to the risk weighting thereof subject to suitable haircuts being applied to the value of such collateral. Under the AIRB approach, banks are allowed to utilise the value of collateral in their own estimates of LGD which directly influences the risk weighting. Financial or other collateral, credit derivatives, netting agreements, put and call options, hedging and guarantees are all commonly used to reduce exposure. The amount and type of credit risk mitigation is dependent on the client product or portfolio categorisation. Credit derivatives are transacted with margined counterparties or, alternatively, protection is procured through the issue of credit linked notes. The bank monitors the concentration levels of collateral to ensure that it is adequately diversified. The following collateral types are common in the marketplace: Retail portfolio Mortgage lending secured by mortgage bonds over residential property. Instalment credit transactions secured by the assets financed. Overdrafts that are either unsecured or secured by guarantees suretyships or pledged securities. Wholesale portfolio Commercial properties are supported by the property financed and a cession of the leases. Instalment credit type of transactions that are secured by the assets financed. Working capital facilities when secured usually by either a claim on specific assets (fixed assets inventory and debtors) or other collateral such as guarantees. Term and structured lending which usually relies on guarantees or credit derivatives (where only internationally recognised and enforceable agreements are used). Credit exposure to other banks where the risk is commonly mitigated through the use of financial collateral and netting agreements. Nedbank Group Limited and Nedbank Limited Pillar 3 June

113 Collateral valuation and management The valuation and management of collateral across all business units of the group are governed by the Group Credit Policy. In the wholesale portfolio collateral is valued at the inception of a transaction and at least annually during the life of the transaction usually as part of the facility review which includes a review of the security structure and covenants to ensure that proper title is retained over collateral. Collateral valuations in respect of mortgage portfolios are updated using statistical indexing models; published data by service providers is used in the case of motor vehicles while a physical inspection is performed for other types of collateral. Physical valuations are performed six monthly on the defaulted book. Physical valuations are performed on approximately 50% of new applications. The remainder of new applications is valued using desktop valuations and these are regularly backtested with physical valuations. Where credit intervention is required, or in the case of default, all items of collateral are immediately revalued. In such instances a physical inspection by an expert valuer is required. This process also ensures that an appropriate impairment is timeous. CREDIT RISK MITIGATION FOR PORTFOLIOS UNDER THE AIRB APPROACH Rm Eligible financial collateral 1 Other eligible collateral 2 Of which is residential property Of which is commercial property Guarantees and credit derivatives 3 Total credit risk mitigation 4 Effects of netting agreements Total credit risk mitigation as % of EAD June 2013 Corporate ,2 Banks ,8 Securities Firms ,0 Retail ,8 Retail Mortgage ,2 SME Retail ,5 Retail Other ,0 Total ,3 June 2012 Corporate ,9 Banks ,5 Securities Firms ,3 Retail ,6 Retail Mortgage ,5 SME Retail ,0 Retail Other ,9 Total ,6 December 2012 Corporate ,6 Banks ,7 Securities Firms ,2 Retail ,9 Retail Mortgage ,0 SME Retail ,7 Retail Other ,9 Total ,4 1 Eligible financial collateral includes pledged cash funds, debtors lists, coins and gems as well as other commodities. 2 Other eligible collateral includes mortgage bonds, commercial covering bonds, pledge investments and insurance policies and pledged shares. 3 Guarantees and credit derivatives includes suretyships. 4 Credit risk mitigation reported above has been capped at EAD on a deal by deal basis. Residential and commercial property collateral exists in the SME Retail and Retail Other asset classes, due to both commercial and residential mortgage lending to small businesses mainly in the Business Banking and Nedbank Wealth portfolios. The increase in commercial property collateral is largely due to the R3,7bn growth in the Property Finance portfolio. Improved property valuations (which increased collateral values), and selective origination strategies (which have reduced exposure) are the key contributors to the increased collateral coverage ratio on the Retail Mortgage asset class Nedbank Group Limited and Nedbank Limited Pillar 3 June

114 The financial collateral reported under the Banks asset class largely relates to collateral posted under International Swaps and Derivatives Association (ISDA) derivative netting agreements and repurchase and resale agreements. Credit risk mitigation for portfolios under TSA With respect to the standardised portfolio Nedbank Group applies neither balance sheet netting nor off balance sheet netting. The bank holds pledged deposits which are negligible with respect the related exposure and therefore it was decided not to recognise this as qualifying collateral as detailed in the regulations. Should the bank hold any significant qualifying collateral, the valuation will be marked to market and revalued at regular intervals not exceeding six months. Physical commercial property collateral is revalued annually. The bank does not avail of guarantors or credit derivative counterparties for credit mitigation purposes. The table below shows the total unmitigated exposures for Nedbank Limited s portfolio under TSA. The decrease in exposure is attributable to the movement of the MFC book onto the AIRB approach in September EXPOSURE SUBJECT TO THE STANDARDISED APPROACH PER RISK WEIGHTING Rm June 2013 June 2012 December % 35% % % % and above Total COUNTERPARTY CREDIT RISK Counterparty credit limits are set at an individual counterparty level and approved within the Group Credit Risk Management Framework. Counterparty credit risk (CCR) exposures are reported and monitored at both a business unit and group level. To ensure that appropriate limits are allocated to large transactions, scenario analysis is performed within a specialised counterparty risk unit. Based on the outcome of such analysis, proposals regarding potential risk mitigating structures are made prior to final limit approval. Limits for the group s Corporate and Business Banking businesses favour a nominal limit to facilitate monitoring. There is continued emphasis on the use of credit risk mitigation strategies, such as netting and collateralisation of exposures. Nedbank Group and its large bank counterparties have International Swaps and Derivatives Association (ISDA) and International Securities Market Association (ISMA) master agreements as well as credit support (collateral) agreements in place to support bilateral margining of exposures. Limits and appropriate collateral are determined on a risk centred basis. Netting is applied only to underlying exposures where supportive legal opinion is obtained as to the enforceability of the relevant netting agreement in the particular jurisdiction. Margining and collateral arrangements are entered into in order to mitigate CCR. Haircuts, appropriate for the specific collateral type, are applied to determine collateral value. Margining agreements are pursued with interbank trading counterparties on a proactive basis. Margining thresholds constitute unsecured exposure to the counterparty and are assessed as such. To deal with a potential deterioration of CCR over the life of transactions, thresholds are typically linked to the counterparty external credit rating. Nedbank Group applies the Current Exposure Method (CEM) for Basel III CCR. The CEM results are also used as input in the economic capital calculations to determine credit economic capital. The Basel III regulatory standards for CCR contain significant enhancements and, in particular, introduce a credit valuation adjustment (CVA) capital charge. On 21 December 2012 the SARB issued directive D3/2012, which came into effect on 1 January 2013, which allows a zero risk weight for CVA on ZAR based derivatives and derivatives with local counterparties pending the finalisation of a centralised counterparty for over the counter (OTC) derivatives in SA. The Basel Committee published a consultative document in June 2013, for comment in September 2013, entitled 'The non internal model method for capitalising counterparty credit risk exposures'. The document relates to the introduction of a new model that will replace the CEM and Standardised Model (SM) with the intention to: address the known deficiencies of both the CEM and the SM; minimise the discretion used by national authorities and banks while helping both national authorities and banks to better understand banks risk profiles relating to derivatives exposures; and improve the risk sensitivity of the capital framework significantly without creating undue complexity. South Africa, as a member of the G20, has committed itself to OTC derivative reform aimed at reducing systemic risk and Nedbank is actively engaged with the industry and its regulators to achieve this objective. Nedbank Group Limited and Nedbank Limited Pillar 3 June

115 Wrong way risk is identified and monitored in line with internal risk processes, and as such no capital requirement is associated with this risk. No excessive wrong way risk exists within Nedbank Group. Potential collateral calls or postings are monitored with our various counterparties under a range of market movements and stress scenarios to provide senior management with a forward looking view of future collateral requirements. Under a worst case scenario or credit rating downgrade, it is estimated that collateral would increase by less than 15%. Over the counter derivatives for Nedbank Group The tables below include a breakdown of the group s OTC derivative CCR exposure by product and Nedbank Group Rating (NGR) band. Overall, the group had an R1,36m increase in fair value, with the increases being to clients with low risk profiles. Rm OTC DERIVATIVE PRODUCTS Jun 2013 Jun 2012 Dec 2012 Notional Gross positive fair Notional Gross positive Notional value value value fair value value Gross positive fair value Credit default swaps Embedded derivatives Trading MarkIt itraxx Europe Third Party Equities Foreign exchange and gold Interest rates Other commodities Total Credit default swaps embedded in credit linked notes issued by Nedbank Group whereby credit protection of R716m is purchased or credit linked notes purchased whereby credit protection of R2 959m is sold. 2 Trading positions MarkIt itraxx Europe through the purchase (R12 440m) and sale (R12 439m) of credit protection. 3 Trading positions third party transactions through the purchase (R1 133m) and sale (R3 700m) of credit protection. Despite an increase in gross positive fair value, both the netted exposure and risk weighted exposure of the group decreased. This was due to increased benefits from netting agreements (ISDA and CSAs), as well as the lower growth in exposure (EAD) to higher risk type clients, which is highlighted in the table below. OTC DERIVATIVE NETTING Gross positive fair Current netting Netted exposure Netted exposure Exposure at Risk weighted Rm value benefits (before mitigation) Collateral (after mitigation) default assets Jun Jun Dec Risk weighted assets for June 2013 consist of CCR of R2 713m and a CVA charge of R474m introduced in Basel III as per SARB issued directive D3/2012. Nedbank Group Limited and Nedbank Limited Pillar 3 June

116 Rm Notional value OTC DERIVATIVES PER NGR (PD) BAND Jun 2013 Jun 2012 Dec 2012 Gross Gross Gross positive fair EAD Notional positive fair EAD Notional positive fair value value value value value value value NGR NGR02 NGR NGR NGR NGR NGR NGR NGR NGR NGR NGR NGR NGR NGR NGR NGR NGR NGR NGR NGR NGR22 NGR23 NGR24 12 NGR NP Total EAD value Securities financing transactions (SFTs) Rm June 2013 Gross positive fair value Collateral value after haircut Netted current credit exposure (after mitigation) Exposure at default Risk weighted assets Repurchase agreements Securities lending Total June 2012 Repurchase agreements Securities lending Total December 2012 Repurchase agreements Securities lending Total SFTs reflect the funding of the bank s listed bonds. The change in resale agreements related to a change in the underlying trading position over the period of June 2012 to June Nedbank Group Limited and Nedbank Limited Pillar 3 June

117 SFTS PER NGR (PD) BAND Jun 2013 Jun 2012 Dec 2012 Rm Gross exposure EAD value Gross exposure EAD value Gross exposure EAD value NGR NGR03 NGR NGR NGR NGR NGR NGR NGR16 NGR NP1 Total SECURITISATION RISK Securitisation activities of the group Nedbank Group uses securitisation exclusively as a funding diversification tool and to add flexibility in mitigating structural liquidity risk. The group currently has two traditional securitisation transactions and one asset backed commercial paper programme: Precinct Funding 1 (RF) Limited (Precinct), a commercial mortgage backed securitisation (CMBS) programme launched in March GreenHouse Funding (RF) Limited, Series 1 (GreenHouse), a residential mortgage backed securitisation (RMBS) programme launched in December 2007 and refinanced in November Synthesis Funding Limited (Synthesis), an asset backed commercial paper (ABCP) programme launched during Synthesis is a hybrid multiseller ABCP programme that invests in longer term rated asset backed securities and bonds and offers capital market funding opportunities to SA corporates. These assets are funded through the issuance of short dated investment grade commercial paper to institutional investors. The assets purchased or funded by Synthesis are evaluated as part of the group s credit approval processes applicable to any other corporate or securitisation exposure held by the group. All the commercial paper issued by Synthesis is assigned the highest short term local currency credit rating by Fitch and is listed on the JSE Limited (the JSE). Nedbank currently fulfils a number of roles in relation to Synthesis, including acting as sponsor, liquidity facility provider, credit enhancement facility provider, swap counterparty and investor. The exposures to Synthesis that Nedbank assumes, primarily in the form of undrawn liquidity facilities, are measured, from both a regulatory capital and economic capital point of view, using the Supervisory Formula Approach under the Internal Ratings based (IRB) Approach for securitisation exposures, thereby ensuring alignment with the methodology adopted across the wider Nedbank Group. The primary risk assumed by Nedbank through the provision of liquidity facilities to Synthesis is liquidity risk. The liquidity risk associated with these liquidity facilities is included in the stress testing for Nedbank and is managed in accordance with Nedbank s overall liquidity position. GreenHouse acquired a portfolio of home loans originated by Nedbank Retail, financed through the issuance of listed, rated notes. The senior notes were placed with SA capital markets investors as part of the Nedbank s group funding strategy, whilst the junior notes were retained by the bank. During November 2012, GreenHouse refinanced a R2bn portfolio of home loans. Nedbank currently fulfils a number of roles in relation to GreenHouse, including acting as originator, servicer, credit enhancement (subordinated loan) facility provider, swap counterparty and investor. The commercial paper issued by GreenHouse has been assigned credit ratings by Fitch and is listed on the JSE. In March 2013 Nedbank launched Precinct, a R2,5bn securitisation of commercial property loans originated by Nedbank Corporate. The CMBS transaction is a further step in the group s strategy to develop capacity to raise funding in the capital markets using different asset classes. The notes issued by Precinct were rated by Moody s, with the senior notes being placed with SA capital markets investors and the junior notes being retained by the bank. Nedbank fulfils the roles of originator, servicer, credit enhancement (subordinated loan) facility provider, swap counterparty and investor to Precinct. Nedbank Group Limited and Nedbank Limited Pillar 3 June

118 ASSETS SECURITISED AND RETAINED SECURITISATION EXPOSURE Assets securitised 1 Assets outstanding Amount retained/purchased 2 Risk weighted assets 3 Rm Year initiated Rating agency Transaction type Asset type Jun 2013 Jun 2012 Dec 2012 Jun 2013 Jun 2012 Dec 2012 Jun 2013 Jun 2012 Dec 2012 Jun 2013 Jun 2012 Dec 2012 GreenHouse 2007 Fitch Traditional securitisation Home loans Precinct 2013 Moody s Traditional securitisation Commercial property loans This includes all assets identified for securitisation, including those home loans and commercial mortgages still awaiting registration of cession of the mortgage bond by the Deeds Office at 30 June This is the nominal amount of exposure and excludes accrued interest. 3 The regulatory capital held against these securitisation exposures is capped to the higher of the capital charge as per the IRB approach applicable to securitisations and the IRB capital that the bank would have held against the underlying assets have they not been securitised. LIQUIDITY FACILITIES PROVIDED TO NEDBANK S ASSET BACKED COMMERCIAL PAPER PROGRAMME Face value of notes outstanding Liquidity facilities Risk weighted assets Rm Year initiated Rating agency Transaction type Asset type Programme size Jun 2013 Jun 2012 Dec 2012 Jun 2013 Jun 2012 Dec 2012 Jun 2013 Jun 2012 Dec 2012 Synthesis 2004 Fitch ABCP programme Asset backed securities, corporate term loans and bonds Risk weighted assets restated for the December 2012 Synthesis securitisation exposures due to a recalibration of the Supervisory Formula Approach model. 2 This does not include Nedbank s investments in third party securitisations. There have been no revisions to the ratings of the notes issued by the group s securitisation programmes and the performance of the underlying portfolios of assets remains acceptable. Nedbank Group also fulfils a number of secondary roles as liquidity facility provider, hedge counterparty and investor to third party securitisation transactions. Proposed securitisation initiatives undertaken by Nedbank Group follow a rigorous internal approval process and are reviewed for approval by Group ALCO, Group Risk and Capital Management Committee and the Board. Retained securitisation exposures are reviewed and monitored by the relevant credit committees in the group, changes to retained securitisation exposures (ratings, redemptions, losses) reflect in the monthly BA 500 regulatory reporting. The processes do not differ for the liquidity facilities provided to Synthesis that are classified as resecuritisation exposures. Nedbank Group does not employ credit risk mitigation techniques to hedge credit risk on retained securitisation exposures or resecuritisation exposures. All securitisation transactions entered into thus far have involved the sale of the underlying assets to the special purpose vehicles. Nedbank Group has not originated or participated in synthetic securitisations. Nedbank Group Limited and Nedbank Limited Pillar 3 June

119 Nedbank Group complies with IFRS in recognising and accounting for securitisation transactions. In particular, the assets transferred to the GreenHouse securitisation vehicle and the Precinct securitisation vehicle continue to be recognised in the balance sheet of the bank and the securitisation vehicles are consolidated under Nedbank Group for financial reporting purposes, as is Synthesis. Securitisations are treated as sale transactions (rather than financing transactions). The assets are sold to the special purpose vehicles at carrying value and no gains or losses are recognised. The regulations relating to banks were amended, effective 1 January 2012, to incorporate the revised market risk and securitisation proposals in accordance with Basel II.5. The primary reasons for the increase in the risk weighted assets of the liquidity facilities provided to Synthesis are the classification of securitisation exposures into normal securitisation exposures and resecuritisation exposures, together with the associated increase in the Supervisory Formula Approach risk weight floor from 7% to 20% for resecuritisation exposures. The various roles fulfilled by Nedbank Group in securitisation transactions are indicated in the table below. Transaction Originator Sponsor Investor Servicer Precinct GreenHouse Synthesis Private Residential Mortgages (Pty) Limited Liquidity facility provider Credit enhancement provider Swap counterparty Private Mortgages 2 (Pty) Limited Fintech Receivables 2 (Pty) Limited MW Asset Rentals (Pty) Limited The table below shows the rating distribution of retained and purchased securitisation exposures. Rating (national scale) Securitisation Exposure GreenHouse Exposure Precinct Exposure Jun Jun Rm AAA or A1/P1 56 AA+ to AA A+ to A BBB+ to BBB BB+ to BB Unrated Unrated liquidity facilities to ABCP programme Total It should be noted that, while national scale ratings have been used in the table above, global scale equivalent ratings are used for regulatory purposes. The liquidity facilities provided to Synthesis have been reclassified as resecuritisation exposures as required in terms of the amended regulations relating to banks, effective from 1 January These resecuritisation exposures are held in the banking book. The table below shows the IRB consolidated group regulatory presentation per risk band for securitised exposures retained or purchased by Nedbank Group. Risk weighted bands Exposure Capital charge Capital deduction Rm Jun 2013 Jun 2012 Dec 2012 Dec 2012 Jun 2013 Jun 2013 Jun 2012 Jun % % % % % % or more % or more % or more % or more % or deducted Total This deduction relates entirely to the GreenHouse exposure. Nedbank Group did not securitise any exposures that were impaired or past due at the time of securitisation. No losses were recognised by the bank during the current reporting period. Dec 2012 Dec 2012 Jun 2013 Jun 2013 Jun 2012 Jun 2012 Dec 2012 Dec 2012 Nedbank Group Limited and Nedbank Limited Pillar 3 June

120 MARKET RISKS Market risk comprises four main areas: Market risk (or position risk) in the trading book, which arises exclusively in Nedbank Capital. Equity risk (a sub risk of investment risk) in the banking book, which arises in the private equity and property portfolios of Nedbank Capital and Nedbank Corporate respectively and in other strategic investments of the group; and property market risk (also a sub risk of investment risk), which arises from business premises, property required for future expansion and properties in possession. Interest rate risk in the banking book, which arises from repricing and/or maturity mismatches between on and off balance sheet components across all the business clusters. Interest rate risk in the Banking book (on page 137) is covered in the asset and liability management (ALM) section. Foreign exchange risk in the banking book which arises from the conversion of the group s/businesses offshore banking book assets or liabilities or commitments or earnings from foreign currency to local or function currency. Foreign exchange risk in the banking book (on page 141) is covered in the ALM section. Other than interest rate risk in the banking book (IRRBB), the group does not have significant risk appetite for, or exposure to, market risk. Nedbank s IRRBB is positioned for an upward interest rate cycle, but has been reduced to protect against downside risk in the short term. The focus of the trading businesses is to continue to develop the flow model by leveraging the deal flow from clients. Proprietary trading has been significantly scaled down. Equity risk in the banking book, or investment risk, is low relative to the rest of the balance sheet. All transactions with hedge funds are executed from a specialist unit with a primary focus on risk mitigation. IRRBB (high) SUMMARY OF NEDBANK GROUP S MARKET RISK PROFILE Jun 2013 Jun 2012 Dec 2012 Net interest income (NII) sensitivity to 1% decline in interest rates (equal and opposite positive NII impact for an increase in interest rates) (Rm) (938) 1 (903) 1 (813) 1 NII sensitivity to 2% decline in interest rates (equal and opposite positive NII impact for an increase in interest rates) (Rm) (1 901) (1 810) (1 665) % of ordinary shareholders equity (board limit: 2,25%) (%) 1,67 1,77 1,51 Trading market risk (low) % of group minimum economic capital requirement (%) 1,3 1,3 1,3 Total value at risk (VaR) (99%, one day VaR) exposure (average) (Rm) 7,0 17,8 14,7 Total stressed VaR exposure (99%, one day VaR at period end) (Rm) 12, ,1 Equity risk in the banking book (low) Total equity portfolio (Rm) % of total assets (%) 0,7 0,7 0,7 % of group minimum economic capital requirement (%) 3,4 4,5 3,9 Foreign currency translation (FCT) risk (low) Impact on group s total regulatory capital ratio for 10% change in the value of the rand (%) 0,1 0,1 0,1 1 Positioned for an upward interest rate cycle. Nedbank Group Limited and Nedbank Limited Pillar 3 June

121 Market risk strategy, governance and policy The Group Market Risk Management Framework, including governance structures, is in place to achieve effective independent monitoring and management of market risk as follows: The board's Group Risk and Capital Management Committee (GRCMC). The Group Asset and Liability Committee and Executive Risk Committee (Group ALCO), which is responsible for ensuring that the impact of market risks is being effectively managed and reported on throughout Nedbank Group, and that all policy, risk limit and relevant market risk issues are reported to the GRCMC. An independent function within the Group Risk Division, namely Group Market Risk Monitoring (GMRM), which monitors market risks across Nedbank Group this is a specialist risk area that provides independent oversight of market risk, validation of risk measurement, policy coordination and reporting. The Trading Risk Committee, which is responsible for ensuring independent oversight and monitoring of the trading market risk activities of the trading areas. In addition, the Trading Risk Committee approves new market risk activities and appropriate trading risk limits for the individual business units within the trading area. Committee meetings are held monthly and are chaired by the Head of GMRM. Members include the Chief Risk Officer, risk managers from the cluster, the cluster's Managing Executive and Executive Head of Risk as well as representatives from GMRM. The federal model followed by Nedbank Group in terms of which business clusters are responsible and accountable for the management of the market risks that emanate from their activities, with a separate risk function within each cluster. Specialist investment risk committees within the business areas. Meetings are convened monthly and as required to approve acquisitions and disposals, and on a quarterly basis to review investment valuations and monitor investment risk activities. Membership includes the Chief Risk Officer, Chief Financial Officer, Managing Executive and Executive Head of Risk of the relevant business cluster as well as a representative from GMRM. The board ultimately approves the market risk appetite and related limits for both the banking book (ALM and investments) and the trading book. GMRM reports on the market risk portfolio and is instrumental in ensuring that market risk limits are compatible with a level of risk acceptable to the board. No market risk is permitted outside these board approved limits. Hedging is an integral part of managing trading book activities on a daily basis. Banking book hedges are in line with Group ALCO strategies and stress testing is performed monthly to monitor residual risk. Nedbank Capital is the only cluster in the group that may incur trading market risk, but is restricted to the formal approval of securities and derivative products. Products and product strategies that are new to the business undergo a new product review and approval process to ensure that their market risk characteristics are understood and can be properly incorporated into the risk management process. The process is designed to ensure that all risks, including market, credit (counterparty), operational, legal, tax and regulatory (eg exchange control and accounting) risks are addressed and that adequate operational procedures and risk control systems are in place. Trading market risk Trading market risk is the potential for changes in the market value of the trading book resulting from changes in the market risk factors over a defined period. The trading book is defined as positions in financial instruments and commodities, including derivative products and other off balance sheet instruments that are held with trading intent or used to hedge other elements of the trading book. Categories of trading market risk include exposure to interest rates, equity prices, commodity prices, currency rates and credit spreads. A description of each market risk factor category is set out below: Interest rate risk primarily results from exposure to changes in the level, slope and curvature of the yield curve and the volatility of interest rates. Equity price risk results from exposure to changes in the price and volatility of individual equities and equity indices. Commodity price risk results from exposure to changes in spot prices, forward prices and volatilities of commodity products such as energy, agricultural products, and precious and base metals. Currency rate risk results from exposure to changes in spot prices, forward prices and volatilities of currency rates. Credit spread risk results from exposure to changes in the interest rate that reflects the spread investors receive for bearing credit risk. Nedbank Group Limited and Nedbank Limited Pillar 3 June

122 In addition to applying business judgement, management uses a number of quantitative measures to manage the exposure to trading market risk. These measures include: Risk limits based on a portfolio measure of market risk exposures referred to as value at risk (VaR), including expected tail loss. Scenario analysis, stress tests and other analytical tools that measure the potential effects on the trading revenue arising in the event of various unexpected market events. The material risks identified by these measures are summarised in daily reports that are circulated to, and discussed with, senior management. VaR is the potential loss in pre tax profit due to adverse market movements over a defined holding period with a specified confidence level. The 99% one day VaR number used by Nedbank Group reflects, at a 99% confidence level, that the daily loss will not exceed the reported VaR and therefore that the daily losses exceeding the VaR figure are likely to occur, on average, once in every 100 business days. The VaR methodology is a statistically defined, probability based approach that takes into account market volatilities as well as risk diversification by recognising offsetting positions and correlations between products and markets. VaR facilitates the consistent measurement of risk across all markets and products, and risk measures can be aggregated to arrive at a single risk number. Nedbank Group uses one year of historical data to estimate VaR. Some of the considerations that are taken into account when reviewing the VaR numbers are: The assumed one day holding period will not fully capture the market risk of positions that cannot be liquidated or offset with hedges within one day. The historical VaR assumes that the past is a good representation of the future, which may not always be the case. The 99% confidence level does not indicate the potential loss beyond this interval. While VaR captures Nedbank Group s exposure under normal market conditions, sensitivity and stress and scenario analysis (and in particular stress testing) are used to add insight into the possible outcomes under abnormal market conditions. In addition, other risk measures are used to monitor the individual trading desks and these include performance triggers, approved trading products, concentration of exposures, maximum tenor limits and market liquidity constraints. Market risk is governed by a number of policies that cover management, identification, measurement and monitoring. In addition, all market risk models are subject to periodic independent validation in terms of the Group Market Risk Management Framework. Trading market risk activities within Nedbank Group are adequately capitalised. In terms of economic capital, the capital requirement is based on value at risk (VaR) trading limits, which is a conservative approach as limit utilisation is generally moderate. In addition to VaR, stress testing is applied on a daily basis to identify exposure to extreme market moves. Trading market risk governance The trading market risk governance structure is aligned with the Group Market Risk Management Framework mentioned above. The relevant documentation has been comprehensively reviewed to ensure that an appropriate management and control environment supports the aspiration of a worldclass risk management environment. At the end of 2010 Nedbank Group's application for approval to use the Internal Model Approach (IMA) for regulatory market risk measurement was approved by the SARB with effect 1 January The daily responsibility for market risk management resides with the trading business unit heads in Nedbank Capital. Nedbank Capital has a market risk team that operates independently of the dealing room and is accountable for independent monitoring of the activities of the dealing room within the mandates agreed by the Trading Risk Committee. Independent oversight is provided to the business by GMRM. Market risk reports are available at a variety of levels and details, ranging from individual trader level right through to a group level view of market risk. Market risk limits are approved at board level and are reviewed periodically, but at least annually. The limits approved by the board are VaR and stress trigger limits. These limits are then allocated within the business clusters. Market risk exposures are measured and reported to management and bank executives on a daily basis. Documented policies and procedures are in place to ensure that exceptions are timeously resolved. Additional risk measures have been set to monitor the individual trading desks and include performance triggers, approved trading products, concentration of exposures, maximum tenor limits and market liquidity constraints. Nedbank Group Limited and Nedbank Limited Pillar 3 June

123 Trading market risk profile Most of Nedbank Group s trading activity is managed in Nedbank Capital. This includes market making and the facilitation of client business in the foreign exchange, interest rate, equity, credit and commodity markets. Nedbank Capital focuses primarily on client activities and flow trading in these markets. Risk type NEDBANK GROUP TRADING BOOK VALUE AT RISK Historical VaR (99%, one day VaR) Rm Average Minimum 1 Maximum 1 End of period January June 2013 Foreign exchange 2,5 0,6 5,8 2,1 Interest rate 4,6 2,6 10,2 3,6 Equity 2,1 0,9 5,4 0,9 Credit 3,5 3,1 4,7 3,4 Commodity 0,4 0,0 1,2 0,4 Diversification 2 (6,1) (4,4) Total VaR exposure 7,0 5,1 11,4 6,0 January June 2012 Foreign exchange 5,3 2,0 15,3 2,4 Interest rate 8,9 4,5 13,8 10,6 Equity 6,1 0,9 13,0 0,9 Credit 2,7 1,6 4,2 2,8 Commodity 0,8 0,4 2,0 1,6 Diversification 2 (6,0) (7,2) Total VaR exposure 17,8 9,6 33,5 11,1 January December 2012 Foreign exchange 4,4 0,8 15,3 1,9 Interest rate 8,6 4,5 15,4 5,0 Equity 4,6 0,9 13,0 2,9 Credit 2,6 1,5 4,2 3,1 Commodity 0,9 0,1 3,1 0,6 Diversification 2 (6,4) (5,5) Total VaR exposure 14,7 6,2 33,5 8,0 1 The maximum and minimum VaR values reported for each of the different risk factors do not necessarily occur on the same day. As a result, a diversification number for the maximum and minimum values has been omitted from the table. 2 Diversification benefit is the difference between the aggregate VaR and the sum of VaRs for the five risk types. This benefit arises because the simulated 99%/one day loss for each of the five primary market risk types occurs on different days. Rm 35 VaR UTILISATION FOR THE 18 MONTHS ENDED JUNE 2013 (99%, ONE DAY VAR) Jan 12 Feb 12 Mar 12 Apr 12 May 12 Jun 12 Jul 12 Aug 12 Sep 12 Oct 12 Nov 12 Dec 12 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 One day VaR Average VaR VaR is an important measurement tool and the performance of the model is regularly assessed through a process called backtesting. This is done by reviewing the daily VaR over a one year period (on average 250 trading days) and comparing the actual and hypothetical daily trading revenue (including net interest income but excluding commissions and primary revenue) with the VaR estimate and counting the number of times the trading loss exceeds the VaR estimate. Nedbank Group Limited and Nedbank Limited Pillar 3 June

124 The graph below illustrates the daily normal VaR for the 18 month period to 30 June Nedbank Group remained within the approved risk appetite and the VaR limits allocated by the board, which remain low, with trading market risk consuming only 1,3% and 1,5% of group economic capital and regulatory capital respectively. During May and June 2012 the higher daily VaR was mainly due to the foreign exchange risk factor. During this period the higher than usual directionality due to options in this risk factor resulted in an elevated potential risk as calculated by the VaR model. These positions were significantly reduced during the latter part of the year, resulting in a decreased contribution from this risk factor. The first quarter of 2013 was characterised by low market volatility. In contrast, the second quarter of 2013 saw a significant uptick in volatility across major risk types, largely due to weaker economic data globally and comments by the US Federal Reserve hinting at a reduction in quantitative easing. VaR PROFIT AND LOSS FOR THE 18 MONTHS ENDED JUNE 2013 Rm (10) (20) (30) (40) Jan 12 Feb 12 Mar 12 Apr 12 May 12 Jun 12 Jul 12 Aug 12 Sep 12 Oct 12 Nov 12 Dec 12 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Profit and loss VaR 1 In November 2012 Nedbank Capital facilitated a number of hedging transactions. These deals resulted in a significant positive trading income. Nedbank Group s trading businesses (including net interest income, commissions and primary revenue credited to Nedbank Group s trading businesses) produced a daily revenue distribution that is skewed to the profit side, with trading revenue being realised on 342 days out of a total of 373 days in the period. The average daily trading revenue generated for the period, excluding that related to investment banking, was R8,03m (December 2012: R7,61m). In November 2012 Nedbank Capital facilitated a number of hedging transactions. These deals resulted in a significant positive trading income. Number of trading days ANALYSIS OF TRADING REVENUE FOR THE 18 MONTHS ENDED JUNE 2013 <(35) (35) to (30) (30) to (25) (25) to (20) (20) to (15) (15) to (10) (10) to (5) (5) to 0 0 to 5 5 to to to to to to 35 >35 Trading income (Rm) Nedbank Group Limited and Nedbank Limited Pillar 3 June

125 Trading market risk stress testing Stress testing is used to supplement VaR. Nedbank Capital uses a number of stress scenarios to measure the impact on portfolio values of extreme moves in markets, based on historical experience as well as hypothetical scenarios. The stress testing methodology assumes that all market factors move adversely at the same time and that no actions are taken during the stress events to mitigate risk, reflecting the decreased liquidity that frequently accompanies market shocks. Stress test results are reported daily to senior management and monthly to the Trading Risk Committee and Group ALCO. RISK EXPOSURES PER RISK FACTOR Rm Average High 1 Low 1 End of period June 2013 Foreign exchange stress Interest rate stress Equity stress Credit spread stress Commodity stress Overall June 2012 Foreign exchange stress Interest rate stress Equity stress Credit spread stress Commodity stress Overall December 2012 Foreign exchange stress Interest rate stress Equity stress Credit spread stress Commodity stress Overall The high and low stress values reported for each of the different risk factors do not necessarily occur on the same day. As a result the high and low risk factor stress exposures are not additive. RISK EXPOSURES FOR THE 18 MONTHS ENDED JUNE 2013 Rm Jan 12 Jan 12 Feb 12 Mar 12 Mar 12 Apr 12 May 12 Jun 12 Jun 12 Jul 12 Aug 12 Sep 12 Sep 12 Oct 12 Nov 12 Nov 12 Dec 12 Equity stress IR stress Credit stress FX stress Commodity stress Nedbank Group trading book stressed VaR As part of the Basel II.5 update to the Banks Act regulations, implemented in South Africa on 1 January 2012, the risk weighted assets (RWA) for market risk now require an addon for stressed VaR as opposed to being based purely on normal VaR as required by Basel II. This resulted in a significant increase of the RWA required for market risk from R3,8bn to R5,3bn and a small impact on normal capital adequacy ratios due to Nedbank Group s risk profile having a very low trading market risk component. Nedbank Group Limited and Nedbank Limited Pillar 3 June

126 Stressed VaR is calculated using market data taken over a period through which the relevant market factors were experiencing stress. Nedbank Group uses historical data from the period 1 July 2008 to 30 June This period captures significant volatility in the SA market. The information in the following table is the comparison of the VaR using three different calculations at 30 June The three different calculations are historical VaR, extreme tail loss and stressed VaR. The extreme tail loss measures the expected loss in the tail of the distribution and stressed VaR uses a volatile historical data period. A 99% confidence level and one day holding period are used for all the calculations. COMPARISON OF TRADING VaR June 2013 Rm Historical VaR 99% (one day VaR) Stressed VaR 99% (one day VaR) Extreme Tail Loss Foreign exchange 2,1 3,1 2,6 Interest rates 3,6 9,6 4,8 Equities 0,9 2,1 1,0 Credit 3,4 7,1 5,0 Commodities 0,4 0,3 0,4 Diversification (4,4) (10,0) (6,3) Total VaR exposure 6,0 12,1 7,6 The table below summarises the 10 day 99% Stressed VaR for Stressed VaR has been calculated for regulatory purposes since 1 January 2012 (following approval from the SARB in the 2011 IMA review). Stressed VaR is calculated weekly and is included on the daily BA325 and monthly BA320 that are submitted to the SARB. It is calculated using a 99% confidence interval for a one day holding period and then scaled to a 10 day holding period. NEDBANK GROUP TRADING BOOK STRESSED VaR Risk type Historical stressed VaR (99%, 10 day VaR) Rm Average Minimum 1 Maximum 1 End of period January June 2013 Foreign exchange 22,5 3,5 59,8 9,7 Interest rate 46,1 25,4 81,0 30,4 Equity 24,4 6,7 44,5 6,7 Credit 24,3 13,9 29,7 22,5 Commodity 1,3 0,2 3,1 0,9 Diversification 2 (51,9) (31,8) Total stressed VaR exposure 66,7 37,4 105,2 38,4 January to December 2012 Foreign exchange 22,8 5,6 48,5 22,2 Interest rate 60,8 36,1 96,5 54,2 Equity 27,4 7,7 80,8 23,9 Credit 8,7 4,3 13,9 13,4 Commodity 2,4 0,2 8,3 2,0 Diversification² (35,4) (61,5) Total stressed VaR exposure 86,7 53,1 171,6 54,2 1 The maximum and minimum VaR values reported for each of the different risk factors do not necessarily occur on the same day, As a result, a diversification number for the maximum and minimum values has been omitted from the table. 2 Diversification benefit is the difference between the aggregate VaR and the sum of VaRs for the five risk types. This benefit arises because the simulated 99%/one day loss for each of the five primary market risk types occurs on different days. During 2012 the Basel Committee on Banking Supervision (Basel Committee) published a consultation paper on the fundamental review of the trading book, despite the new 2012 requirements of Basel II.5. Although the final form of the proposals will only crystalise in 2013, it is clear that a major regulatory shift is expected. Nedbank is well positioned with its current market risk systems to implement the proposals currently being considered. Nedbank Group Limited and Nedbank Limited Pillar 3 June

127 Trading market risk under the IMA for regulatory capital The graph below shows the reconciliation between regulatory capital and economic capital requirements for market risk as at 30 June ECONOMIC CAPITAL VERSUS REGULATORY CAPITAL Rm (47) 591 (201) Undiversified ECap 30 June 2012 ECap VaR limit versus RegCap VaR utilisation 30 June 2012 Basel II.5 RegCap 30 June 2012 Change in RegCap Basel III RegCap 30 June 2013 ECap VaR limit versus RegCap VaR utilisation 30 June 2013 Undiversified Ecap 30 June 2013 Equity risk The total equity portfolio for investment risk is R4 722m (December 2012: R4 492m). A total of R3 218m (December 2012: R3 414m) of this portfolio is held for capital gain, while the balance predominantly comprises strategic investments. Rm Fair value disclosed in balance sheet (excluding associates and joint ventures) Fair value disclosed in balance sheet (including associates and joint ventures) Jun 2013 Publicly listed Privately held Total Jun 2012 Dec 2012 Jun 2013 Jun 2012 Dec 2012 Jun 2013 Jun 2012 Dec Equity risk in the banking book is a very small component of the group s balance sheet, comprising only 0,7% of the group s total assets, 3,4% of the group s total economic capital requirement and 3,9% of the group s risk weighted assets. EQUITY INVESTMENTS HELD FOR CAPITAL GAIN (PRIVATE EQUITY) REPORTED IN NON INTEREST REVENUE (NIR) Nedbank Group Nedbank Capital Nedbank Corporate Jun Jun Dec Jun Jun Dec Jun Jun Dec Rm Securities dealing (71) (105) 43 (38) Investment income dividends received Total Realised Unrealised (73) 22 (49) (105) (47) (103) Total Equity investments held for capital gain are generally classified as 'fair value through profit and loss', with fair value gains and losses reported in NIR. Strategic investments are generally classified as 'available for sale', with fair value gains and losses recognised directly in equity. Nedbank Group Limited and Nedbank Limited Pillar 3 June

128 ASSET AND LIABILITY MANAGEMENT Asset and liability management (ALM) addresses two of the 17 key risk types in the group's Enterprisewide Risk Management Framework (ERMF), namely liquidity risk and market risk in the banking book, which in turn includes interest rate risk in the banking book and foreign currency translation risk on foreign based capital, investments, loans and/or borrowings. Liquidity risk There are two types of liquidity risk, specifically funding liquidity risk and market liquidity risk. Funding liquidity risk is the risk that Nedbank Group is unable to meet its payment obligations as they fall due. These payment obligations could emanate from depositor withdrawals, the inability to roll over maturing debt or meet contractual commitments to lend. Market liquidity risk is the risk that the group will be unable to sell assets, without incurring an unacceptable loss, in order to generate cash required to meet payment obligations under a stress liquidity event. The primary role of a bank in terms of financial intermediation is the transformation of short term deposits into longer term loans. By fulfilling the role of maturity transformation banks are inherently susceptible to liquidity mismatches and consequently funding and market liquidity risks. Through the robust Liquidity Risk Management Framework, Nedbank Group manages the funding and market liquidity risk to ensure that banking operations continue uninterrupted under normal and stressed conditions. The key objectives that underpin the Liquidity Risk Management Framework include maintaining financial market confidence at all times, protecting key stakeholder interests and meeting regulatory liquidity requirements. Liquidity risk management is a vital risk management function in all entities across all jurisdictions and currencies, and is a key focus for Nedbank Group. Liquidity risk governance and policy The board of directors retains ultimate responsibility for the effective management of liquidity risk. Through the Group Risk and Capital Management Committee (GRCMC) (a board subcommittee), the board has delegated its responsibility for the management of liquidity risk to the Group ALCO. Nedbank Group's Liquidity Risk Management Framework articulates the board approved risk appetite in the form of limits and guidelines, and sets out the responsibilities, processes, reporting and assurance required to support the management of liquidity risk. The Liquidity Risk Management Framework is reviewed annually by Group ALCO and approved by the GRCMC. Within Nedbank Group's Balance Sheet Management (BSM) cluster a dedicated funding and liquidity function is responsible for the strategic management of funding and liquidity across the group. The group's daily liquidity requirements are managed by an experienced Centralised Funding Desk (CFD) within Group Treasury. Within the context of the board approved Liquidity Risk Management Framework, BSM and the CFD are responsible for proactively managing liquidity risk at an operational, tactical and strategic level. KEY AREAS OF FOCUS Operational liquidity Daily CFD focus: operational and tactical Projected daily liquidity requirements Liquid assets and cash reserve requirements Daily clearing and settlement Participation in the money market shortage and interbank reliance Operation within approved liquidity risk limits and guidelines Managing and maintaining market access Tactically managing seasonal and cyclical liquidity requirements Liquidity risk appetite and strategy Tactical and strategic liquidity Weekly monthly, quarterly and annual BSM focus: strategic and tactical Balance sheet optimisation Funding base diversification Liquidity buffers and internal assessment of liquidity selfsufficiency for stress scenarios Pricing for liquidity risk through the funds transfer pricing process Enhancing structural liquidity Best international practice a Nedbank Group Limited and Nedbank Limited Pillar 3 June

129 In terms of the overall liquidity risk management process independent oversight and assurance are provided by Group Market Risk Monitoring (GMRM) and Group Internal Audit, which conduct independent reviews. In the case of Nedbank Group's subsidiaries and foreign branches, liquidity risk is managed through the individual Asset and Liability Committees (ALCOs) established in each of these businesses. These businesses are required to have appropriate governance structures, processes and practices designed to identify, measure, manage and mitigate liquidity risk in accordance with the group's Liquidity Risk Management Framework. These businesses are required to report into the Group ALCO on a monthly basis. Liquidity Risk Management Framework and management processes Based on the Basel Committee's principles for sound liquidity risk management and other best practice principles, Nedbank Group's Liquidity Risk Management Framework takes into account all sources and uses of liquidity and seeks to optimise the balance sheet by balancing the trade off between liquidity risk on the one hand and cost or profitability on the other. This optimisation process (as depicted below) is managed by taking cognisance of: Nedbank Group's contractual maturity mismatch between assets and liabilities. The business as usual (BaU) mismatch arising from normal market conditions. The stress mismatch or stress funding requirement likely to arise from a continuum of plausible stress liquidity scenarios. The quantum of stress funding sources available to meet a scenario specific stress funding requirement. NEDBANK S LIQUIDITY RISK MANAGEMENT FRAMEWORK Stress Funding Requirement Stress Funding Sources Embedded within the Liquidity Risk Management Framework is Nedbank Group's Internal Liquidity Adequacy Assessment Process (ILAAP). The ILAAP involves an ongoing and rigorous assessment of Nedbank Group's liquidity self sufficiency under a continuum of stress liquidity scenarios, taking into consideration the board approved risk appetite. The ILAAP also involves an ongoing review and assessment of all components that collectively make up and/or support the Liquidity Risk Management Framework. The objective of this review and assessment process is to ensure that the framework remains sound in terms of measuring, monitoring, managing and mitigating liquidity risk, taking cognisance of best practise and regulatory developments. Based on the most recent internal review process it is evident that Nedbank Group is compliant with the Basel 'Principles for Sound Liquidity Risk Management' and the new Basel III requirements while Nedbank s Liquidity Risk Management Framework and ILAAP appropriately encapsulate the key principles embedded in the Basel III liquidity standards. Nedbank Group Limited and Nedbank Limited Pillar 3 June

130 Nedbank Group's ILAAP internal review and assessment process, which is designed to ensure that the Liquidity Risk Management Framework remains robust is depicted graphically below. NEDBANK GROUP'S INTERNAL REVIEW AND ASSESSMENT PROCESS Annually Semi annually/quarterly Monthly/daily Liquidity risk policies Liquidity risk contingency plan (LRCP) Liquidity risk appetite, limits, guidelines and buffers Liquidity model assumptions, principles and methodologies Principles and methodologies applied to pricing assets and liabilities for liquidity risk Annual funding strategy (Designed to support liquidity objectives and balance sheet optimisation) Independent review of liquidity risk management in subsidiaries and branches Liquidity risk premium and charges applied through the Funds Transfer Pricing Framework Appropriateness of the continuum of liquidity stress testing scenarios Off balance sheet liquidity risk (Loan covenants, securitisation vehicles, derivative positions, revocable and irrevocable commitments, etc) Liquidity early warning indicators Best practice and regulatory developments a Monthly funding and liquidity review: (As reported to ALCO) Key areas of focus Compliance with limits, guidelines and buffers Prevailing market conditions from a funding and market liquidity risk perspective Actual asset/liability growth versus funding plan impact on liquidity risk management objectives Liquidity adequacy based on stress testing and scenario analysis Depositor concentration risk Rollout of liquidity risk mitigating strategies Liquidity risk within subsidiaries and branches Daily funding and liquidity review: Key areas of focus Projected liquidity requirements Compliance with limits, guidelines and buffers Cash reserves and liquid assets Participation in the money market shortage Settlement and clearing Access to market As presented above, the Liquidity Risk Management Framework is supported by a number of management processes designed to manage and mitigate liquidity risk under normal and stressed market conditions. The key management processes and activities are summarised below: Intraday liquidity risk management The need to manage and control intraday liquidity in real time is recognised by the group as a critical process. The CFD is responsible for ensuring that the bank always has sufficient intraday liquidity to meet any obligations it may have in the clearing and settlement systems. In addition, net daily funding requirements are forecast by estimating daily rollovers and withdrawals and managing the funding pipeline of new deals. The CFD is responsible for maintaining close interaction with the bank's larger depositors in order to manage their cashflow requirements and the consequential impact on the bank's intraday liquidity position. Liquidity buffer portfolio A portfolio of marketable and highly liquid assets, which could be liquidated to meet unforeseen or unexpected funding requirements, is maintained. The market liquidity by asset type (and for a continuum of plausible stress scenarios) is considered as part of the internal stress testing and scenario analysis process. Funding strategy formulation and execution In terms of achieving the board approved liquidity risk appetite, the BSM cluster formulates a detailed funding strategy on an annual basis, which is approved by Group ALCO. The execution of the annual funding plan is then monitored monthly through the Funding Strategy Forum and Group ALCO. As per the current funding strategy the key objectives can be summarised as follows: Continue to diversify the funding base to achieve an optimal mix between wholesale, commercial and retail funding. Maintain the funding profile to achieve the targeted contractual and BaU maturity mismatch. Achieve the lowest weighted average funding cost within the context of the targeted liquidity risk profile. Nedbank Group Limited and Nedbank Limited Pillar 3 June

131 Scenario analysis and stress testing The BSM cluster conducts regular scenario analysis and stress testing in order to assess the adequacy of the group's liquidity buffers and contingency funding plans required to meet idiosyncratic and market wide stress liquidity events. Through scenario analysis and stress testing the BSM cluster is able to: Evaluate the impact of various scenarios on the group's liquidity. Set limits and guidelines designed to position the group better for a stress liquidity event. Formulate appropriate actions designed to reduce the severity of a liquidity crisis. Determine appropriate funding strategies and initiatives designed to support liquidity risk mitigation. The objective of scenario analysis and stress testing is to identify potential weaknesses or vulnerabilities, thus enabling the group to formulate strategies designed to mitigate potential weaknesses. Nedbank Group's approach to estimating the stress maturity mismatch in relation to the BaU and contractual maturity mismatch is depicted graphically below. CONTRACTUAL VERSUS BUSINESS AS USUAL VERSUS STRESS MATURITY MISMATCH Stress and scenario testing is a key risk management process that complements sound liquidity risk management and contingency planning. Contingency funding and liquidity planning Nedbank Group's Liquidity Risk Contingency Plan (LRCP) as set out in the Liquidity Risk Management Framework is designed to protect depositors, creditors and shareholders under adverse liquidity situations. The LRCP has been formulated in the belief that early detection, advance preparations and prompt responses can contribute to liquidity crisis avoidance or minimisation, and that accurate, timely and coordinated communication both internally and externally is essential for managing a crisis situation. The LRCP establishes guidelines for managing a liquidity crisis, identifying early warning signs of a possible liquidity event and the need for heightened liquidity risk monitoring and reduced liquidity risk exposure. In addition, the LRCP identifies the individuals responsible for formulating and executing Nedbank Group's response to a liquidity event (the Liquidity Steering Committee). The LRCP was rigorously tested in 2011 through a liquidity simulation that involved all relevant internal and external participants. The simulation was managed independently by one of the large audit firms and now forms part of the group s regular stress testing. The group performed exceptionally well during this exercise. Any areas of improvement identified have subsequently been implemented. Nedbank Group Limited and Nedbank Limited Pillar 3 June

132 The process for invoking the LRCP is depicted in the following table. LIQUIDITY RISK CONTINGENCY PLAN Early warning indicators/triggers Liquidity triggers monitored daily by BSM and the Central Funding Desk BSM and Central Funding Desk Any member of Group ALCO can escalate trigger breaches to the Chief Executive (CE), Chief Financial Officer (CFO), Chief Operating Officer (COO) and Chief Risk Officer (CRO) CE, CFO, COO and CRO Group CE invokes the plan and convenes the LSC and handles all communication Liquidity Steering Committee (LSC) LSC informs board and SARB of actions being taken Board and SARB Liquidity risk portfolio review Nedbank Group remains well funded with a strong liquidity position, underpinned by a further lengthening of the funding profile, a large surplus liquid asset buffer, a strong loan to deposit ratio, low reliance on interbank and foreign currency funding, and a reduction in capital market issuance during the first half of 2013 as part of the group s capital planning. On 6 January 2013 the Basel Committee announced final revisions to, and confirmed the implementation of, the liquidity coverage ratio (LCR). The LCR will be phased in between 2015 and Previously 100% compliance was required from 2015, whereas now the minimum LCR requirement will be phased in starting at 60% in 2015, and increasing by 10% each year to 100% in The definition of 'high quality liquid assets (HQLA)' has been widened and 'Level 2' assets now include a new '2B' subcategory. The definitions of net cash outflows have been relaxed. The Basel Committee will continue to do further work in terms of the role of central bank liquidity facilities in jurisdictions where there are insufficient HQLAs available for purposes of the LCR. In May 2012 the SARB, as per Guidance Note 05/2012, announced that it would provide a committed liquidity facility (CLF) for an amount up to 40% of the LCR requirements. Based on industry estimates, compliance with the net stable funding ratio (NSFR) remains structurally challenging. Consequently Nedbank will continue to work closely with the SARB, peer groups and National Treasury in addressing the structural challenges. The Basel Committee has, however, announced that work to revise the NSFR will commence in 2013 and span a period of up to 24 months. Across the globe market participants are expecting fundamental changes to the NSFR. Nedbank s strong liquidity and funding position is illustrated by the following: Based on the current level of qualifying HQLA, Nedbank is well positioned to meet the minimum LCR requirement of 60% in 2015 excluding any use of the SARB s CLF. Assuming targeted access to the currently available CLF, Nedbank is well positioned to exceed the 100% requirement of Nedbank has maintained significant sources of quick liquidity amounting to R102,7bn, representing 14,4% of total assets, which is underpinned by R25,0bn of surplus statutory liquid assets, ie an excess over and above the prudential statutory liquid asset requirement. The surplus statutory liquid assets are aligned with internal targets and represent a level deemed appropriate from the perspective of already positioning Nedbank Group to meet the 2015 Basel III LCR requirement. Nedbank Group Limited and Nedbank Limited Pillar 3 June

133 NEDBANK GROUP HAS SIGNIFICANT SOURCES OF QUICK LIQUIDITY 5% 7% 3% 16% 5% 7% 3% 9% 6% 7% 2% 7% Corporate bonds and listed equities Marketable securities 13% 11% R113,1bn 22% 14% 12% R105,4bn 24% 15% 12% R102,7bn 24% Surplus liquid assets, including notes and coins Prudential liquid assets Cash reserves Other bank paper and unutilised bank credit lines 23% 26% 27% Jun Dec 2012 Jun 2013 Price sensitive overnight loans Other 1 In June 2012 Nedbank had unusually large liquidity inflows as a result of a corporate action transaction where this surplus liquidity was parked in marketable securities. The three month average long term funding ratio increased to 28% in June 2013, compared with 26% in December The successful commercial mortgage backed securitisation issue of R2bn in March 2013 contributed to the longer funding profile and further growth in the Nedbank Retail savings bonds of R0,5bn, bringing the total amount issued to R7,7bn, has contributed positively to diversifying Nedbank s long term funding sources. In addition to the issuances outlined above that supported the long term funding profile in the first half of 2013, Nedbank successfully issued R3,2bn in senior unsecured debt in July 2013, positioning Nedbank well for the second half of While Nedbank targets an average long term funding ratio of no less than 25%, the actual ratio does fluctuate around this target level, based on aggregate demand for long term deposits and other term instruments. The loan to deposit ratio remains consistently below 100%, at 96,3%. The annual Internal Liquidity Adequacy Assessment Process (ILAAP) and Internal Capital Adequacy Assessment Process (ICAAP) were signed off by the board of directors through the GRCMC on 8 July LIQUIDITY AND FUNDING PROFILE Jun 2013 Jun 2012 Dec 2012 Total sources of quick liquidity (Rm) Surplus statutory liquid assets (Rm) Statutory liquid assets and cash reserves (ie SARB prudential minimum) (Rm) Other sources of quick liquidity 1 (Rm) Total sources of quick liquidity as a % of total assets (%) 14,4 16,9 15,4 Long term funding ratio (three month average) (%) 28,0 27,0 26,0 Senior unsecured debt (Rm) Retail Savings Bond 2 (Rm) Green Retail Savings Bond 2 (Rm) Reliance on NCDs 3 (%) 14,4 16,1 14,0 Capital market issuance (Rm) Loan to deposit ratio (%) 96,3 95,6 95,7 Basel III pro forma liquidity ratios LCR (effective date 2015 to 2019) including targeted access to the CLF 4 (%) Pro forma compliant Pro forma compliant Pro forma compliant NSFR (effective date 2018) 5 (%) WIP 6 WIP 6 WIP 6 1 This includes corporate bonds, listed equities and other marketable securities. 2 These represent Nedbank s Retail Savings Bonds with tenures of two, three and five years. During 2012 Nedbank launched the Green Retail Savings Bond, the proceeds of which are earmarked for renewable energy projects. 3 As a % of total deposits. 4 A 60% minimum LCR is required from 2015, increasing 10% per annum to 100% by Finalisation of the NSFR by the Basel Committee is still 12 to 24 months away. Globally it is expected that the ratio will be significantly revised and that a pragmatic approach will ultimately be followed. 6 WIP = work in progress. Nedbank Group Limited and Nedbank Limited Pillar 3 June

134 The contractual and BaU liquidity mismatches of the group are presented below. Based on client behavioural attributes, it is estimated that 95% (December 2012: 94%) of the amounts owed to depositors are stable. NEDBANK GROUP CONTRACTUAL LIQUIDITY GAP Rm Next day 2 to 7 days 8 days to 1 month 1 to 2 months 2 to 3 months 3 to 6 months 6 to 12 months > 12 months Total June 2013 Cash and cash equivalents Other short term securities Derivative financial instruments Government and other securities Loans and advances Other assets Total assets Total equity Derivative financial instruments Amounts owed to depositors Provision and other liabilities Long term debt instruments Total equity and liabilities Net liquidity gap June 2013 ( ) (14 735) (4 283) (15 604) Net liquidity gap June 2012 ( ) (22 280) (5 870) (11 832) (23 428) NEDBANK GROUP BAU LIQUIDITY GAP Rm Next day 2 to 7 days 8 days to 1 month 1 to 2 months 2 to 3 months 3 to 6 months 6 to 12 months > 12 months Total June 2013 Cash and cash equivalents Other short term securities Derivative financial instruments Government and other securities Loans and advances Other assets Total assets Total equity Derivative financial instruments Amounts owed to depositors Provision and other liabilities Long term debt instruments Total equity and liabilities Net liquidity gap June (305) (67 102) Net liquidity gap June (1 303) (42 176) Net liquidity gap December (925) (61 851) Nedbank Group Limited and Nedbank Limited Pillar 3 June

135 The BaU table above shows the expected liquidity mismatch under normal market conditions after taking into account the behavioural attributes of stable deposits, savings and investment products, rollover assumptions associated with term deals, but excluding BaU management actions. The next day BaU liquidity mismatch is positive with cash inflows exceeding outflows. As illustrated below, Nedbank Group s overnight to one month liquidity position has improved so far in 2013 compared with 2012 based on the BaU liquidity mismatch. This has been achieved through a strategy of lengthening the funding profile and managing the asset/liability composition from a behavioural perspective. Furthermore, Nedbank has enhanced its behavioural models using statistical approaches and assumptions that are more aligned with empirical historical data observed from Nedbank s balance sheet. NEDBANK GROUP'S BEHAVIOURAL LIQUIDITY MISMATCH 1 % % (1) (3) 1) (5) 2) (7) #REF! #REF! 1 Expressed on total assets and based on maturity assumptions before rollovers June 2012 December 2012 ) (9) June 2013 (11) 4) Next day 2 to 7 days 8 days to 1 month 1 to 2 months 2 to 3 months 3 to 6 months 6 to 12 months >12 months 1 Expressed on total assets and based on maturity assumptions before rollovers and risk management. NEDBANK LIMITED CONTRACTUAL LIQUIDITY GAP Rm Next day 2 to 7 days 8 days to 1 month 1 to 2 months 2 to 3 months 3 to 6 months 6 to 12 months > 12 months Total June 2013 Contractual maturity of assets Loans and advances Trading, hedging and other investment instruments Other assets Contractual maturity of liabilities Stable deposits Volatile deposits Trading and hedging instruments Other liabilities Net liquidity gap June 2013 ( ) (133) (11 688) (2 038) (21 915) Net liquidity gap June 2012 ( ) (17 403) (3 458) (10 125) (30 059) Net liquidity gap December 2012 ( ) (12 538) (19 564) (8 490) (17 170) Nedbank Group Limited and Nedbank Limited Pillar 3 June

136 The BaU table below shows the expected liquidity mismatch under normal market conditions after taking into account the behavioural attributes of Nedbank Limited s stable deposits, savings and investment products. NEDBANK LIMITED BAU LIQUIDITY GAP Rm Next day 2 to 7 days 8 days to 1 month 1 to 2 months 2 to 3 months 3 to 6 months 6 to 12 months > 12 months Total June 2013 BaU maturity of assets Loans and advances Trading, hedging and other investment instruments Other assets BaU maturity of liabilities Stable deposits Volatile deposits Trading and hedging instruments Other liabilities Net liquidity gap June (54 951) Net liquidity gap June (3 536) (3 618) (34 611) Net liquidity gap December (19) (2 434) (43 227) Nedbank Limited s BaU inflows exceed outflows in the cumulative next day one month time bucket taking into account behavioural assumptions, including rollover assumptions associated with term deals, but excluding BaU management actions. As illustrated below, Nedbank Limited s overnight one month liquidity position has improved so far in 2013 compared with 2012 based on the BaU liquidity mismatch. This has been achieved through a strategy of lengthening the funding profile and managing the asset/liability composition from a behavioural perspective. NEDBANK LIMITED S BEHAVIOURAL LIQUIDITY MISMATCH 1 % % (1) (3) 1) (5) #REF! #REF! 1 Expressed on total assets and based on maturity assumptions before rollovers June 2012 December ) (7) 3) (9) June ) (11) Next day 2 to 7 days 8 days to 1 month 1 to 2 months 2 to 3 months 3 to 6 months 6 to 12 months >12 months 1 Expressed on total assets and based on maturity assumptions before rollovers and risk management. Nedbank Group Limited and Nedbank Limited Pillar 3 June

137 Interest rate risk in the banking book Nedbank Group is exposed to interest rate risk in the banking book (IRRBB) primarily due to the following: The bank writes a large quantum of prime linked advances. To lengthen the funding profile of the bank, term funding is raised across the curve at fixed term deposit rates that reprice only on maturity. Three month repricing swaps and forward rate agreements are typically used in the risk management of term deposits and fixed rate advances. Short term demand funding products reprice to different short end base rates. Certain non repricing transactional deposit accounts are non rate sensitive. The bank has a mismatch in net non rate sensitive balances, including shareholders funds that do not reprice for interest rate changes. This is evident when reflecting on the group's balance sheet repricing profile before hedging (illustrated on page 139). The balance sheet is clearly asset sensitive as assets reprice quicker than liabilities due to the extent of prime linked advances, followed by a repricing of term deposits as they mature out to one year and fixed rate advances as they mature after that. A net non rate sensitive credit balance sheet position remains, which comprises equity, non repricing transactional deposits, debtors, fixed assets and creditors. IRRBB comprises: Repricing risk (mismatch risk) timing difference in the maturity (for fixed rate) and repricing (for floating rate) of bank assets, liabilities and off balance sheet positions. Reset or basis risk imperfect correlation in the adjustment of the rates earned and paid on different instruments with otherwise similar repricing characteristics. Yield curve risk changes in the shape and slope of the yield curve. Embedded optionality the risk related to interest related options embedded in bank products. IRRBB strategy, governance, policy and processes IRRBB is managed within Nedbank Group's ERMF under market risk. The board of directors retains ultimate responsibility for the effective management of IRRBB. Through the Group Risk and Capital Management Committee (GRCMC) (a board subcommittee) the board has delegated its responsibility for the management of IRRBB to the Group ALCO. The Group ALCO, a subcommittee of the board's GRCMC, proactively manages IRRBB. BSM provides strategic insight and motivation in managing IRRBB to Group ALCO through appropriate risk reporting and analytics and by providing strategic input based on the committee's interest rate views, impairment sensitivity and defined risk appetite. The board assumes ultimate responsibility for IRRBB and has defined the group's overall risk appetite for IRRBB. Appropriate limits have been set to measure this risk for both earnings and economic value, within which this risk must be managed. Compliance with these limits is measured and reported to the Group ALCO and the board on a monthly basis. IRRBB is actively managed through a combination of on and off balance sheet strategies, including hedging activities. Hedging is typically transacted on a portfolio basis for deposits and retail advances, albeit that larger, longer dated deposits along with fixed rate advances are typically individually hedged. The principle interest rate related contracts used include interest rate swaps and forward rate agreements. Basis products, caps, floors and swaptions may be used to a lesser extent. The principle on balance sheet components used in changing the repricing profile of the balance sheet include the liquid asset portfolio, term deposits and fixed rate advances. IRRBB strategies are evaluated regularly to align with interest rate views, impairment sensitivity and defined risk appetite. Group ALCO continues to analyse and manage IRRBB incorporating the likely change in impairments for similar interest rate changes. This relationship between interest rate sensitivity and impairments, which is seen as a natural net income hedge, is a key focus of the Group ALCO in managing IRRBB. This analysis includes an assessment of the lag in impairment changes and the increasing change in impairment charges for consecutive interest rate changes. Due to the complexity in determining the extent of this natural net income hedge, particularly during interest rate peaks and troughs, the modelling of this relationship and associated risk management strategies is challenging and continues to be refined and improved. On balance sheet strategies are executed through any one of the business units, depending on the chosen strategy. Changes to the structural interest rate risk profile of the banking book are achieved primarily through the use of the derivative instruments mentioned above and/or new on balance sheet products. Hedges are transacted through Group Treasury via the ALM desk, whereby unwanted IRRBB is passed through a marketmaking desk into market risk limits or into the external market. Hedged positions and hedging instruments are regularly measured and stress tested for effectiveness and reported to Group ALCO on a monthly basis. These hedged positions and hedging instruments are fair valued in line with the appropriate accounting standards and designation. Group ALCO typically has strategic appetite up to one year and, largely as a matter of policy, eliminates reprice risk longer than Nedbank Group Limited and Nedbank Limited Pillar 3 June

138 one year, unless Group ALCO chooses to lengthen the investment profile of its equity and/or the non repricing transactional deposit accounts in order to improve the alignment of interest rate sensitivity with impairment sensitivity or improve the balance sheet position for forecast interest rate changes. Such strategic decisions must however maintain interest rate sensitivity and the economic value of equity within boardapproved limits. IRRBB cannot be taken by business units and is accordingly extracted from these units via an established matched maturity funds transferpricing solution. This solution removes repricing risk from the business units, while leaving credit and funding spread in the businesses, on which they are measured. However, certain basis risk and the endowment on free funds and non repricing transactional deposits reside within these businesses in order for basis risk to be managed through pricing and for the endowment on these balances to naturally hedge impairment sensitivity for similar interest rate changes. Strategies regarding the reprice risk are measured and monitored separately, having been motivated by the Balance Sheet Management (BSM) cluster and approved by Group ALCO. IRRBB measurement, policies and portfolio review The group employs various analytical techniques to measure interest rate sensitivity monthly within the banking book on both an earnings and economic value basis. This includes a repricing profile analysis, simulated modelling of the bank's earnings at risk and economic value of equity for a standard interest rate shock, and stress testing of earnings at risk and economic value of equity for multiple stressed interest rate scenarios. These analyses include the application of both parallel and non parallel interest rate shocks and rate ramps. Assets, liabilities and derivative instruments are modelled and reported based on their contractual repricing or maturity characteristics. Where advances are exposed to prepayments and deposits to ambiguous repricing, Group ALCO approves the use of prepayment models for the hedging of fixed rate advances and behavioural repricing assumptions for the modelling and reporting of ambiguous repricing deposits. Nedbank Group's interest rate repricing profile graphically represents the repricing of floating rate assets and liabilities and maturity of fixedrate assets and liabilities through a repricing time series. The net repricing profile before hedging (graph on the following page) clearly highlights the asset sensitivity of the group's balance sheet. The net repricing profile after hedging highlights the impact of hedging that better aligns the repricing of assets and liabilities across the curve, with the residual risk largely transferred into the three month repricing area clearly depicted graphically before and after hedging. Rm NEDBANK GROUP INTEREST RATE REPRICING GAP < 3 months > 3 months < 6 months > 6 months < 12 months > 1 year Non rate sensitive and trading book June 2013 Net repricing profile before hedging (7 169) (20 065) (70 060) Net repricing profile after hedging (70 060) Cumulative repricing profile after hedging June 2012 Net repricing profile before hedging (18 532) (26 399) (62 586) Net repricing profile after hedging (2 254) (62 586) Cumulative repricing profile after hedging December 2012 Net repricing profile before hedging (11 216) (4 490) (72 540) Net repricing profile after hedging (72 540) Cumulative repricing profile after hedging Rm June 2013 NEDBANK LIMITED INTEREST RATE REPRICING GAP < 3 months > 3 months < 6 months > 6 months < 12 months > 1 year Non rate sensitive and trading book Net repricing profile before hedging (9 060) (21 091) (46 178) Net repricing profile after hedging (46 178) Cumulative repricing profile after hedging June 2012 Net repricing profile before hedging (18 347) (28 541) (37 778) Net repricing profile after hedging (1 778) (1 832) (37 778) Cumulative repricing profile after hedging December 2012 Net repricing profile before hedging (14 112) (5 279) (43 993) Net repricing profile after hedging (1 331) (43 993) Cumulative repricing profile after hedging Nedbank Group Limited and Nedbank Limited Pillar 3 June

139 The Nedbank Limited < 3 months positive net repricing profile after hedging has started to increase in 2013, with a corresponding decrease in this position between the > 3 months and < 12 months repricing buckets, as a result of the Group ALCO strategy to reduce the group s sensitivity for a further interest rate cut, in the short to medium term, nearing maturity. This strategy was executed through the acquisition of treasury bills as part of the group s liquid asset buffer portfolio. These assets were not hedged, thereby exposing the group to fixed interest rate risk, thus reducing interest rate sensitivity through a period of uncertainty in which there was increased downside risk to interest rates. Rm * NEDBANK GROUP INTEREST RATE REPRICING PROFILE June 2012 net repricing profile aer hedging December 2012 net repricing profile aer hedging June 2013 net repricing profile before hedging (20 000) (40 000) (60 000) (80 000) < 3 months > 3 months < 6 months Area of active risk management actions > 6 months < 12 months * > 1 year Non rate sensitive and Trading book * June 2013 net repricing profile aer hedging Non rate sensitive capital, working capital and transactional balances expose the balance sheet to sensitivity as net advances are positioned to reprice in < 3 months. Rm * NEDBANK LIMITED INTEREST RATE REPRICING PROFILE June 2012 net repricing profile aer hedging December 2012 net repricing profile aer hedging June 2013 net repricing profile before hedging (20 000) (40 000) (60 000) (80 000) < 3 months > 3 months < 6 months Area of active risk management actions > 6 months < 12 months * > 1 year Non rate sensitive and Trading book * June 2013 net repricing profile aer hedging Non rate sensitive capital, working capital and transactional balances expose the balance sheet to sensitivity as net advances are positioned to reprice in < 3 months. At June 2013 the net interest income (NII) sensitivity of the group s banking book for a 1% parallel reduction in interest rates is 1,67% of total group ordinary shareholders equity (December 2012: 1,51%), which is well within the board s approved risk limit of 2,25%. This exposes the group to a decrease in NII of approximately R938m before tax should interest rates fall by 1%, measured over a 12 month period. NII sensitivity, as currently modelled, exhibits very little convexity and results in an increase in pretax NII of approximately similar amounts should interest rates increase by 1%. Over the past 18 months the group s NII sensitivity has been actively managed through on and off balance sheet interest rate risk management strategies for the groups expected interest rate view. Nedbank Limited s economic value of equity (EVE), measured for a 1% parallel decrease in interest rates remain at a low level of R113m at June 2013 (December 2012: R81m). The low level of EVE is the result of the group s risk management strategies whereby assets and liabilities are positioned to reprice in the < 3 month repricing bucket and net working capital offsets the non rate sensitive transactional balances. Nedbank Group Limited and Nedbank Limited Pillar 3 June

140 The table below highlights the group's and bank's exposure to interest rate risk, measured for normal and stressed interest rate changes. Rm Note NII sensitivity 1 EXPOSURE TO INTEREST RATE RISK Jun 2013 Nedbank Limited Other Group Companies Nedbank Group Jun 2012 Dec % instantaneous decline in interest rates (749) (721) (643) (189) (182) (170) (938) (903) (813) 2% instantaneous decline in interest rates (1 523) (1 447) (1 325) (378) (363) (340) (1 901) (1 810) (1 665) Basis interest rate risk sensitivity 2 0,25% narrowing of prime/call differential (294) (240) (258) (0) (3) (0) (294) (243) (258) Economic value of equity sensitivity 3 1% instantaneous decline in interest rates (113) (299) (81) n/a n/a n/a n/a n/a n/a 2% instantaneous decline in interest rates (249) (613) (174) n/a n/a n/a n/a n/a n/a NII sensitivity Instantaneous stress shock 1 4 (5 679) (5 006) (5 269) n/a n/a n/a n/a n/a n/a Instantaneous stress shock modelled as a ramp 1 5 (4 291) (3 648) (4 217) n/a n/a n/a n/a n/a n/a 1 Stressed interest rate changes. n/a: not modelled. Notes 1. NII sensitivity, as currently modelled, exhibits very little convexity. In certain cases the comparative figures have been estimated assuming a linear risk relationship to the interest rate moves. 2. Basis interest rate risk sensitivity is quantified using a narrowing in the prime/call interest rate differential of 0,25% and is an indication of the sensitivity of the margin to a squeeze in short term interest rates. 3. Economic value of equity sensitivity is calculated as the net present value of asset cashflows less the net present value of liability cashflows. 4. The instantaneous stress shock is derived from the principles espoused in the Basel Committee paper 'Principles for the Management and Supervision of Interest Rate Risk'. 1st and 99th percentile observed interest rate changes over a five year period with a one year holding period have been used. 5. The instantaneous stress shock modelled as a ramp uses the same interest rate shock as the instantaneous stress shock described above, but the rate shock is phased in over an eight month period. Liquid asset portfolios Nedbank s management of IRRBB comprehensively covers the interest rate risk associated with its prudential and buffer liquid asset portfolios, including reprice risk and basis risk. Risk strategies comprise on and off balance sheet components whereby the associated interest rate risk of the group s liquid asset portfolios is used to reduce the reprice sensitivity associated with long term debt, to manage apposing basis risk on such debt and/or is hedged using derivatives positions removing the associated repricing risk. Alternatively, where the associated risk cannot be used within the banking book such risk is transferred through market risk limits into the trading book. Sound risk management of this portfolio is a clear example of Nedbank s embedded interest rate risk management approach in managing risks within clearly defined risk appetite. By way of reference, if this portfolio was not risk managed, as articulated above, significant losses would have been realised on these portfolios as global bond yields spiked in May This followed a significant weakening of the Rand as emerging markets fell out of favour and the reference made by Ben Bernanke to a reduction in the pace of bond purchases this year. Jun 2013 Jun 2012 Dec 2012 Jun 2013 Jun 2012 Dec 2012 June 2013 Rm Notional At fair value through profit or loss Designated Available for sale financial assets Held to maturity investments Government and other securities Other short term securities Total Nedbank s liquid asset portfolios accounting treatment is determined by the group s interest rate risk management strategies as described above. Nedbank Group Limited and Nedbank Limited Pillar 3 June

141 Sensitivity June 2013 Rm Notional Portfolio sensitivity per bp Δ H1 Δ in yield (bps) (portfolio average) Sensitivity assuming no risk management Maximum H1 Δ in yield (bps) (portfolio average) Sensitivity assuming no risk management Government and other securities ,7 +77 (746) +168 (1 628) Other short term securities ,3 +30 (38) +52 (65) Total ,0 +71 (783) +155 (1 694) ZAR AND BOND YIELD VOLATILITY IN 2013 ZAR / USD 10,50 10,25 10,00 9,75 9,50 9,25 9,00 8,75 8,50 8,25 8,00 % 7,50 7,25 7,00 6,75 6,50 6,25 6,00 5,75 5,50 5,25 R203 Dec 12 Jan 13 Jan 13 Jan 13 Jan 13 Feb 13 Feb 13 Feb 13 Feb 13 Mar 13 Mar 13 Mar 13 Mar 13 Apr 13 Apr 13 Apr 13 Apr 13 Apr 13 May 13 May 13 May 13 May 13 Jun 13 Jun 13 Jun 13 Jun 13 ZAR/USD R203 Bond The fair value losses on these portfolios would have approximated R0,8bn at June 2013 and, at the height of bond yield moves during this period, could have been as high as R1,7bn had this portfolio not been appropriately risk managed as described above. Foreign currency translation risk Foreign currency translation risk is the risk that the bank s exposures to foreign capital will lose value as a result of shifts in the exchange rate. As Nedbank Group is a rand reporting entity, its risk is in a strengthening of the rand. In accordance with the SARB circular 2/2012 foreign currency translation (FCT), share based payments (SBP) and available for sale (AFS) reserves qualify as regulatory capital under Basel III with effect from 1 January The inclusion of FCT in qualifying regulatory capital and reserves results in an additional supply of Common Equity Tier 1 capital of R957m for the group at June $m (US dollar equivalent) NEDBANK GROUP OFFSHORE CAPITAL SPLIT BY FUNCTIONAL CURRENCY Jun 2013 Jun 2012 Dec 2012 Total Total Forexsensitive Non forexsensitive Forexsensitive Non forexsensitive Forexsensitive Non forexsensitive US dollar Pound sterling Swiss franc Malawi kwacha Other Total Limit Equity in forex sensitive foreign subsidiaries has decreased marginally by 7,48% to $283m. Total offshore capital has also decreased by 8,58% to $826m at 30 June 2013, largely as a result of the weaker pound sterling relative to the US dollar (ie $1,5228/GBP relative to $1,6175/GBP at end of June 2013 and December 2012 respectively). Foreign currency translation risk remains relatively low and is aligned with the appropriate offshore capital structure of the group. The total risk weighted assets for the group s foreign entities is approximately R17,3bn, being low at approximately 4,52% of the group. The average Total Tier 1 ratio for capital of the group s foreign denominated business is 8,7% and well above the regulatory requirements. Any foreign exchange rate movement will therefore have a small effect on Nedbank Group s capital adequacy. Total Nedbank Group Limited and Nedbank Limited Pillar 3 June

142 Net interest margin Net interest income (NII) grew 6,9% to R10 309m (June 2012: R9 642m), supported by growth in average interest earning banking assets of 6,1%. NIM has continued to improve in a challenging macroeconomic environment, on the back of the group s portfolio tilt strategy and strong margin management. NIM improved by 4bps from 3,54% in June 2012 to 3,58% in June 2013 and by 5bps from 3,53% in December Margin gains were underpinned by mix enhancements, sound risk adjusted pricing of new advances and backbook advances runoff, offset to a degree by lower endowment margin as a result of lower interest rates following the interest rate cut in July The improvement in the marginal cost of funds is due to a small decrease in rates and deposit mix enhancements. Liability pricing improved due to the increase in mix contribution from current accounts in Corporate and Business Banking and strong growth in call, term and fixed deposits as a result of the increased focus on deposit strategies, allowing a reduced reliance on wholesale deposits. It is pleasing to highlight that all business clusters, with the exception of Nedbank Wealth (who experienced a squeeze across most advances categories as a result of very low interest rates in their offshore related business and increasingly competitive markets), have grown NIM. Jun 2013 Jun Dec bps Rm bps Rm bps Rm Interest earning banking assets (year to date average) Opening NIM Growth in banking assets Improved asset mix and pricing Cost of enhancing liquidity risk (Basel III) (12) (4) (248) (6) (330) Impact due to interest rate change (2) (123) 13 (3) (162) Reduction in marginal cost of funds Improved liability mix (2) (94) Lower reliance on long term debt 1 57 (1) (26) (1) (37) Other (15) 1 46 (1) (64) Closing NIM Prior year s numbers restated to align with current period. NIM breakdown by business Bps (Increase Decrease ) Jun 2013 Jun 2012 Dec 2012 Nedbank Group Nedbank Capital Nedbank Corporate Nedbank Business Banking Nedbank Retail Nedbank Wealth Central Management including Rest of Africa STRENGTHENING NIM TRENDS 1 DESPITE LOWER INTEREST RATES AND CONTINUING TOUGH MACRO ENVIRONMENT SINCE ,60 % 3,58 12,50 11,90 12,00 3,55 3,53 11,50 11,00 3,50 3,48 10,50 3,45 10,00 9,90 9,50 9,00 8,50 8,50 9,00 3,40 8,50 3,39 3,36 8,00 3,35 7,50 Dec 2009 Dec 2010 Dec 2011 Dec 2012 Jun 2013 Nedbank Group Prime (RHS) NIM has been adjusted for the reclassification of acceptances. Nedbank Group Limited and Nedbank Limited Pillar 3 June

143 INSURANCE RISK Insurance underwriting risk Insurance underwriting risk can be defined as the risk associated with the underwriting process where it permits the client to enter risk pools with a higher level of risk than priced for by the group, resulting in a possible loss. Nedbank Group insurance risk encompasses underwriting and product design risk. Actuarial and statistical methodologies are used to price insurance risk (eg morbidity, mortality, theft). Underwriters align clients with this pricing basis and respond to any anti selection by placing clients in substandard risk pools, pricing this risk with an additional risk premium, excluding certain claim events or causes, or excluding clients from entering pools at all. The failure to reinsure with acceptable quality reinsurers (beyond the level of risk appetite mandated by the board of directors) for risks underwritten by the short term insurance and/or life assurance activities of the group, and also including catastrophe insurance (ie more than one insurance claim on the group arising from the same event), could lead to disproportionate losses (reinsurance risk). Insurance underwriting activities are predominantly undertaken by Nedgroup Life Assurance Company Limited (Nedgroup Life) and Nedgroup Insurance Company Limited (Nedgroup Insurance) within the Nedbank Wealth Cluster. Nedgroup Life offers credit life, simple risk and savings solutions, as well as a set of differentiated underwritten individual risk life products supported by a wellness programme. A large part of the book is derived from the provision of life cover linked to Nedbank Group s lending activities. Nedgroup Insurance is a short term insurer that focuses predominantly on homeowner s insurance, personal accident and vehiclerelated value add products for the retail market. Insurance underwriting risk strategy, governance and policy Insurance risk is included in the ERMF, which consists of formal risk policy documentation and effective governance structures. These structures encompass management oversight to achieve independent monitoring. The insurance risk policy for the group formalises and communicates an approach to managing underwriting risk by adopting industrywide principles and standards. Although Nedgroup Life and Nedgroup Insurance are responsible and accountable for the management of all risks that emanate from insurance activities, underwriting risk is included in the Group ERMF and rolls up into various other governance structures, via its link into the Insurance Risk Framework. Internal and external actuaries at appropriate levels, play an oversight role with respect to underwriting activities including reporting and monitoring procedures in respect of product, valuation, reinsurance, pricing, and regulation. The framework seeks to ensure that risk characteristics are properly understood, incorporated and managed where insurance activities are undertaken. Risks associated with new or amended products in the insurance business units follow the group's formal product approval policy, which include pricing and risk reviews by the statutory actuary; an approval at cluster executive and group executive level, which are subsequently managed through the Risk Management Framework outlined above. The boards of Nedgroup Life and Nedgroup Insurance acknowledge responsibility for risk management. Management is accountable to the board and the group for designing, implementing and integrating a risk management process. This allows for optimised risk taking that is objective and transparent and ensures that the business prices risk appropriately, linking it to return, and adequately addressing insurance underwriting risks in its day to day activities. Insurance underwriting risk is managed during the underwriting process in the following manner: Monitoring of the concentration of exposures and changes in the environment. Profile analysis. Monitoring of key ratios to ensure that they are in line with expectations and to identify any potential areas of concern or any changes in the claims patterns. Biannual monitoring of policy movements to identify possible changes to initial risk profiles and pricing. Compilation of an underwriting manual to ensure proper underwriting guidelines are in place and to ensure consistency in the risk acceptance process. Assessing underwriting engine assumptions and results to help revise future assumptions Annual repricing of premiums if the claim experience is worse than anticipated. Monitoring of the concentration of insurance risk, which includes the assessment of geographical spreads, the impact of catastrophe reinsurance, maximum losses per single events and mitigations that include sufficient reassurance and reviewable pricing and exclusions. Nedbank Group Limited and Nedbank Limited Pillar 3 June

144 Monitoring of rigorous assessment procedures to ensure that only valid claims are paid. Monitoring of effective reinsurance programmes. Independent monitoring by the group on a quarterly basis to assess capital adequacy ratios, net claims ratios and maximum losses per client after taking reinsurance into consideration. Monitoring of key process and key risk indicators in the Actuarial Review Committee and the Underwriting Review Committee. Seeking board approval for significant decisions including the assessment of investment risk, evaluation of reinsurance partners, review of capital provision, credit appetite and financial soundness. Monitoring of underlying investment risk by the Investment Committee on a quarterly basis, which covers asset and liability matching and fund and asset management performance. However, policyholder investment mandates are matched on a monthly basis. Exposure limits are agreed and approved by the boards of the company before approval is sought from the Group ALCO. Following and applying modelling methodologies that are regulated by the Actuarial Society of South Africa, or in the absence of such guidance, in accordance with worldclass risk management principles. Solvency II and SAM The Financial Services Board (FSB) is introducing a revised prudential regime for insurance, the Solvency Assessment and Management (SAM) regime, to ensure that regulation of the SA insurance sector remains in line with international best practice. SAM is based on Solvency II, a risk based capital adequacy directive being implemented for European insurers and reinsurers in SAM, like Basel II, is based on three pillars and is intended to be implemented on 1 January 2016 (previously 2015). The FSB will be running light parallel runs in 2014 with more comprehensive parallel runs in The insurance businesses are on track with their SAM implementation through a proactive approach that has been embedded in risk management frameworks, strategic initiatives and system enhancements. Nedbank is comfortable that these requirements will become part of our business as usual reporting as the regulations evolve further. SAM regulations have been embedded into existing risk frameworks with a heightened focus on governance structures and reporting. Governance committees, policies and processes have been optimised to cater for the new requirements within the existing business units and oversight. The approach taken by the businesses is to ensure strategic alignment of SAM by using risk management in the business decision making framework and business planning processes. This is evident in a detailed Own Risk and Solvency Assessment (ORSA) process that is being embedded in the existing reporting structures. It is an integral component of the insurance companies Enterprisewide Risk Management Framework (ERMF), Capital Management Framework, strategy and business planning and day to day business operations and decisions. Insurance risk in Nedbank As discussed above, insurance risk arises in the Nedbank Wealth cluster and is assumed by Nedgroup Life and Nedgroup Insurance. The Nedbank Wealth Cluster, which also provides banking and asset management services, is a capital and liquidity 'light' business that generates high returns off a low risk profile. Accordingly, it is considered a high growth area in the group s portfolio tilt strategy. Insurance risk consumes only 1,2% (December 2012: 0,8%) of the group minimum economic capital requirement. The solvency ratios are reflected in the following table: Regulatory minimum SOLVENCY RATIOS Long term insurance (Nedgroup Life) 1,00x > 1,5x 5,3x 5,8x 5,1x Short term insurance (Nedgroup Insurance) 1,25x > 1,3x 1,8x 2,0x 1,6x 1 Management target range is based on the greater of regulatory and economic capital. Target range 1 Jun 2013 Jun 2012 Dec 2012 In SA the regulators currently require insurers to hold capital at a minimum of 1 times cover for long term insurance and 1,25 times for shortterm insurance. The long term insurance ratio is well above statutory and management target levels mainly due to strong organic earnings over the year. The ratios improved slightly from 5,1 times at year end to 5,3 times at 30 June The short term insurance ratio improved from 1,6 times (December 2012) to 1,8 times (June 2013), which is well above the target level. Nedbank Group Limited and Nedbank Limited Pillar 3 June

145 OPERATIONAL RISK Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputational risk. Legal risk includes, but is not limited to, exposure to fines, penalties or punitive damages resulting from supervisory actions, as well as private settlements. Operational risk is not typically taken in pursuit of an expected return, but exists as part of the normal course of business at all levels. Operational risk management is aimed at protecting the business (by inter alia minimising internal losses, reducing cost, enhancing controls, preventing or detecting revenue leakage) and to build a durable business (for example, increase efficiencies and effectiveness, streamline processes, reduce waste, redundancy and downtime, introduce new internal controls, lessening the impact of external events like natural disasters). Nedbank Group s approach to managing operational risk In December 2010 the South African Reserve Bank (SARB) authorised Nedbank Group to use the Advanced Measurement Approach (AMA). Consequently, the group now calculates its operational risk regulatory capital requirements using partial and hybrid AMA. Partial use is where a bank, controlling company or banking group is using AMA for some parts of its operations and The Standardised Approach (TSA) for the remainder of its operations. Hybrid AMA is the attribution of group operational risk capital to legal entities by means of an allocation mechanism. The approval by the SARB confirms the existence, across the group, of sound operational risk governance practices aimed at identifying, measuring, managing and mitigating operational risks. The group continues to invest in the improvement of its operational risk measurement and management approaches. The AMA Operational Risk Management Framework (ORMF) was approved by the board s Group Risk and Capital Management Committee (GRCMC). The AMA methodologies contained therein have been rolled out and embedded in the businesses, including for the purposes of the ICAAP. Business clusters act as the first line of defence and are responsible for the identification, management, monitoring and reporting of operational risk. Operational risk is reported and monitored through the divisional and cluster enterprise wide risk committees and overseen by the Group Operational Risk Committee (GORC) and the board s GRCMC. The Group Operational Risk Management division within the Group Risk cluster acts as the second line of defence in the Nedbank ERMF. The primary responsibilities of Group Operational Risk Management are to develop, maintain and champion the Group ORMF, policies and enablers to support operational risk management in the business as well as implementation of the Basel III, regulatory requirements and international best practice for operational risk management. To ensure that Nedbank operational risk practices remain sound and aligned with new operational risk standards, Nedbank benchmarked itself with the papers published by the Basel Committee in 2011: 'Principles for the Sound Management of Operational Risk' and 'Operational Risk and Supervisory Guidelines for the Advanced Measurement Approaches'. Operational Risk Management Framework The diagram below depicts Nedbank Group s AMA ORMF elements: NEDBANK GROUP S AMA ORMF ELEMENTS Nedbank Group Limited and Nedbank Limited Pillar 3 June

146 Specialist functions in Group Risk, for example Forensic Services, Business Continuity Planning, Group Legal, Information Security and Corporate Insurance, also assist group businesses with specialist advice, policies and standard setting. Pervasive operational risk trends are monitored and reported on to the enterprise wide risk committees and, where appropriate, to GORC and to the board s GRCMC. Group Internal Audit, being the third line of defence, provides assurance to GORC and the board. Operational risk measurement, processes and reporting systems The primary operational risk measurement processes in the group include risk and control self assessments, internal loss data collection processes and governance, the tracking of key risk indicators (KRIs), external loss data, scenario analysis and capital calculation, which are designed to function in an integrated and mutually reinforcing manner. Risk and control self assessment Risk and control self assessment is a forward looking process through which business unit management identifies risks that could threaten the achievability of business objectives and offers a set of controls and actions to mitigate the risks. Key risk indicators KRIs are designed to be both forward and backward looking in the sense that they function not only as early warning indicators, but also as escalation triggers where set risk tolerance levels have been exceeded. Internal loss data collection The internal loss data collection process and tracking is backward looking and enables the monitoring of trends and the analysing of the root causes of loss events. Operational risk losses are reported in the Nedbank Internal Loss Data Collection System. Nedbank internal loss data trends 100% GROSS LOSSES BY EVENT TYPE % 17,83% 20,21% 80% 37,67% 43,95% 36,47% 44,45% 70% 60% 46,33% 39,64% 50% 27,97% 40% 39,63% 36,42% 27,30% 30% 20% 10% 0% 25,69% 10,08% 7,40% 10,15% 12,63% 12,23% Dec 08 Dec 09 Dec 10 19,91% 12,68% 15,65% 15,57% Dec 11 Dec 12 31,73% 8,42% Jun 13 Other Internal Fraud Execution, Delivery and Process Management Clients, Products and Business Practices External Fraud Business Disruption and System Failures The graph above reflects the top three categories for Nedbank Group s gross internal losses by event type for each year from 2008 to Nedbank Group s operational risk loss profile, from internal loss data, over the five year period is dominated by execution delivery and process management, external fraud and clients, products and business practices (CPBP). Business Disruption and System Failures feature more significantly in the first half of 2013, whilst CPBP is not as significant as in previous periods. The gross losses depicted are prior to any recoveries being taken into account. A low percentage of operational risk loss experience to gross operating income was maintained and significant material loss events were limited. Boundary events Boundary events are those losses and near misses that manifest themselves in other risk types, such as credit and market risk, but have relevance to operational risk because they emanate from operational breakdowns or failures. Boundary events are often identified by credit and market risk management, and are included in credit risk loss databases and operational risk capital calculations respectively. Nedbank Group Limited and Nedbank Limited Pillar 3 June

147 Material credit risk events caused by operational failures in the credit processes are flagged separately in the Internal Loss Data Collection System. In line with the Banks Act and Basel III requirements, holding of capital related to these events remains in credit risk. These events are included as part of the ORMF to assist in the monitoring, reporting and management of the control weaknesses and causal factors within the credit process. Material market risk events caused by operational failures in the market risk processes are also flagged separately in the Internal Loss Data Collection System. The capital holding thereof is included in operational risk capital. External loss data External data is used to incorporate infrequent, yet relevant and potentially severe, operational risk exposures into the measurement model. The group currently incorporates the effects of external data in the operational risk capital calculation model indirectly, in conjunction with the scenario analysis process. Nedbank is a member of and actively participates in working groups of the Operational Riskdata exchange Association (ORX). ORX accumulates data submitted by each of the 64 member banks on a quarterly basis. In addition, the group subscribes to the SAS OpRisk Global Database which is data sourced from the media and other sources within the public domain. Scenario analysis Operational risk scenario analysis is a required element of the AMA and is defined in the ORMF as one of the data sources for operational risk modelling and measurement. It serves as the main input for operational risk loss exposure estimation. Scenario analysis is conducted in a disciplined and structured way using expert judgement to estimate the operational risk exposure of the group. Scenario analysis focuses on solvency and aims to identify the major operational risks that can negatively affect the solvency of the group. Nedbank shares and uses a set of anonymous operational risk scenarios shared through ORX in order to identify trends and benchmark with international peers. Business environment and internal control factors (BEICFs) The group takes into account BEICFs during the conduct of risk and control self assessments. Consideration of BEICF enables the group to take into account any changes in the external and internal business environment, consider inherent risks as a result of any changes in the business environment and design appropriate controls. Capital modelling and capital allocation Nedbank calculates its operational risk regulatory capital requirements using partial and hybrid AMA with effect from 31 December The majority of the group is on AMA and only a small portion of the group is on the TSA (10%) which includes operations in the Rest of Africa. Under AMA, Nedbank has approval to use an internal model to more accurately determine risk based operational risk capital requirements for all business units on AMA. Internal loss data and operational risk scenarios represent the main input into the model. The outputs of the other data elements, internal loss data, external loss data and BEICFs are the main inputs into the scenarios. The model generates a regulatory capital requirement, which is determined at a 99,9% confidence level. The final capital is then calculated by including updates for TSA entities and meeting SARB minimum requirements relating to a capital floor. The model and outputs undergo a robust annual validation exercise. Any issues identified are reported, tracked and addressed in accordance with Nedbank s risk governance processes. Operational risk capital is allocated on a risk sensitive basis to clusters in the form of economic capital charges, providing an incentive to improve controls and to manage these risks within established operational risk appetite levels. Operational risk appetite Nedbank has a board approved operational risk appetite statement which is aligned to the Group Risk Appetite Policy. The operational risk appetite combines both quantitative metrics and qualitative judgement to encapsulate financial and non financial aspects of operational risk. The operational risk appetite statement makes explicit reference to key operational risks. The group continues to focus on refining the operational risk appetite and participates in industry forums such as ORX to continuously enhance the process and remain aligned with international leading practice. Reporting A well defined and embedded reporting process is in place. Operational risk profiles, loss trends and risk mitigation actions are reported to and monitored by the risk governance structures of the group. Nedbank Group Limited and Nedbank Limited Pillar 3 June

148 Operational risk governance structure The diagrams below depict the operational risk among others, governance and reporting structures within Nedbank Group. NEDBANK GROUP S GOVERNANCE STRUCTURE Board BOARD COMMITTEES Group Risk and Capital Management Committee (GRCMC) GOVERNANCE FLOW EXECUTIVE COMMITEE Operational Committee (OPCOM) Group Operational Risk Committee (GORC) Internal Model Committee (IMC) Independent Model Validation CLUSTER LEVEL Client facing cluster (x6) Non client facing cluster (x8) Enterprisewide Risk Committee (ERCO) 1 ST LINE OF DEFENCE Group Operational Risk Management 2 ND LINE OF DEFENCE Internal Audit 3 RD LINE OF DEFENCE NEDBANK GROUP S REPORTING AND COMMITTEE STRUCTURE Board GROUP LEVEL Operational Committee (OPCOM) Group Risk and Capital Management Committee (GRCMC) Independent Model Validation Group Operational Risk Committee (GORC) Internal Model Committee (IMC) Scenario Review Forum INFORMATION FLOW INDEPENDENT MONITORING LEVEL Operational Risk Monitoring Business Continuity Management Information Risk Services Group Legal and Risk Services Group Forensic Services Corporate Insurance Tax Compliance Financial Control Initiative INTERNAL AUDIT Client facing cluster (x6) Non client facing cluster (x8) EXECUTION LEVEL Enterprisewide Risk Committees (ERCO) Cluster Division Business unit Nedbank Retail Business Banking Nedbank Corporate Nedbank Wealth Nedbank Capital Rest of Africa Group Technology Human Resources Balance Sheet Management Finance Group Risk Enterprise Governance and Compliance Group Strategic Planning Group Marketing Communications and Corporate Affairs Nedbank Group Limited and Nedbank Limited Pillar 3 June

149 Managing subcomponents of operational risk Specific subcomponents of operational risks recognised and managed by Nedbank Group include: Financial crime We consider financial crime a major operational risk that has the potential to lead to significant losses. As such, we undertake vigorous active risk management to mitigate this risk. Fraud risk management Given the financial losses and negative social impact of fraud, we proactively combat this type of crime and dishonesty in our group while also striving to protect our shareholders and clients from falling victim to unscrupulous individuals and organised crime groupings. Fraud prevention measures include internal and external whistleblowing reporting lines, anti corruption initiatives and cybercrime combating capabilities. Internal fraud and dishonesty At Nedbank Group we maintain a policy of zero tolerance towards any dishonesty among our staff members. During January to July 2013, 83 Nedbank employees were dismissed for dishonesty as a result of internal investigations. Assessment of fraud and corruption risk The risk of internal and external fraud is evaluated on several levels within the organisation: Risk and control self assessments are regularly conducted to ensure appropriate controls and monitoring; Fraud key risk and control indicators are monitored, tracked and reported on; Facilitated fraud risk assessments are undertaken as per the International Standards for Auditing 240 (ISA 240); New products, and all processes related to their use, are evaluated to ensure that all aspects of fraud risk, legal risk and regulatory risk (such as the anti money laundering requirements) are considered; and Annual fraud and corruption risk assessments are conducted in terms of the UK Bribery Act Personnel integrity management Nedbank employees are expected to maintain the highest standards of honesty and integrity and to act with due care and diligence at all times. People risk is managed and minimised through specific controls that are incorporated into our recruitment and selection processes for all employees, including permanent staff, contractors, temporary employees and consultants. In addition to minimising the group s vulnerability to fraud, embezzlement, theft, corruption and mismanagement, these processes help to cultivate a culture of ethics and integrity in keeping with our group s values. The Financial Advisory and Intermediary Services (FAIS) Act, 37 of 2002, determines the 'fit and proper' requirements that are applicable to all financial service providers, key individuals, representatives and compliance officers. We undertake screening of these individuals every 24 months to ensure the highest level of honesty and integrity. During May 2013, a total of records were updated with the latest debarment, FAIS qualifications and credit information. A process is being developed that will facilitate the automated renewal and maintenance of these clearances. As required by the Banks Act, 94 of 1990, the process of appointing directors or executive directors includes screening to ensure compliance with the requirements of honesty and integrity. Nedbank has secured a pass rate of 96% out of a total of FAIS affected staff from representatives and key individuals (transitional FAIS affected) that have complied with the FAIS first level regulatory exam deadline as at 31 March The following actions were taken on the remaining staff members that failed to meet the 31 March 2013: Business removed 94 representatives from the FAIS register and redeployed them into non FAIS functions within the organisation. We submitted 81 extension applications to the FSB to grant the extensions for representatives that failed to meet the deadline, the FSB approved the application and granted a final extension to 31 October 2013 for these representatives to become FAIS compliant. Due diligence Due diligence investigations are performed on request from the various Nedbank business units or divisions. These investigations form part of comprehensive background assessments of prospective and existing clients, partners, vendors, agents, intermediaries and joint venture partners and are designed to help mitigate national and international business and reputational risks. On going assessments are also performed on the commercial, political, social and security environments in which such business is undertaken or is likely to be undertaken. Social, economic and governmental changes in a country can create an environment that reduces security and increases the risk to the group s assets, staff, premises and information and, consequently, its ability to continue to do business. During the period January to July 2013, (2012: 500) due diligence investigations on companies and individuals were performed in 67 countries. Nedbank Group Limited and Nedbank Limited Pillar 3 June

150 Whistleblowing At Nedbank Group we strive to create a safe and enabling environment where concerns, suspicions, irregularities and unethical conduct can be reported safely and without fear of retribution or victimisation. To this end, various reporting channels are available to employees, vendors, service providers and clients. Security and fraud related incidents can be reported, at any time, through an internal reporting line, which is supported by an external, independently managed, whistleblowing hotline available to staff and clients. The facility is also available to Nedbank Africa subsidiaries in Namibia, Swaziland, Lesotho, Malawi and Zimbabwe. An ethics panel has been established for the appropriate handling of ethics related reports of a sensitive or serious nature. Staff members are regularly reminded about the existence of these whistleblowing facilities and the type of activities or suspicions to look out for and report. During January to July 2013 a total of 469 tipoffs were received (January to July 2012: 743) and a total of 206 anonymous whistleblowing reports were referred for investigation to Group Forensic Services. Of these investigations, 13 led to disciplinary action against staff members. Staff members are also able to report suspicions of fraud, corruption and dishonesty via the Nedbank Group Risk Reporting Line which is managed by Group Forensic Services. Online fraud The successful rollout of Nedbank s new client security mechanism known as 'Approve It' has had a positive impact by significantly reducing the incidence of online fraud among our client base. However, we are aware of the fact that fraudsters are constantly developing new ways of committing their crimes and our clients remain vulnerable to malware attacks (not yet significantly adopted by the SA criminal fraternity) as well as so called 'sim swap' attacks. We therefore continue to work tirelessly to develop additional forms of protection for our clients and our systems and liaise with law enforcement agencies and other industry stakeholders to review security measures and stand together against online fraud attacks. Corruption As a responsible lender and corporate citizen, Nedbank Group is opposed to corruption in all its forms. In the fourth quarter of 2012 we called on our staff, managers and Exco to sign an anticorruption pledge committing themselves to take a stand against corruption and uphold ethical and transparent business practices. To date 95% of all Nedbank Group employees have signed the pledge. This includes staff members in our African subsidiaries. Phase 2 of the UK Bribery Act programme was partially completed in 2012 with the introduction of a due diligence policy, which will be finalised early in Phase 2 of the programme included a review of the corruption risk assessments conducted in 2011, enhancement of the due diligence conducted on new vendors, and the finalisation of the audit begun in Enhancements to the new procurement system are in its final stages and testing will start shortly. The enhancements include a questionnaire that require all new (at first application) and existing vendors (during annual review) that requires vendors to disclose information regarding their corruption risk management processes in their own organisations. A manual for 'Conducting risk based Anti Corruption Due Diligence' was also introduced. Cybercrime risk We are acutely aware of the increasing impact of cybercrime on the entire banking industry and its clients. As a result, we have established extensive internal digital forensic and ediscovery capabilities to deal with this risk effectively. We continue to work with other financial institutions through the SA Bank Risk Information Centre (SABRIC), to establish a financial sector Cyber Security Incident Response Team (CSIRT). This will be aligned with the envisaged National CSIRT as outlined in the Draft Cyber Security Policy of South Africa issued by the Department of Communication. Legal risk Legal risk management involves activities aimed at managing a particular set of legal risks and/or risks that can be addressed by legal means. The Basel accord definition for legal risk includes, but is not limited to, exposure to fines, penalties, or punitive damages resulting from supervisory actions, as well as private settlements. Nedbank Group has a decentralised legal risk management model. Our experts in various legal fields ensure conformity with the business and legal principles that apply in the jurisdictions where we do business. The key types of legal risks that are taken into account are: Documentation the risk of the group s contractual arrangements not being enforceable as envisaged, or being enforced against the group in an adverse manner. Litigation the risk that the group s litigation is not managed effectively. Regulatory the risk that the group does not comply with applicable laws and regulations. Nedbank Group Limited and Nedbank Limited Pillar 3 June

151 Dispute resolution the risk of not achieving optimal results when claims are made by, or against, any part of the group. Appointment of external lawyers the risk that inadequate control is exercised over the appointment, nature of the instruction, service standards and cost of law firms. Internal legal advisers the risk that inadequate control is exercised over the appointment, capacity and capability of legal advisers within the group. Legal advice and engagement the risk that the group incurs potential financial or reputational damage as a result of not making optimal use of the internal legal advisers across the group. Competition law the risk that competition law is not followed and the risk that relationships with competition authorities are not appropriately managed in the territories where the group conducts its business. Intellectual property the risk that the group s intellectual property will not be legally protected in all applicable jurisdictions. Compliance and regulatory risk Compliance and regulatory risk has become increasingly significant given the heightened regulatory environment in which financial services organisations operate. We remain committed to the highest regulatory and compliance standards, especially given the increasing scale and complexity of laws and regulations. The fact that Nedbank operates globally means it is subject to a variety of complex local and international laws, regulations and supervisory requirements. We therefore have extensive board approved policies, procedures and governance structures in place to direct compliance risk management and associated activities. Nedbank implements new regulation or amendments to regulation via the Business Risk Management Forum, a group executive subcommittee chaired by the Chief Risk Officer. Any reference to 'regulation' means any statute, legislation, subordinate legislation, regulation, code, guideline, guidance note, supervisory requirement or regulatory directive with which Nedbank must by law comply or to which it adheres for the purposes of ensuring good corporate governance. The Business Risk Management Forum primary objectives are to identify, promote and allocate accountability for programme management of regulatory requirements; ensure the internalisation and operationalisation of legislation within the three lines of defence governance structure; oversee the successful implementation of regulations across Nedbank, but excluding those covered in any existing governance structures; ensure a strategic approach is adopted to achieve compliance and sound risk management and elevate the group to best practice and ensure the group meets regulatory the standards expected of it under all regulations both in the letter and spirit. The board also exercises its oversight of compliance risk via the Directors Affairs Committee and regulatory risk via the Group Risk and Capital Management Committee. In addition, the group has an independent Enterprise Governance and Compliance function that forms part of the second line of defence within its risk management model. The key activities undertaken by Enterprise Governance and Compliance in support of the directors, executive officers, management and employees in discharging their compliance responsibilities include: Providing continuous strategic compliance risk management leadership. Undertaking independent compliance risk monitoring. Setting the group s governance and compliance framework. Working closely with the various cluster governance and compliance functions to embed compliance risk management practices within their respective businesses. Some of the key regulatory developments in 2012 and 2013 included: Stricter reporting requirements for cross border transactions and governance of the Financial Surveillance Reporting System. The Companies Act was promulgated in May 2011, which represented a total 'overhaul' of the previous governing legislation. Nedbank responded to the new requirements via a coordinated group wide implementation programme. The Consumer Protection Act was promulgated and became effective from April 2011, making provision for a fair, accessible and sustainable marketplace for consumer products and services. Nedbank embraced this legislation and has a compliance programme to manage all the requirements with due consideration to all compliance requirements of the National Credit Act. The Protection of Personal Information Bill (POPI) was passed by the National Assembly in August 2013 and has been send for presidential assent and promulgation. The POPI Act once promulgated, promotes the protection of personal information processed by public and private bodies; introduces certain conditions so as to establish minimum requirements for the processing of personal information; provides for the establishment of an Information Regulator to exercise certain powers and to perform certain duties and functions in terms of this Act and the Promotion of Access to Information Act, 2000; provides for the issuing of codes of conduct; provides for the rights of persons regarding unsolicited electronic communications and automated decision making; regulates the flow of personal information across the borders of the Republic; and provides for matters connected therewith. Nedbank Group Limited and Nedbank Limited Pillar 3 June

152 Some initiatives which have continued into 2013 are review of business processes which utilise personal information; continued privacy and awareness and training for Nedbank; assessment and enhancement of information technology security controls over personal information; focus on classification and dissemination of personal information; and enhancing our process to deal with client requests for personal information and complaints handling. Our focus in 2014 is to implement and ensure that we continue to respect our clients right to privacy, and entrench the provisions of the Protection of Personal Information Bill. FATCA Foreign Account Tax Compliance Act The Foreign Account Tax Compliance Act (FATCA) was passed as law in the USA in March The FATCA provisions were included as part of the Hiring Incentives to Restore Employment Act (HIRE Act). This imposes additional reporting and disclosure requirements for 'US Persons' with any interest in a specified foreign financial asset held by a foreign financial institution. If a foreign financial institution does not enter into an agreement with the US Internal Revenue Service, all relevant US sourced payments, such as dividends and interest paid by US Institutions, are subject to a 30% withholding tax. The implementation dates for FATCA have been granted a six month extension by the Internal Revenue Service (IRS) and will commence on 1 July FATCA is aimed at insuring that all Financial Institutions are in a position to clearly identify clients and entities through an enhanced process of on boarding and reporting. SARS has stated its intent to all Financial Institutions in SA to widen the scope of FATCA beyond US Persons and follow the OECD criteria of tax reporting. Nedbank is an active participator in the Inter Governmental Agreement (IGA) industry working group which is actively supporting SARS in the negotiations for an IGA and the relevant annexures and guidance notes. Treating Customers Fairly (TCF) The National Treasury s policy document entitled 'A safer financial sector to serve South Africa better' includes proposals to strengthen financial sector regulation in response to lessons learnt from the recent global financial crisis and domestic financial sector challenges. The key policy priorities identified include: Financial sector regulation. Consumer protection. Market conduct. Financial stability and soundness (prudential regulation). Expanding access through financial inclusion. Combating financial crime. Given the aforementioned policy priorities of strengthening both prudential and market conduct regulation, South Africa is moving towards a 'twin peaks' model of financial regulation with the SARB tasked with prudential regulation of the sector, and the FSB, tasked with market conduct regulation (mandate extended to include market conduct regulation of retail banking). The National Treasury policy document highlights the TCF initiative as 'an important step in strengthening market conduct objectives in the financial sector'. The FSB has therefore been given an unequivocal mandate by the National Treasury to introduce TCF as a key mechanism to drive the policy priority of ensuring consumer protection through strengthened market conduct regulation. Governance structures The Brand Committee has been mandated to exercise TCF management oversight, whilst the Transformation, Social and Ethics Committee will exercise board oversight of TCF, including its implementation. Progress Update and next steps The Nedbank client facing clusters are working on the completion of the FSB self assessment tool to determine the state of readiness in terms of the TCF outcomes. Appointing a programme manager to manage TCF across the business. Occupational Health and Safety (OHS) risk management Nedbank Group occupational health and safety risk management aims at ensuring Nedbank complies with the Occupational Health and Safety Act and Regulations and the Compensation for Occupational Injuries and Diseases Act. Nedbank ensures a safe and healthy workplace for all employees, contractors, visitors and the public at large through the employ of health and safety risk management best practices and standards and compliance with all regulatory requirements. This entails constant management and monitoring of Nedbank health and safety policies, procedures and practices and the support of all staff and the Nedbank Group Executive Management to ensure all staff and management are fully aware of their responsibilities and trained in health and safety matters. Nedbank Group Limited and Nedbank Limited Pillar 3 June

153 National Credit Act The National Credit Act (NCA) came into effect in March The Act promotes a fair and non discriminatory marketplace for access to credit, responsible credit granting practices and prohibits unfair practices by credit providers. Nedbank has always considered itself to be a responsible lender and welcomes the NCA, which supports our credit policy and strategy to become the most admired bank in Africa by, among others, our clients and the communities we work in. Nedbank continues to maintain a good relationship with the National Credit Regulator through regular interaction and cooperation in respect of the various compliance requests and reviews. Information security risk Information security risk arises from an inability to ensure the confidentiality, integrity and availability of business and client information for which the group is accountable. All Nedbank Group information security responsibilities have been consolidated and fall within the responsibility of the Chief Information Security Officer (CISO). Nedbank is a member of the Information Security Forum (ISF) and subscribes to the ISF s Standards of Good Practice as part of the Information Security Management Framework. Nedbank also participates in the annual ISF Information Security Benchmark. The CISO office manages information security through the Information Security Steering Committee (ISSC) which consists of senior representatives from the various clusters. Important risk matters are presented and discussed at the ISSC, which informs the focus of ongoing action to address issues such as information and data classification, decentralised SQL databases, open file shares, hard drive encryption, information security awareness, risk management, metrics and reporting. Physical security risk Nedbank strives to make its physical environment safe and secure for customers and staff. We continue to participate in SABRIC initiatives and collaborate with the SA Police Service and the National Prosecuting Authority (NPA) in combating crime. Key physical security focus areas for 2013 are to: implement a risk assessment programme; increase security awareness levels; improve governance, procurement and management of security services, and continue implementing appropriate measures for creating a safe and secure transacting environment for employees and clients. Money laundering, terrorist financing and sanctions risk management Nedbank Group will not be associated with money laundering or terrorist financing. The group endeavours to identify any business relationships or applications for business relationships or transactions with individuals, entities and countries targeted in financial sanctions legislation. Clearly defined policies, processes, practices, procedures and plans ensure compliance with all statutory duties and regulatory obligations or, in the absence of these, agreed standards. The Business Risk Management Forum, provides among others strategic direction for, and monitors the effective implementation of: Anti Money Laundering (AML). Combating the Financing of Terrorist and related activities (CFT). Sanctions compliance initiatives throughout the group. The AML, CFT and Sanctions Programmes Executive Steering Committee, a subcommittee of the BRMF, ensures the internalisation and operational implementation of AML, CFT and sanctions compliance. Money laundering, terrorist financing and sanctions risk management issues are also reported and monitored through the quarterly Enterprisewide Risk Committees. Nedbank Group Risk maintains a close and transparent working relationship with the Financial Intelligence Centre and the Bank Supervision Department of the SARB. It attends quarterly meetings with the regulator and supervisor to ensure compliance with their requirements and to obtain clarification where necessary. Training for AML, CFT and sanctions remains a high priority. Awareness Training for AML and CFT is conducted on an on going basis and Nedbank Group Awareness Training for Sanctions Compliance was launched during the year under review. An automated client risk profiling system went live in July 2012 to profile clients within specific risk bands, increase the focus on higher risk clients (enhanced due diligence and on going monitoring) and undertake on going client detail maintenance. Various cash threshold reports and suspicious transaction reports have been submitted to the Financial Intelligence Centre. Our AML, CFT and Sanctions Programmes continue to enjoy the full support of group, cluster, and business line executives. All key decision makers are active members of the AML, CFT and Sanctions Programmes Executive Steering Committee or its related governance forums and structures. Nedbank Group Limited and Nedbank Limited Pillar 3 June

154 The intention going forward is to continue building on the positive interactions with the regulator and supervisory structures, thereby cementing sustainable and trusting relationships that unlock benefits for all parties involved. Nedbank Group will continue to focus on the implementation of innovative initiatives that limit money laundering and terrorist financing and promote sanctions compliance. Business Continuity Management Business Continuity Management (BCM) is aimed at ensuring resilient group business activities in emergencies and disasters. The BCM function provides overall guidance and direction, monitors compliance with regulatory and best practice requirements and facilitates regular review of BCM practices. Identified critical business units conduct annual business recovery tests from three regional business resumption areas. There were 123 business units that conducted business recovery tests from the regional resumption areas during the past 12 months. Business Continuity Plans (BCPs) were updated and retests were performed where minor problems were experienced during testing. As at 1 August 2013 there were BCPs in Nedbank of which 997 (81%) were completed and 868 (70%) were tested within the past 240 day cycle. All Payments Association of South Africa (PASA) related recovery is tested in conjunction with the quarterly disaster recovery tests at the group s disaster recovery site. Nedbank obtained certification from PASA in April 2013 and remain the only bank in South Africa that has achieved this. Insurance obtained to mitigate the bank s exposure to operational risk Continuous modification to the group insurance programmes, taking into account insurance market appetite/product offering and Nedbank s changing needs, ensures the group has a well structured insurance programme for its financial and nonfinancial operational risk exposures. The group insurance operation reports to the Group Chief Risk Officer and is responsible for the design and management of the principal insurance programmes addressing the group insurable, operational risk exposures. This function is responsible for ensuring that the cover purchased for the group is up to date with the best coverage available within the insurance markets and relevant to the group s operating environment. Cover is reviewed annually and, wherever possible, extended to align with Nedbank Group s strategy and aspirations. The division also ensures that cover is purchased where required to meet any statutory or regulatory requirements. The primary insurance policies that cover exposures to operational risk include: Financial lines insurance (comprehensive crime, professional indemnity and fraud). Assets all risks insurance (eg damage to physical assets). General insurance (eg motor insurance, public liability, travel, terrorism and sabotage). BUSINESS RISK Business risk is not specified for Basel III Pillar 1 regulatory capital. It is, however, measured in Nedbank Group's economic capital Model, in line with current best practice, which is an earnings volatility methodology. Business risk is the risk caused by uncertainty in profits due to changes in the competitive environment that damage the franchise or operational economics of a business. In other words, it is the risk the bank faces due to fluctuations in earnings, readily observable and driven mainly by volumes, margins and fees. In the extreme, business risk can be seen as the risk of being unable to cover one's cost base should all or most of an entity's earnings fall away. Business risk is also associated with losses due to external factors such as the market situation or government regulations. This quantified risk category also essentially addresses Nedbank Group's strategic risk. The fluctuations in earnings captured here are those not attributable to the influence of other risk types. Business risk thus closes the circle and, together with the other risks defined in Nedbank Group's risk taxonomy, provides for a complete coverage of the quantifiable economic risks Nedbank Group faces. Business risk is not specified for Basel II.5 Pillar 1 regulatory capital. It is, however, measured in Nedbank Group's economic capital Model, in line with current best practice. Nedbank Group has adopted the widely accepted methodology of measuring business risk through the quantification of earnings volatility or earnings at risk, and has developed a sophisticated Earnings Volatility Model. Nedbank Group has adopted the widely accepted methodology of measuring business risk through the quantification of earnings volatility or earnings at risk, and has developed a sophisticated Earnings Volatility Model. The major driver or input used in the earnings at risk methodology is a time series of historical profit and loss, cleansed of the effects of other risk types. The volatility of this time series of historical profits and losses becomes the basis for the measurement of capital. The methodology is based on internal Nedbank Group data, which allows for analysis to understand more about earnings at risk across business units within the bank as more historical data is accumulated. Economic capital for business risk increases with increasing volatility of income streams, but can be offset by variable cost structures that may exist within a business unit. In other words, a business unit would be penalised for high volatility in income, but would receive credit for the ability to reduce costs when faced with declining incomes. Nedbank Group Limited and Nedbank Limited Pillar 3 June

155 ACCOUNTING AND TAXATION RISKS These key risks are actively managed within Nedbank Group's ERMF and in compliance with IFRS, including strong valuation controls over its exposure to fair value mark to market (MTM) accounting. Significant governance and risk management operates effectively to manage these risks in Nedbank Group. Information obtained from the valuation of financial instruments is used by the group to assess the performance of the business and, in particular, provide assurance that the risk and return measures the business has taken are accurate and complete. It is important that the valuation of financial instruments accurately represents the financial position of the group while complying with the requirements of the applicable accounting standards. Taxation risk has been high due to the legacy structured finance book. As a result of proactive management the higher than normal taxation risk has been significantly reduced over the past six years. The primary role of the Executive Taxation Committee is monitoring tax compliance and ensuring that the management of tax risk throughout the group is in accordance with Nedbank Group's tax policy. Furthermore, the committee assists the Group Audit Committee in discharging its responsibility relative to the oversight of tax risk. Provisions are raised/held in respect of tax risks. These are all subject to rigorous external audit, and challenge/review by the Group Audit Committee and the board. TECHNOLOGY RISK Technology risk stems from risks associated with misalignment with business strategy; an uncoordinated or inefficient information technology (IT) strategy; failure of projects to deliver desired change, data protection and information privacy; effects of physical disasters on information systems; IT outsourcing, IT performance and information systems governance. The use of IT, and therefore the associated technology risk (IT risk), is pervasive in a large bank such as Nedbank Group. Accordingly, IT risk is recognised as one of the 17 key risks in Nedbank Group's risk universe and is addressed appropriately as follows: There is a separate major support cluster for IT, ie Group Technology (GT). The managing executive of GT is a member of the Group Executive Committee (Exco). The GT cluster manages information and technology risk through the Technology Management Policy. GT is Nedbank Group's centralised technology unit with responsibility for all components of the group's technology processing, development and systems support. The functions that operate all of the group's IT systems, databases, technology infrastructure, software development and IT projects/programme management are centrally managed to provide economies of scale and facilitate a cohesive group wide service oriented architecture and technology strategy. One of the board subcommittees, Group IT Committee, specifically focuses on IT from both an operational and strategic perspective inclusive of IT risk. The Executive IT Committee, a subcommittee of the Group Exco, serves as a steering committee for IT related matters at group level. As with the other business clusters, the head of Risk is a member of the GT cluster Exco and reports directly to the managing executive of GT. REPUTATIONAL, STRATEGIC, SOCIAL AND ENVIRONMENTAL AND TRANSFORMATION RISKS Reputational, strategic, social and environmental and transformation risks are also potentially pervasive in a banking group, and each is separately identified and addressed as key risks in the group's ERMF. To this end significant time, resources and focus are afforded these risks on an ongoing basis. The following highlights illustrate this: The Directors' Affairs, Group Finance and Oversight, and Transformation, Social and Ethics Committees operate at board level. Group Exco is assisted by the Group Operational, Brand, Transformation and Human Resources Committees and the Business Risk Management Forum. Reputational risk is, to a large degree, mitigated by adequately managing the other 16 key risks in Nedbank Group's ERMF. External communication to investment analysts, shareholders, rating agencies and the financial media is controlled by risk policies, with designated group spokespeople. There is a comprehensive, formal, well documented and closely monitored strategic planning process group wide. Sustainability is fundamental to ensuring financial prosperity and stability for investors and staff, integrating social and environmental responsibility for local communities and the countries in which the group operates, and remaining relevant and accessible to clients. Sustainability is a crucial part of the Nedbank Group culture, and one of the group s Deep Green aspirations remains 'to be highly involved in the community and environment'. Details on this and the group's sustainability focus, strong governance and transparent reporting, which are integral to maintaining the group's credibility among its stakeholders, appear in the Nedbank Group Integrated Report Nedbank Group Limited and Nedbank Limited Pillar 3 June

156 Transformation is a business imperative in South Africa and Nedbank Group's focus and progress in this regard are sound and on track to meet its targets, details of which appear in the Nedbank Group Integrated Report The adoption of a long term leadership role in sustainability which Nedbank is currently developing to align more closely to support government s National Development Plan objectives The Group Marketing and Corporate Affairs cluster plays a major role in managing the group's image and reputation. Key functions include marketing and communications. The cluster is also responsible for the Nedbank Foundation as well as for the delivery of the group's objectives in terms of the Financial Sector Charter and the Department of Trade and Industry (dti) Codes of Good Practice. The Nedbank Group brand image reflects the group's strong marketing and communication drive that has led to positive changes while retaining the aspirational elements, which are distinctly different from those of its competitors. Enterprise Governance and Compliance is responsible for the monitoring of regulatory and reputational risk and the setting of related policies. It also manages the Enterprisewide Governance and Compliance Framework (EGCF). Nedbank Group's governance strategy, objectives and structures have been designed to ensure that the group complies with legislation and a myriad of codes, while at the same time moving beyond conformance to governance performance. The Chief Governance and Compliance Officer is a member of Group Exco, reports directly to the Chief Executive and attend the board committee meetings by invitation. He also has direct access to the Chairman of Nedbank Group and other Nedbank Limited boards. A strong network of divisional governance and compliance officers works closely with the central EGCF in training, project implementation and monitoring, as well as creating an appropriate governance and compliance culture. Nedbank Group's EGCF incorporates a full range of governance objectives, a delineation of responsibilities at board committee, Group Exco and management level, and the identification of champions and key functions for corporate governance integration into all operations. Key features of achieving an effective governance process are the cooperation between executive management and non executive directors, and the significant emphasis, resources and structure given to executive management to champion corporate governance on a day to day basis and assist the board committees and individual non executive directors with their corporate governance and compliance responsibilities. More details on Nedbank Group's EGCF appear in the Nedbank Group Integrated Report HUMAN RESOURCES (OR PEOPLE) AND TRANSFORMATION RISKS People risk is the risk associated with inadequacies in human capital and the management of human resources, policies and processes resulting in the inability to attract, manage, motivate, develop and retain competent resources, with concomitant negative impact on the achievement of strategic group objectives. The group vigorously manages people risk through Group Human Resources. People and transformation risks, which are also key risks in the ERMF, are afforded the same focus as given to the other ERMF risks, with acknowledgement of the ongoing 'war for talent' in the marketplace. From a governance perspective people risk is supported through the following structures: Group Remuneration Committee a sub committee of the board. Group Transformation, Social and Ethics Committee a subcommittee of the board. Transformation and Human Resources Committee a subcommittee of Exco. Enterprisewide Human Resources Exco comprising of HR cluster representatives in the business. Group Human Resources Exco. Group Human Resources Risk Committee. The Group Human Resources Executive represents the HR community in these committees and is a representative of Group Exco. Succession planning is an important focus area for Group Executive, Cluster Executive and Divisional Committee roles. A formal talent review process takes place annually culminating in order to identify Nedbank Group s key talent and to ensure the approval of succession plans by the appropriate forums. Group Executive succession plans are signed off by the Chief Executive and the Directors Affairs Committee of the Board. The Chief Executive is required to report regularly to the board on the group's management development, transformation, organisational culture and talent management. The overall purpose of total remuneration in Nedbank Group is to attract, retain, motivate and reward all of its people appropriately. The total remuneration philosophy is aimed at encouraging sustainable long term performance of the group. At all times, the alignment of performance with the strategic direction and specific value drivers of the business is sought. The interests of all stakeholders, in a manner that does not encourage excessive risk taking, is also integral to the total remuneration philosophy. The group's ERMF, ICAAP and financial performance rely heavily on the group's ability to attract and retain highly skilled individuals, and so the effective management of people risk is a critical success factor. The group s current status and the extent of such skills are believed to be sound. However, the group recognises that this has to be actively managed and monitored on an ongoing basis. Nedbank Group Limited and Nedbank Limited Pillar 3 June

157 Leading transformation continues to be one of the group's key focus areas. Nedbank Group maintained its level 2 rating in respect of the Broadbased Black Economic Empowerment (BBBEE) Codes of Good Practice of the Department of Trade and Industry (dti Codes). Nedbank Group was ranked South Africa s third most empowered corporate for the third year in a row. Building a unique and innovative culture remains a key source of Nedbank Group's competitive advantage and brand differentiation and is entrenched within its leadership philosophy of being 'vision led and values driven'. It directly impacts on its effectiveness in delivering highquality client service. Alignment between the organisational and employee values leads to higher levels of commitment and engagement, which in turn positively influences innovation, creativity and accountability, as well as greater levels of trust, adaptability and productivity. The Barrett culture survey results confirm that values and vision drive the corporate culture, which in turn drives employee fulfilment; and that employee fulfilment positively impacts client satisfaction, thereby increasing shareholder value. Based on this premise the group strives to understand the current organisational climate and culture within which it operates by utilising employee surveys such as the Barrett and Nedbank Group Staff Survey, as well as engagement surveys. Long term sustainable success is highly dependent on the culture that leaders create. And the culture that leaders create is highly dependent on their behaviour and their relationships with other leaders and employees in the organisation. Leading for Deep Green is an initiative that is aimed at Nedbank Group's leadership community to enable it to create a values driven leadership core that supports its strategic objectives. Transformation is a key component within organisational culture. 'Leading Transformation' is a core organisational aspiration. To be a true reflection of the society in which it operates, is a key transformational challenge that the group faces. The Diversity Management Strategy is fundamentally aimed at creating a workplace where diversity is embraced and free of all irrelevant prejudgements and stereotypes. As such diversity management forms a key part of Nedbank Group's transformation process. Nedbank Group understands the reality that most organisations are either 'strategically' or 'culturally' deficient and that deficiency in either sphere leads to failure. The diversity management initiatives form an integrated part of the Nedbank Group's effort to develop and build an organisational culture that can execute its strategy. CONCENTRATION AND OFF BALANCE SHEET RISKS Nedbank Group has enhanced its holistic group wide concentration risk measurement, which is a key feature of its Risk Appetite Policy and Framework. The Basel Committee published Basel II.5, enhancements to the Basel II framework, which includes 'concentration risk' and was effective in South Africa from January All economic capital (ICAAP) and ERMF risk types are analysed by appropriate segmentation for possible concentrations. Segmentations that are considered include single name, industry, geographic, product, collateral and business unit. Credit risk is the most material risk type as can be seen in its percentage contribution to total economic capital (refer page 58). A liquidity crisis is a plausible event that could ultimately 'break a bank'. Therefore liquidity risk and credit risk are considered the two concentration risk focus areas for Nedbank, and this aligns with lessons learned from the global financial crisis. Concentration risk appetite targets were set both in areas where Nedbank Group is materially exposed to concentration risk as well as areas of under concentration, and so potential growth. The targets are agreed by senior management and approved by the board of directors. The potential areas of major concentration risk in Nedbank include credit risk, property investment risk, property risk, liquidity risk, capital and interest rate risk in the banking book (IRRBB). Concentration risk is also a key feature of Nedbank Group's Market Risk Framework. However, undue concentration risk is not considered to prevail in the group's trading, forex and equity risk portfolios (evident in the low percentage contributions to total economic capital, see page 58. These concentrations are monitored by Group ALCO and the board s Group Risk and Capital Management Committee. Credit risk Within Nedbank Group the credit concentration risk is actively managed, measured and ultimately capitalised for in the group s economic capital and Internal Capital Adequacy Assessment Process (ICAAP). Single name credit concentration risk Of the total group credit economic capital, only 5,6% is attributable to the top 20 largest exposures, excluding banks and government exposure, and 4,6% to the top 20 banks largest exposures, highlighting that Nedbank Group does not have undue single name credit concentration risk. Direct exposure to the SA government relates mainly to statutory liquid asset requirements and constitutes 6,6% of total balance sheet credit exposure. The group s credit concentration risk measurement incorporates the asset size of obligors/borrowers into its calculation of credit economic capital. Single name concentration is monitored at all credit committees within the group s Enterprisewide Risk Management Framework (ERMF), which includes the applicable regulatory and economic capital per exposure. Nedbank Group Limited and Nedbank Limited Pillar 3 June

158 TOP 20 NEDBANK GROUP EXPOSURES June 2013 Excluding banks and government exposure Banks only Internal NGR 2 EAD % of total group credit economic capital Internal NGR 2 No (PD) rating Rm % (PD) rating Rm % EAD % of total group credit economic capital 1 NGR ,57 NGR ,09 2 NGR ,07 NGR ,06 3 NGR ,27 NGR ,06 4 NGR ,01 NGR ,02 5 NGR ,05 NGR ,12 6 NGR ,43 NGR ,08 7 NGR ,01 NGR ,11 8 NGR ,52 NGR ,26 9 NGR ,20 NGR ,13 10 NGR ,01 NGR ,06 11 NGR ,33 NGR ,07 12 NGR ,46 NGR ,08 13 NGR ,21 NGR ,12 14 NGR ,01 NGR ,05 15 NGR ,04 NGR ,04 16 NGR ,00 NGR ,06 17 NGR ,03 NGR ,03 18 NGR ,25 NGR ,03 19 NGR ,24 NGR ,11 20 NGR ,21 NGR ,04 Total of top 20 exposures , ,64 Total group Total group EAD includes all Nedbank Group subsidiaries. Although the subsidiaries have adopted The Standardised Approach (TSA), credit benchmarks are applied for the purpose of estimating internal credit economic capital. 2 NGR = Nedbank Group Rating. Geographic concentration risk Given that 93% of the group s loans and advances originate in South Africa, local geographic exposure is high. Practically, however, this concentration has proven positive for Nedbank Group, given the global financial crisis, and reflects its focus on its area of core competence. 1,96% 3,97% GEOGRAPHIC CONCENTRATION RISK 1,94% 4,31% 1,95% 5,17% South Africa Rest of Africa Rest of world 94,08% 93,75% Jun 2012 Dec 2012 Jun 2013 In view of the ongoing uncertainty and concerns in the Eurozone, a summary of Nedbank Group s exposure to that region, and specifically to banks in the Portugal, Italy, Ireland, Greece and Spain (PIIGS), is provided below. The direct exposure of Nedbank Group to the banking sectors of PIIGS is low at R489m, with total Eurozone exposure at R This is monitored on an ongoing basis. The group holds no sovereign bonds issued by these countries. Direct lines to banks in Italy and Spain are restricted to systemically important banks. 92,88% The extent of the total Eurozone exposure is only 1,82% (June 2012: 1,59%) of total balance sheet credit exposure. Nedbank Group Limited and Nedbank Limited Pillar 3 June

159 SUMMARY OF EXPOSURE TO BANKS IN THE EUROZONE Exposure as a % of balance Exposure as a % of balance Exposure as a % of balance Rm sheet credit sheet credit sheet credit Jun 2013 exposure Jun 2012 exposure Dec 2012 exposure Total exposure to banks in the PIIGS 489 0, , ,03 France , , ,75 Other , , ,58 Total exposure to banks in the Eurozone , , ,36 Sovereign exposure , , ,23 SA government , , ,88 Other countries , , ,35 1 Predominantly comprising statutory liquid asset requirements. 2 Includes the 17 European Union member states that have adopted the Euro as their common currency. Industry concentration risk GROSS LOANS AND ADVANCES (% OF TOTAL) 35% 30% 25% 31,4% 29,9% 27,4% 25,3% 23,9% Total residential mortgages 20% 15% 10% 5% 0% 17,5% 17,6% 18,2% 18,2% 9,7% 2,1% Dec 09 17,3% 10,5% 11,0% 11,2% 11,1% 2,7% Dec 10 3,5% Dec 11 4,3% 3,9% Dec 12 Jun 13 Total commercial mortgages Total retail motor vehicle finance Total personal loans Commercial mortgage lending has remained relatively stable at 17,3% of gross loans and advances, and consequently Nedbank Group has maintained its dominant local market share position. This potentially high concentration is mitigated by high levels of collateral, low average loans to value (approximately 50%), the underpinning of corporate leases and a highly experienced management team. Although total mortgage exposure (ie residential and commercial) remains a significant part of the balance sheet at 41,2%, this has consistently been decreasing from its peak levels of 2009 at 48,9% in line with the selective origination in Retail Home Loans, while Nedbank remains comfortable with its dominant commercial mortgage market share position in the industry. While Nedbank has the smallest residential mortgage portfolio among the local peer group, the contribution of these advances as a percentage of total gross loans and advances is substantial at 23,9% at June 2013 (December 2012: 25,3%). Nedbank has adopted a selective origination, client centric growth strategy as part of its portfolio tilt initiative, resulting in a planned reduction of residential mortgages as a proportion of total credit exposure. Total retail motor vehicle finance exposure within Nedbank Group is only 11,1% of gross loans and advances, while current market share is approximately 28,7%. Sound risk management principles are applied by an experienced management team and this was further enhanced with the approval by the SARB in 2012 of the Basel III Advanced Internal Ratings based (AIRB) Approach for the MFC portfolio. Nedbank currently has the lowest market share in retail secured lending among its peers. However, it stands on 35,0% of total group loans and advances and has decreased slightly in line with the home loans portfolio tilt strategy. Given the continuing concerns in the mining sector, exposure to these clients is carefully monitored and is low at approximately 4,4% of total credit economic capital. The differences between the above industry concentration exposure and other sources of external reporting, which are based on loans and advances, is that the credit exposure includes additional items such as derivatives, government stock, short term securities and off balancesheet exposures. Nedbank Group Limited and Nedbank Limited Pillar 3 June

160 NEDBANK GROUP INDUSTRY EXPOSURE 4,9% 4,4% 0,9% 10,9% 2,0% 0,6% 8,7% Agriculture, hunting, forestry and fishing Construction Financial intermediation and insurance Community, social and personal services Electricity, gas and water supply Business services 5,4% 5,2% 0,8% 8,2% 1,5% 1,1% 9,8% 34,6% 3,1% Real estate Manufacturing Other Mining and quarrying 33,5% 4,1% 15,2% 16,5% Private households Transport, storage and communication 4,3% 8,9% 0,1% Wholesale and retail trade, repair of specified items, hotels and restaurants Dec 2012 Jun ,1% 9,6% 0,5% The group concludes that credit concentration risk is adequately measured, managed, controlled and ultimately capitalised. There is no undue single name concentration and any sector concentrations that exist are well managed as indicated above. While there is a concentration of Nedbank Group loans and advances in South Africa, this has been positive for Nedbank Group as evident after the global financial crisis. Property investment risk 38% of the investment portfolio is concentrated in real estate but constitutes only 0,37% of total assets at 30 June In terms of sector split, 35% of the real estate portfolio is in retail and 15% in the commercial sector, while 21% is listed. In terms of geographic classification, 35% of the real estate portfolio is concentrated in Gauteng. Concentration risk in listed real estate is managed by secondary limits. The investment risks are neither unduly large nor concentrated for Nedbank Group. Property risk Property market risk includes exposure in Nedbank's business premises, property acquired for future expansion and properties in possession. Property risk is highly concentrated with 74% in Gauteng. The concentration risk in the head office (including regional) buildings is driven by the strategic need for Nedbank to own the key buildings from which it operates. Sandton is a high growth area and the 'financial centre of Africa'. However, any further property investment activities in the Sandton area will be considered against the existing concentration risk. Liquidity risk Wholesale funding reliance, consistent with local peers Nedbank currently sources 42,7% of total funding from wholesale deposits. Wholesale funding is typically used to lengthen term funding. The funding plan and Portfolio Tilt strategy includes a reduction in wholesale funding through increases in retail and commercial deposits, both in conjunction with the group s NIR and primary client strategies, and the retention of Nedbank's strong household deposits position. Interest rate risk in the banking book Prime/JIBAR reset risk and endowment sensitivity Nedbank, like its local peer group, is concentrated to the Prime lending rate given the large quantum of assets linked to the Prime index rate. This portfolio is typically funded through deposits linked to short term deposit rates and term deposit rates that are risk managed back to the three month repricing Johannesburg Interbank Agreed Rate (JIBAR). This creates short end reprice risk that exposes the balance sheet to a Prime/JIBAR reprice mismatch. Nedbank s balance sheet is also funded through a large amount of 'free funds' raised through equity and/or transactional deposits. These deposit balances and equity are insensitive to rate changes as they yield 0% and accordingly earn a higher return when interest rates are high and a lower return when interest rates are low, given that they have been deployed into variable rate linked assets. This exposes the bank to endowment sensitivity, which is the main reason for exposure to IRRBB in the balance sheet (see page 140). Off balance sheet risks As regard off balance sheet risks, there are only two 'plain vanilla' securitisation transactions (see page 117), which have funding diversification rather than risk transfer objectives. In addition there are no 'exotic' credit derivative instruments nor any risky off balancesheet special purpose vehicles. Nedbank Group Limited and Nedbank Limited Pillar 3 June

161 ANNEXURE A: COMPOSITION OF CAPITAL DISCLOSURE Annexure A: Composition of Capital Disclosure Composition of capital disclosure for the six months ended 30 June 2013 Nedbank Group AMOUNTS SUBJECT TO Rm PRE BASEL III TREATMENT Common Equity Tier 1 capital: instruments and reserves Directly issued qualifying common share capital (and equivalent for non joint stock companies) plus related stock surplus Retained earnings Accumulated other comprehensive income (and other reserves) Directly issued capital subject to phase out from CET1 (only applicable to non joint stock companies) Public sector capital injections grandfathered until 1 January 2018 Common share capital issued by subsidiaries and held by third parties (amount allowed in group CET1) Common Equity Tier 1 capital before regulatory adjustments Common Equity Tier 1 capital: regulatory adjustments Prudential valuation adjustments Goodwill (net of related tax liability) Other intangibles other than mortgage servicing rights (net of related tax liability) Deferred tax assets that rely on future profitability excluding those arising from temporary differences (net of related tax liability) Cash flow hedge reserve Shortfall of provisions to expected losses Securitisation gain on sale Gains and losses due to changes in own credit risk on fair valued liabilities Defined benefit pension fund net assets Investments in own shares (if not already netted off paid in capital on reported balance sheet) Reciprocal cross holdings in common equity Investments in the capital of banking, financial and insurance entities that are outside the scope 656 of regulatory consolidation, net of eligible short positions, where the bank does not own more than 10% of the issued share capital (amount above 10% threshold) Significant investments in the common stock of banking, financial and insurance entities that are outside the scope of regulatory consolidation, net of eligible short positions (amount above 10% threshold) Mortgage servicing rights (amount above 10% threshold) Deferred tax assets arising from temporary differences (amount above 10% threshold, net of related tax liability) Amount exceeding the 15% threshold of which: significant investments in the common stock of financials of which: mortgage servicing rights of which: deferred tax assets arising from temporary differences National specific regulatory adjustments REGULATORY ADJUSTMENTS APPLIED TO COMMON EQUITY TIER 1 IN RESPECT OF AMOUNTS SUBJECT TO PRE BASEL III TREATMENT OF WHICH: [INSERT NAME OF ADJUSTMENT] OF WHICH: Regulatory adjustments applied to Common Equity Tier 1 due to insufficient Additional Tier 1 and Tier 2 to cover deductions Total regulatory adjustments to Common equity Tier Common Equity Tier 1 capital (CET1) Nedbank Group Limited and Nedbank Limited Pillar 3 June

162 Additional Tier 1 capital : instruments Directly issued qualifying Additional Tier 1 instruments plus related stock surplus of which: classified as equity under applicable accounting standards of which: classified as liabilities under applicable accounting standards Directly issued capital instruments subject to phase out from Additional Tier Additional Tier 1 instruments (and CET1 instruments not included in line 5) issued by subsidiaries and held by third parties (amount allowed in group AT1) of which: instruments issued by subsidiaries subject to phase out Additional Tier 1 capital Additional Tier 1 capital: regulatory adjustments Investments in own Additional Tier 1 instruments Reciprocal cross holdings in Additional Tier 1 instruments Investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation,net of eligible short positions, where the bank does not own more than 10% of the issued common share capital of the entity (amount above 10% threshold) Significant investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation (net of eligible short positions) National specific regulatory adjustments REGULATORY ADJUSTMENTS APPLIED TO COMMON EQUITY TIER 1 IN RESPECT OF AMOUNTS SUBJECT TO PRE BASEL III TREATMENT OF WHICH: OF WHICH: Regulatory adjustments applied to Additional Tier 1 due to insufficient Tier 2 to cover deductions Total regulatory adjustments to Additional Tier 1 capital Additional Tier 1 capital (AT1) Tier 1 capital (T1 = CET1 + AT1) Tier 2 capital and provisions Directly issued qualifying Tier 2 instruments plus related stock surplus Directly issued capital instruments subject to phase out from Tier 2 Tier 2 instruments (and CET1 and AT1 instruments not included in lines 5 or 34) issued by subsidiaries and held by third parties (amount allowed in group Tier 2) of which: instruments issued by subsidiaries subject to phase out Provisions 73 Tier 2 capital before regulatory adjustments Tier 2 capital : regulatory adjustments Investments in own Tier 2 instruments Reciprocal cross holdings in Tier 2 instruments Investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation, net of eligible short positions, where the bank does not own more than 10% of the issued common share capital of the entity (amount above the 10% threshold) Significant investments in the capital banking, financial and insurance entities that are outside the scope of regulatory consolidation (net of eligible short positions) National specific regulatory adjustments REGULATORY ADJUSTMENTS APPLIED TO COMMON EQUITY TIER 2 IN RESPECT OF AMOUNTS SUBJECT TO PRE BASEL III TREATMENT OF WHICH: OF WHICH: Total regulatory adjustments to Tier 2 capital Tier 2 capital (T2) Total capital (TC = T1 + T2) RISK WEIGHTED ASSETS IN RESPECT OF AMOUNTS SUBJECT TO PRE BASEL III TREATMENT OF WHICH: OF WHICH: Total risk weighted assets Capital ratios Common Equity Tier 1 (as a percentage of risk weighted assets) 11,3% Tier 1 (as a percentage of risk weighted assets) 12,5% Total capital (as a percentage of risk weighted assets) 14,4% Institution specific buffer requirement (minimum CET1 requirement plus capital conservation 7,0% buffer plus countercyclical buffer requirements plus G SIB buffer requirement, expressed as a percentage of risk weighted assets) of which: capital conservation buffer requirement 2,5% of which: bank specific countercyclical buffer requirement of which: G SIB buffer requirement Common Equity Tier 1 available to meet buffers (as a percentage of risk weighted assets) 2,3% 656 Nedbank Group Limited and Nedbank Limited Pillar 3 June

163 National Minima (if different from Basel 3) National Common Equity Tier 1 minimum ratio (if different from Basel 3 minimum) 4,5% National Tier 1 minimum ratio 6,0% National total capital minimum ratio 9,5% Amounts below the threshold for deductions (before risk weighting) Non significant investments in the capital of other financials Significant investments in the common stock of financials Mortgage servicing rights (net of related tax liability) Deferred tax assets arising from temporary differences (net of related tax liability) 101 Applicable caps on the on the inclusion of provisions in Tier 2 Provisions eligible for inclusion in Tier 2 in respect of exposures subject to standardised 73 approach (prior to application of cap) Cap on inclusion of provisions in Tier 2 under standardised approach 281 Provisions eligible for inclusion in Tier 2 in respect of exposures subject to internal ratings based approach (prior to application of cap) Cap for inclusion of provisions in Tier 2 under internal ratings based approach Capital instruments subject to phase out arrangements (only applicable between 1 Jan 2018 and 1 Jan 2022) Current cap on CET1 instruments subject to phase out arrangements Amount excluded from CET1 due to cap (excess over cap after redemptions and maturities) Current cap on AT1 instruments subject to phase out arrangements Amount excluded from AT1 due to cap (excess over cap after redemptions and maturities) Current cap on T2 instruments subject to phase out arrangements Amount excluded from T2 due to cap (excess over cap after redemptions and maturities) Nedbank Limited Rm Common Equity Tier 1 capital: instruments and reserves Directly issued qualifying common share capital (and equivalent for non joint stock companies) plus related stock surplus Retained earnings Accumulated other comprehensive income (and other reserves) 363 Directly issued capital subject to phase out from CET1 (only applicable to non joint stock companies) Public sector capital injections grandfathered until 1 January 2018 Common share capital issued by subsidiaries and held by third parties (amount allowed in group CET1) Common Equity Tier 1 capital before regulatory adjustments AMOUNTS SUBJECT TO PRE BASEL III TREATMENT Common Equity Tier 1 capital: regulatory adjustments Prudential valuation adjustments Goodwill (net of related tax liability) Other intangibles other than mortgage servicing rights (net of related tax liability) Deferred tax assets that rely on future profitability excluding those arising from temporary differences (net of related tax liability) Cash flow hedge reserve Shortfall of provisions to expected losses Securitisation gain on sale Gains and losses due to changes in own credit risk on fair valued liabilities Defined benefit pension fund net assets Investments in own shares (if not already netted off paid in capital on reported balance sheet) Reciprocal cross holdings in common equity Investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation, net of eligible short positions, where the bank does not own more than 10% of the issued share capital (amount above 10% threshold) Significant investments in the common stock of banking, financial and insurance entities that are outside the scope of regulatory consolidation, net of eligible short positions (amount above 10% threshold) Mortgage servicing rights (amount above 10% threshold) Deferred tax assets arising from temporary differences (amount above 10% threshold, net of related tax liability) Amount exceeding the 15% threshold of which: significant investments in the common stock of financials of which: mortgage servicing rights of which: deferred tax assets arising from temporary differences National specific regulatory adjustments Nedbank Group Limited and Nedbank Limited Pillar 3 June

164 REGULATORY ADJUSTMENTS APPLIED TO COMMON EQUITY TIER 1 IN RESPECT OF AMOUNTS SUBJECT TO PRE BASEL III TREATMENT OF WHICH: OF WHICH: Regulatory adjustments applied to Common Equity Tier 1 due to insufficient Additional Tier 1 and Tier 2 to cover deductions Total regulatory adjustments to Common equity Tier Common Equity Tier 1 capital (CET1) Additional Tier 1 capital : instruments Directly issued qualifying Additional Tier 1 instruments plus related stock surplus of which: classified as equity under applicable accounting standards of which: classified as liabilities under applicable accounting standards Directly issued capital instruments subject to phase out from Additional Tier Additional Tier 1 instruments (and CET1 instruments not included in line 5) issued by subsidiaries and held by third parties (amount allowed in group AT1) of which: instruments issued by subsidiaries subject to phase out Additional Tier 1 capital Additional Tier 1 capital: regulatory adjustments Investments in own Additional Tier 1 instruments Reciprocal cross holdings in Additional Tier 1 instruments Investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation,net of eligible short positions, where the bank does not own more than 10% of the issued common share capital of the entity (amount above 10% threshold) Significant investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation (net of eligible short positions) National specific regulatory adjustments REGULATORY ADJUSTMENTS APPLIED TO COMMON EQUITY TIER 1 IN RESPECT OF AMOUNTS SUBJECT TO PRE BASEL III TREATMENT OF WHICH: OF WHICH: Regulatory adjustments applied to Additional Tier 1 due to insufficient Tier 2 to cover deductions Total regulatory adjustments to Additional Tier 1 capital Additional Tier 1 capital (AT1) Tier 1 capital (T1 = CET1 + AT1) Tier 2 capital and provisions Directly issued qualifying Tier 2 instruments plus related stock surplus Directly issued capital instruments subject to phase out from Tier Tier 2 instruments (and CET1 and AT1 instruments not included in lines 5 or 34) issued by subsidiaries and held by third parties (amount allowed in group Tier 2) of which: instruments issued by subsidiaries subject to phase out Provisions 27 Tier 2 capital before regulatory adjustments Tier 2 capital : regulatory adjustments Investments in own Tier 2 instruments Reciprocal cross holdings in Tier 2 instruments Investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation, net of eligible short positions, where the bank does not own more than 10% of the issued common share capital of the entity (amount above the 10% threshold) Significant investments in the capital banking, financial and insurance entities that are outside the scope of regulatory consolidation (net of eligible short positions) National specific regulatory adjustments REGULATORY ADJUSTMENTS APPLIED TO COMMON EQUITY TIER 2 IN RESPECT OF AMOUNTS SUBJECT TO PRE BASEL III TREATMENT OF WHICH: OF WHICH: Total regulatory adjustments to Tier 2 capital Tier 2 capital (T2) Total capital (TC = T1 + T2) RISK WEIGHTED ASSETS IN RESPECT OF AMOUNTS SUBJECT TO PRE BASEL III TREATMENT OF WHICH: OF WHICH: Total risk weighted assets Nedbank Group Limited and Nedbank Limited Pillar 3 June

165 Capital ratios Common Equity Tier 1 (as a percentage of risk weighted assets) 9,7% Tier 1 (as a percentage of risk weighted assets) 11,2% Total capital (as a percentage of risk weighted assets) 13,3% Institution specific buffer requirement (minimum CET1 requirement plus capital conservation 7,0% buffer plus countercyclical buffer requirements plus G SIB buffer requirement, expressed as a percentage of risk weighted assets) of which: capital conservation buffer requirement 2,5% of which: bank specific countercyclical buffer requirement of which: G SIB buffer requirement Common Equity Tier 1 available to meet buffers (as a percentage of risk weighted assets) 0,7% National Minima (if different from Basel 3) National Common Equity Tier 1 minimum ratio (if different from Basel 3 minimum) 4,5% National Tier 1 minimum ratio 6,0% National total capital minimum ratio 9,5% Amounts below the threshold for deductions (before risk weighting) Non significant investments in the capital of other financials Significant investments in the common stock of financials Mortgage servicing rights (net of related tax liability) Deferred tax assets arising from temporary differences (net of related tax liability) 98 Applicable caps on the on the inclusion of provisions in Tier 2 Provisions eligible for inclusion in Tier 2 in respect of exposures subject to standardised 27 approach (prior to application of cap) Cap on inclusion of provisions in Tier 2 under standardised approach 88 Provisions eligible for inclusion in Tier 2 in respect of exposures subject to internal ratings based approach (prior to application of cap) Cap for inclusion of provisions in Tier 2 under internal ratings based approach Capital instruments subject to phase out arrangements (only applicable between 1 Jan 2018 and 1 Jan 2022) Current cap on CET1 instruments subject to phase out arrangements Amount excluded from CET1 due to cap (excess over cap after redemptions and maturities) Current cap on AT1 instruments subject to phase out arrangements Amount excluded from AT1 due to cap (excess over cap after redemptions and maturities) Current cap on T2 instruments subject to phase out arrangements Amount excluded from T2 due to cap (excess over cap after redemptions and maturities) Nedbank Group Limited and Nedbank Limited Pillar 3 June

166 ANNEXURE B: CAPITAL INSTRUMENTS MAIN FEATURES DISCLOSURE Annexure B: Capital Instruments Main Features Disclosure Disclosure template for main features of regulatory capital instruments for the six months ended 30 June 2013 Issuer Nedbank Limited Nedbank Group Limited Nedbank Limited Unique identifier (eg CUSIP, ISIN or Bloomberg identifier for private placement) Governing law(s) of the instrument Regulatory treatment Banks Act, Companies Act Unlisted ZAE ZAE Banks Act, Companies Act Banks Act Transitional Basel III rules Common Equity Tier 1 Common Equity Tier 1 Additional Tier 1 Post transitional Basel III rules Common Equity Tier 1 Common Equity Tier 1 Ineligible Eligible at solo/group/group and solo Group and solo Group Group and Solo Instrument type (types to be specified by each jurisdiction) Ordinary share capital Ordinary share capital Preference share capital Amount recognised in regulatory capital (Currency in mil, as of most recent reporting date) Par value of instrument ,4 Accounting classification Shareholders equity Shareholders equity Shareholders equity Original date of issuance 2 January November December 2002 Perpetual or dated Perpetual Perpetual Perpetual Original maturity date N/A N/A N/A Issuer call subject to prior supervisory approval Yes Yes Yes Optional call date, contingent call dates and redemption amount N/A N/A N/A Subsequent call dates, if applicable N/A N/A N/A Coupons / dividends Fixed or floating dividend/coupon Floating Floating Floating Coupon rate and any related index N/A N/A Maximum of 83,33% of Prime lending rate Existence of a dividend stopper N/A N/A N/A Fully discretionary, partially discretionary or mandatory Fully discretionary Fully discretionary Partially discretionary Existence of step up or other incentive to redeem N/A N/A N/A Noncumulative or cumulative Noncummulative Noncummulative Noncummulative Convertible or non convertible N/A N/A N/A If convertible, conversion trigger(s) N/A N/A N/A If convertible, fully or partially N/A N/A N/A If convertible, conversion rate N/A N/A N/A If convertible, mandatory or optional conversion N/A N/A N/A If convertible, specify instrument type convertible into N/A N/A N/A If convertible, specify issuer of instrument it converts into N/A N/A N/A Write down feature N/A N/A N/A If write down, write down trigger(s) N/A N/A N/A If write down, full or partial N/A N/A N/A If write down, permanent or temporary N/A N/A N/A If temporary write down, description of write up mechanism N/A N/A N/A Position in subordination hierarchy in liquidation (specify instrument type immediately senior to instrument) Preference shares, Hybrid debt, Subordinated debt, Senior unsecured debt, deposits, creditors Preference shares, Hybrid debt, Subordinated debt, Senior unsecured debt, deposits, creditors Hybrid debt, Subordinated debt, Senior unsecured debt, deposits, creditors Non compliant transitioned features No No Yes If yes, specify non compliant features N/A N/A No contractual nor statutory loss absorbency clause included Nedbank Group Limited and Nedbank Limited Pillar 3 June

167 Issuer Nedbank Limited Nedbank Limited Nedbank Limited Unique identifier (eg CUSIP, ISIN or Bloomberg identifier for private placement) ZAG ZAG ZAG Governing law(s) of the instrument Banks Act Banks Act Banks Act Regulatory treatment Transitional Basel III rules Additional Tier 1 Additional Tier 1 Tier 2 Post transitional Basel III rules Ineligible Ineligible Ineligible Eligible at solo/group/group and solo Group, Solo Group, Solo Group, Solo Instrument type (types to be specified by each jurisdiction) Hybrid subordinated debt Hybrid subordinated debt Subordinated debt Amount recognised in regulatory capital (Currency in mil, as of most recent reporting date) Par value of instrument Accounting classification Liability amortised cost Liability amortised cost Liability amortised cost Original date of issuance 20 May May September 2006 Perpetual or dated Dated Dated Dated Original maturity date N/A N/A N/A Issuer call subject to prior supervisory approval Yes Yes Yes Optional call date, contingent call dates and redemption amount 20 November November September 2013 Subsequent call dates, if applicable N/A N/A N/A Coupons / dividends Fixed or floating dividend/coupon Fixed to Floating Floating Fixed to Floating Coupon rate and any related index 15,05% 3 month JIBAR + 4,75% p.a. 9,84% Existence of a dividend stopper No No No Fully discretionary, partially discretionary or mandatory Mandatory Mandatory Mandatory Existence of step up or other incentive to redeem Yes Yes Yes Noncumulative or cumulative Noncumulative Noncumulative Cumulative Convertible or non convertible non convertible non convertible non convertible If convertible, conversion trigger (s) N/A N/A N/A If convertible, fully or partially N/A N/A N/A If convertible, conversion rate N/A N/A N/A If convertible, mandatory or optional conversion N/A N/A N/A If convertible, specify instrument type convertible into N/A N/A N/A If convertible, specify issuer of instrument it converts into N/A N/A N/A Write down feature N/A N/A N/A If write down, write down trigger(s) N/A N/A N/A If write down, full or partial N/A N/A N/A If write down, permanent or temporary N/A N/A N/A If temporary write down, description of write up mechanism N/A N/A N/A Position in subordination hierarchy in liquidation (specify instrument type immediately senior to instrument) Subordinated debt, Senior unsecured debt, deposits, creditors Subordinated debt, Senior unsecured debt, deposits, creditors Senior unsecured debt, deposits, creditors Non compliant transitioned features Yes Yes Yes If yes, specify non compliant features Hybrid debt instrument Hybrid debt instrument Has step up and no contractual nor statutory loss absorbency clause included prior to gone concern Nedbank Group Limited and Nedbank Limited Pillar 3 June

168 Issuer Nedbank Limited Nedbank Limited Nedbank Limited Unique identifier (eg CUSIP, ISIN or Bloomberg identifier for private placement) ZAG ZAG ZAG Governing law(s) of the instrument Banks Act Banks Act Banks Act Regulatory treatment Transitional Basel III rules Tier 2 Tier 2 Tier 2 Post transitional Basel III rules Ineligible Ineligible Ineligible Eligible at solo/group/group and solo Group, Solo Group, Solo Group, Solo Instrument type (types to be specified by each jurisdiction) Subordinated debt Subordinated debt Subordinated debt Amount recognised in regulatory capital (Currency in mil, as of most recent reporting date) Par value of instrument Accounting classification Liability amortised cost Liability amortised cost Liability amortised cost Original date of issuance 8 February September July 2007 Perpetual or dated Dated Dated Dated Original maturity date 8 February September July 2022 Issuer call subject to prior supervisory approval Yes Yes Yes Optional call date, contingent call dates and redemption amount 8 February September July 2017 Subsequent call dates, if applicable N/A N/A N/A Coupons / dividends Fixed or floating dividend/coupon Fixed to Floating Fixed to Floating Floating Coupon rate and any related index 8,90% 10,54% 3 month JIBAR + 0,47% p.a. Existence of a dividend stopper No No No Fully discretionary, partially discretionary or mandatory Mandatory Mandatory Mandatory Existence of step up or other incentive to redeem Yes Yes Yes Noncumulative or cumulative Cumulative Cumulative Cumulative Convertible or non convertible non convertible non convertible non convertible If convertible, conversion trigger (s) N/A N/A N/A If convertible, fully or partially N/A N/A N/A If convertible, conversion rate N/A N/A N/A If convertible, mandatory or optional conversion N/A N/A N/A If convertible, specify instrument type convertible into N/A N/A N/A If convertible, specify issuer of instrument it converts into N/A N/A N/A Write down feature N/A N/A N/A If write down, write down trigger(s) N/A N/A N/A If write down, full or partial N/A N/A N/A If write down, permanent or temporary N/A N/A N/A If temporary write down, description of write up mechanism N/A N/A N/A Position in subordination hierarchy in liquidation (specify instrument type immediately senior to instrument) Senior unsecured debt, deposits, creditors Senior unsecured debt, deposits, creditors Senior unsecured debt, deposits, creditors Non compliant transitioned features Yes Yes Yes If yes, specify non compliant features Has step up and no contractual nor statutory loss absorbency clause included prior to gone concern Has step up and no contractual nor statutory loss absorbency clause included prior to gone concern Has step up and no contractual nor statutory loss absorbency clause included prior to gone concern Nedbank Group Limited and Nedbank Limited Pillar 3 June

169 Issuer Nedbank Limited Nedbank Limited Unique identifier (eg CUSIP, ISIN or Bloomberg identifier for private placement) XS ZAG Governing law(s) of the instrument Banks Act Banks Act Regulatory treatment Transitional Basel III rules Tier 2 Tier 2 Post transitional Basel III rules Ineligible Ineligible Eligible at solo/group/group and solo Group, Solo Group, Solo Instrument type (types to be specified by each jurisdiction) Subordinated debt Subordinated debt Amount recognised in regulatory capital (Currency in mil, as of most recent reporting date) US$ Par value of instrument US$ Accounting classification Liability amortised cost Liability amortised cost Original date of issuance 3 March December 2008 Perpetual or dated Dated Dated Original maturity date 3 March December 2018 Issuer call subject to prior supervisory approval Yes Yes Optional call date, contingent call dates and redemption amount 3 March December 2013 Subsequent call dates, if applicable N/A N/A Coupons / dividends Fixed or floating dividend/coupon Floating Fixed to Floating Coupon rate and any related index 3 month US$ LIBOR + 1,5% p.a. 3 month JIBAR + 2,50% p.a. Existence of a dividend stopper No No Fully discretionary, partially discretionary or mandatory Mandatory Mandatory Existence of step up or other incentive to redeem Yes Yes Noncumulative or cumulative Cumulative Cumulative Convertible or non convertible non convertible non convertible If convertible, conversion trigger (s) N/A N/A If convertible, fully or partially N/A N/A If convertible, conversion rate N/A N/A If convertible, mandatory or optional conversion N/A N/A If convertible, specify instrument type convertible into N/A N/A If convertible, specify issuer of instrument it converts into N/A N/A Write down feature N/A N/A If write down, write down trigger(s) N/A N/A If write down, full or partial N/A N/A If write down, permanent or temporary N/A N/A If temporary write down, description of write up mechanism N/A N/A Position in subordination hierarchy in liquidation (specify instrument type immediately senior to instrument) Senior unsecured debt, deposits, creditors Senior unsecured debt, deposits, creditors Non compliant transitioned features Yes Yes If yes, specify non compliant features Has step up and no contractual nor statutory loss absorbency clause included prior to gone concern Has step up and no contractual nor statutory loss absorbency clause included prior to gone concern Nedbank Group Limited and Nedbank Limited Pillar 3 June

170 ANNEXURE C: ABBREVIATIONS Annexure C: Abbreviations ABBREVIATION DEFINITION AFR Available financial resources AFS Available for sale AIRB Advanced Internal Ratings based ALCO Asset and Liability Committee ALM Asset and liability management AMA Advanced Measurement Approach AML Anti money laundering Basel Committee Basel Committee on Banking Supervision BaU Business as usual BCM Business continuity management BCP Business Continuity Plan BEEL Best estimate of expected loss BEICF Business environment and internal control factors BI Business intelligence bps Basis points BRMF Business Risk Management Forum BSM Balance Sheet Management cluster CAPM Capital Adequacy Projection Model CAR Capital adequacy ratio CCB Countercyclical capital buffer CCP Centralised Clearing Counterparties CCR Counterparty credit risk CEM Current Exposure Method CET1 Common Equity Tier 1 CFD Centralised Funding Desk CFT Combating the financing of terrorists CISO Chief Information Security Officer CLF Committed Liquidity Facility CLR Credit loss ratio CMVU Credit Model Validation Unit COE Cost of equity CPBP Clients, products and business practices CRE Commercial Real Estate CSA Credit support annex CSIRT Cyber security incident response team CVA Credit valuation adjustment DCC Divisional credit committees del Downturn expected loss Nedbank Group Limited and Nedbank Limited Pillar 3 June

171 ABBREVIATION DEFINITION dlgd Downturn loss given default dti Department of Trade and Industry EAD Exposure at default EaR Earnings at risk ECap Economic capital EGCF Enterprisewide Governance and Compliance Framework EL Expected loss EP Economic profit ERMF Enterprisewide Risk Management Framework Exco Executive Committee FAIS Financial Advisory and Intermediary Services FATCA Foreign Account Tax Compliance Act FCT Foreign currency translation FCTR Foreign currency translation risk FSB Financial Services Board FSP Financial Services Provider GCC Group Credit Committee GCRM Group Credit Risk Monitoring GDP Gross domestic product GMRM Group Market Risk Monitoring GOI Gross operating income GORC Group Operational Risk Committee GRCMC Group Risk and Capital Management Committee GreenHouse GreenHouse Funding (Pty) Limited, Series 1 Group ALCO Group ALCO and Executive Risk Committee GT Group Technology cluster HQLA High quality liquid assets HVCRE High volatility commercial real estate IAS International Accounting Standard IASB International Accounting Standard Board ICAAP Internal Capital Adequacy Assessment Process IFRS International Financial Reporting Standards ILAAP Internal Liquidity Adequacy Assessment Process IMA Internal Model Approach IMM Internal Model Method IPRE Income producing real estate IRB Internal Ratings based IRRBB Interest rate risk in the banking book ISDA International Swaps and Derivatives Association ISF Information Security Forum ISSC Information Security Steering Committee IT Information technology JIBAR Johannesburg Interbank Agreed Rate KRI Key risk indicator LCR Liquidity coverage ratio LGD Loss given default LIBOR London Interbank Offered Rate LRCP Liquidity Risk Contingency Plan LTV loan to value MEFM Macroeconomic Factor Model MRC Minimum required capital MTM Mark to market NCA National Credit Act Nedbank Group Limited and Nedbank Limited Pillar 3 June

172 ABBREVIATION DEFINITION NCD Negotiable certificate of deposit Nedgroup Insurance Nedgroup Insurance Company Limited Nedgroup Life Nedgroup Life Assurance Company Limited NGR Nedbank Group Rating NII Net interest income NIM Net interest margin NIR Non interest revenue NSFR Net stable funding ratio NTR Nedbank Group Transaction Rating OHS Occupational Health and Safety ORMF Operational Risk Management Framework ORX Operational Riskdata exchange Association OTC Over the counter PASA All Payments Association of South Africa PD Probability of default PIIGS Portugal, Italy, Ireland, Greece and Spain PiPs Properties in possession PIT Point in time PR Property revaluation PSE Public Sector Entities QRM Quantitative Risk Management RAPM Risk adjusted performance measurement RAROC Risk adjusted return on capital RBB Retail and Business Banking RegCap Regulatory capital RMBS Residential mortgage backed securitisation programme ROA Return on assets ROE Return on equity RORAC Return on risk adjusted capital RORWA Return on average risk weighted assets RWA Risk weighted assets SABRIC South African Bank Risk Information Centre SAM Solvency Assessment and Management SARB South African Reserve Bank SBP Share based payments SCP Strategic capital plan SFT Securities financing transaction SME Small and Medium sized Enterprises SREP Supervisory Review and Evaluation Process SRWA Simple Risk Weight Approach Standard & Poor s Standard & Poor s Rating Services STI Short term Incentive Synthesis Synthesis Funding Limited T1 Tier 1 TCF Treating Customers Fairly The JSE JSE Limited TSA The Standardised Approach TTC Through the cycle UL Unexpected loss VaR Value at risk WIP Work in progress Nedbank Group Limited and Nedbank Limited Pillar 3 June

173 ANNEXURE D: GLOSSARY OF RISK TERMS AND DEFINITIONS Annexure D: Glossary of Risk Terms and Definitions TERM DEFINITION Accounting and taxation risk (Since accounting and taxation risk is an operational risk, for economic capital purposes accounting and taxation loss events are categorised in terms of one of the subrisks of operational risk) The risk that the integrity and accuracy of the financial statements and related information cannot be upheld. This risk has two subrisks: accounting risk and taxation risk. Accounting risk The risk that: (subrisk of Accounting and taxation risk) Inappropriate accounting information causes suboptimal decisions to be made, due to inappropriate policy, faulty interpretation of policy, or plain error. (Operational risk will cover classification of causal analysis outcome). The financial statements and other statutory and regulatory reporting do not accord with International Financial Reporting Standards (IFRS) and/or other relevant statutory requirements eg Tax Act, are not based on appropriate accounting principles and do not incorporate required disclosures. (Business Risk component). Internal financial and operational controls of accounting and administration do not provide reasonable assurance that transactions are executed and recorded in accordance with generally accepted business practices and group s policies and procedures and that assets are safeguarded. Advanced approaches Methods available to banks to calculate their regulatory capital requirements based on own risk estimates. These include the foundation and Advanced Internal Ratings based (AIRB) approach for credit risk, the advanced measurement approaches (AMA) for operational risk, and the Internal Model Approach (IMA) for market risk. Under AMA the banks are allowed to develop their own empirical model to quantify required capital for operational risk or under Basel III, operational risk charges can be calculated by using one of the three methods (or approaches) that increase in sophistication and risk sensitivity. ALM risk ALM risk is a composite risk category that includes interest rate and foreign exchange risk in the banking book and liquidity risk. Foreign exchange risk in the banking book encompasses. Foreign exchange translation risk. Foreign exchange transaction risk. Nedbank Group Limited and Nedbank Limited Pillar 3 June

174 TERM DEFINITION Asset and liability management (ALM) Asset and liability management is the ongoing process of formulating, implementing, monitoring, and revising strategies related to banking book assets and liabilities in an attempt to: maximise the interest margin; and manage the risk to earnings and capital from changes in financial market rates, which result from the group s mix of assets and liabilities. ALM encompasses the management of liquidity risk, interest rate risk and exchange rate risk in the banking book through the use of both on and off balance sheet instruments and strategies. Backtesting Banking book Brand positioning (a subrisk of reputational risk) The validation of a model by feeding it historical data and comparing the model s results with historic reality. The process of comparing model predictions with actual experience. Group assets, liabilities and off balance sheet items that are not in the trading book. Failure to manage well the group and subsidiary brands which significantly impact the fundamentals underpinning the objective of the group/subsidiary. Damage to the group s brand may expose it to loss of client brand awareness, customers, profits and competitiveness. Business disruption and system failures (subrisk of operational risk) The risk of losses arising from disruption of business or system failures. Business continuity is included in this subrisk and is defined as business disruption and non continuous service to customers (both internal and/or external to the group) due to physical site, human resources, systems or information being unavailable. Included in Business Continuity is disaster recovery: the ability of the group s IT system(s) to recover timeously, or respond with an acceptable alternative temporary solution, system or site following a disaster impacting the group, which might result in financial loss or reputational damage. Business risk Business risk is not specified for Basel III Pillar 1 regulatory capital. It is, however, measured in Nedbank Group's economic capital model, in line with current best practice, which is an earnings volatility methodology. Business risk is the risk caused by uncertainty in profits due to changes in the competitive environment that damage the franchise or operational economics of a business. In other words, it is the risk the bank faces due to fluctuations in earnings, readily observable and driven mainly by volumes, margins and fees. In the extreme, business risk can be seen as the risk of being unable to cover one's cost base should all or most of an entity's earnings fall away. Business risk is also associated with losses due to external factors such as the market situation or government regulations. This quantified risk category also essentially addresses Nedbank Group's strategic risk. The fluctuations in earnings captured here are those not attributable to the influence of other risk types. Business risk thus closes the circle and, together with the other risks defined in Nedbank Group's risk taxonomy, provides for a complete coverage of the quantifiable economic risks Nedbank Group faces. Nedbank Group has adopted the widely accepted methodology of measuring business risk through the quantification of earnings volatility or earnings at risk, and has developed a sophisticated earnings volatility model. The major driver or input used in the earnings at risk methodology is a time series of historical profit and loss, cleansed of the effects of other risk types. The volatility of this time series of historical profits and losses becomes the basis for the measurement of capital. The methodology is based on internal Nedbank Group data, which allows for analysis to understand more about earnings at risk across business units within the bank as more historical data is accumulated. Economic capital for business risk increases with increasing volatility of income streams, but can be offset by variable cost structures that may exist within a business unit. In other words, a business unit would be penalised for high volatility in income, but would receive credit for the ability to reduce costs when faced with declining incomes. Nedbank Group Limited and Nedbank Limited Pillar 3 June

175 TERM Capital management Capital risk DEFINITION Capital management is the set of processes that: ensures the group s capital is in line with the requirements of the regulators, internal assessment of the level of risk being taken by the group, the expectations of the rating agencies and debtholders as well as the returns expected by shareholders; takes advantage of the range of capital instruments and activities to optimise the financial efficiency of the capital base; and manages capital risk. The risk that the group will become unable to absorb losses, maintain public confidence and support the competitive growth of the business. Capital risk includes failure of the group s entities to maintain the minimum regulatory capital requirements laid down by the Registrar of Banks, Registrar of Securities Services, Registrar of Collective Investment Schemes, Registrars of Long term and Short term Insurance and the JSE Limited. Cashflow at risk (CFaR) Old Mutual Plc risk exposure metric: The reduction in the amount of cash earnings generated by business units over the next one year forward looking time horizon that should only be exceeded 1 in 10 years. Clients, products and business practices (subrisk of operational risk) Collateral risk (subrisk of credit risk) Compliance risk (since materialised compliance risk is an operational risk, for economic capital purposes compliance loss events are categorised in terms of one of the subrisks of operational risk) Concentration risk The risk of losses arising from an unintentional or negligent failure to meet a professional obligation to specific clients (including fiduciary and suitability requirements), or from the nature or design of a product. This subrisk includes money laundering. The potential financial loss due to the inability to realise full collateral value due to unforeseen legal or adverse market conditions (eg property market slump) which cause the value of certain specific collateral types to deteriorate. The risk of legal or regulatory sanctions, material financial loss, or loss to reputation the group may suffer as a result of its failure to comply with laws, regulations, rules, related self regulatory organisation standards, and codes of conduct applicable to its banking and other activities. (Basel) Compliance risk is the current and prospective risk of damage to the organisation s business model or objectives, reputation and financial soundness arising from non adherence to regulatory requirements and expectations of key stakeholders such as customers, employees and society as a whole. It exposes the organisation to fines, civil claims, loss of authorisation to operate and an inability to enforce contracts. (CISA) Risk resulting from: (subrisk of credit risk, market risk in the trading book and liquidity risk) In terms of market risk in the trading book and credit risk: an excessive concentration of exposure to a single client or group of related clients, specific financial instrument(s), an individual transaction, a specific industry sector or geographical location, security or collateral; and the degree of positive correlation between clients and groups of clients as well as between financial instruments/markets under stressed economic conditions. In terms of liquidity risk, over reliance on funding or liquidity from a single depositor or small group of depositors. Corporate governance Corporate governance is the structures, systems, processes, procedures, and controls within an organisation, at both board of directors level and within the management structure, that are designed to ensure the group achieves its business objectives effectively, efficiently, ethically and within prudent risk management parameters. Good governance requires that an effective risk management process exists that can ensure that the risks to which the group are exposed are addressed effectively. Nedbank Group Limited and Nedbank Limited Pillar 3 June

176 TERM Counterparty credit risk (subrisk of credit risk) DEFINITION The risk that a counterparty to a financial transaction will fail to perform according to the terms and conditions of the contract, thus causing financial loss. Country risk Country risk includes the following components: (subrisk of credit risk) the risk that a borrower will be unable to obtain the necessary foreign currency to repay its obligations, even if it has the necessary local currency (referred to as transfer risk); the risk of the group s assets in the country being appropriated; and the risk of default by the government on its obligations (referred to as sovereign risk). Credit rating A credit rating is an assessment as to the borrower's ability to meet future payment obligations, ie it is the probability of default of the borrower. The group's credit ratings are based on statistical probabilities, derived from a range of bespoke rating models that measure the likely probability of default of individual borrowers. Credit risk The risk arising from the probability of borrowers and/or counterparties failing to meet their repayment commitments (including accumulated interest) and in particular risks arising from impaired or problem assets and the bank s related impairments, provisions or reserves. It also includes risk arising from exposure to related persons. Credit risk has the following subrisks: collateral risk; concentration risk; counterparty risk; country risk; issuer risk; industry risk; settlement risk; transfer (sovereign) risk; underwriting (lending) risk; and securitisation risk or resecuritisation structures. Credit scoring A method used by a bank to calculate the statistical probability that a loan granted will be repaid. The score is usually a single quantitative measure that represents the borrower's probable future repayment performance. Credit spread The difference in yield between two debt issues of similar maturity and duration. The credit spread is often quoted as a spread to a benchmark floating rate index such as LIBOR or JIBAR or as a spread to highly rated reference security such as a government bond. The credit spread is often used as a measure of relative creditworthiness with a reduction in the credit spread reflecting an improvement in the borrower s perceived creditworthiness. Currency Referred to as foreign exchange. Damage to physical assets (subrisk of operational risk) The risk of losses arising from loss of or damage to physical assets from natural disaster or other events. Nedbank Group Limited and Nedbank Limited Pillar 3 June

177 TERM DEFINITION Default Default occurs with respect too a particular obligor when: The bank considers thatt the obligor is unlikely to pay its credit obligations to the bank in full without recourse by the bank to actions such as realising security (if held). The obligor is past duee more than 90 days on any material credit obligation to the bank. Overdraftss will be considered as being past due once the t customer has breached ann advised limit or been advised of a limitt smaller than current outstanding amount. In terms of o Nedbank s Group Credit Policy, a borrower will also be assumed to be in default where the borrower is placed under business rescue in terms of the Companies Act and where a borrower requests r a restructure of its facilities as a result of distress. Defaulted loans and advances Derivative financiall instruments EAD Any advance orr group of loanss and advances that has triggered the Basel II II definition of default d criteria and which is in line with the revised South African banking regulations. For retail portfolios p this is product centric and therefore a default would be specific to a client or borrower account (a specific advance). For all other portfolios except specialised lending it is client or borrower centric meaning that should anyy transaction within a borrowing group default then all transactions within the borrowing group would be treated as defaulted. At a minimum a default is deemed to have occurred where for example a specific impairment is raised against a credit exposure due to a significant perceivedd decline in the credit quality, a material obligation is past due for moree than 90 days or an obligor has h exceeded ann advised limit for more than 90 days. Derivatives are financial instruments whose value is derivedd from the valuee of an underlying asset (such as gold, wheat or other commodities) or other financial instruments including bonds, or market benchmarks such as interest rates. Derivatives findd application in credit risk, marketing risk in the t trading book, market risk in the banking book and investment risk. See exposure att default. Earnings at risk (EaR) Nedbank Groupp risk appetite metric: Percentage pretax earnings potentially lost over a one year period that should only be exceeded e 1 in 10 years. Old Mutual Plc risk exposure measure: The reduction in i planned pretax IFRS adjusted operating profit p over a one year forward looking time horizon that should only be exceeded 1 in 10 years. ECap Economic capital (ECap) See economic capital. c Economic capital is the capitall that the group holds and allocates internallyy as a result of its own assessment of risk. r It differs from regulatory capital, which is i determined by regulators. It represents the amount of economic lossess the group could withstand and still remain solvent with a target level of confidence c (solvency standardd or default probability) over a one year time horizon. Nedbank Group Limited andd Nedbank Limited Pillar 3 June

178 TERM Economic capital at risk (ECaR) DEFINITION Old Mutual Plc risk exposure measure: ECaR is defined as the reduction in post tax economic value (market consistent embedded value for life entities and IFRS equity for non life entities) over a oneyear forward looking time horizon that should only be exceeded 7 in years (99,93%). ediscovery Employment practices and workplace safety ediscovery (electronic Discovery) is an enterprise product (EnCase ediscovery) that automates the search for specific data on the bank s network. It is mainly used for litigation support, but this product can be used for digital forensic investigations as it is specifically designed to retrieve data in a forensically sound manner. The risk of losses arising from acts inconsistent with employment, health or safety laws or agreements, from payment of personal injury claims, or from diversity/discrimination events. (subrisk of operational risk) Enterprisewide risk Composite of risk types and categories (called the risk universe) across all business lines, functions, geographical locations and legal entities of the group. There are 17 risk types (ERMF risks): accounting and taxation risks; capital risk; compliance risk; credit risk; information technology risk; insurance and assurance risk; investment risk; liquidity risk; market risk in the banking book; market risk in the trading book; new business risk; operational risk; people risk; reputational risk; social and environmental risk; strategic risk; and transformation risk. Enterprisewide risk management Enterprisewide risk management is a structured and disciplined approach aligning strategy, processes, people, technology, and knowledge with the purpose of evaluating and managing the opportunities, uncertainties and threats the group faces as it creates value. It involves integrating risk management effectively, across an organisation s risk universe, business units and operating divisions, geographical locations and legal entities. Enterprisewide Risk Management Framework (ERMF) The risk framework developed by the group and applied to all of its divisions in order to identify, assess or measure, manage, monitor and report risk. The ERMF contains the group s risk universe, which lists 17 risk categories (the ERMF risks). Environmental risk (subrisk of social and environment risk) The risk that an activity or process in the group will degrade, devalue or destabilise the environment and lead to further damage, cause harm to bank employees, cause harm to people in the community/society or damage the long term prospects of the bank. It includes the risk of the financing of or the association with environmentally unfriendly companies or projects. Nedbank Group Limited and Nedbank Limited Pillar 3 June

179 TERM Equity risk in the banking book (also termed investment risk) (subrisk of investment risk) ERMF ERMF risks Execution, delivery and process management (subrisk of operational risk) Expected loss (EL) DEFINITION The risk of decline in the net realisable value of equity exposures in the banking book. These include: Investment in securitiess (listed and unlisted equity holdings whether direct orr indirect and includes private equity). Investment in associate companies and joint ventures. Property investments (managed by the Property Finance division and excludes owner occupied and repossessed properties). See Enterprisewide Risk Management Framework. The 17 risks listed in the ERMF. The risk of losses from failed transaction processing or process management, from relations with trade counterparties and vendors. Losses that a bank expects to bear over a certain time period (generally one year). These losses are a consequence off doing business namely the bank s role as financial intermediary. Generally impairments should cover expected losses with respect to credit c risk and losses relating to t operational risk should be budgeted b for. Expected shortfall Exposure at default (EAD) External fraud (subrisk of operational risk) Extreme loss Expected average loss for losses greater than value at risk (VaR). Quantification of o the exposuree at risk in case of default. The risk of losses due to acts of a type intended to defraud, misappropriatee property or circumvent the law by a third party. p The loss arising from a loss event of catastrophic magnitude. Such an event often leads too the failure of a bank. Nedbank Group Limited andd Nedbank Limited Pillar 3 June

180 TERM Fair value DEFINITION Fair value is defined in IAS 39 as 'the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm s length transaction.' Financial Group Directive (FGD) Surplus capital at risk (FCaR) Old Mutual risk exposure measure: The reduction in FGD surplus over a one year forward looking time horizon that should only be exceeded 1 in 10 and 1 in 200 years. Foreign currency translation risk (subrisk of market risk in the banking book) The risk to earnings or capital arising from converting the group s offshore banking book assets or liabilities or commitments or earnings from foreign currency to local or functional currency. Foreign exchange transaction risk (in the banking book) (subrisk of market risk in the banking book) The risk that known or ascertainable currency cashflow commitments and receivables are uncovered and as a result have an adverse impact on the financial results and/or financial position of the group due to movements in exchange rates. Foreign exchange transaction risk in the banking book includes: Known or ascertainable currency cashflow commitments and receivables (termed residual foreign exchange risk). Foreign funding mismatch (Group Asset and Liability Committee has approved a foreign funding mismatch position for the group, which is run by the Centralised Funding Desk in Treasury, Nedbank Capital). Any other transaction extending credit or making an investment that attracts foreign exchange risk. Gross risk Hedge See inherent risk. A risk management technique used to reduce the possibility of loss resulting from adverse movements in commodity prices, equity prices, interest rates or exchange rates arising from normal banking operations. Most often, the hedge involves the use of a financial instrument or derivative such as a forward, futures, option or swap. Hedging may prove to be ineffective in reducing the possibility of loss as a result of, inter alia, breakdowns in observed correlations between instruments, or markets or currencies and other market rates. Hedging ICAAP Impaired loans and advances Industry risk (subrisk of credit risk) Action taken by the group to reduce or eliminate the possibility of loss resulting from adverse movements in commodity prices, equity prices, interest rates or exchange rates. See Internal Capital Adequacy Assessment Process. Impaired loans and advances are defined as loans and advances in respect of which the bank has raised a specific impairment under the IAS 39 definition. The risk that defaults will arise in an industry because of factors specifically affecting that industry. Information technology (IT) risk The risk associated with information technology has a strategic and an operational component. Information technology risk encompasses the strategic component, while the operational component is included in operational risk. The risk resulting from system inadequate or system inappropriate information technology investment, development, implementation, support or capacity with a concomitant negative impact on the achievement of strategic group objectives. This includes the risk of an uncoordinated, inefficient and/or under resourced information technology strategy, as a result of which the group becomes progressively less competitive. Nedbank Group Limited and Nedbank Limited Pillar 3 June

181 TERM DEFINITION Inherent risk Assessing inherent risk exposure requires a determination of the severity and frequency of each operational risk should an event materialise. An inherent risk exposure assessment provides the business with an understanding of the extent of possible exposure in an uncontrolled environment Inherent risk is also known as gross risk. An ERMF risk, if applicable with respect to the achievement of objective(s), is an inherently high (or red) risk. Insurance and assurance risk The risk that the underwriting process permits clients to enter risk pools with a higher level of risk than priced for, resulting in a loss to the business unit or group. Actuarial and statistical methodologies are used to price insurance risk (eg morbidity, mortality, theft, storm). Underwriters align clients with this pricing basis and respond to any anti selection by placing clients in substandard risk pools and price these risks with an additional risk premium and/or exclude certain claims, events or causes, or exclude clients from entering pools at all. The failure to reinsure with acceptable quality reinsurers, beyond the level of risk appetite (excessive risk) mandated by the board of directors, risks underwritten by the short term insurance and/or life assurance activities of the group, including catastrophe insurance (ie more than one insurance claim on the group arising from the same event), leading to disproportionate losses to the group. (Reinsurance risk). The risk of no or inadequate insurance cover for insurable business risks. (Insurance risk). Insurance underwriting risk in the group arises in the following areas: Short term insurance underwriting risk arises exclusively from Nedgroup Insurance Company Limited, a business unit in the Nedbank Wealth cluster. Long term insurance underwriting risk arises from the Nedgroup Life Assurance Company Limited, a business unit in Nedbank Wealth cluster. Interest rate risk in the banking book (subrisk of market risk in the banking book) Interest rate risk in the banking book is the risk that the group s earnings or economic value will decline as a result of changes in interest rates. The sources of interest rate risk in the banking book are: repricing risk (mismatch risk) [timing differences in the maturity (for fixed rate) and repricing (for floating rate) of bank assets, liabilities, and off balance sheet positions]; basis risk (imperfect correlation in the adjustment of the rates earned and paid on different instruments with otherwise similar repricing characteristics); yield curve risk (changes in the shape and slope of the yield curve); and embedded options risk (the risk pertaining to interest related options embedded in bank products). Internal Capital Adequacy Assessment Process (ICAAP) The process by which banks demonstrate that chosen internal capital targets are well founded and that these targets are consistent with their overall risk profile and current operating environment. The five main features of a rigorous process are: board and senior management oversight; sound capital assessment; comprehensive assessment of risks; monitoring and reporting; and internal control review. Nedbank Group Limited and Nedbank Limited Pillar 3 June

182 TERM Internal control system Internal fraud (subrisk of operational risk) Investment risk Issue versus risk Issuer risk (subrisk of credit risk) Key risk indicator (KRI) DEFINITION An internal control system comprises the policies, procedures and activities within the group designed to: ensure that risks are contained within the risk tolerances established by the risk management process; and provide reasonable assurance of reliable and accurate information, ensure compliance with policies, procedures and laws, use resources efficiently, protect assets and achieve operational objectives. Internal control is a ˈprocessˈ affected by the board of directors, senior management and all levels of staff in the group. The objectives of the internal control process are to provide reasonable assurance of: efficiency and effectiveness of activities (performance objectives); reliability, completeness and timeliness of financial and management information (information objectives); and compliance with applicable laws and regulations (compliance objectives). The risk of losses due to acts of a type intended to defraud, misappropriate property or circumvent regulations, the law or company policy, excluding diversity/discrimination events, which involves at least one internal party. Internal fraud includes insider trading. The risk of a decline in the net realisable value of investment assets arising from adverse movements in market prices or factors specific to the investment itself (eg reputation and the quality of management). Market prices are independent variables, which include interest rates, property values, exchange rates, and equity and commodity prices. Investment risk is also called equity risk in the banking book. An issue (or event) has materialised or is in the process of doing so, while a risk has not yet materialised. The risk that a particular payment or set of payments due from an issuer or a listed instrument (eg corporate bond) will not be forthcoming as scheduled. A management information indicator that provides continuous insight into the level of risk in the group/business. KRIs enable management to proactively manage and monitor risk proactively on an ongoing basis. KRIs may be leading, concurrent or lagging indicators. (Note: It is preferable to focus on leading indicators proactively to prevent a risk from materialising). King III The King Report on Governance for South Africa Legal risk (subrisk of operational risk) (For economic capital purposes legal risk is a subcategory of operational risk s subrisk clients, products and business practices) Legal risk arises from the necessity that the group conduct its activities in conformity with the business and contractual legal principles applicable in each of the jurisdictions where the group conducts its business. The possibility that a failure to meet these legal requirements may result in unenforceable contracts, litigation, fines, penalties or claims for damages or other adverse consequences. It comprises risk arising from inadequate documentation, legal or regulatory incapacity, insufficient authority of a counterparty and uncertainty about the validity or enforceability of an obligation in counterparty insolvency. It includes contravention, failure to prevent, detect or promptly correct violations of the terms and provisions of contractual agreements and related documents entered into with clients, counterparties, suppliers and other parties, which include common law and other applicable statutory liabilities. Letter of representation A letter of representation is signed by the Chief Executive and Chief Risk Officer of the Nedbank Group twice a year as part of Old Mutual plc Board s annual review process. It serves to confirm that there has been no indication of any significant business risk occurring, nor any material malfunction in controls, procedures or systems during the reporting period, resulting in loss or reputational damage, which impacts negatively on the attainment of Nedbank Group s business s objectives during the year and up to the date of approval of the Annual Report. Exceptions are noted and reported. In addition the letter confirms that Nedbank Group will continue as a going concern for the year ahead. Nedbank Group Limited and Nedbank Limited Pillar 3 June

183 TERM LGD Likelihood Liquidity risk DEFINITION See loss given default. An assessment of how likely it is that a risk will occur. A similar term is probability. There are two types of liquidity risk, namely funding liquidity risk and market liquidity risk. Funding liquidity risk is the risk that the group is unable to meet its payment obligations as they fall due. These payment obligations could emanate from depositor withdrawals, the inability to roll over maturing debt or meet contractual commitments to lend. Market liquidity risk is the risk that the group will be unable to sell assets, without incurring an unacceptable loss, in order to generate cash required to meet payment obligations under a stress liquidity event. The primary role of a bank in terms of financial intermediation is the transformation of short term deposits into longer term loans. By fulfilling the role of maturity transformation banks are inherently susceptible to liquidity mismatches and consequently funding and market liquidity risks. Concentration risk is a subrisk of liquidity risk. Loss given default (LGD) This is an estimate of the portion of the exposure at default that will not be recovered, usually expressed as a percentage. It also includes other economic costs such as legal costs. Market risk in the banking book The risk of loss in the banking book as a result of unfavourable changes in foreign exchange rates and interest rates. The subrisks of market risk in the banking book are: interest rate risk in the banking book; foreign exchange translation risk; and foreign exchange transaction risk in the banking book. Equity (investment) risk Property risk Market risk in the trading book The risk of loss as a result of unfavourable changes in market prices, such as foreign exchange rates, interest rates, equity prices, credit spreads and commodity prices. There is trading market risk within the group s proprietary trading activities (trading on the group s own account). Concentration risk is a subrisk of market risk. Model risk (a subrisk of operational risk) The risk that business decisions are made using model results that are incorrect. This includes the possibility of losing perspective of the limitations of models in general and to the pitfalls associated with their use. Net risk See residual risk. New business risk The risk that new product and business lines do not generate anticipated revenue or cost savings to the group. This could be as a result of providing to clients or potential clients inappropriate products and business lines that fail to meet clients or potential clients requirements or otherwise fail to impress, compete with competitors products or provide Nedbank Group with a leading edge in product development and delivery. Management of this risk requires that new products and business development do not reach the client distribution channel without the appropriate signoff for compliance with the risk management requirements for all 17 risks in the Enterprisewide Risk Management Framework. Nedbank Group Limited and Nedbank Limited Pillar 3 June

184 TERM Objective Operational risk OpsRisk DEFINITION It is a goal that management has set for the entity (group or business) to achieve. The risk of loss resulting from inadequate or failed internal processes, people or systems or from external events. This includes legal risk but, excludes strategic risk and reputational risk. The event types of operational risk are: business disruption and system failures; clients, products and business practices; damage to physical assets; employment practices and workplace safety; execution, delivery and process management; external fraud 1 ; internal fraud 1 ; legal risk (legal risk is a sub category of the subrisk clients, products and business practices); and model risk 1 Measures are in place for the proactive prevention and detection of criminal activities. Old Mutual Plc risk exposure metric: Reduction in pretax economic value due to 1 in 10 operational loss events. Outsourcing risk Risk arising from the outsourcing of material tasks or functions. Outsourcing means the contracting out of services, administration, or operation of core business functions and/or activities and/or services of the bank, in terms of an service level agreement (SLA), to a supplier, to independently perform such activities on a continuing basis, as would normally be undertaken by the bank. Past due PD People risk A loan or advance is considered past due when it exceeds its limit (fluctuating types of advances) or is in arrears (linear types of advances). See probability of default. The risk associated with people has a strategic and operational component. People risk encompasses the strategic component, while the operational component is included in operational risk. People risk is the risk associated with inadequacies in human capital and the management of human resources, policies and processes, resulting in the inability to attract, manage, motivate, develop and retain competent resources, at the same time having a negative impact on the achievement of strategic group objectives. It includes: the risk that effective risk adjusted performance measurement and indicators are not implemented in the group, resulting in incorrect reward allocation, failure to optimise the use/allocation of the group s capital and wrong corporate behaviour resulting in sub optimal returns; the risk that the group fails to motivate staff through the use of inappropriate incentive schemes, or the poor administration of incentive schemes; the risk that the group does not ensure that skills and experience are developed, consistently and methodically retained (or capitalised) and enhanced to create value for the group (for example, in the form of innovative product designs, developed systems, methods and procedures); and risks arising from or related to inappropriate compensation practices for directors and executive officers. Point in time rating A credit rating based on point in time risk measures. Point in time measures take into account the current state of the economic environment when measuring the risk of the borrower. Compare to through the cycle rating, which the group uses for capital measurement. Nedbank Group Limited and Nedbank Limited Pillar 3 June

185 TERM Portfolio impairment Probability DEFINITION The standard portfolio represents all the loans and advances that have not been impaired. These loans and advances have not yet individually evidenced a loss event but loans and advances exist within the standard portfolio that may have impairment without the bank yet being aware of it. A period of time will elapse between the occurrence of an impairment event and objective evidence of the impairment becoming evident. This period is generally known as the emergence period. For each standard portfolio an emergence period is estimated as well as the probability of the loss trigger and the loss given events occurring. These estimates are applied to the total exposures of the standard portfolio to calculate the portfolio impairment. An assessment of how probable it is that an event will occur. A similar term is likelihood. Probability of default (PD) Property risk Quantification of the likelihood of a borrower being unable to pay during a specific time horizon, usually 12 months. Property risk is the risk of decline in the net realisable value of property arising from adverse movements in property prices or factors specific to the property itself (eg location). Property comprises business premises, property acquired for future expansion and properties in possession (PiPs). Regulation 39 A regulation issued in terms of the Banks Act titled ˈProcess of corporate governanceˈ. The regulation states that the ˈconduct of the business of a bank entails the management of risks, which may include, amongst others, the following types of risk: capital risk; compliance risk; concentration risk; counterparty risk; country risk and transfer risk; credit risk, and in particular risks arising from impaired or problem assets and the bank s related impairments, provisions or reserves; currency risk; detection and prevention of criminal activities; equity risk arising from positions held in the bank s banking book; interest rate risk; liquidity risk; market risk (position risk) in respect of positions held in the bank s trading book; operational risk; reputational risk; risk arising from exposure to a related person; risk arising from the outsourcing of material tasks or functions; Risk arising from all relevant payment and settlement services, processes or systems; risk relating to procyclicality; risks arising from or related to inappropriate compensation practices for directors and executive officers; risks related to securitisation or resecuritisation structures; risks related to stress testing; risks related to the inappropriate valuations of instruments, assets or liabilities; solvency risk; strategic risk; technological risk; translation risk; and any other risk regarded as material by the bank.ˈ Nedbank Group Limited and Nedbank Limited Pillar 3 June

186 TERM Regulatory capital DEFINITION The total of Tier 1 and Tier 2 capital. Reputational risk The risk of impairment of the group s image in the community or the long term trust placed in the group by its shareholders as a result of a variety of factors, such as the group s performance, strategy execution, brand positioning and competitiveness, ability to create shareholder value, or an activity, action or stance taken by the group. This may result in loss of business and/or legal action. Residual risk Residual risk is the product of the impact of the risk on the objective(s) and the likelihood of the risk occurring taking into consideration current management actions/controls in place to mitigate the risk. Residual risk is also known as net risk. Return on risk adjusted capital (RORAC) RORAC is a relative performance measurement whereby capital is calculated on a risk adjusted basis (ie economic capital) RORAC= IFRS earnings+capital benefit economic capital Risk Risk is anything which may prevent the bank from achieving its objectives or otherwise have an adverse impact on the bank. Risk acceptance Risk acceptance is used in risk management to describe an informed decision to accept the consequences and likelihood of a particular risk. In terms of best practice, risk can only be accepted if it can be illustrated that the risk is within set risk appetite limits. Risk appetite Risk appetite is an articulation and allocation of the risk capacity or quantum of risk Nedbank Group is willing to accept in pursuit of its strategy, duly set and monitored by Group Exco and the board, and integrated into our strategy, business, risk and capital plans. Risk appetite is expressed quantitatively as risk measures such as earnings at risk and other ratios, covering all quantifiable risk types, with appropriate targets and ˈstressedˈ limits, and qualitatively in terms of policies and controls. Risk avoidance Risk avoidance is used in risk management to describe an informed decision not to become involved in activities that lead to the possibility of the risk being realised. Risk identification The ongoing recognition and discernment of risk. Risk management and control The proactive management of risks within risk appetite to reasonably assure achievement of objectives. Risk management consists of taking action to align risks with the group s risk appetite and ensuring that such actions are properly executed. Appropriate risk management will require at least: a system of internal controls; approval processes; limit systems; key risk indicators; reviews of Enterprisewide Risk Management policies, processes and procedures and their implementation; and reviews of controls, approvals and limits. Nedbank Group Limited and Nedbank Limited Pillar 3 June

187 TERM Risk management framework DEFINITION The outline for the management of a risk, more fully developed or described elsewhere. A risk management framework comprises: An appropriate risk management environment: risk philosophy risk culture risk appetite risk governance structure policies, processes and procedures staff and other resources Risk strategy Risk management process risk identification risk measurement risk management and control risk reporting risk monitoring Risk management process Risk management strategy Risk measurement Risk mitigation Risk monitoring Risk reporting Risk management is the identification, assessment, and prioritisation of risks (defined in ISO as the effect of uncertainty on objectives, whether positive or negative) followed by coordinated and economical application of resources to minimise, monitor, and control the probability and/or impact of unfortunate events or to maximise the realisation of opportunities. The strategies to manage risk include transferring the risk to another party, avoiding the risk, mitigating the risk by reducing the negative effect of the risk, and accepting some or all of the consequences of a particular risk (see transfer of risk, risk avoidance and risk mitigation). The evaluation of the magnitude of risk and its impact on the achievement of business objectives. Risk mitigation is used in risk management to describe steps taken to control or prevent an issue or event hazard from causing harm and to reduce risk to a tolerable or acceptable level and within risk appetite levels. The ongoing and systematic tracking and evaluating of risk management decisions and actions against strategies, risk appetite, policies, limits and key risk indicators. Risk monitoring incorporates a feedback loop into the other components of the risk management process namely risk identification, measurement/assessment, management and/or reporting. The communication of risk information in all phases of the risk management process namely identification, measurement, management and monitoring. Risk reporting includes at least the reporting of: aggregate exposures against targets/strategies; key issues for the key issues control log; compliance with limit system; key risk indicators; and review findings. Risk strategy A risk strategy describes the fundamental direction with regard to each of the 17 Enterprisewide Risk Management Framework risks and associated subrisks. A risk strategy is built around and supports the business strategy. Generic risk strategies are: avoid (or terminate), transfer, mitigate (or treat) or accept (or tolerate). Risk versus issue A risk has not (yet) materialised while an issue has materialised or is in the process of doing so. Nedbank Group Limited and Nedbank Limited Pillar 3 June

188 TERM DEFINITION Risk adjusted performance measurement (RAPM) There are two main measures implemented through Nedbank Group s RAPM framework: risk adjusted return on capital (RAROC), which expresses the risk adjusted profit with respect to the capital necessary to generate the revenue, giving a relative measure of performance; and economic profit (EP), an absolute measure of shareholder value creation. Risk adjusted return on capital (RAROC) The International Financial Reporting Standards (IFRS) earnings of the business adjusted for the difference between expected loss and impairments and divided by the economic capital consumed by that business, giving a relative measure of performance. Risk weighted assets (RWA) Risk weighted assets are determined by applying risk weights to balance sheet assets and off balance sheet financial instruments according to the relative credit risk of the counterparty. The risk weighting for each balance sheet asset and off balance sheet financial instrument is regulated by the South African Banks Act, 94 of 1990, or by regulations in the respective countries of the other banking licences. Securitisation risk (subrisk of credit risk) Risk arising from the creation and issuance of tradable securities, such as bonds, that are backed by the income generated by an asset, a loan, a public works project or other revenue source. Security (function of Group Risk services) Security is a risk management function consisting of physical security, information security and personnel integrity. The objectives of physical security are to protect: physical assets under the control of the group; the wellbeing of staff, clients and the public; and the group's reputation as it relates to safety and security, ie the protection of the image and reputation of the bank in providing a safe and secure, environmentally friendly business environment. The objectives of information security are to protect the group from breaches in the confidentiality or integrity of group information and from the unavailability of such information when required. This includes all information in the group, not only internally system generated information. The objectives of personal integrity are to ensure that staff members do not compromise resources or allow resources to be compromised, be it on purpose, through neglect or unintentionally. Settlement risk (subrisk of credit risk) The risk that an organisation gives but fails to receive consideration from a counterparty during the settlement of a transaction. The settlement may be cash or securities. Foreign exchange settlement risk is the risk of loss when a bank in a foreign exchange transaction pays the currency it sold but does not receive the currency it bought. Social and environmental risk The risk of reputational impairment and ultimately loss of business and profitability as a result of noncompliance with legislation that governs the banks activities as it relate to social and environmental impacts of the bank s direct operations and indirect lending activities. Social and environmental risk has two subrisks: social risk; and environmental risk. Nedbank Group Limited and Nedbank Limited Pillar 3 June

189 TERM DEFINITION Social risk (subrisk of social and environmental risk) The risk of reputation damage, political intervention, heightened regulatory pressure, protests, boycotts and operational stoppages and ultimately loss of business and profitability due to the real or perceived negative impact of group business practices on a broad range of matters related to human, societal and community welfare such as health and economic opportunity. Sovereign risk The risk of default by the government of the country on its obligations (also see country risk). Strategic risk The risk of an adverse impact on capital and earnings due to business policy decisions (made or not made), changes in the economic environment, deficient or insufficient implementation of decisions, or a failure to adapt to changes in the environment. Strategic risk is either the failure to do the right thing, doing the right thing poorly, or doing the wrong thing. Strategic risk includes: the risk associated with the deployment of large chunks of capital into strategic investments that subsequently fail to meet stakeholders expectations; the risk that the strategic processes to perform the environmental scan, align various strategies, formulate a vision, strategies, goals and objectives and allocate resources for achieving, implementing, monitoring and measuring the strategic objectives are not properly in place or are defective; and failure to adequately review and understand the environment in which the group operates leading to underperformance of its strategic and business objectives (specific environmental components include: industry, political, economic, government, competitive and regulatory factors). Brand positioning is a subrisk of strategic risk. Stress testing Stress and scenario testing recognises and estimates the potential volatility of Nedbank s impairments, headline earnings, capital requirements, capital resources and the base case (expected) three year plan projections, and ultimately the adequacy of Nedbank s capital buffers and target capital ratios. The process includes macroeconomic factor stress testing, additional stress scenarios, reverse stress testing, benchmarking to international stress testing exercises, procyclicality tests and cluster and business unit level stress testing. Subrisk A component of a risk covered by the Enterprisewide Risk Management Framework. A separate risk management framework is defined for a subrisk. Taxation risk (a subrisk of accounting and taxation risk) The risk that effective tax planning, coordination and strategy, compliance with tax laws and regulations, proactive identification and management of tax risks are not enforced or a poor relationship with revenue authorities exits, resulting in loss and/or missed opportunities, financial or otherwise, as a result of the organisations approach to taxation. In building a taxation risk profile, two key elements are considered: A tax ˈriskˈ refers to a future uncertainty relating to tax that has the potential for adverse consequences or may lead to missed opportunities. Such adverse consequences would usually be monetary; in the form of tax, interest and penalties, but they may also include risks such as the damage to reputation, for example with revenue authorities, investors, shareholders, or the general public. A tax ˈissueˈ refers to a past event that has the potential for adverse consequences or may lead to missed opportunities. Such adverse consequences would usually be monetary; in the form of tax, interest and penalties, but they may also include risks such as the damage to reputation, for example with revenue authorities, investors, shareholders, or the general public. Nedbank Group Limited and Nedbank Limited Pillar 3 June

190 TERM Through the cycle rating Tier 1 capital Tier 2 Trading book Transfer of risk Transformation risk (since transformation risk is an operational risk, for economic capital purposes transformation losss events are categorised in terms of one of the subrisks of operational risk) UL Underwriting risk Unexpected loss DEFINITION A credit rating based b on through the cycle risk measures. Through the cycle measures evaluate the financial condition of the borrower over a longer term that incorporates a full economic (or( business) cycle. Compare to point in time rating. Tier 1 capital consists of issuedd ordinary share capital, retained earnings and reserves [Common Equity Tier 1], and other qualifying additional Tier 1 instruments. Preference P shares do not fully qualify as Tier 1 capital, they are a however subject to grandfathering evenlyy over 10 year w.e.f. 1 Januaryy Hybrid debt instruments are being phased out as qualifying capital,, subject to limits, and will be fully disqualified w.e.f. 1 January This amount is then reduced by the portion of capital that t is allocated to trading activities and other specified regulatoryy deductions. Tier 2 capital is made up of subordinated debt and portfolioo impairment subject to a limit This comprises positions in financial instruments and commodities, including derivative products p and other off balance sheet instruments that are held with trading intent or too hedge other elements of the trading book. It includes financial instruments and commodities that: are held for short term resale; or are held with the intention of benefiting from short term price variations; or arise from broking and market making; or are held too hedge other elements of the trading book. Transfer of risk is used in risk management to describe the shifting s of the burden of the risk to another party. Insurancee is a common example of risk transfer. The risk of failure by the groupp to adequately, proactively and positively respond to and address a transformation issues such as black economic empowerment and uphold related law such as the Employment Equity Act. See unexpectedd loss. When an investment banker buys the balance or all of the new n shares thatt a company is selling, the risk that the price will go downn before they are sold, or thatt investors will not want to buy them. Losses which may exceed the expected loss within a certain time period (eg one year) and within a specified confidence level (ie 99,93%). Unexpected loss is the difference between value at a risk and expected loss. Nedbank Group Limited andd Nedbank Limited Pillar 3 June

191 TERM Use test Value at risk (VaR) DEFINITION Requirement that the components of advanced approaches for the calculation of regulatory capital should not be used merely for the calculation of regulatory capital. Instead they should play an essential role in how a bank measures and manages risk in its business. Formally, the probabilistic bound of losses over a given period of time (the holding period) expressed in terms of a specified degree of confidence (the confidence interval). Put more simply, VaR is the worst case loss expected over the holding period within the probability set out by the confidence interval. Larger losses are possible, but with a lower probability. For example: if a portfolio has a VaR of R10m over a one day holding period with a 95% confidence interval, the portfolio would have a 5% chance of suffering a one day loss greater than R10m. Wrong way risk Wrong way risk can be classified as either specific or general. Specific wrong way risk is defined as the positive correlation of a counterparty s credit rating with the underlying value of a derivative(s) transaction. General wrong way risk is defined as the broad positive correlation of overall counterparty credit risk with a given trading portfolio valuation. Nedbank Group Limited and Nedbank Limited Pillar 3 June

192 NEDBANK GROUP LIMITED Incorporated in the Republic of South Africa Registration number: 1966/010630/06 COMPANY DETAILS Registration address: Nedbank Group Limited, Nedbank Sandton, 135 Rivonia Road, Sandown, Sandton, 2196 PO Box 1144, Johannesburg, 2000