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Capital Adequacy and Risk Management
Pillar 3 Disclosure Report
As of 31 December 2014
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Capital Adequacy and Risk Management
Pillar 3 Disclosure Report
DHB BANK
2014
Table of Contents
I. BACKGROUND AND OVERVIEW .............................................................................. 2
II. RISK AND CAPITAL MANAGEMENT.................................................................... 4
1. Regulatory development .............................................................................................. 4
2. Risk Governance ........................................................................................................... 5
3. Risk Appetite ................................................................................................................ 8
4. Capital Management Framework ................................................................................ 10
III. CAPITAL BASE ....................................................................................................... 14
IV. PILLAR 1 RISKS AND CAPITAL REQUIREMENTS ........................................... 15
V. CREDIT RISK .............................................................................................................. 18
1. Overview of credit risk management ........................................................................ 18
2. Credit risk profile ...................................................................................................... 18
3. Counterparty risk and derivatives ............................................................................ 21
4. Credit risk mitigation ................................................................................................ 22
5. Asset quality .............................................................................................................. 22
VI. MARKET RISK ........................................................................................................ 25
VII. OPERATIONAL RISK ............................................................................................. 26
VIII. PILLAR 2 RISKS .................................................................................................. 27
1. Interest rate risk in the banking book (IRRBB) ........................................................ 27
2. Liquidity risk ............................................................................................................. 29
3. Concentration risk .................................................................................................... 30
4. Other risks: Legal, compliance and reputation risk.................................................. 30
IX. CAPITAL ADEQUACY CONCLUSION ................................................................. 32
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I. BACKGROUND AND OVERVIEW
This document discloses DHB’s risk profile, risk management practices and capital adequacy
position to fulfill the Basel III disclosure requirements, as stipulated in the Capital Requirements
Regulation and Directive IV (CRR/CRD IV).
The CRD IV was enforced in the Dutch law as amendments to the ‘Wet op het financieel toezicht’
and further accompanying regulations. Jointly, these regulations represent the new regulatory
framework applicable in the Netherlands to, among other things, capital, leverage and liquidity as
well as Pillar 3 disclosures.
The Basel III framework holds three pillars. Each pillar concentrates on a different aspect of
banking regulation:
- Pillar 1 defines the way banking institutions calculate their regulatory capital requirements in
order to cover credit risk, market risk and operational risk.
- Pillar 2 addresses the banks’ risk management structure and processes for assessing overall
capital adequacy in relation to risks, including other risks not identified in the first pillar such as
concentration risk. Pillar 2 also introduces the Supervisory Review and Evaluation Process
(SREP), the response of the Supervisor to the internal capital adequacy assessment process
(ICAAP) conducted by banking institutions.
- Pillar 3 complements the first two pillars of Basel III by requiring a range of disclosures on
capital and risk assessment. Its aim is to encourage market discipline by enhancing
transparency that will allow market participants to make a better assessment of the bank’s
capital, risk exposure, risk assessment processes, and hence the capital adequacy of the
institution.
The new regulatory framework became effective on January 1, 2014, subject to certain transitional
rules. This report fulfills the disclosure required in the CRD IV regulation.
The Pillar 3 report consists of both quantitative and qualitative information as at 31 December
2014. The quantitative exposures in this report are not directly comparable to the numbers in the
2014 Annual Report. The numbers in the Annual Report refer to book values and classifications in
line with the International Financial Reporting Standards (IFRS). In this document, credit
exposure is defined as the estimate of the amount lost in the event of default or through the decline
in value of asset. This estimate takes into account contractual commitments to undrawn amounts.
In contrast, an asset in the Bank’s balance sheet, as published in the Annual Report, is reported as a
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drawn balance only. This is one of the reasons why exposure values in the Pillar 3 report can differ
from asset values as reported in the published accounts.
Where this document discloses (credit) risk exposures or capital requirements, DHB has followed
the scope and application of its Pillar 1 capital adequacy calculations. Where figures for
impairment or losses are disclosed within this document, DHB has followed the IFRS definitions as
used in DHB’s Annual Report.
Furthermore, the bank’s Pillar 3 report supplements the qualitative information provided in the
2014 Annual Report on corporate governance, risk and capital management as well as the Notes to
the financial statements.
The information is not required to be and therefore has not been subject to external audit.
However, it has been subject to internal review procedures broadly consistent with those
undertaken for interim reports. DHB publishes Pillar 3 disclosures annually on its website:
www.dhbbank.com.
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II. RISK AND CAPITAL MANAGEMENT
1. Regulatory development
New capital adequacy regulations were introduced in 2014. Regulation 575/2013 EU (CRR)
came into force in the EU on 1 January 2014 and is directly applicable in the Netherlands.
Directive 2013/36/EU (CRD IV) was also implemented in the Dutch law by the Wft. The
directive specifically monitors the reinforcement of the capital and liquidity of banks and
investment firms.
The new requirements stipulate that the bank must have common equity tier 1 capital of at least
4.5 percent, tier 1 capital of at least 6 percent, and own funds that correspond to at least 8 percent
of the total risk-weighted exposure amount for credit risks, market risks and operational risks.
In addition to maintaining capital to meet the minimum capital requirement, the Bank must also
maintain common equity tier 1 capital to comply with combined buffer requirements, which will
be phased in over coming years, and requirements under Pillar 2 of the regulations. The
requirements are decided by the supervisory authority after the Bank performs an ICAAP, in
which all risks and capital requirements are assessed rigorously.
In the forthcoming years, banks will be subjected not only to demanding capital and liquidity
requirements but also to other closely related evolving regulations such as on how to proceed in
case of financial distress (Recovery and Resolution Planning). On 15 April 2014, the European
Parliament adopted the Bank Recovery and Resolution Directive (BRRD), which came into force
on 1 January 2015. Its implementation in Dutch legislation has not been completed yet.
The purpose of a Resolution Plan is to document how a bank can be resolved in case the recovery
plan does not prevent the institution from reaching the point of non-viability. The recovery plan
documents the ability of banks to recover from a situation where their business model is so
challenged by the economic environment that it is necessary to revise its strategy in order to avoid
reaching a point of non-viability. DHB delivered an update of its recovery plan to DNB in
January 2015.
The BRRD introduces a Minimum Requirement for own funds and Eligible Liabilities (MREL).
The liability items qualifying for the bail-in buffer are referred to as Eligible Liabilities. These
‘own funds and eligible liabilities’ form a buffer to absorb losses. In this connection, the aim of
BRRD is to introduce a bail-in regime with effect from 1 January 2016. This means that, in the
event of a bank failure, first the shareholders and lenders are ‘charged’ for an amount of at least 8
percent of the balance sheet total or 20 percent of the risk-weighted assets. Only then can any
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public funds be used. The amount in retail deposits exceeding Euro 100 thousand will not fall
under the 8% 'bail-in'.
Another important development in 2014 was the the enactment of the Policy Rule on Maximizing
the Deposits and Exposures Ratio under the Act on Financial Supervision (hereafter referred to as
New Business Model Policy Rule) in February 2014.
In nutshell, the New Policy Rule requires Dutch banks to comply with a certain ratio between the
banks’ exposure outside the European Economic Area (EEA) and their deposits under the
coverage of the Dutch deposit guarantee scheme, with the required ratio determined in relation to
the respective banks’ balance sheet size. Accordingly, DHB will continue to shift its lending
activities more towards the EEA, thus continuing in a direction that the bank had already started
to pursue following the 2008 crisis in the context of its strategic alignment. This strategic path
will further strengthen the bank’s commercial standing by increasing the diversification in its
assets. It is notable that country risk diversification would not only strengthen the Bank’s risk
posture but would also allow it to reduce Pillar 2 capital add-on requirements under the current
capital regime.
Overall, the banking sector continues to face a growing number of ever stricter international and
regulatory requirements and a more severe monitoring of compliance by supervisors.
Furthermore, data and reporting requirements are expected to increase substantially. DHB has
assigned appropriate resources to the implementation of the regulations and is prepared to meet
the consequences of the new regulatory requirements proactively.
2. Risk Governance
Risk and capital management are key success factors for DHB’s business and play a crucial role
in enabling management to operate more effectively in a changing environment. The Bank
assumes various risks, the most important being credit risk. Other relatively important risks are
liquidity risk, interest rate risk and operational risk.
DHB continually strives to further strengthen the bank-wide risk and capital management
framework in terms of organizational structure, processes and responsibilities, as well as the
methods for identification, measurement, monitoring and control of risks. Accordingly, the Bank
ensures that all risk-related policies are fully communicated and adopted at all levels.
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The Bank’s risk governance framework is based on the risk strategy and the risk appetite, which
is integrated within the risk organization, policies and methods. The framework aims to safeguard
the Bank’s risk profile and steer risk management processes in line with the risk appetite of the
Bank.
The Supervisory Board has the final authority to approve the risk strategy and the risk appetite
statement proposed by the Managing Board, exercising its oversight of risk management
principally through the Board’s Risk & Audit Committee (RAC), supported by assessments and
reports prepared by the Internal Audit Department (IAD), Risk Management Department (RMD)
and Compliance & Legal Department (CL). RAC is responsible for the oversight of policies and
processes by which risk assessment and management are carried out within the governance
structure. RAC also reviews internal control and financial reporting systems that are relied upon
to ensure integrated risk measurement and disclosure processes.
The responsibility for risk management resides at all levels of the organization, from members of
the board to individuals in the business units. The control environment in the Bank is based on the
three lines of defense principles for segregation of duties. The structure starts with lines of
business being responsible for managing risks in their operations within approved risk appetites.
The three lines of defense structure provide clarity to every staff with regard to their role and the
level of risk awareness that is expected at difference phases in the lifecycle of respective risks.
With business units assuming the first line of defense function, RMD (Risk Management
Department), Credit Analysis Department and Compliance & Internal Control department form
the main second line of defense. They support the business units in their decision-making, but
also have sufficient independence and countervailing power in managing risks. The Internal
Audit Department as the third line of defense oversees and assesses the functioning and
effectiveness of the first two lines.
Formal risk governance processes are established in the Bank, whereby the management of risk is
guided and monitored by a number of committees.
Within the governance structure, DHB’s Risk Management Committee (RMC), Credit Committee
and Asset & Liability Management Committee (ALCO) oversee particular risks. RMC oversees
the management and control of the Bank’s risks on an aggregate level, in addition to the
committees and specialized functions that focus on specific risk areas. RMC also discusses and
ultimately endorses the methodology and outcomes of the ICAAP and the ILAAP by RMD.
7
The RMC consists of Managing Board members, two Assistant General Managers responsible for
credit analysis and for operational processes, respectively, the head of risk management
department, the ORCA (Operational Risk and Control Assessment) project leader and the
Compliance Officer. Chief Internal Auditor also participates in the meetings as an
observer/adviser in order to provide the committee with insight from an audit perspective.
IT related risk factors are controlled and monitored by different committees. The access control to
the core banking application resides on SPD (System Analysis and Process Improvement
Department) while technical control is exercised by the IT Department. Information security in
the broadest sense (including access control, technical control and business continuity policies
and activities) is ensured by the Information Security Manager (referred to as “ISM”). SPD, ISM
and IT units are assigned together in the IT & IS Steering Committee, a platform for
communication and decision on IT-related procedures and measures.
IT related risk factors are controlled and monitored through the IT & IS Steering Committee that
is chaired by the responsible Managing Board member and the Assistant General Manager,
responsible also for operational risk policies. To mitigate the IT related risk exposure further, an
(Information) Security Assessment and Response Team (referred to as “SART”) has been
established, which reports to the IT & IS Steering Committee. SART, chaired by the ISM,
consists of four IT specialists to bring in expertise to the committee in the fields of database &
core banking applications, network, Internet and third-party interfaces.
In the framework of compliance, the Security Officer, beside anti-money laundering measures, is
responsible for the incident and the complaint management systems. In addition to the immediate
benefits, the ultimate aim for maintaining these systems is gathering sufficient data needed to
model operational risks in time.
The overall control with respect to the non-financial risks is carried out by the Internal Control
Unit (referred to as “ICU”) and the internal and the external auditors. The ICU executes
predefined operational controls daily, weekly or quarterly depending on the risks attributed to the
concerned activities. The internal and external auditors also execute their inspections on the risk
management systems, policies and practices. Finally the Compliance Officer, who reports directly
to the Managing Board, is responsible for integrity and compliance in the broadest context.
Both financial risks and non-financial risks are reported to the Risk Management Committee
meeting at least four times a year with a special focus on regulatory risk, earnings risk, capital
risk and strategy risk. The Managing Board is in turn responsible for reporting to the Risk &
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Audit Committee and the Supervisory Board. With this structure, a consistent segregation of
duties is achieved between risk generating, measuring, controlling and reporting units. The
independent organizational structure of the Internal Audit Department and the Compliance
Department, with a direct information line to the RAC, also ensures an effective control in the
respective fields.
The risk governance at DHB is depicted in the following figure:
3. Risk Appetite
Risk appetite framework is central to an integrated approach to risk, capital and business
management and supports the bank in achieving its strategic objectives as well as being a key
element of meeting the bank’s obligations under the supervisory review process.
The Bank defines risk appetite after performing the assessment of key risk sources and
perspectives of all key stakeholders (i.e. shareholders, regulators, external rating agencies,
auditors and customers) in the context of the Bank’s prevailing strategy.
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A clear articulation of the overall risk appetite that reflects multiple risk perspectives, stakeholder
expectations and business objectives not only help protect the Bank’s performance and comply
with regulations and safeguard reputation, but it also moves risk management well beyond risk
mitigation toward optimization of risk and return characteristics across the business as well as
toward the identification of unused risk capacity.
Risk appetite is articulated by the Managing Board of DHB as part of the strategic planning
process, assessed by the Risk & Audit Committee, and approved by the Supervisory Board prior
to communicating the respective document to the wider organization involved with risk
management and to the stakeholders via various disclosures.
The articulation of risk appetite is also linked to the results of a comprehensive risk assessment,
which is periodically performed during ICAAP and ILAAP. On an annual basis, the Risk
Appetite Statement (RAS) is discussed and re-evaluated by the Supervisory Board’s Risk &
Audit Committee to enable the alignment of the Bank’s future strategy with the chosen risk
appetite, as and if circumstances and various stakeholders’ risk expectations change. RAS can
also be revised during the year when there are material changes in the Bank’s strategy or business
environment.
To facilitate monitoring, risk appetite is quantified (to the extent possible) and expressed through
risk based performance targets and limits. In addition, the Bank also uses stress testing and
scenario analysis to formulate risk appetite, especially in liquidity and capital adequacy
management. Periodic risk assessment and reporting of inherent risks in the Bank’s activities is
part of the risk management framework to allow for an aggregated view of risks. If risk limits and
targets are breached, or an activity or a product seems to be straying from the approved risk
profile, decisions must be made timely and pro-actively.
RAS is communicated to the head of departments and country managers and used as the main
starting point for quarterly risk assessment reports for discussion in RMC and RAC. RAS, and
also other policy documents, are accessible for all relevant staffs. By communicating within the
organization and embedding it in the internal processes, the Bank encourages a more conscious
risk taking behavior and reinforces risk culture within the organization. A strong and widespread
risk culture is in its turn an essential catalyst that elevates a risk appetite statement from a set of
words into a statement of action.
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4. Capital Management Framework
The bank’s risk environment requires continual monitoring and assessment in order to identify
and manage complex interactions. The risk governance and ownership, risk appetite as well as the
scope and nature of monitoring and reporting processes that DHB has put in place are aimed at
meeting these challenges.
Furthermore, DHB ensures that it has adequate own resources to cover unexpected losses arising
from discretionary risks such as credit risk and market risk, or non-discretionary risks, which are
risks arising by virtue of its operations, such as operational risk and reputation risk.
DHB essentially has two approaches for the calculation of its capital need: a regulatory and an
internal approach.
The regulatory approach is largely based on fixed, uniform rules for covering the bank’s risks in
accordance with the Basel II/III standards.
The internal approach sets capital adequacy targets and uses the bank’s risk appetite along with its
risk profile and business plans as a basis. Other determining factors are expectations and/or
requirements of the stakeholders as well as the position of the bank in the Dutch banking sector. As
a consequence, the internal approach has to encompass the regulatory approach in order to be
comprehensive, effective and consistent.
The requirements/expectations of regulators concerning capital adequacy are not only driven by the
Basel guidelines for Pillar 1 and Pillar 2 risks, but also by a new capital add-on requirement
introduced in the Netherlands in July 2010 to achieve a certain prudential objective, namely to
reduce banks’ credit risk concentration in emerging countries.
The internal capital management approach is embedded in a formal ICAAP whose regulatory
framework is rooted in the CRD IV. DHB defines the ICAAP by which the Managing Board
examines the bank’s risk profile from both regulatory and economic capital viewpoints and ensures
that the level of available capital:
i. Exceeds the bank’s minimum regulatory capital requirements by an agreed margin,
ii. Remains sufficient to support the bank’s risk profile,
iii. Remains consistent with the bank’s strategic goal,
iv. Is sufficient to absorb potential losses under severe stress scenarios.
Although the regulatory approach and constraint have become more dominant as indicated above,
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the ICAAP framework of DHB as an integral part of risk management retains its relevance since
it ensures a coherent link between the bank’s risk profile, its risk management, risk mitigation and
capital. The bank’s ICAAP framework also promotes a continuous monitoring of the risk
environment and an integrated evaluation of risks and their interactions. It represents a bank-
wide approach to deal with all material risks and all business activities of DHB.
The process itself starts with risk identification, assessment and measurement, which involves all
relevant departments. DNB‘s Financial Institutions Risk Analysis Method (FIRM) has been
chosen by DHB as an integral part of the ICAAP for its comprehensiveness in identifying and
assessing risks and control qualities. Identified risk types are classified into low, medium and
high risk levels based on the assessment of their relevance and potential impacts.
The table below shows a summary of the risk assessment results and methodologies under the
ICAAP framework for FYE 2014:
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Risk area Risk type Risk
assessment
Desired
direction of risk level
Regulatory reference, benchmark and method for
risk evaluation
Capital requirement calculation approach
Pillar 1 Pillar 2
Credit Risk (CR)
Default and rating migration
Medium
Standardized Approach (SA), periodical credit portfolio risk assessment, collective provisioning and stress testing
Underestimation of CR in the SA
Low Qualitative assessment and
adjustment
Concentration:
-Borrower Medium Adapted from Bank of Spain Approach
-Sector Medium
Country risk Medium to
High
Policy Rule on the treatment concentration risk in emerging countries (2010)
Market Risk (MR)
Trading risk Low
Standardized Approach, Value-at-risk model (VaR) and Limits
FX risk Low Standardized Approach, Value-at-risk model (VaR) and Limits
Underestimation of MR in the SA
Low No add-
on
Interest Rate Risk in the Banking Book
Low
(Duration) Gap analysis, Earnings-at-Risk and Capital-at-Risk models
Liquidity Risk Low
Addressed in Internal Liquidity Adequacy Assessment Process (ILAAP)
No add-
on
Operational Risk (OR)
IT related risks Low
Basic Indicator Approach Non-IT related risks
Low
Underestimation of OR under SA
Low No add-
on
Other Risks
Legal Low
Qualitative review
No add-on
Reputation Low
Business (incl. strategy)
Medium
Pension Low
Model Low
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Stress tests are part of the bank’s capital planning in the ICAAP and an important tool for
analyzing the bank’s risk profile. By incorporating appropriate stress testing and capital
planning, the ICAAP result is expected to reflect internal measures to establish if the bank is
adequately capitalized now and in the future.
The bank has also developed its capital management framework by benchmarking its ICAAP and
stress testing methodology against recommended good practices. As the regulation and
supervision of financial institutions are currently undergoing a period of significant change in
response to the global financial crisis, the bank has dedicated considerable time to monitor policy
actions that may influence its capital position and capital management framework. Refinement of
the internal methodology has been performed regularly since its first implementation in
2007/2008.
DHB performs regular internal stress tests designed to replicate shocks that are particularly
relevant for the bank’s existing business mix and macro environment. The stress test reveals how
the capital need varies during a stress scenario, and how the financial position, Pillar I capital
requirement and target capital ratio are affected. Outcomes of the stress tests are also used as
early warning indicators to evaluate the adequacy of the above mentioned recovery plan.
14
III. CAPITAL BASE
Under CRD IV, DHB’s capital structure consists entirely of common tier 1 capital - which
includes paid-in capital, reserves and minority interests.
The total capital base of DHB rose to Euro 225.7 million at the end of 2014 from Euro 223.6
million a year earlier. The components of the capital base are presented in the table below:
Capitalization (1,000) 2014(CRD IV)
2013(CRD III)
Total Equity - IFRS (EU) 230,429 232,611
Intangible assets - -
Cash flow hedge reserve -
Expected dividend pay-out (4,686) (9,053)
Regulatory adjustments -
Common equity tier 1 (CET 1) capital 225,743 223,559
Additional Tier 1 capital - -
Tier 2 capital - -
Total regulatory capital (net after deduction) 225,743 223,559
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IV. PILLAR 1 RISKS AND CAPITAL REQUIREMENTS
This section describes DHB’s regulatory capital requirements that arise from Pillar 1 risks in the
CRD, namely credit, market and operational risks as of 31 December 2014.
The regulatory minimum capital requirement is expressed as eight percent of risk weighted assets
(RWA). To calculate RWA according to the Basel II/III framework, DHB adopted the
Standardized Approach (SA) for credit and market risk, and the Basic Indicator Approach for
operational risk. The adopted approach is consistent with the size, complexity and nature of its
activities in 2014.
In order to calculate the regulatory capital requirements under the SA, the bank uses eligible
external ratings from Standard & Poor’s, Moody’s and Fitch Ratings. These are applied to all
relevant exposure classes in the SA. If more than one rating is available for a specific borrower,
the selection criteria as set out in the CRR are applied in order to determine the relevant risk
weight for the capital calculation.
The following standardized exposure classes apply to DHB:
Sovereigns
Exposures to governments consist of sovereign governments, central monetary institutions and
agencies guaranteed by a sovereign government. Sovereign exposures are risk weighted based on
their credit ratings. Exposures to central governments within the European Union are assigned a
risk weight of 0%, where such claims are denominated and funded in the relevant domestic
currency of that sovereign.
Banks
Exposures to banks relate to all claims on financial institutions authorized and supervised by the
competent authorities and subject to prudential requirements comparable to those in the European
Union. Exposures to a bank are risk weighted based on the ratings assigned to them by eligible
rating agencies. Exposures to a bank of up to three months residual maturity for which a credit
assessment by eligible rating agencies is available are assigned risk weights that are generally one
category more favorable than the standard risk weights applied to banks exposures (see CRR
Article 120).
16
Corporates
Exposures to corporates include exposures to large non-bank corporations as well as to small and
medium-sized companies, which do not meet the conditions of retail exposure. Exposures to
corporates with external credit ratings by eligible rating agencies are assigned a risk weight from
20% to 150%. Exposures without external rating are assigned a risk weight of 100%.
Retail
Exposures are classified as retail exposures upon meeting the conditions stipulated in the Dutch
Regulation on Solvency Requirements for Credit Risk. Retail exposures are assigned a risk
weight of 75%.
Exposure secured on real estate property
This exposure class refers to the exposures or any part of an exposure secured by mortgages on
residential property. Exposures in this class are assigned a risk weight of 35%.
Past due items
In line with the requirements of the Dutch Central Bank, this exposure class only includes claims
which are past due more than 90 days. Shorter past due items are included in the corresponding
exposure classes mentioned above. The unsecured part of any past due item is assigned a risk
weight of 150% if value adjustment allowances are less than 20% and 100% if value adjustments
allowances are no less than 20% of the unsecured part.
Others
Other items consist of fixed assets, prepayments and other assets for which no counterparty can
be determined. Other items are assigned a risk weight of 100%.
17
An overview of the capital requirements and the RWA at the year-ends of 2014 and 2013 divided
into the different risk types is presented in the table below.
RWA (Basel III)
Capital Requirement
8%
RWA(Basel II)
Capital Requirement
8%1,263,373 101,070 1,211,354 96,908
of which: Sovereign - - 0Banks 337,237 26,979 358,899 28,712Corporates 897,923 71,834 810,700 64,856Retail 2,948 236 23,581 1,887Exposure secured on real estate property 3,274 262 3,505 280Past due items 8,240 659 1,151 92Others 13,751 1,100 13,517 1,081
Market risk 6,856 548 2,845 228 Operational risk 70,343 5,627 70,713 5,657
4 -
1,340,576 107,245 1,284,912 102,793
Credit valuation adjustment (CVA)
2014 2013
Pillar 1 Risks and Capital Requirement, Euro (1,000)
TOTAL
Credit risk
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V. CREDIT RISK
Credit risk is the largest risk making up 94.2% of the total RWA at 31 December 2014. The
information in this section is analyzed in several dimensions to give an in-depth view of the
distribution of the credit portfolio in different exposure classes, risk weights, geography, and
industry.
1. Overview of credit risk management
DHB manages credit risk in a coordinated manner at all relevant levels within the organization.
A primary element of the credit approval process is a thorough risk assessment of the credit
exposure associated with each borrower and obligor. An obligor is defined as a group of
individual borrowers that are linked to one another by various numbers of criteria, including
capital ownership, demonstrable control over business or other indication of group affiliation.
The Bank measures and consolidates all claims on the same obligor (“one obligor principle”),
requiring the aggregation of all facilities (direct or contingent) to the borrower itself, its
subsidiaries, parent and related affiliates.
The creditworthiness of a borrower or an obligor is represented by internal rating. While DHB
uses the standardized approach for credit risk, internal rating system has been further refined in
order to strengthen the Bank’s credit risk management system. In addition to the internal rating on
obligor, the Bank’s risk assessment procedures also take into consideration the risks specific to
the type of credit facility or exposure.
DHB dedicates considerable resources to controlling credit risk effectively. Credit monitoring is
carried out through credit reviews on obligor level by the Credit Risk Management that reports to
the Credit Committee on a regular basis. An independent credit portfolio risk assessment is
conducted monthly by the Risk Management Department, which reports directly to the Managing
Board.
2. Credit risk profile
This section presents an overview of DHB’s credit risks in terms of key credit risk dimensions.
All exposures in this document refer to on-and off balance sheet items after specific provisions
and the application of credit conversion factors.
In the following table, the credit exposures are broken down into risk weights at the end of 2014
and 2013.
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The next tables provide the distribution of DHB’s total exposure by remaining maturity at the end
of 2014 and 2013 respectively.
ExposuresRWA
(Basel III) Exposures
RWA(Basel III)
0% 202,633 - 195,468 020% 163,434 32,687 96,139 19,228 35% 9,356 3,274 10,014 3,505 50% 550,384 275,192 507,804 253,902 75% 3,930 2,948 5,011 3,758
100% 949,269 949,269 922,403 922,403 150% 2 3 5,706 8,558
Other risk weights - - - -
TOTAL 1,879,008 1,263,373 1,742,545 1,211,354
2014 2013Credit exposures by risk weights, Euro (1,000)
Credit Exposures by maturity at 31 December 2013, Euro (1,000)
< 3 months3 < 6
months6 < 12
months1-3 years > 3 years TOTAL
Sovereign 102,494 - - - 5,821 108,315 Banks 117,150 111,652 227,480 279,268 33,924 769,474 Corporates 283,087 101,751 82,890 333,428 163,746 964,902 Retail 5,623 136 646 1,597 3,884- 4,118 Exposure secured on real estate property - - 4 138 9,214 9,356 Past due items 3,258 - - 3,670 1,311 8,239 Other items - - 14,605 - - 14,605 Total Credit Exposures 511,612 213,539 325,625 618,101 210,132 1,879,009
Credit Exposures by maturity at 31 December 2013, Euro (1,000)
< 3 months3 < 6
months6 < 12
months1-3 years > 3 years TOTAL
Sovereign 120,106 - - 2,000 - 122,106 Banks 130,578 105,310 97,113 326,652 66,316 725,968 Corporates 393,839 66,008 38,381 220,887 116,303 835,418 Retail 7,005 117 351 12,376 13,783 33,633 Exposure secured on real estate property - - - 167 9,847 10,014 Past due items 768 - - - - 768 Other items - - 14,637 - - 14,637 Total Credit Exposures 652,296 171,435 150,483 562,082 206,249 1,742,545
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The following table breaks down the main exposure categories according to the sectors of DHB’s
counterparties at the year-ends of 2014 and 2013.
The tables below show the credit exposures divided into main geographical areas according to the
location of the ultimate shareholder at the end of 2014 and 2013 respectively.
2014 2013
Sovereign 108,316 122,106
Banks 769,473 725,968
Corporates 964,903 835,418
of which: Non‐bank Financial institutions 257,619 374,451
Construction and infrastructure 133,504 98,068
Tranportation 57,992 39,287
Metals 75,162 47,090
Energy 48,833 46,748
Communications and post 16,836 32,766
Textile 33,481
Food beverages 25,594 9,299
Media advertising 40,128 ‐
Petroleum refining & related industries 2,271 2,665
Domestic & International trade 45,142 27,248
Chemicals 30,584 21,123
Mining and quarrying ‐
Tourism 23,838 21,370
Automative 43,486 22,607
Oil & gas 19,689 23,324
Plastics 6,464
Real estate 40,840 5,106
Agricultural products 10,144 6,786
Electrical equipment 840
Paper 3,674 4,350
Corporate individuals 22,123 6
Retail individuals 30,808 ‐
Other 36,635 12,339
Retail 4,117 26,717
Exposure secured on real estate property 9,356 7,431
Past due items 8,239 569
Other items 14,605 24,536
Total Credit Exposures 1,879,008 1,742,745
Credit Exposures by exposure class and industry, Euro
(1,000)
Credit exposures by exposure class and geographyat 31 December 2014, Euro (1,000)
NetherlandsOther
EuropeTurkey CIS Others TOTAL
Sovereign 102,469 5,846 - - 108,315
Banks 148,234 220,725 279,183 20,055 101,276 769,473
Corporates 25,216 342,092 398,500 71,052 128,042 964,902
Retail 3,437 17 663 - 4,117
Exposure secured on real estate property 1,940 7,265 130 - 20 9,355
Past due items 22 5,132 3,086 - 8,240
Other items 5,720 8,885 - - 14,605
Total Credit Exposures 287,038 589,962 681,562 91,107 229,338 1,879,007
21
3. Counterparty risk and derivatives
Derivatives not only affect the market risk but also counterparty risk measured within the
calculation of RWA related to the credit risk. DHB uses derivatives to manage interest rate and
currency risks on an ongoing basis.
Counterparty risk is the risk that DHB’s counterparts in a derivative contract defaults prior to
maturity of the contract and that DHB at that time has a claim on the counterpart.
As per year-ends of 2014 and 2013, the main sources of counterparty risk were currency swap
and interest rate swap.
DHB uses the mark-to-market method to calculate the exposure value according to the credit risk
framework in CRR. Counterparty credit exposure comprises the sum of current exposure
(replacement cost) and potential future exposure. The potential future exposure is an estimate
that reflects possible changes in the market value of the individual contract during the remaining
life of the contract, and is measured as the notional principal amount multiplied by a risk weight.
The size of the risk weight depends on the contract’s remaining lifetime and the underlying asset.
The Bank applies limits to mitigate counterparty risk similar to any other credit risk. In addition,
the Bank enters into collateral agreements with all major counterparties.
Credit exposures by exposure class and geographyat 31 December 2013, Euro (1,000)
NetherlandsOther
EuropeTurkey CIS Others TOTAL
Sovereign 120,007 2,099 - - - 122,106
Banks 64,893 157,392 203,061 153,417 147,205 725,968
Corporates 15,415 165,282 519,781 74,069 60,871 835,418
Retail 4,612 18,173 10,848 - - 33,633
Exposure secured on real estate property 2,754 6,659 579 - 22 10,014
Past due items 101 1 666 - - 768
Other items 6,485 8,152 - - - 14,637
Total Credit Exposures 214,267 357,757 734,936 227,487 208,098 1,742,545
Exposures*RWA
(Basel III)Capital
requirement Exposures*
RWA(Basel II)
Capital requirement
Interest rate contracts 3,082 1,655 132 9,764 2,380 190 Foreign exchange contracts 2,816 671 54 24,408 2,570 206 Other contract - - - TOTAL 5,898 2,326 186 34,172 4,950 396
2014 2013Derivative Contracts Euro (1,000)
*The exposures represent the credit exposure to derivative transaction after taking account of legally enforceable netting agreements and collateral arrangements
22
4. Credit risk mitigation
DHB uses a variety of instruments to mitigate and reduce credit risk on its lending. The most
essential of these is to assess, at the outset, the ability of an obligor to service the proposed level
of borrowing without distress. As a result, depending on the customer’s standing and the type of
product, credit facilities may be granted on an unsecured basis. However, DHB usually obtains
collaterals for the loans granted. Collateral as a credit risk mitigant is considered even if it does
not affect the regulatory capital adequacy calculations for the exposure on hand. The internal
rating assignment process also includes the assessment and valuation of collaterals among other
factors.
Besides cash collaterals to a small extent, the Bank also accepts unfunded credit protection
mainly in the form of mortgages, third party (customer) cheques, promissory notes, assignment of
receivables or guarantees. For the cases of insurance and guarantee, risk mitigation is effected in
the form of substituting the risk of the counterparty by the risk of the provider of credit
protection. However, this shift only takes place when the risk weighting of the guarantor is better
than that of the obligor and other prudential conditions are met. The following table gives
information on the credit risk mitigation for regulatory capital calculation purposes as per year-
end of 2014 and 20131.
5. Asset quality
The information presented in this section uses financial statement values and is largely sourced
from the 2014 Annual Report of DHB.
1 The valuation of credit risk mitigation (e.g. collateral, guarantee) that is in place to meet internal risk management objectives is much greater than the amounts reported for regulatory capital calculation purposes (see Annual Report 2014).
Credit Exposures
Collateralised GuaranteedCredit
ExposuresCollateralised Guaranteed
Sovereign 108,316 - - 122,106 - - Banks 769,473 45,000 21,672 725,968 35,061 2,000 Corporates 964,903 44,746 - 835,418 27,279 - Retail 4,117 30 30,808 33,633 42 - Exposure secured on real estate property 9,356 - - 10,014 - - Past due items 8,239 - - 768 0 - Other items 14,605 - - 14,637 - -
TOTAL 1,879,009 89,776 52,480 1,742,545 62,382 2,000
2014 2013Credit exposures and credit risk mitigation, Euro (1,000)
23
An assessment is made at each balance sheet date to test whether there is objective evidence that
a specific financial asset or group of financial assets may be impaired (‘loss event’).
Developments that lead to loss events may include:
- A breach of contract, such as default in the payment of interest or principal;
- Significant financial difficulty of the issuer or obligor;
- Restructuring of the loan where a concession is granted due to the borrower’s financial
difficulty.
If such evidence exists, an impairment loss is recognized in the statement of income.
An indication of the overall credit quality of DHB’s financial assets can be derived from the table
below as per year-ends of 2014 and 2013.
The creditworthiness of the customers that are not rated by external rating agencies is assessed
with reference to the Bank’s internal credit rating system. The internal rating is based on many
factors derived from both financial and non-financial assessments of the borrower. The internal
rating system is an essential tool for managing and monitoring the credit risk for the Bank.
The assessment and administration of past due and impaired loans, write-offs and provisions fall
under the responsibilities of the credit risk management units and the Credit Committee.
Provisions are set aside for estimated losses in outstanding loans for which there is doubt about
the borrower’s capacity to repay the principal and/or interest. Provision amounts are determined
through a combination of specific reviews, historical data and estimates. Provisions for loan
losses are determined separately for each exposure for wholesale loans, and according to a pre-
defined model for retail loans.
Provisions against a particular impaired loan may be released when there is improvement in the
quality of the loan. The Bank’s write-off policies are determined on a case-to-case basis. For
Asset Quality Euro (1,000) 2014 2013
Neither past due nor impaired 1,869,689 1,730,036
Past due and/or impaired 27,025 23,757
of which impaired 26,029 23,137
Provisions (17,706) (11,248)
Total 1,879,008 1,742,544
24
restructured loans, the policy enables reclassification of a restructured loan into a performing loan
when a certain number of repayments are executed.
The following table details the change of provisions balance at the end of 2014 and 2013
respectively.
Though provisions for loan losses are considered adequate, the use of different methods and
assumptions could produce different provisions for loan losses, and amendments may be required
in the future, as a consequence of changes in the expected loss, the value of collateral and other
economic events.
Furthermore, the Bank also sets aside provisions to cover potential losses in relation to loans for
which a triggering event has occurred, while the related individual loan is not yet identified as
such at the balance sheet date. This process to determine incurred but not reported losses includes
an estimate, based on a model, by management to reflect current market conditions.
Change of total credit risk provisions 2014 2013
Opening balance, 1 January 11,248 8,232
Addition 7,925 5,180
Release (1,723) (1,285)
Write-off (411) (467)
Exchange rate movement 667 (412)
Closing balance, 31 December 17,706 11,248
25
VI. MARKET RISK
DHB uses the Standardized Approach to capture the market risk capital requirement. As of 31
December 2014, the capital requirement for market risk is solely due to foreign currency
positions.
Foreign currency risk is hedged generally by using derivatives to reduce currency exposures to
acceptable levels. After taking into account foreign currency derivatives, the Bank has no
material net exposure to foreign exchange rate fluctuations.
The Bank uses a combination of value-at-risk (VaR) model and stress tests to monitor the risk
arising from open foreign currency positions representing the net value of assets, liabilities, and
derivatives in foreign currency. The internal VaR model and risk limits are used only for risk
management purposes and not regulatory capital measurement purposes.
The following table shows the breakdown of capital requirement for market risk at the end of
2014 and 2013 respectively.
RWA(Basel III)
Capital Requirement
8%
RWA(Basel II)
Capital Requirement
8%
6,856 548 2,845 228 of which:
Foreign Exchange 6,856 548 1,899 152Trading Book - 945 76
Market risk
2014 2013
Market Risk and Capital Requirement, Euro (1,000)
26
VII. OPERATIONAL RISK
The Bank defines operational risk as the potential for incurring losses in relation to employees,
technology, system failure (including non-availability) and frauds. It excludes legal, compliance,
business and reputation risk.
The capital requirement for operational risk is calculated at DHB according to the Basic Indicator
Approach. Under this approach, the capital requirement for operational risk is equal to 15% of
the three- year average gross income, which results in a capital requirement for operational risk of
Euro 5.7 million at 31 December 2014.
Operational risk is inherent in all business activities and can never be eliminated entirely.
However, shareholder value can be preserved and enhanced by managing, mitigating and, in
some cases, insuring against operational risk.
For the purpose of mitigating operational risk, since 2007 DHB has implemented a risk self-
assessment program called ORCA, which stands for Operational Risk and Control Assessment.
The main aim of this project is to enhance the risk awareness of every staff member in the Bank
and minimize operational risk at every stage of the daily activities.
The ORCA program covers all units of the Bank and involves all staff in developing a strong
control environment. This program focuses on different areas of operational risks (IT related
risks, process related risk, staff related risks and external risks) according to the specific business
activities, business lines, departments and countries.
With the guidance of Risk Management Department, all the units proceed through a predefined
route to identify risks by using tools such as questionnaires, interviews and workshops; estimate
their potential impact, and devise an action plan suitable to the size and nature of those risks. As a
permanent self-improvement initiative, the project cycle foresees continuous monitoring and
periodical independent review of the involved risks and respective measures in response to
changing activities and operating environments.
27
VIII. PILLAR 2 RISKS
1. Interest rate risk in the banking book (IRRBB)
Interest rate risk inherent in the banking book consists of exposures deriving from the balance
sheet and is measured in several ways in accordance with the financial supervisory authority’s
guidelines. The IRRBB is monitored and controlled both from a value perspective (such as using
the duration of equity and PV01 measure) and from an income perspective (sensitivity in net
interest income, NII)2.
Through its management of interest rate risk, DHB aims to hedge the effect of prospective
interest rate movements that could reduce its future net interest income, while balancing the cost
of such hedging activities on the current net revenue stream.
Regarding the income perspective, NII is exposed to external factors such as yield curve
movements and competitive pressure. The NII risk depends on the overall business profile,
especially mismatches between interest-bearing assets and liabilities in terms of volumes and
repricing periods. The IRRBB is minimized as the Bank’s rate sensitive assets and liabilities are
mostly floating rate, where duration is lower. In general, DHB aims to use matched currency
funding and usually converts fixed rate instruments to floating rate to better manage the duration
in the asset book.
The following tables indicate the Bank’s interest rate sensitivities in the banking book from the
income perspective at the end of 2014 and 2013 respectively. It is notable that the interest
sensitivity results are based on the regulatory assumption that the level of interest rates after
downward rate shocks do not fall below zero percent.
2 Non-maturity interest rate sensitive assets and liabilities are bucketed in the short term. The bank’s equity is considered a non-interest sensitive component and is excluded from the interest rate risk computations.
200 bp decrease 200 bp increase
EURO 436 ‐1,012
US Dollar ‐176 ‐262
Other ‐18 ‐30
TOTAL 242 ‐1,304
NII sensitivities by major currencies
at 31 Dec 2014, Euro (000)
Interest rate shock of +/‐ 200 bp
28
In addition to the regular monitoring of the interest rate risk using the above mentioned metrics,
on a monthly basis DHB performs stress testing to calculate the immediate net effect on the fair
value (FV) of a range of parallel shocks in rates, by currency. Furthermore, the Bank reports
PV01 to measure changes in economic value resulting from a one basis point (0.01%) parallel rise
in interest rates. The PV01 measure incorporates the entire rate sensitive segment of the balance
sheet for the Bank and is classified into appropriate buckets.
As per the regulatory requirements, interest rate risk reporting also include the measurement of
the ‘outlier criterion’, which refers to the maximum loss of market value expressed as a
percentage of capital base in the event of a parallel rate hike or drop of 200 basis points. The
‘outlier criterion’ is subject to a limit of 20%. The following tables show a range of severe
interest rate shocks with positions at the end of 2014 and 2013 respectively. At 31 December
2014, the standard instantaneous parallel shock (decline) of 200 bps leads to a potential decrease
of Euro 5.7 million, or 2.6% of the capital base. In term of the outlier criterion, the Bank’s
interest rate risk position increased somewhat in 2014 to a risk level that is generally considered
low in view of the abovementioned 20% threshold.
200 bp decrease 200 bp increase
EURO 4,609 2,951
US Dollar 759 ‐1,100
Other 12 ‐87
TOTAL 5,380 1,764
NII sensitivities by major currencies
at 31 Dec 2013, Euro (000)
Interest rate shock of +/‐ 200 bp
Fair value sensitivity to interest rate
shocks at 31 Dec 2014, Euro (000)‐300 ‐200 ‐100 +100 +200 +300 PV01
Euro 8,265 5,504 2,749 ‐2,743 ‐5,480 ‐8,212 ‐27
USD 584 362 167 ‐139 ‐251 ‐335 ‐2
Other 25 18 9 ‐10 ‐21 ‐32 0
TOTAL 8,874 5,884 2,925 ‐2,892 ‐5,752 ‐8,579 ‐29
Capital base 225,743
Standard 200 bps shock as % of
capital‐2.55%
Fair value sensitivity to interest rate
shocks at 31 Dec 2013, Euro (000)‐300 ‐200 ‐100 +100 +200 +300 PV01
Euro ‐49 32 48 ‐112 ‐289 ‐530 ‐2
USD 3,297 2,087 988 ‐877 ‐1,643 ‐2,299 ‐8
Other 92 63 33 ‐35 ‐72 ‐111 0
TOTAL 3,340 2,182 1,069 ‐1,024 ‐2,004 ‐2,939 ‐10
Capital base 223,559
Standard 200 bps shock as % of
capital‐0.90%
29
2. Liquidity risk
Liquidity risk is the risk of being able to meet liquidity commitments only at increased cost or,
ultimately, being unable to meet obligations as they fall due.
Liquidity risk is categorized into two risk types - funding liquidity and market liquidity:
a. Funding liquidity risk occurs when the Bank cannot fulfill its obligations as they come
due without incurring excessive losses. Payments have to be executed on the day when
they are due, or the Bank is declared illiquid if it fails to perform.
b. Market liquidity risk occurs when the Bank is unable to sell specific assets without losses
in price.
In the aftermath of the global financial crisis, regulators have introduced stricter supervisory
guidelines in many areas, notably in the Netherlands, with regard to liquidity standards. The
Netherlands is also among the first country in the EU that has started to monitor and observe the
local (Dutch) banks’ compliance plan with Basel III.
The liquidity and funding position of DHB in 2014 comfortably met the requirements. The
Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) are well above the
expected future regulatory requirements of 100%.
Furthermore, DHB has also carried out an internal liquidity adequacy assessment process
(ILAAP) based on DNB’s ILAAP Policy Rule and submitted the required documentation to DNB
for purposes of supervisory review and evaluation process (SREP). The internal process,
governance and consultative dialogue with the regulatory supervisory body required to meet the
ILAAP rules are similar to the ICAAP mentioned above.
Policy statements that are part of the ILAAP package stipulate that DHB’s liquidity management
reflects a conservative attitude towards liquidity risk. The Bank defines the liquidity risk appetite
by setting limits for applied liquidity risk measures. The most central measure is the Survival
Horizon, which defines the risk appetite by setting a minimum survival of 3 months under a
combination of bank-specific and market-wide stress scenarios with limited mitigation actions3.
Furthermore, to ensure funding in situations where DHB is in urgent need of cash and the normal
funding sources do not suffice, the Bank holds a liquidity buffer that consists of ECB eligible
debt securities and highly liquid assets.
3 The stress scenario used to measure compliance with the risk appetite framework includes among others an assumption of saving deposit outflows amounting to respectively 30%, 40% and 50% in one-month , three-month and six-month periods along with significant haircuts on the bank’s liquidity buffer.
30
Please refer to the DHB Annual Report as of 31 December 2014 for a maturity distribution table.
Under the ICAAP framework, no capital was allocated to cover liquidity risk considering the
strength of the Bank’s liquid assets as mentioned above and the appropriateness of the Bank’s
current policies and measures.
3. Concentration risk
DHB deals with concentration risk by taking into account separately single name concentration,
country concentration and sector concentration.
A main assumption used in the determination of the Pillar 1 risk weights is that the credit
portfolio is well diversified. In practice, however, a portfolio is not necessarily fully diversified,
causing the so-called concentration risk problem that is to be addressed under Pillar 2.
DHB has a framework to measure concentration risk quantitatively and established an approach
that links concentration risk levels to capital allocation within the ICAAP process in a
conservative manner.
The Bank also has to comply with the Large Exposure Rule as embedded in CRD IV, and the
higher-mentioned policy rule on the treatment of concentration risk in emerging countries,
introduced by DNB in July 2010, to reduce the banks’ credit concentration in emerging markets.
An overall implication of these new directives is that the DHB’s concentration level will decline
further in the future.
4. Other risks: Legal, compliance and reputation risk
Legal risk is the possibility that lawsuits, adverse judgments or contracts that turn out to be
unenforceable can disrupt or adversely affect the operations of the Bank. The Compliance and
Legal Affairs Department supports various departments to manage legal risk. External legal
advisors are also consulted where necessary. In addition, the Compliance Officer has a proactive
role in this respect, aiming at reducing pro-actively the risk of compliance, as well as legal and
eventual reputation risk.
Reputation risk is highly correlated with integrity and compliance risk management, which are
embedded in the policies and corporate governance of the Bank. The Managing Board takes the
necessary actions to establish a proper ethical culture within the Bank. The Bank’s line
management is responsible for applying, monitoring and controlling the integrity policy and rules
31
in their units, and reports to the Managing Board and the Compliance Officer. As a third line of
defense, the Internal Audit Department also evaluates integrity issues in particular and
compliance issues in general during its regular and specific audits.
32
IX. CAPITAL ADEQUACY CONCLUSION
DHB is committed to exceed its capital adequacy targets on a continuous basis. Overall risk
position and capital level are constantly monitored and adjusted, if necessary, to meet the capital
requirement from regulatory and economic perspectives. DHB’s capital base and Tier 1 capital
exceed the regulatory minimum requirements outlined in CRR/CRD. Considering the results of
capital adequacy stress testing, and business expectations, the Bank assesses that the buffers held
for regulatory and economic capital purposes are sufficient. Capital ratio in 2014 was about 2.2
times the regulatory capital ratio of 8%.
The following table provides an overview of DHB’s capital adequacy ratios as per year-ends of
2014 and 2013.
Capital Adequacy Ratios, Euro (1,000)2014
(Basel III)2013
(Basel II)
RWA (Pillar 1) 1,340,576 1,284,912
Regulatory capital requirements 107,246 102,793
Tier 1 capital 225,743 226,373
Capital base 225,743 229,236
Tier 1 ratio (in %) 16.8% 17.6%
Capital ratio (in %) 16.8% 17.8%
Capital ratio/Regulatory capital requirement (in %) 210.5% 223.0%
