Financial Diagnostic of the Development Bank of Mongolia Final … · 2019. 4. 5. · Investment Portfolio 0 3 FX risk 2 3 (1 replacement) Accounts Receivable 2 1 (replacement) There

PricewaterhouseCoopers Audit LLC

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Financial Diagnostic of the Development Bank of Mongolia

Final Report

04.12.2018

Fi nal report – Dev elopment Bank of Mongolia

St rictly private a nd con fidential. Not to be distributed to t hird parties without ou r prior written con sent.

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ST RICTLY PRIVATE AND CONFIDENTIAL Batbayar Balgan, Chief Executive Officer, Development Bank of Mongolia Sukhbaatar Disctrict, Peace Avenue 19 Ulaanbaatar Mongolia

04 December 2018

Dear Mr. Batbayar Balgan,

Contract #: DBM012018

T ransmittal letter –Final Report – Development Bank of Mongolia

This report has been prepared by PricewaterhouseCoopers Audit LLC (“PwC” or “Consultant”) for the Development Bank of Mongolia under the terms of the contract between PwC and the Development Bank of Mongolia, numbered as DBM012018, dated 31 August 2018 (the “Contract”) for the provision of a Financial Diagnostic of the Development Bank of Mongolia (the “Project”), and its contents are strictly confidential.

This deliverable has been prepared for the purposes of providing final information to the Development Bank of Mongolia on the results of the Project. This report is intended to be read and used as a whole and not in parts. Separation or alteration of any section or page from the main body is strictly forbidden.

The assignment was carried out from 03.09.2018 to 09.11.2018. This document has been prepared as a collection of comments and recommendations, where applicable, from individual project work blocks.

The assignment was not an audit, it was a special in-depth financial diagnostic. The purpose of this assignment was to inform the main stakeholders (i.e. Ministry of Finance, the Bank of Mongolia and

DBM board) of DBM’s financial status so that needed actions can be formulated.

Scope of work was divided into 2 parts and following methodology was used:

1 . Corporate Governance and Internal Control - Consultant assessed the adequacy and effectiveness,

using internationally recognized benchmarks and methodologies, of DBM’s corporate governance

and internal control environment from January 2012 to December 2017.

2. Assets, Liabilities, Earnings, Risks profile and Off-Balance Sheet Transactions - Consultant

assessed DBM’s capital adequacy and capacity for debt servicing and repayment of borrowed funds

for the period from January 2012 to December 2017. Based on the assessments specified in Contract,

the Consultant estimated the amount of capital required to absorb losses, if any, in accordance with

the regulatory requirement and the applicable IFRS/IAS, such as IFRS 9 and 13, and IAS 39.

The Financial Diagnostic of the Development Bank of Mongolia includes a review of the loan portfolio performed predominantly based on the AQR Manual v1 of the European Central Bank, as localised for Mongolian local market specificities in several areas. This review of the loan portfolio takes into account historical accounting information at snapshot dates as at 31 December (from years between 2012 and 2017).



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Our work included the performance of all workblocks from the Contract (in accordance with the methodology agreed in the Contract). For a full understanding of the approach and methodology that serves as the base to this report and the associated restrictions and limitations of that work, we refer you to the Contract.

Our deliverable contains information obtained or derived from a variety of sources described within the deliverable in more detail, in particular information from the Development Bank of Mongolia, real estate valuers, mining licences valuers and other sources. PwC has not sought to establish the reliability of those sources or verified the information so provided. Accordingly no representation or warranty of any kind (whether express or implied) is given by PwC to any person (except to the Development Bank of Mongolia) as to the accuracy or completeness of the deliverables and information provided by third parties.

We have not carried out any work or made any enquiries of the management of the bank since 01.11.2018 being the date to which we hav e carried out our fieldwork for the purposes of the deliverable. The deliverable does not incorporate the effects, if any , of events and circumstances which may have occurred or information which may have come to light subsequent to that date. We make no representation as to whether, had we carried out such work or made such enquiries, there would have been a material effect on the deliverable.

We draw your attention to important comments regarding the scope of our work, the purpose for which the advice is to be used, our assumptions and limitations in the information on which the advice is based set out in our deliverable. This report is subject to the terms and conditions set out in the Contract including exclusions of liability, particularly with regard to third parties.

PwC is not responsible for any decisions made in connection with the implementation or use of this report. No investor or security holder should rely on the content of this report in any way in connection with the purchase or sale of any security.

Consultant shall accept no liability to any other party.

There are no third-party beneficiaries of this engagement and Consultant accepts no duty of care to any person (except to DBM / Procuring entity [see above] under the Contract) for the preparation of the deliverable. Consultant accepts no responsibility to any third party for any reliance that is taken by the third party on the results of its work and the contents of any report. Regardless of the form of action, whether in contract, tort or otherwise, and to the extent permitted by applicable law, Consultant accepts no liability of any kind and disclaims all responsibility for the consequences of any action (other than to DBM on the above basis) or for any decisions made or not made which are based upon any deliverable.

In consideration for PwC agreeing to the publishing of the Report on your website, you agree that you will

not hold PwC responsible for the consequences of us doing so; accordingly PwC, its partners, staff and

third parties engaged by us to providing the Services related to the Project, shall have no liability to you

for any loss, damage, cost or expense suffered by y ou as a result of publishing the Report, unless it

contradicts the provisions of law.

Should you have any questions concerning this deliverable, please contact our office.

Y ours sincerely,

PricewaterhouseCoopers Česká republika s.r.o. Hvězdova 1734/2c, 140 00 Prague 4, Czech Republic

The Financial Diagnostic, including the loan review element, represents a targeted review of individual transactions over time. It focuses on assets held by the bank as at the snapshot dates and does not assess transactions prior to or after the snapshot dates. Consequently, information is not available and

has not been received and obtained for matters that were not relevant as at the snapshot dates.



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Table of Contents

1 . Executive summary 5

2. Our work and approach 11

3. Corporate governance 15

4. Internal control 36

5. Liquidity position 38

6. Investment portfolio 45

7 . Foreign exchange risk 48

8. Accounts receivable 51

9. Liabilities 53

10. Quality of earnings 55

11 . Review of financial statements 63

12. Loan portfolio and off-balance sheet transactions review 66

13. Fixed assets 93



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1. Executive summary

This report has been prepared under the terms of the contract between PwC and the Development Bank

of Mongolia (“DBM”), numbered as DBM012018, for the provision of a Financial Diagnostic of the

Development Bank of Mongolia (the “Project”). This executive summary outlines the main

developments of the Bank in recent years, weaknesses identified, improvements implemented, and

areas for further development.

It is fair to say that we have noted during our work that the level of corporate governance, policies and

procedures and internal control has improved significantly since the enactment of the DBM law in April

2017. It is clear that the Bank has spent considerable effort to improve its internal governance,

processes and controls since that date. On the other hand, it is also fair to say, that there are still some

areas where DBM can further strengthen its practice comparing to the international standards, this is

however pretty much in line with the overall maturity of the Mongolian banking sector.

Prior to those changes, there were significant weaknesses within the Bank. As can be seen below, the

Bank has implemented a number of new policies post-April 2017 in a number of areas of operations.

Work Block Existing Policies pre-2017 Additional New Policies post-2017

Liquidity Management 8 6 (2 replacements)

Investment Portfolio 0 3

FX risk 2 3 (1 replacement)

Accounts Receivable 2 1 (replacement)

There have also been new policies implemented in the areas of corporate governance, internal control and risk management, but we have not quantified those new policies here.

Our findings on each of the key work blocks is set out below.

1. Key Work Block of Interest: Loans and Provisions for Doubtful Debts

We have reviewed classification and provision requirement as per agreed methodology for years 2012-

2017 for all three main portfolios: Corporate portfolio, on-lending portfolio and portfolio of loans to be

repaid from state budget. Loans and advances given to corporate projects are to be repaid from the

project’s or borrower’s future cash flow generation and the Bank also holds collateral. On-lending to

corporate projects which the Government considers priority commercial activities (air transport

development, support of mining industry, railway, infrastructure, Small and Medium Enterprises (SME),

housing and manufacturing projects). All portfolios were rapidly growing from 2012 to 2016, when almost

full amount of loans to be repaid from state budget was transferred to Ministry of Finance. From 2017,

new lending was only done to corporate and on-lending portfolios.

During our review we have reclassified several debtors in corporate portfolio from performing to non-

performing status, which led to an additional provision, as defined in the methodology. We have done no

reclassification in on-lending or loans to be repaid from the state budget portfolios. Reclassification is

summarised in table below.



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Cor porate por t folio

2017 2016 2015 2014 2013 2012

Ba n k Ou r r ev iew






PE debtors 2 1 1 0 3 3 4 3 8 3 4 3 3 2

NPE debtors 1 9 3 0 1 3 1 3 1 1 1 2 6 1 1 3 4 0 1

Reclassification % 2 7 .50% 0.00% 6 .67% 3 5.71% 1 4.29% 3 3.33%

The most common impairment triggers on which reclassification was based are:

1) DSCR below 1.1;

2) a material decrease in cash flows over the last 12 months;

Collateral values also affect the amount of additional provision for non-performing debtors. In our review we have identified that market value of collaterals recorded in Bank’s system is consistently lower than corresponding market value our subcontractor have estimated for same collaterals. The results of the review of collateral and real estate valuation suggest that the value of collateral recorded in the Bank’s sy stems is not compliant with BoM’s requirements on collateral valuation, i.e. not performed according to IVSC International Valuation Standards. Further, in our review we have discounted market value of collaterals using time to sell, cost to sell and effective interest rates as agreed in the methodology. This discounted collateral value was consistently lower than value recorded in Bank’s system. Please note, number of collaterals revalued were always minimum of 70% of total monetary collateral value for each debtor. Remaining part of collaterals was extrapolated based on the revaluation data. Differences in values as described above are summarised in following table:

In mln MNT Bank’s market value

Market value after review

Discounted market value after review

% change to our market valuation

% change to our discounted valuation

2017 7 81,543 1 ,196,813 579,795 153.1% 7 4.2%

2016 604,534 871,925 450,635 144.2% 7 4.5%

2015 311,650 535,762 274,703 171.9% 88.1%

2014 248,732 291,642 148,688 117.3% 59.8%

2013 32,859 45,058 23,524 137 .1% 7 1.6%

2012 0 0 0 0% 0%

Both the reclassification of debtors from performing to non-performing status combined with lower amounts of applied discounted collateral values led to additional provisions to be created. These additional provisions have negative impact on capital adequacy of the Bank. We have aggregated impact of these additional provisions on Bank’s requirement of capital adequacy ratio over y ears in table below. Only in years 2014 and 2015, Bank would not be able to meet the regulatory requirement of 10%. Most importantly, as end of 2017 Bank was sufficiently capitalised and there is no need to increase capital for the time being.



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Ca pital Impact

T ot al ca pital

prior t o rev iew (m ln. MNT )

T ot al ca pital

a dequacy ra tio prior t o review

(%)

Identified a djustments du ring ou r

rev iew

(m ln. MNT)

T ot al ca pital

following ou r review

(m ln. MNT)

T ot al ca pital

a dequacy ra tio a fter ou r review

(%)

Ca pital su rplus or

deficit over regulatory m inimum

of 10%

(%)

2 017 1 ,038,823 3 3.60% -2 17,056 8 21 ,747 2 6 .58% 1 6.58%

2 016 9 53,557 3 0.50% -2 32,584 7 20,973 2 3.06% 1 3.06%

2 015 2 87 ,402 1 4.22% -1 89,130 9 8 ,272 4 .86% (5 .14%)

2 014 2 46,536 1 3.66% -2 10,852 3 5,684 1 .98% (8 .02%)

2 013 1 43,879 17 .76% -1 9,163 1 24,716 1 5.39% 5 .39%

2 012 6 6 ,992 1 3.65% -7 ,443 5 9,549 1 2.14% 2 .14%

Identified adjustments during our review for y ear 2017 are predominantly stemming from 3 debtors, which have been granted loans in years prior to 2017.

There are still on-going relationships between the Bank and the Government of Mongolia, especially in terms of the state budget, for loans provided to customers prior to April 2017, where the government is a guarantor of the loan. Since April 2017, no new loans granted by the Bank are collateralised by a government guarantee.

2. Work Blocks with Significant Remedial Actions Required

Work block Initial situation pre-2017 Im provements post-2017

Corporate Gov ernance

Im portance: H

Cor porate g ov ernance n ot fully

dev eloped.

In ternal policies and g uidelines

m issing or out of date.

No tr ansparent decision making

pr ocess and monitoring function

Ch anges in or g anisational str ucture supporting

m or e in dependent decision making process and

m on itoring function

Upda te a n d im plementation of crucial/v ital

in ternal policies and guidelines

Repor ting of prudential ratios and m onitoring by

BoM

Im plementation of on line loan application sy stem

A reas for Im provements

Risk management framework (e.g. establish risk strategy, RAS and RA F);

Cr edit approval process (debtor creditworthiness assessment process, collateral valuation m ethodology) and risk monitoring; and

Cor porate gov ernance itself (e.g. conflict of interest policy implementation)

Int ernal Con t rol

Im portance: H

V ery limited a mount of internal

con trols in place.

A u dit fu n ction n ot su fficiently

in dependent

Dev elopment a nd approval of the In ternal audit ch arter in line with international standards and g u idance for the professional practice;

Dev elopment a nd approval of the In ternal audit pla n; a nd



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Im prov ement of the second line of the defence a n d monitoring of the fulfilment of the BoD r esolutions


Im prov ement of internal controls sy stem;

Reg u lar assessment and reporting of internal controls sy stem; and

Mu lt iyear internal audit plan based on the r isk assessment

Liqu idity

Im portance: M

Liqu idity m anagement w as n ot well

dev eloped. Described in a very general

m anner. No limits, liqu idity stress

test ing or con tingency funding plan

in troduced. No a ct ive identification,

m easurement, m onitoring and

con trolling of the liquidity risk

Im prov ed liquidity management policies

In tr oduction of LCR/NSFR limits


Need for a r obust liquidity framework with liquidity limits

Need for a cumulative gap limits for ov erall position/per individual currencies

Need for a liquidity stress-testing concept. Results of stress test n ot taken into a ccount for definition of liquidity limits.

FX Risk Ma na gement

Im portance: M

Th ere w a s n o a ct ive identification,

m easurement, m onitoring and

con trolling of th e FX r isk. The Bank

w a s running an open FX position.

Th e Bank’s management started to manage the FX posit ion and significantly reduced the open FX posit ion.


Need for a r obust FX risk management framework and FX stress testing concept

Ma x imum open FX position for a ll currencies/in each currency cannot exceed 50% of DBM

ca pital. This limit allows the bank to expose itself to significant FX risk. However, this is also

su bject to availability of FX h edging instruments.

3. Work Blocks with No / Minor Remedial Actions Required

Work block Initial situation pre-2017 Im provements post-2017

Inv estment Port folio

Th e investment process was before the

in troduction of the new law was v ery

in flexible a nd subject to the approval

of Min istry of Finance.

In v estment decision making process was sta ndardised and passed to the Ba nk m anagement

A ccou nts Receivable

Th e Ba nk was managing a significant

v olume of a ccounts r eceivables,

m a inly from the Ministry of Finance.

Th e volume of a ccounts r eceivables was sig n ificantly reduced after 2017 and t here a r e no material accounts receivables as of December 2017.

Lia bilities

Th e Ba nk started to a cquire FCY log-

term funding. The funding was mainly

secured by th e gov ernment

g u arantees.

Ba n k was a ble to diversify the funding in terms of currency and maturity. The bank w a s also a ble to a cquire a long-term funding w ithout g ov ernment guarantees or by using for eign credit insurance companies, however w e did not analyse to what extent the in v estors considered implicit g ov ernment g u arantee as DBM r emains 100% Gov ernment of Mon golia owned.



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On the one hand, the Ba nk’s long-term r efinancing structure is fully dependent on FCY funding due to a lack of local long-term investors. On the other hand, the m aturity profile is well opt imised. Consequently there is a refinancing risk in FCY in ca se of w orsening the credit risk profile of Mon golia.

Qu a lity of Ea rnings No a dv erse findings noted from our work.

Rev iew of Financial St a tements

We h ave reviewed the methodologies and techniques for data compilation and potential m issing items in n otes to the financial statement for years ended 31 December 2016 a n d 2017. Our scope was limited to presentation and disclosures related to standalone fin ancial statements, only. There were no deficiencies identified in methodologies and techniques for da ta compilation, in th e m issing items in n otes to the financial sta tement, however, w e have identified sev eral missing disclosures in accordance with th e IFRS.

Fixed Assets

We h ave compared amount of fixed assets as r ecorded in your statement of financial posit ion with market comparable value. Difference identified, however, does not ca use any issue with the compliance with local rules.

4. Recommendations for Next Steps

We recommend DBM to develop a remediation program that would address our key findings, which

would further strengthen DBM’s practices in line with international standards following number of key

improvements since the enactment of the DBM law in April 2017. From our point of v iew, the key area

of focus shall be credit risk and collateral management due to the fact , that credit risk represents key

risk for the bank and there are identified deficiencies against international best practices.

Recommendations related to policies and procedures:

Approve risk strategy, RAS and RAF and develop robust risk management framework to all material

risks, and review at least annually for relevant risk policies and limits. This shall also include greater precision on the fiscal cost of such direct lending (short term recommendation)

Review methodology for NPL definition and adopt methodology for identification of forborne exposures (short term recommendation)

Adopt the stress-testing methodology and perform stress testing exercise for all material risks (medium term recommendation)

Adopt the Conflict of Interest policy and clearly define the situations that could create conflict of

interest (short term recommendation) Improve the charts of committees and specify their chairmanship and membership (short term

recommendation) Develop a wider and more detailed range of credit risk indicators (medium term recommendation) Adopt the Internal control framework and define overall methodology, components of ICS and

responsibilities of first and second line of defense (short term recommendation)

Recommendations related to processes:

Separate Audit and Risk committees (short term recommendation)

Improve credit granting process, so it mainly relies on reliable information and debtor’s ability to repay the loan from its cash flow (short term recommendation)

Update collateral valuation methodology for accepting only IVS compliant valuation reports (short term recommendation)

Perform and regularly review risk mapping and risk materiality assessment (medium term

recommendation) Perform a mapping and analysis of existing 1st and 2nd line controls and formalise them (medium

term recommendation) Manage, control and monitor the risks on consolidated level (short term recommendation)



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Develop internal rating system and establish credit limits per debtor based on their rating (medium term recommendation)

Recommendation related to data:

Obtain audited financial statements of the debtors on regular monitoring purpose

Verify the reliability of business plans of the debtors more closely. Actual versus business plan should be analysed on regular basis to obtain reliance on the plan as it has directly used for cash flow projections when assessing the loan loss provisions.

Track the collateral register properly and formal control and procedure should be in place to ensure the completeness and accuracy of the register and to reflect the register in case of amendment into the contract.

Tracked off-balance exposures in complete and accurate way. New standards on loan loss provision started to consider the off balance exposure when assessing loan loss provision

Improvements in above-mentioned areas will further significantly strengthen stability of DBM.



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2. Our work and approach

2.1. Overview of the approach

We have summarised our approach into work blocks, as described below:

Corporate governance and internal control system

This work block encompassed evaluation of the existing corporate governance and internal control system

from the point of v iew of compliance with international “good practices” for corporate governance,

internal control, risk and credit risk management. This evaluation has been done against recognised

international standards.

Liquidity position

We have assessed DBM’s liquidity both in terms of its ability to manage its assets and liabilities positions

as well as in terms of its ability to generate operating cash sufficient to cover it s operating expenses.

Assessment has been done against international standard for liquidity management.

Investment portfolio

In this work block, we have assessed the adequacy of reflection of the securities investment portfolio and

related gains/losses in the bank’s financial statements. Securities portfolio has been assessed based on

the IFRS standards and ECB’s AQR manual.

Accounts receivables

We have reviewed the portfolio of accounts receivables and determined the adequacy of the reflection in

the bank’s financial statements. Accounts receivables portfolio has been reviewed against IFRS standards.

Liabilities

In this work block, we have analysed funding risks, such as maturity and/or currency mismatches and

assess possible impact on liquidity management as well as on earnings.

Foreign exchange risk

We have analysed DBM’s foreign exchange risk exposure and its translation into bank’s financial

statements. This has been done following IFRS standards and good practice.

Quality of earnings

We have analysed quality and sustainability of earnings. This has been done against IFRS rules.

Review of financial statements

In this work block, we have reviewed financial statements of DBM for years 2016 and 2017.

Loan portfolio and off-balance sheet transactions review

In this work block, we have reviewed classification of a loan portfolio, on- and off-balance sheet

transactions and where a non-performing status is recognised, reviewed available cash flow and collateral

valuations. Subsequently, a relevant provision is calculated.

Review of the collateral has been done using methodology as described in ECB’s AQR manual localised

with requirement of at least of 70% of total monetary collateral value to be revalued through this process

and the remainder extrapolated.

Fixed assets

We have reviewed fixed assets as recorded in the balance sheet. Market value approach is to be used in

comparison to bank’s valuation approach.



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2.2. Overview of the work conducted

We have summarised list of activities we have done during this project below:

Corporate governance and internal control system

In this workblock we have reviewed:

The existing corporate governance structure including the composition, roles and responsibilities

and proceedings of the board of directors;

The organisational structure including the board committees and management committees and the reporting lines;

The processes for the nomination and appointment of board members and senior management

Internal controls sy stem – regulatory requirements, design of internal controls, linkage to

strategies, activities products

Internal audit function – role and structure of internal audit, reporting lines, responsibilities and functions, capacity

Board oversight of controls – role of audit committee, coordination with external auditors/supervisors/regulators, reporting and internal controls

External audit and follow up actions with regard to issues identified in management letters

Policies and procedures for loan administration and credit risk. Managing and administering its loan portfolio in general and problem loans in particular

Risk management policies and procedures for identifying and monitoring initial and changing levels of risk associated with approved credit exposure;

The process for classification of loans and other assets;

DBM’s capacity to assess, administer, supervise, and recover loans, advances, guarantees and other credit investments, based on the review of its internal policies and procedures;

Adequacy of accounting policies and effectiveness of the accounting system in recording/ monitoring

Adequacy of risk control associated with off-balance sheet transactions management and board oversight

Liquidity position

We have reviewed following activities in this work block:

Maturity gaps between assets and liabilities

Liquidity support provided by any organisation, such as the Government, the BOM, another financial institution and the relative impact of such support on DBM in terms of profitability,

liquidity, and interest rate exposures

Large funding concentrations and their legal status, particularly as regards related parties and/or large lenders

The frequency and level of borrowing

Sensitivity to external/domestic credit lines and syndicated financing, etc.

Reliance on the other government agencies, or other sources of liquidity or term support

Investment portfolio

In this workblock we have reviewed activities as below:

Listing and classification of securities; The underlying asset quality, where appropriate and possible The paying capacity of the obligors based on information provided by the Bank in their Comments

on borrowers Clear title to the securities being held by DBM Any permanent reduction for recoverable values of securities Appropriate allowances for losses provided for where necessary;

The translation exposure of any securities denominated in foreign currencies



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Foreign exchange risk

We have reviewed following areas:

DBM’s Market risk management framework, Market risk strategy DBM’s FX risk exposure (the extent of actual and potential foreign exchange losses, open positions) The posting of forex transactions in the bank’s financial statements

Credit risk arising from possible un-hedged client positions (FX lending risk)

Accounts receivable

In this work block we have reviewed following activities:

Determined the appropriateness of the Regulations on Asset Classification for assessing accounts receivables (A/R)

Addressed the underlying asset quality of the A/R, evaluating the asset quality of the A/R in light of the Regulations

Identified gaps by preparing a pro forma provision comparing to the current provision Assessed the legal risks involved, in particular, ascertaining that the bank has clear title to the

assets Determined accuracy of the translation of the asset value Ensured that all reconciliations between banks are reviewed and outstanding items satisfactorily

cleared

Liabilities

We have reviewed following activities:

Collected data on liabilities, funding sources, maturities and currencies Identified mismatches with assets in maturity or currencies

Identified and assess impacts on liquidity management and potential impact on earnings

Quality of earnings

In this work block we done following activities:

Reviewed earnings generated from related party transactions Reviewed the earnings generated from accrued but uncollected interest, fees and FX revaluations

Reviewed the policies and criteria for decision making process on capitalisation of interest and renewal and refinancing of existing loans

Reviewed the income recognition policies Reviewed the accounting procedures for deferred expenses and derivative trading

Review of financial statements

We have done following activities in this work block:

Identify any material items which could, in the absence of a note, mislead a reader accustomed to financial statements prepared in accordance with IFRS/ IAS

Explain methodologies and techniques used in compiling the data which may differ from methodologies normally relied upon by DBM

Loan portfolio and off-balance sheet transactions review

Reviewed classification of the loans within selected period based on latest applicable

methodology

For impaired loans we have reviewed the level of provisioning

Portfolio analysis to understand credit risk concentrations

The nature and volume of credit commitments, contingent liabilities, and guarantees



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Credit risk associated with those off-balance sheet instruments, especially when the counterparty

to an off-balance sheet instrument is also a borrower

Derivative transactions and/or exposures

The financial strength of clients related to off-balance sheet liabilities and the prospects and

timing for possible draws on guarantees and other off-balance sheet items;

Unsettled claims and contingent losses

Reviewed of the collaterals and cash flows when calculating provisions

Fixed assets

We have reviewed the value of Bank’s valuation of fixed asset and compared it against the market value.

2.3. Tim eline and key activities

A graphical display of all activities, their linkages and real dates



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3. Corporate governance

Within this workblock we have analysed the existing overall corporate governance framework from the

point of v iew of compliance with BCBS Guidelines - Corporate governance principle for banks (BCBS

d328).

3.1. Level of development of overall corporate governance

Within the overall corporate governance framework, the assessment focus has been on:

The existing corporate governance structure (rules and responsibilities, key policies - Internal

control framework, risk and compliance policies and policies to identify and avoid conflicts of interest);

The organisational structure including the Board of Directors (BoD) and management

committees;

The process for the nomination of BoD members and senior management; and

Key policies - Internal control framework, risk and compliance policies, policies to identify and avoid conflicts of interest, remuneration policy).

The DBM Act (in force since April 2017) defines the DBM as a for-profit commercial entity and requires the Bank to apply and follow the corporate governance principles of:

Profitability; Sustainability of operations; Independence;

Transparency; Responsibility; Decision making based on collective management; and

Independent supervision. The new DBM Act has improved the supervisory system of DBM and introduced

The power of the Bank of Mongolia to set the prudential ratios for DBM and monitor the compliance with the regulation;

Independent internal audit function; and Overseeing function on the implementation of projects financed by DBM.

However, the requirements of DBM Act do not cover all corporate governance principles according to the BCBS Guidelines (e.g. conflict of interest policy and related party transaction policy with crucial significance in order to ensure greater independence and profitability of the Bank especially in credit granting process). Therefore, DBM’s corporate governance guidelines based on the DBM act – despite a significant improvement comparing the period 2012-2016 - are not fully in line with international standards. We have identified key findings related to the non-compliance with good practices for corporate governance and suggests recommendation in Table 1 below.

T able 1: Findings and recommendations related to corporate governance framework

Ref. No.

Applicable standards and guidelines

Finding Recommendation

1 Board’s overall

responsibilities – key

policies

The Bank has not adopted

internal control

framework.

The bank should adopt the

internal control framework

and define overall

methodology, components



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Principle 1 (26) (BCBS d 328)

Board should approve the

approach and oversee the

implementation of key policies

pertaining to the bank’s capital

adequacy assessment process,

capital and liquidity plans,

compliance policies and

obligations, and the internal

control system

Principle 1 (BCBS d 223)

An effective internal audit

function provides independent

assurance to the board of

directors and senior management

on the quality and effectiveness of

a bank’s internal control, risk

management and governance

sy stems and processes.


At least once a y ear, the board of

directors should review the

effectiveness and efficiency of the

internal control system based, in

part, on information provided by

the internal audit function.


The internal audit function should

independently assess the

effectiveness and efficiency of the

internal control, risk management

and governance systems and

processes created by the business

units and support functions and

provide assurance on these

sy stems and processes.

Internal control system,

Risk management system

and corporate governance

assessment reports not

performed in 2012-2017

The BoD is not currently

sufficiently involved in the

process of control and

oversight of ICS, RM, and

corporate governance

despite the fact, that the

board has ultimate

responsibility for the

bank’s ICS, governance

structure and practices and

risk management.

(control environment, risk

assessment, control

activities, information &

communication, monitoring

activities) of ICS and

responsibilities of first and

second line of defense.

The bank should ensure that

ICS and RM reports are

performed and

communicated to the BoD

and the identified

shortcomings are resolved

without undue delay.

2 Board qualifications and

composition


Board members should be and

remain qualified, individually and

collectively, for their positions.

No comments, bank is in

line with international

good practice

The fit & proper criteria are

defined by DBM Act and

also are in line with

No recommendations



17

They should understand their

oversight and corporate

governance role and be able to

exercise sound, objective

judgment about the affairs of the

bank.

international good

practice.

3 Board’s own structure and

practices – conflict of

interest

Principle 3 (82 - 86) (BCBS d

328)

The board should oversee the

implementation and operation of

policies to identify potential

conflicts of interest. Where these

conflicts cannot be prevented,

they should be properly managed

(based on the permissibility of

relationships or transactions

under sound corporate policies

consistent with national law and

supervisory standards).

The board should have a formal

written conflicts-of-interest policy

and an objective compliance

process for implementing the

policy.

Board’s overall

responsibilities – related

parties transactions


The board should ensure that

transactions with related parties

(including internal group

transactions) are reviewed to

assess risk and are subject to

appropriate restrictions (eg by

requiring that such transactions

be conducted on arm’s length

terms) and that corporate or

business resources of the bank are

not misappropriated or

misapplied.

Principle 5 (98) (BCBS d

328)


the Conflict of Interest

policy and follow only the

general applicable law.

The general procedures for

the credit granting and

approval procedures are

applied to all clients -

nevertheless, the Bank has

not adopted Related party

transaction policy.

The Bank has identified a

list of related parties, but it

is not updated or verified

for its completeness

regularly.

The Bank should adopt the

Conflict of Interest policy

and clearly define the

situations that could create

conflict of interest.

The bank should adopt

formalised Related Parties

Transactions Policy.

The bank should adopt

policies and control

mechanism governing

related-party transactions.



1 8

The subsidiary Board should

ensure that the group’s corporate

governance framework includes

appropriate processes and

controls to identify and address

potential intragroup conflicts of

interest, such as those arising

from intragroup transactions, in

appropriate recognition of the

interest of the group.

4 Board’s own structure and

practices - committees

Principle 3 (64 - 67) (BCBS d

328)

Each committee should have a

charter that sets out its mandate,

scope and working procedures.

This includes how the committee

will report to the full board, what

is expected of committee

members and any tenure limits

for serving on the committee.

The board should disclose the

committees it has established,

their mandates and their

composition (including members

who are considered to be

independent).

A BoD committee chair should be

an independent, non-executive

board member.

Principle 3 (68, 7 1) (BCBS d

328)

An audit committee should be

distinct from other committees

A Risk committee should be

distinct from the Audit

Committee.

The charts of BoD

committees and

management committees

are not detailed enough

(not defined chairmanship

and membership).

Disclosure not in line with

good practices.

Audit and Risk committees

are not distinct.

The Bank should :

Specified the

membership of

committees

Split the Audit

Committee and Risk

Committee

Improve the

content of

disclosure

5 Senior management


Under the direction and oversight

of the board, senior management

should carry out and manage the

bank’s activities in a manner

The internal guidelines

governing the Executive

management operations

issued in 2016. New act

from 2017 didn’t trigger

any change in this area.

No recommendation



1 9

consistent with the business

strategy, risk appetite,

remuneration and other policies

approved by the board.

6 Governance of group

structures


In a group structure, the board of

the parent company has the

overall responsibility for the

group and for ensuring the

establishment and operation of a

clear governance framework

appropriate to the structure,

business and risks of the group

and its entities. The board and

senior management should know

and understand the bank group’s

organisational structure and the

risks that it poses.

The Bank’s internal

control and risk

management, monitoring

and reporting function

does not cover the

subsidiaries (i.e. DBM

leasing LLC, which

provides equipment lease

services to the local

entrepreneurs;

DBM Asset Management

Securities LCC, which aims

to support the increase of

foreign currency inflow

and foreign direct

investment; and

National Export Insurance

LLC).

The Bank should manage,

control and monitor the

risks on consolidated level

(including consideration of

subsidiaries risk exposure .

7 Risk m anagement function

Principle 6(BCBS d 328)

Banks should have an effective

independent risk management

function, under the direction of a

chief risk officer (CRO), with

sufficient stature, independence,

resources and access to the board.

No comments. In line with

international good practice

No recommendations

8 Risk identification,

m onitoring and controlling


Risks should be identified,

monitored and controlled on an

ongoing bank-wide and individual

entity basis. The sophistication of

the bank’s risk management and

internal control infrastructure

should keep pace with changes to

the bank’s risk profile, to the

external risk landscape and in

industry practice.

See findings – Risk

management framework

See recommendations –

Risk management

framework



2 0

9 Risk communication


An effective risk governance

framework requires robust

communication within the bank

about risk, both across the

organisation and through

reporting to the board and senior

management.

See findings – Risk


See recommendations –

Risk management

framework

10 Compliance


The bank’s board of directors is

responsible for overseeing the

management of the bank’s

compliance risk. The board

should establish a compliance

function and approve the bank’s

policies and processes for

identifying, assessing, monitoring

and reporting and advising on

compliance risk.

The Bank has established

compliance function,

nevertheless

appropriate risk mapping (i.e. identification of risks to which the Bank is or might be exposed) and risk materiality assessment is not performed

a formalised mapping of second line of controls is missing.

Therefore it cannot be

certain that all compliance

risks are covered by regular

internal controls

procedures other than the

ones performed

periodically by IA ( third

line).

The Bank should update

the compliance policy in

order to define the main

areas of compliance risk

exposure and processes by

which compliance risk are

to be identified and

managed.

We recommend to perform

compliance reviews based

on annual risk-based plan.

11 Internal audit


The internal audit function should

provide independent assurance to

the board

IA is required to perform a

periodic assessment of the bank’s

overall risk governance

framework, including

the effectiveness of the risk management and compliance functions;

Internal control system,

risk management system

and corporate governance

report not performed in

2012-2017 as a result of

inadequate/insufficient IA

capacity in 2012-2016.

Capacity issues have been

remedied in 2017.

The Bank should ensure the

regular assessment and

reporting on ICS, Risk


and compliance function.

The Bank should ensure

that reports are

communicated to the BoD.



2 1

3.2. Risk management framework

Within this section we have analysed the existing risk management framework from the point of view of

compliance with international good practice:

the quality of risk reporting to the board and senior management;

the effectiveness of the bank’s sy stem of internal controls.

12 Compensation


The bank’s remuneration

structure should support sound

corporate governance and risk

management.


BoD should set appropriate

performance and remuneration

standards for senior management

consistent with the long-term

strategic objectives and the

financial soundness of the bank;


The compensation committee

works closely with the bank’s risk

committee in evaluating the

incentives created by the

remuneration system. The risk

committee should examine

whether incentives provided by

the remuneration system take

into consideration risk, capital,

liquidity and the likelihood and

timing of earnings.

Remuneration policy of risk takers not different

from other employees.

There is no measurable

indicator related to

motivating risk takers to

maintain and decrease risk

in required level.

The Bank should ensure the

remuneration system

dependent on fulfilment of

the approved strategy and

risk limits (RAS). The

remuneration system

should prevent conflicts of

interest.

13 Disclosure and transparency


The governance of the bank

should be adequately transparent

to its shareholders, depositors,

other relevant stakeholders and

market participants.


internal guidelines

governing disclosure. We

have identified

discrepancies in reports

published 2012-2018.

These include Annual

Reports, Consolidated

Financial Statements and

independent Auditor’s

Report


disclosure policy and

ensure the review of reports

before disclosure



2 2

BCBS Guidelines - Corporate governance principle for banks (BCBS d328) FSB – Principles for an Effective Risk Appetite Framework

BCBS Principles for the Management of Credit Risk (BCBS d75) BCBS Standards - Supervisory framework for measuring and controlling large exposures (BCBS

d283) BCBS Guidelines - Prudential treatment of problem assets –definitions of non-performing

exposures and forbearance (BCBS d403)

We have reviewed Bank’s risk governance principles, internal policies and procedures:

Risk management policy (April 2017 and old version dated 2012)

Credit policy (April 2017) Regulation on decision for financing projects and program ( November 2017) Regulation on credit committee operation (July 2018)

Regulation on credit operation (October 2017 and previous version dated July 2012) Decision making procedures on project financing ( November 2017) DBM strategy 2018-2022 Loan provisioning policy

We have identified findings related to the risk appetite framework, risk strategy and risk appetite statement and suggests recommendations as shown in tables 2 and 3 on page 23 and 26.

3.3. Adequacy of risk management framework

The FSB Principles and BCBS Guidelines require the banks to develop a risk appetite framework (hereinafter also referred to as “RAF“) that is institution-specific and reflects its business model and organisation. The RAF should consider material risks to the institution and align with the Bank's strategy. The Risk appetite statement (hereinafter RAS) represents the aggregate level and types of risk that the Bank is willing to accept- or to avoid. It should include qualitative statements and quantitative measures. The risk management strategy should include the internal definitions of the risks to which the Bank is (or might be) exposed, the policies governing the assessment of risks and the risk management methods, including the stress testing.

Within the RAF and Risk strategy, assessment focus has been primarily on following key area:

whether the risk appetite framework considers all material risks to which the DBM is (or might be) exposed and contains risk limits, tolerances and thresholds;

whether the risk appetite and risk strategy are consistent;

whether the risk appetite framework is forward-looking and in line with the strategic planning horizon (2018-2022), and regularly reviewed;

whether the responsibility of the management body in respect of the r isk appetite framework is clearly defined and exercised in practice;

whether the risk strategy appropriately considers the financial resources of the Bank (i.e. risk appetite should be consistent with own funds and liquidity resources)

The DBM’s risk governance is not fully in line with good practices. We have identified findings related to the risk appetite framework, risk strategy and risk appetite statement and suggests recommendations as shown in tables 2 and 3 on pages 23 and 26.

3.4. Adequacy of the existing process for granting and monitoring loans

We have reviewed and discussed with the Bank’s management the internal policies and procedures for credit granting process (with focus on credit granting criteria and assessment of the client’s risk profile. We have also reviewed the loan approval process against the meeting minutes of the Credit Committee (to potentially identify any discrepancies between approval process recommended and applied.



2 3

Within the credit risk management framework assessment focus has been primarily on following key areas:

Credit risk environment

Credit approval process

Measurement and monitoring

Control and oversight

The DBM’s policies and procedures for loan administration and credit risk management are not fully in line with international good practices. We have identified key findings related to the non-compliance with good practices and suggest recommendations as shown in tables 2 and 3 on pages 23 and 26.

3.5. Adequacy of the existing process for the classification of loans and other

assets

The Bank’s definition of non-performing loans (hereinafter NPL) is not in line with BCBS Guidelines - criteria for categorising loans are focused on delinquency status - 90 days past due or the unlikeliness of repayment.

The Bank follows the “Regulation on asset classification, provisioning and its disbursement“, issued by

BoM in Oct, 2017. According to this regulation (which is non-compliant with BCBS) - based on an

accounting-related concept, loans are classified at 5 levels depending on provisioning rate level:

1 . Performing (up to 5%) 2. Special mention (5%-25%)

Non-performing:

3.Substandard (25%-50%) 4. Doubtful (50%-75%) 5. Loss (75%-100%)

The following exposures are considered as non-performing under BCBS Guidelines – “Prudential treatment of problem assets –definitions of non-performing exposures and forbearance” (hereinafter BCBS d403):

all exposures that are “defaulted” under the Basel II framework (i.e. a default is considered to have occurred with regard to a particular client when either or both of the two situations have taken place - the bank considers that the client is unlikely to pay its credit obligations in full, without recourse by the bank to actions and/or the client is past due more than 90 days on any material credit obligation;

all exposures that are credit-impaired according to the applicable accounting framework;

all other exposures that are not defaulted or impaired but nevertheless are material exposures that are more than 90 days past due or where there is evidence that full repayment based on the contractual terms (original or modified) is unlikely without the bank’s realisation of collateral;

In the case of debt securities, a situation of partially or totally missed payment for more than 30 day s will trigger a specific assessment of the counterparty’s creditworthiness.

The BCBS’s definitions of non-performing exposures (hereinafter NPE) and forbearance represent a harmonised asset quality indicator that can provide an asset quality comparison across jurisdictions and is indifferent to a jurisdiction’s stage of implementation of the different versions of the Basel capital framework. BCBS standards are requirements which apply to internationally active banks – therefore they are important for DBM.



2 4

Considerable improvements have been achieved during the period from 2017 - but important progress in risk management is still needed. We have identified key findings related to the non-compliance with good practices and suggest recommendations as shown in tables 2 and 3 below

T able 2: List of findings and recommendations related to risk management framework, credit granting and monitoring process, and classification of loans and other assets

Ref.

No.

Applicable standards and

guidelines Finding Recommendation

1 Principle 1 (33, 36)

(BCBS d328)

An effective risk governance

framework includes a well

developed risk appetite

articulated through the RAS.

The bank’s RAS should:

• include both quantitative

and qualitative

considerations;

• establish the individual and

aggregate level and types of

risk that the bank is willing to

assume in advance of and in

order to achieve its business

activities within its risk

capacity;

Principle 1 (7 1) (BCBS

d328)

The bank is required to

review the bank’s risk policies

at least annually


the Risk Strategy. The Risk

management policy,

(approved by BoD in April

2017 – replacing the Policy

adopted in 2012) does not

define the RAF and RAS.

The frequency of Risk policy

(risk limits) review and

update have not been clearly

defined.

As part of the strategic

decisions, the BoD should

approve RAF, RAS and Risk

strategy to establish effective

risk governance framework

The bank should ensure the

regular (at least once a year)

and ad-hoc (in response to

significant changes of external

or internal conditions)

evaluation and – where

necessary - modification of all

relevant risk strategies,

policies, procedures and limits.

2 Principle 1 (33, 36)

(BCBS d328)

Risks should be identified,

monitored and controlled on

an ongoing bank-wide and

individual entity basis.

The Bank has not performed

appropriate risk mapping

(i.e. identification of risks to

which the Bank is or might

be exposed) and risk

materiality assessment.

The Bank should perform and

regularly review

Risk mapping

Risk materiality

assessment

Risk Control Self

Assessment

in order to identify all inherent

and residual risks.

3 Principle 1, 7 (BCBS d328)

Because of missing forward-looking risk triggers (RAS)

the DBM Strategy for 2018-

The Bank should ensure the consistency among Bank’s



2 5

The RAF should be aligned

with the business plan,

strategy development, capital

planning and compensation

schemes of the financial

institution.

2022 does not cover and

include detailed risk targets.

The Bank has not developed

a capital plan

The Procedure on designing

a business plan does not

require the involvement of

RM.

Strategy (medium and long

term), business plan and RAS.

The Bank should develop the

capital plan.

The bank should update the

Procedure on designing

business plan

4 Principle 7 (124) (BCBS

d328)

Effective risk identification

and measurement approaches

are likewise necessary in

subsidiaries. Material risk-

bearing subsidiaries should

be captured by the bank-wide

risk management system and

should be a part of the overall

risk governance framework

Principle 8 (130) (BCBS

d328)

Risk monitoring and

reporting should cover not

only the disaggregated level

(including material risk

residing in subsidiaries) but

also be the aggregated view to

allow for a bank-wide or

integrated perspective of risk

exposures.

The Bank’s Risk

management, monitoring

and reporting function does

not cover the risk exposure

in subsidiaries (on

consolidated level)

The Bank should manage the

risks on consolidated level

(including consideration of

subsidiaries risk exposure in

Risk strategy, RAF, RAS and

risk reporting).


d328)

Risk management should

establish an early warning or

trigger system for breaches of

the bank’s risk appetite or

limits

The DBM’s Risk

management policy defines

only one level of risk limits

and therefore does not

provide the triggers within early warning / trigger system indicating breaches referring to normal/warning/crisis situation

The Bank should develop the

traffic light system - colour

coding system :

green light/performance in line with targets and allocated limits

y ellow light/trigger breach - business goals and shareholders’ expectations at risk



2 6

allow sufficient lead time and timely intervention

red light/ limit breach (Capital / liquidity adequacy and/or regulatory limits at risk)

for setting the signalling

threshold of relevant changes.

The traffic light system allows

to prioritise escalation procedures and remedial actions

timely intervention to avoid most costly or last resort remediation measures


d328)

As part of its quantitative and

qualitative analysis, the bank

should utilise stress tests and

scenario analyses to better

understand potential risk

exposures under a variety of

adverse circumstances

No comprehensive stress test

is performed. The Bank only

perform liquidity stress test

(no formalised stress testing

policy).

The bank should adopt the

stress-testing methodology.

Internal stress tests should

cover a range of scenarios

based on reasonable

assumptions (basic

macroeconomic indicators -

GDP, unemployment and

inflation rate).

Senior management should

define and the Board should

review the scenarios that are

used in the bank’s risk

analyses.

7 Principle 7 (BCBS d328)

The CRO’s responsibilities

also include managing and

participating in key decision-

making processes (e.g

strategic planning, capital

and liquidity planning, new

products and services,

compensation design and

operation).

Responsibility for new

product approval lies on

Executive Committee –

nevertheless the bank has

not adopted formalised

written rules for new product

approval (i.e. assessment of

risk inherent in new or non-

standard products,

transactions, services and

other activities, markets,

client segments,

geographical areas and

counterparties).


internal rules stipulated

development and

implementation (launching) of

the new products (for DBM

and subsidiaries).


d328)

The Bank's financial

performance risk report

(performed on quarterly

basis) does not provide the

We recommend extending the

content of Risk report in order

to ensure that the BoD and

executive management are



2 7

T able 3: List of findings and recommendations to Credit Risk Management Framework:

Risk reporting should also

include information about the

external environment to

identify market conditions

and trends that may have an

impact on the bank’s current

or future risk profile.

information on

macroeconomic and

financial markets

development.

informed of all factors that

might have a negative impact

on the Bank’s financial

position - including the effects

of changes in external

environment.

Ref. No.

Applicable standards and

guidelines Finding Recommendation


The BoD should have responsibility for approving

and periodically (at least annually) reviewing the credit risk strategy and

significant credit risk policies of the bank. The strategy should reflect the bank’s

tolerance for risk and the level of profitability the bank expects to achieve for

incurring various credit risks.

Principle 1 (7 1) (BCBS

d328)

The bank is required to

review the bank’s risk policies at least annually

The DBM’s Credit policy has been approved by BoD in April 2017 and replaced the Regulation on Credit Operations approved by CEO in 2012

This document has not been reviewed internally since, missing a required review of minimum 12 months

The DBM’s Strategy 2018-2022 is assessed on only one credit risk target, the NPL ratio.

The Bank does not establish any other comprehensive credit risk targets based or alternative indicators

The Bank has not set up limits for any industries (concentration risk) and for total loan to total asset, which is suggested by BoM in 2017.

As a result of missing risk mapping, the Bank does not consider all subcategories of credit risk (e.g. FX lending risk and credit concentration risk).

The bank should adopt the internal rule governing the preparation, approval, evaluation and regular update of the risk policies.

The Bank should develop a wider and more detailed range of credit risk indicators (e.g. Cost of Risk ratio, growth rate of gross non-performing loans) targets when defining its credit risk appetite and risk strategy.

The Bank should follow the

BoM request for concentration

risk limit.

The Bank should perform and

regularly review the risk

mapping, risk materiality

assessment and Risk Control

Self Assessment (see Risk

management framework – ref.

No 2).

2 BCBS Guidelines (d403)

The harmonised recognition criteria for NPE consider:

Uniform 90 DPD criterion applied to all ty pes of exposure including those secured by real estate

The Bank follows the

“Regulation on asset

classification, provisioning

and its disbursement “,

issued by BoM in Oct, 2017.

The definition of NPL is not

in line with BCBS Guidelines

(harmonised criteria for

DBM should review the NPL

definition and amend in line

with international good

practice.



2 8

and public sector exposures.

The 90 DPD

criterion is supplemented by considerations for

analysing a counterparty’s unlikeliness to pay, for which the

definition emphasises the importance of

financial analysis.

Collateralisation plays no direct role in the categorisation of NPE. Any recourse by the bank shall not be considered in this assessment.

categorising loans focused on

delinquency status - 90 days

past due or the unlikeliness of

repayment).

3 BCBS Guidelines (d403)

Forbearance includes

concessions that are granted

due to debtor’s financial

difficulty on any exposure (a

loan, a debt security or an

off-balance sheet item - loan

commitments or financial

guarantees), regardless of the

measurement method for

accounting purposes.

Forborne exposures should

be identified as non-

performing when they meet

the specific criteria provided

for in this definition.

The Bank has not adopted the

forbearance methodology.

DBM should adopt the

methodology for identification

of forborne exposures in line

with international good

practice.


Senior management should

have responsibility for

implementing the credit risk

strategy approved by the

board of directors and for

developing policies and

procedures for identifying,

measuring, monitoring and

controlling credit risk. Such

policies and procedures

should address credit risk in

Finding described in greater

detail in finding No 1 .

Recommendation described in

greater detail in

recommendation No 1.



2 9

all of the bank’s activities and

at both the individual credit

and portfolio levels.


Banks should identify and

manage credit risk inherent

in all products and activities.

Banks should ensure that the

risks of products and

activities new to them are

subject to adequate risk

management procedures and

controls before being

introduced or undertaken,

and approved in advance by

the board of directors or its

appropriate committee.

The bank has not adopted the

New product approval

framework.

DBM should develop the New

product approval policy.


Banks are required operate

within sound, well-defined

credit-granting criteria.

These criteria should include

a clear indication of the

bank’s target market and a

thorough understanding of

the borrower or

counterparty, as well as the

purpose and structure of the

credit, and its source of

repayment.

The credit granting criteria

are not based on

documented, data-based risk

targets.

There are no formalised

triggers (no specific financial

indicators clearly defined) for

debtor’s creditworthiness

assessment during credit

approval and monitoring

process. Risk assessment

(low-medium-high) depends

on expert judgment.

In the absence of objective

credit-risk triggers, the DBM

is exposed to the risk of

inadequate creditworthiness

assessment.

DBM should update the Credit policy to include formalised,

data-based credit risk targets

and debtor creditworthiness

criteria/levels to support the

lending decisions for all

products.

Financial analysis of non-retail

clients may include following

ratios: leverage ratio;

debt/EBITDA ratio; interest

coverage ratio; current

liquidity ratio; or ratio of

(operating cash flow + interest

expenses)/interest expenses;

loan-to-value ratio; and any

other relevant indicators.


Banks should have

procedures to identify

situations where, in

considering credits, it is

appropriate to classify a

group of obligors as

connected counterparties

and, thus, as a single obligor.

Despite the fact that

procedures for identification

of connected clients are

performed (as a part of credit

granting process and

monitoring), there is no

formalised internal procedure

for identification and periodic

update of the composition of

The Bank should develop

formalised internal procedure

for identification and

monitoring of groups of

connected clients.

The procedure should define

the criteria a periodic update

of the composition of groups of

connected counterparties to



3 0

BCBS Standards (d283)

The framework specifies that

two parties are connected if

at least one of the following

criteria is satisfied:

a control relationship, where one of the counterparties has direct or indirect control over the other; and/or

economic interdependence, where, if one of the counterparties were to experience financial problems, such as funding or repayment difficulties, the other would also encounter financial difficulties.

groups of connected

counterparties.

The criteria for identification

of connected parties are

based on ownership and does

not take into account

economic interdependence

identify changes in ownership

and economic

interdependence.


Banks should have a policy

for collateral acceptance and

a methodology for evaluating

the fair value and liquidity of

collateral both at acceptance

and over the duration of the

exposure.

Banks should have

procedures for the ongoing

valuation of such collateral,

and a process to ensure that

collateral is and continues to

be enforceable and realisable.

The Regulation on collateral

and Guidance on collateral

clearly defined acceptable

and prohibited collaterals.

Nevertheless in-house

valuation methodology is not

detailed enough, no

certification and qualification

requirements for internal

appraiser are defined and

independent appraisal is not

required.

The collateral revaluations

are not required to be

compliant with the

International Valuation

Standards.

The Bank should update the

Regulation on collateral and

Guidance on collateral and

implement the methodology in

line with IVS.


In considering potential

credits, banks must recognise

the necessity of establishing

provisions for identified and

expected losses and holding

adequate capital to absorb

unexpected losses. The bank

should factor these

considerations into credit-

The Loan provisioning policy

(based on IAS 39) is not

detailed enough and

therefore does not allow to

follow an audit trail.

The Bank should update the

Loan provisioning policy (i.e.

define clear indicators and

ratios) in order to ensure that

all provisioning-related

controls and decisions can be

step-by-step

retraced/replicated.



3 1

granting decisions, as well as

into the overall portfolio risk

management process.


Banks should establish

overall credit limits at the

level of individual borrowers

and counterparties, and

groups of connected

counterparties that aggregate

in a comparable and

meaningful manner different

ty pes of exposures, both in

the banking and trading book

and on and off the balance

sheet.

The Bank assesses the

debtor's credit applications

on a one-by-one (ad-hoc)

basis, without establishing

overall exposure limits for

individual debtors or group of

debtors (connected parties).

There is no credit limit policy

that would link a debtor's

creditworthiness risk (low,

medium, high) to an

exposure limit.

The Bank should establish

credit limits per debtor based

on their rating results

(creditworthiness assessment)

to facilitate credit approval and

monitoring.

See Finding /Recommendation

No 15 – missing internal

rating methodology.


Banks should consider the

results of stress testing in the

overall limit setting and

monitoring process.

The bank has not performed

any comprehensive stress

test. (see also Risk

management framework - ref

No 6 and CRM finding No

19).


methodology for the future

comprehensive stress tests.

(See Risk management

framework ref No 6 and

CRMF finding No 19).

DBM should consider the

stress testing exercise in the

credit granting/limit setting

and monitoring procedures.

(See Risk management

framework ref No 6 and

CRMF finding No 19).


Banks should have a clearly-

established process in place

for approving new credits as

well as the amendment,

renewal and re-financing of

existing credits.

No major comments,

responsibilities are clearly

defined, but sound granting

process need to be developed

as described in finding 6.

n/a


All extensions of credit must

be made on an arm’s-length

basis. In particular, credits to

related companies and

individuals must be

authorised on an exception

basis, monitored with

The bank does not adopt the

Related parties policy.

(See also section Corporate

governance )

DBM should adopt the Related

parties policy.



3 2

particular care and other

appropriate steps taken to

control or mitigate the risks

of non-arm’s length lending.

Principle 1 (27) (BCBS

d328)

The board should ensure that

transactions with related

parties (including internal

group transactions) are

reviewed to assess risk and

are subject to appropriate

restrictions (e.g. by requiring

that such transactions be

conducted on arm’s length

terms) and that corporate or

business resources of the

bank are not

misappropriated or

misapplied.


Banks must have in place a

sy stem for monitoring the

condition of individual

credits, including

determining the adequacy of

provisions and reserves.

Principle 10 (BCBS d75)

Internal risk ratings are an

important tool in monitoring

and controlling credit risk. In

order to facilitate early

identification of changes in

risk profiles, the bank’s

internal risk rating system

should be responsive to

indicators of potential or

actual deterioration in credit

risk.

Credits with deteriorating

ratings should be subject to

additional oversight and

monitoring.

The Credit operation

regulation describes the

monitoring procedures,

nevertheless the

responsibilities and

frequency are not clearly

defined.

The bank performs

monitoring in half year basis

for provisioning purposes.

As a result of missing credit

granting/monitoring triggers

(re-assessment of low-

medium-high risk status) the

Bank's capability to monitor

the development of the

quality of the loan portfolio is

significantly diminished.

DBM should update the Credit

operation regulation and

include formalised, data-based

credit risk targets and debtor

creditworthiness

criteria/financial ratios for

monitoring purposes



3 3


Banks are required to

develop and utilise an

internal risk rating system in

managing credit risk. The

rating system should be

consistent with the nature,

sise and complexity of a

bank’s activities.

The Bank has not developed

an internal rating

methodology and system.

DBM should develop their own

internal rating system

(internal rating scales to

categorise loans) and define

various grades differing credit

risk characteristics and loan

quality (from satisfactory to

unsatisfactory).

16 Principle7 (121) (BCBS

d403)

Banks should regularly

compare actual performance

against risk estimates (i.e.

backtesting) to assist in

judging the accuracy and

effectiveness of the risk

management process and

making necessary

adjustments.

The Bank has not performed

any back testing of its

internal credit risk

assessment of individual

debtors.

DBM should develop the


back testing of the bank's

internal rating model.


Banks must have information

sy stems and analytical

techniques that enable

management to measure the

credit risk inherent in all on-

and off-balance sheet

activities. The management

information system should

provide adequate

information on the

composition of the credit

portfolio, including

identification of any

concentrations of risk.

As a result of missing

concentration risk triggers

(limits for one industry) the

Bank's capability to monitor

the concentration of risk is


(See Finding No 1).

The Bank should implement

the system for monitoring the

concentration risk.


Banks must have in place a

sy stem for monitoring the

overall composition and

quality of the credit portfolio.


monitoring triggers (re-

assessment of low-medium-

high risk status) the Bank's

capability to monitor the

development of the quality of

the loan portfolio is


The Bank should implement

the system for monitoring the

development of riskiness of the

borrowers (quality of the loan

portfolio).

19 Principle 13 (BCBS d75) DBM should improve the

creditworthiness assessment



3 4

Banks should take into

consideration potential

future changes in economic

conditions when assessing

individual credits and their

credit portfolios, and should

assess their credit risk

exposures under stressful

conditions.

The bank has not performed

any comprehensive stress

test.

(see also Risk management

framework - ref No 6)

methodology in order to

consider external factors - to

take into account the economic

cy cles, market movements and

cy clical aspects of industry

sectors and the resulting shifts

in the composition and quality

of the individual loans and

overall credit portfolio.



comprehensive stress tests.


Banks must establish a

sy stem of independent,

ongoing assessment of the

bank’s credit risk

management processes and

the results of such reviews

should be communicated

directly to the board of

directors and senior

management.

The Credit operation

regulation covers the control

procedures, nevertheless the

responsibilities and

frequency are not clearly

defined.

The Bank does not have a

formalised mapping of first

line and second line controls.

(Supervision and Monitoring

Div ision, Evaluation and

Monitoring Department, Risk

Evaluation and Management

Department) controls.

Therefore it cannot be certain

that all areas of the credit

granting and monitoring

process and credit risk

management are covered by

regular internal controls

procedures other than the

ones performed periodically

by IA (third line).

The Bank should perform a

mapping and analysis of its

existing firs and second line

controls and formalise them.

Based on the analysis, the

bank should adopt any

necessary additional regular

first and second line controls

(internal controls matrix) in

order to cover whole credit

granting and monitoring

process and credit risk

management.


Bank must ensure that the

credit-granting function is

being properly managed and

that credit exposures are

within levels consistent with

prudential standards and

internal limits. Banks should

establish and enforce internal

controls and other practices

See findings No 6,7,10,15,

18,20

See recommendations No

6,7 ,10,15, 18,20



3 5

to ensure that exceptions to

policies, procedures and

limits are reported in a

timely manner to the

appropriate level of

management for action.


Banks must have a system in

place for early remedial

action on deteriorating

credits, managing problem

credits and similar workout

situations.

According to Guidance on

working with risky loan,

credit officer include loan to

watch list in case of pre-

defined changes after

granting loan.


monitoring triggers (re-

assessment of low-medium-

high risk status) and internal

rating grades ( ranging from

satisfactory to unsatisfactory)

the Bank's capability to

identify problem loans in the

beginning is significantly

diminished.

DBM should improve the early

warning system (monitoring

and watch list triggers).



3 6

4. Internal control

4.1. Level of development of internal control system

Within the internal control framework assessment focus has been on the extent to which the Bank has

established an internal control framework (and its components) and on significant topics:

Whether the framework is implemented in all areas of the institution and clearly defines roles

and responsibilities of first, second and third line of defense

Whether the Bank has established an independent control functions

Whether the regular reporting on ICS, Risk management framework, corporate governance and

compliance function is performed

whether the institution has a compliance policy and a permanent and effective compliance

function that reports to the management body

We have identified positive progress related:

Development and approval of the Internal audit charter in line with international standards and guidance for the professional practice

Development and approval of the Internal audit plan

The improvement of the second line of the defence and monitoring of the fulfilment of the BoD resolutions.

We have also identified key findings related to the non-compliance with good practices and suggest

recommendations as shown in tables 4 below.

4.2. Internal audit function

We have reviewed the IA chart, BoD and Audit and Risk committee meeting minutes and also a sample of IA reports performed in 2017.

In our opinion the internal audit function is independent and operates in accordance with established international standards and requirements.

We also have verified whether IA adequately covers all necessary areas in the risk-based audit plan, including the areas of risk management, internal controls, compliance and governance.

There is a significant improvement of the IA function quality in 2017 (comparing the period 2012-2016), however we have identified key findings related to the non-compliance with good practices and suggest recommendations as shown in tables 4 below.

4.3. Board oversight of controls

As a result of above mentioned deficiencies identified in Internal control framework and Risk

management framework (and assessment of its quality and effectiveness) the BoD is not currently

sufficiently involved in the process of control and oversight of ICS, RM, and corporate governance despite

the fact, that the board has ultimate responsibility for the bank’s ICS, governance structure and practices

and risk management.

4.4. External audit and follow up actions

We have verified that the Bank has established the system of remedial actions monitoring and reporting. The responsibility for assessment of the fulfilment of corrective measures lies on second line of defense (Valuation and monitoring unit) under CEO reporting line.



3 7

T able 4: List of findings and recommendation to internal control system and audit function

Ref. No.

Applicable standards and guidelines

Finding Recommendation

1 Principle 6 (BCBS d 223)

The head of internal audit is

responsible for establishing an

annual internal audit plan that can be

part of a multi-year plan. The plan

should be based on a robust risk

assessment (including input from

senior management and the board)

and should be updated at least

annually

Multiyear audit plan not

performed.

IA plan not based on risk

assessment (partially due to

the missing risk mapping)

The bank should adopt multiyear IA plan based

on risk assessment and

input from senior

management.


Every activity and every entity of the

bank should fall within the overall

scope of the internal audit function.

The responsibility for

assessment of the fulfilment

of corrective measures lies

on second line of defense

(Valuation and monitoring

unit) under CEO reporting

line.

Subsidiaries not included in

IA for and ICS /Risk

/Governance report (2018

included)

The IA should assess the

remedial actions

fulfilment in order to

ensure independent

opinion.

IA plan should cover the

subsidiaries assessment.


As part of their oversight

responsibilities, the board of

directors should review the

performance of the internal audit

function. From time to time, the

board of directors should consider

commissioning an independent

external quality assurance review of

the internal audit function.

No independent external

quality assurance review of

IA function performed in

2012-2017

The bank should

consider the quality

assurance rev iew in

medium term horizon (5

y ears).



3 8

5. Liquidity position

5.1. DBM’s approach for measuring and managing liquidity and funding risk

In general, prior to the implementation of the newly amended law in April 2017, the Bank's

operations were implemented under the Government's resolutions on lending, investment and

debt management. There were no legal regulations on making decision as of professional banking

institution and the Ministry of Finance used to set the regulations and limitations on Bank’s

activities and required prudential ratios. During 2011-2015, the Bank long-term funds and liquid

assets were sufficient. However, there were no limits on measuring the risks, focusing on the free

cash position and liquidity structure. In these years, the Bank used its free funds (Euro bond,

Samurai bond) to finance the related projects according to the government’s re solutions and

favourable market conditions for issuing debt bonds. From 2014 the Bank’s management team

raised the problems to its regulators regarding the Bank’s independence. As a result, the Law on

DBM has been updated by the Parliament in February 2017 (effective from April 2017) to improve

the independence of the Bank.

The Bank’s approach for measuring and monitoring liquidity risk currently does not meet the

good practices in this area as stated in the table below. Nevertheless, we observed a positive

progress in improving a liquidity risk since 2016 when a new revised law on DBM was established

and in funding management from 2017. All previous decisions were taken v ia Government

resolutions. The below mentioned analysis was based on the following documents received

during the project. The following table also shows a lack of relevant procedures, policies and

strategies in previous years.



3 9

T able 5: List of provided documents that were obtained and reviewed

T able 6: Components of liquidity risk management subject to review

Areas Comment Risk appetite statement (RAS)/Risk appetite framework (RAF)

Current situation: There is no RAS/RAF in place since 2012. RAS/RAF,

however, is one of the main components in risk management (including

liquidity risk) described under international good practice. RAS and RAF

importance is more explained in section 3.2 Risk management framework.

Robust liquidity risk m anagement framework

Current situation: There is no such framework in place since 2012. The

provided documents describe the framework only in a very general manner.

This approach does not meet the good practice in this area. Since 2017 based

on the revised law on DBM, policies and business strategies are approved by

BoD, asset classification procedure and prudential ratio procedure are

Document name Approved date

2012 2013 2014 2015 2016 2017

Asset and liability management policy

4/20/2017 Absent Absent Absent Absent Absent

Asset and liability management policy

8/21/2012 Replaced

Operational manual on assets and liabilities committee


Operational manual on treasury

2/10/2015 Absent Absent Absent

Short and long term funding regulation to improve solvency and profitability


Regulation on capital adequacy requirement and monitoring




Risk management policy 4/20/2017 Absent Absent Absent Absent Absent Risk management policy 1/10/2012 Replaced Resolution on minimum amount of liquid asset

10/21/2016 Absent Absent Absent Absent

Resolution on minimum amount of deposits at commercial bank

1/20/2016 Absent Absent Absent Absent

Resolution on procedures improvement of liquid asset

12/28/2015

Absent Absent Absent Absent

Contingency funding plan 3/9/2018 Absent Absent Absent Absent Absent Absent General terms on interest rate and commission rate

1/10/2012

Policy on placement at commercial banks

2/10/2015 Absent Absent Absent



4 0

approved by BoM based on discussion with MoF and other methodologies are

approved by Management of the Bank.

Past situation: In 2012 the Bank’s Board of Directors approved the newly

amended risk management policy which contains main principle of robust

liquidity risk management such as identifying the potential risk, monitoring

and performing stress test.

Moreover, in 2016 the Risk management department started to work on to

setting the methodology to evaluate prudential ratios for Bank’s financial

performance. This methodology was not approved by the Bank’s management

team.

According to the newly amended law of DBM the Board approved the policies

that regulate the Bank’s all activities in every business area and investment and

financing and decision making process.

Liquidity costs, benefits and risks in the internal pricing

Current situation: The Bank has in place a methodology for transferring the

cost of funding. Since 2016 the Bank is applying the cost of funding based on

the Bank's funding pool. The Bank's ALCO committee reviews the cost of

funding every quarter. The cost of funding is set for each currency and each

tenor. In case of funding MNT deals from the FCY funding the Bank applies the

cost of hedging into overall client credit margin. We consider this approach in

line with best practice.

Past situation: The approach the Bank was using before 2016 was based on the

case-by-case (credits were assigned to the given funding; cost of hedging was

not taken into account in every case).

Identifying, m easuring, m onitoring and controlling liquidity risk

Current situation: Current identification, measurement, monitoring and

controlling processes are not still in line with best practices and in line with

Basel recommendations. The bank currently measures and monitors the

liquidity only via LCR/NSFR ratios. No cumulative gap limits are introduced.

Past situation: There was no active identification, measurement, monitoring

and controlling of the liquidity risk since 2012. In 2014 the Bank established a

new division responsible for the financial risk. In terms of liquidity risk

management the only activity was to prepare a liquidity gap report from 2015.

Nevertheless, no liquidity limits were imposed, measured and managed.

Since 2013 the Bank started to evaluate its capital adequacy ratio, liquidity

ratio and foreign currency positions and this includes daily and monthly

reports that provided by Risk Management department.

In 2014 the Bank established the Risk management department which started

many researches on GAP report (based on expected maturity of assets and

liabilities) and identifying the financial risk management. The Risk

management department introduced the above mentioned reports and

researches to the Bank’s top management committee and Board committee.

Unfortunately, no decisions were taken due to the delayed amendment of the

Law on Development Bank of Mongolia.



4 1

Funding strategy

Current situation: Since 2014 the funding strategy is a part of the business plan

that is approved by BoD on a yearly basis.

Past situation: There was no funding strategy since 2012 that would provide

effective diversification of the sources and tenor of funding.

Formerly revised Law of DBM approved and business and legal environment

changes, from 2014 the bank reflected the government’s policies and medium–

long term strategies into the bank’s yearly business plans.

In 2012 to 2013 the Bank successfully issued the bonds in international capital

market and raised funds.

Liquidity stress testing

Current situation: There is no officially approved liquidity stress testing

methodology in place since 2012.

Past situation: the Risk management department was preparing the liquidity

stress tests for the end of the years of 2014, 2015 and 2017.

All these stress-testing reports were submitted to the relevant committees.

However, there were no follow-up decision taken with respect to the results of

the stress testing.

Contingency funding plan

Current/past situation: There was no contingency funding plan in place within

the y ears 2012-2017.

(Such plan was developed and approved by BoD in 2018. According to our

review, this plan already meets partly the requirements for a CFP. The plan is

reviewed on a quarterly basis)

Disclose information on a regular basis

The bank discloses the information about liquidity risk positions and

management since 2012. This is in a line with good practice.

5.2. Key risk drivers for liquidity and funding risk exposure

There are two key risk metrics the Bank is using: Liquidity Coverage ratio (LCR) and Net Stable

Funding Ratio (NSFR). Both ratios were introduced in 2017 for the first time. Before 2017 the

Bank was using no key risk metrics.

After we reviewed the methodology for the calculation, both ratios are calculated in line with BoM

methodology. However, the BoM approach is not in line with Basel International Standards for

calculation of LCR/NSFR.

In addition, from 2015 the Bank approved the policy that regulates all activities related to placing

surplus of free funds into domestic commercial banks.

The bank was producing liquidity gap reports since 2015 but no limits were introduced.

The limits are set in the following manner:

Min LCR limit = 100% (position as of 2017 YE= 365 %)

Min NSFR limit=80% (position as of 2017 YE=151%)

Recommendations:



4 2

A common practice is also to introduce cumulative gap limits for all currencies and

cumulative gap limits for each currency. This approach reduces the mismatch in long

term funding and prevents the Bank from getting into funding problem due to a limited

access to the FX market. The good practice is to also calculate and manage the LCR/NSFR

ratios for all individual currencies.

Follow the methodology /recommendations set by Basel standards for the calculation of

LCR/NSFR ratios.

5.3. Integration of liquidity risk management into management and decision-making processes

The integration of liquidity risk management into management and decision-making process is

limited since 2012 and focusing and relying on the liquidity gap. As mentioned above there were

no limits in place and the decision making process was executed solely on the given business

requirement. Final decision on acquiring a new funding from international markets was made by

DBM's Board of Directors resolution based on Government of Mongolia, ALCO's decision, Risk

assessment and Internal Legal opinion.

Since 2017 the bank introduced the liquidity ratios (LCR/NSFR). Regular reporting and

monitoring of these ratios is a part of the decision–making process within DBM bank.

According to the operational regulation of short/medium term funding plan approved in 2017,

the Bank’s management makes strategic decisions based on the revised DBM charter (BoD sets

the decision making rules).

Based on our v iew the integration of liquidity risk management into decision-making process is

not in line with good practice. The main reason is the lack of cumulative gap limits.

5.4. Liquidity needs over different time horizon

Refinancing needs

Based on the liquidity gap report as of December 15, 2017 the bank will have in a short term

horizon (up to 1 year) a negative USD position starting from 2018 amounting to USD 230 mln.

The position will continue worsening unless the bank will renew the USD funding for a longer

term. The bank will need to refinance in longer-term horizon (over 1 year) until 2020 a total

amount USD 318 mln.

As for EUR currency, in a short-term horizon the Bank will need to refinance EUR 4.8 mln. In a

long-term horizon, the Bank will need to refinance EUR 18 mln.

The bank expects to refinance the above needs with the following counterparties:

United States Department of Agriculture, USD 200 mln, expected maturity 3 years

International Investment Banking, EUR 30 mln, maturity 7 y ears

The bank is also planning to issue long term USD bonds totalling USD 500 mln for the refinancing

purposes.

New business

Based on the business plan for 2018 the Bank expects to obtain a long/medium term horizon

funding from the following counterparties

Counterparty 1, USD 1 bln, for gas and oil factory project



4 3

Counterparty 2, RUB 100 bln for expansion of power plant, improvement of the

efficiency and railway projects

Counterparty 3, USD 148.6 mln for improvement of industrial park and infrastructure

However, the above-mentioned funding are determined for the development projects as stated

are in risk due to the IMF restriction. Any new FCY debt is a subject of the IMF approval. The

exemption is any FCY debt for refinancing purposes.

Based on the our view the long-term refinancing structure is fully dependent on FCY funding due

to a lack of local long-term investors. Even though the maturity profile is reasonably optimised,

the refinancing risk in FCY represents a major risk for the Bank in case of worsening the credit

risk profile of Mongolia.

5.5. The liquidity support provided by the Government, the BOM and financial institutions

Since inception, the Government provided systematic capital injections to the Bank to improve

its liquidity position. Although the Bank was able to grow, the Government passed Resolutions

to increase the share capital in order to facilitate the rapid growth. The liquidity and funding

support provided by the Government focused also on issuing 10Y/5Y USD Chinggis bonds in 2013

on the international markets. This 5Y USD Chinggis bond has been refinanced in 2018 by another

5Y bond.

T able 7: Information on the Government support.

All numbers in bln MNT.

Year 2012 2013 2014 2015 2016 2017 T otal

Detailed Capital increase and Depo information

Capital increase – Dec 28, MNT 23,600

Capital increase – Jul 24, MNT 10,000 Aug 22, MNT 5,000 Sep 03, MNT 35,000

Capital increase -Jun 30, MNT 20,579

Capital increase -June 6, MNT 101,457

Capital increase -Dec 28, MNT 850,457 MoF - Short Depo: Dec 18, MNT 13.2 June 3, 201: MNT 30.0

Capital increase- 31 Mar, MNT 120,507 MoF - Short Depo: May 8, MNT 50.0 May 31, MNT 18.0

Total Capital increase

MNT 23,600

MNT 50,000

MNT 20,579

MNT 101,457

MNT 850,457

MNT 120,507

MNT 1 ,166,600

Total Depo - - - - MNT 43,2 MNT 68,0 MNT 111,2

The reason for an increase of the capital in 2016 is related due to the lack of capital and the

repayment of the Chinggis bonds.

There is no liquidity support from the BoM, although DBM is able to conduct swaps with BoM if

needed. The main role of BoM is a supervising function. This role is also defined in the Law on

DBM.



4 4

5.6. Concentration of funding

The funding strategy for DBM is based on the issuance of international bonds and accepting loans

from abroad. The long-term funding is consisted of different sources (commercial banks,

supranational institutions and local government) and is well diversified. The external funding

is usually obtained in USD, EUR or JPY and is usually supported by the guarantee of the local

government (USD 732 mln, JPY 30 bln) or insured by a credit insurance (USD 19.9 mln, EUR 13

mln) of the country from where the funding is coming from. There is also a long term funding in

FCY provided to DBM by the supranational institutions without any guarantee (EUR 50 mln,

USD 85 mln). The government will continue providing guarantees in case of need. However, the

Bank strategy is to acquire the long term funding without state guaranties.

T able 8: Summary of funding structure

Funding type 2012 2013 2014 2015 2016 2017

Bond International 99,53% 31,49% 28% 27 % 52% 21%

Bond Domestic 0,00% 0,00% 0% 3% 6% 9%

Borrowing International 0,00% 0,00% 15% 17% 38% 41%

Borrowing Domestic 0,00% 64,37% 52% 44% 0% 0%

Due to banks 0,00% 3,60% 4% 8% 2% 27%

Customer account 0,00% 0,53% 1% 1% 1% 0%

Other 0,47% 0,01% 0% 0% 1% 1%

T otal 100,00% 100,00% 100,00% 100,00% 100,00% 100,00%

5.7. Vulnerabilities of DBM’s funding risk

The Bank has a very good access to local money market for short term funding. In case of long

term, funding the bank is facing the lack of credit lines from the local banks (similar to other

commercial banks). Other limitation is that any external FCY debt must be approved by the

Ministry of Finance. This exemption is not required in case of refinancing the old/maturing FCY

debt. The restriction comes from the IMF Extended Fund Facility for Mongolia in 2017.

According to the previous version of Law on DBM, the bank had been entitled to various types of

support from the Government, including unconditional and irrevocable sovereign guarantees on

debt issuance and borrowings, FX hedging with BoM, and others. DBM’s Government guaranteed

obligations include Samurai bonds issued in the Japanese capital market (JPY 30 bln), Senior-

sy ndicated loan through Credit Suisse (USD 30 mln), Credit Facility from China Development

Bank (USD 162 mln). Even though, there are many advantages of having Government guarantee

when acquiring funding, DBM is driving towards raising capital on own way without explicit

guarantee from the Government of Mongolia in order to implement good management and

governance practises.



4 5

6. Investment portfolio

6.1. Classification of securities

We have reviewed the classification of all investment securities (MNT government bonds, USD

notes, equity investment into MIK Corporation). The investment securities are classified in line

with business expectations of the Bank and accounting policy. In case of MIK the Bank does not

have significant influence or joint control over the company. The table below summarises all

investments held by the bank at each year-end. There were no investments in securities in the

period 2012-2013.

T able 9: Overview of investment structure

6.2. Underlying asset quality

Debt instruments:

In 2014, the Bank has started investing in a number of government bonds issued by the Ministry

of Finance. Coupon rate of bonds ranged from 8.3% to 14.9% for MNT and 5.5% for USD. At the

end of 2017, there were no outstanding government securities.

In late 2016, the Bank had purchased MNT 1 trillion zero coupon government bonds in order to

increase the equity based on Government resolution. In other words, the Bank purchased the

bonds from Government and Ministry of Finance increased the capital of DBM. Those bonds were

classified under cash equivalent and investment available for sale at year-end 2016. In March

2017, those bonds were all settled by offsetting payable to Ministry of Finance.

All debt investments were issued by Government of Mongolia. The government securities

were/are considered as risk-free investments.

Equity instruments:

From the risk point of v iew, the investment into MIK equity represents an investment risk.

Mongolian Mortgage Corporation LLC (MIK) includes a subsidy scheme for mortgage financing

to create stable environment for mortgage financing.

Under the programme, the commercial banks in Mongolia are granted loans at lower interest

rates to issue subsidised interest rate mortgage loans or refinance their existing loans with the

subsidised interest rate mortgage financing.

Classification Loans and receivable

Loans and receivable

Available for sale

Available for sale

Investment type

Debt Debt Debt Equity

Counterparty Government Government Government MIK

Currency USD MNT MNT MNT

2014 Amount 116,318 41,118,581 - 11 ,200,000

% 81% 15% 0% 4%

2015 Amount 60,696 10,004,548 - 27 ,737,595

% 7 6% 6% 0% 17%

2016 Amount - 128,025,101 104,647,352 37,599,851

% 47% 39% 14%

2017 Amount - - - 32,206,430

% 0% 0% 0% 100%



4 6

In March 2014, based on the Government decision, the bank acquired 14.88% of shares in

Mongolian Mortgage Corporation LLC (MIK) at a cost of MNT 10 bln.

In late December 2015 MIK initiated a successful IPO placement of its shares on Mongolian Stock

Exchange at par value of MNT 12,000 per share. DBM was offered to purchase additional 462,264

shares at market value to sustain its existing ownership of MIK’s shares.

During the period between 2015-2017, MIK has declared dividends of MNT 539 mln, MNT 743

mln and MNT 1,453 mln respectively as a result of the financial years 2014-2016

Relevant documents

We have reviewed the following internal documents of the bank. Based on the interviews and

provided documents the decision making process for investment securities in the period 2012-

2016 under Old Law on DBM required the approval of the Government of Mongolia. There were

no internal documents defining the investment policy and strategy. Since 2017 when a new

revised Law on DBM was introduced, the decision making process remains within DBM bank.

For this reason the Bank developed in 2017 a set of internal investment documents that are a

subject of the approval of the Government.


2012 2013 2014 2015 2016 2017

Investment policy 4/20/2017 Absent Absent Absent Absent Absent

Investment operations regulation


Absent

Regulation on asset classification, provisioning and its disbursement for DBM, approved by BoM

10/3/2017

Absent Absent Absent Absent Absent

Revised DBM Law 2/10/2017 Absent Absent Absent Absent Absent

Scheme of the decision making process for the Investment securities

The Bank currently follows the Law on DBM, namely the Section 15.1. This Section of the DBM

law is the part of the DBM Investment regulation approved by DBM in 2018 and Investment

policy approved in 2017.

6.3. Investment portfolio and credit quality of obligors

See the chapter 6.2

6.4. Inventory of all clear titles

The list of all investment securities is in the table in the chapter 6.1. We have fully reviewed the

inventory of all clear titles to the securities and comments on securities without any kind of lien

from creditors or other parties and poses no question as to legal ownership.

6.5. Securities without lien

All above-mentioned securities were without lien.

6.6. Permanent reduction for recoverable values of securities

We did not identify any permanent reduction for recoverable value of securities.



4 7

6.7. Levels of allowances for losses

There were no allowances for debt and equity investments. Debt securities were issued by the Government of Mongolia and considered as risk free assets. For equity investments, the bank had its internal model for valuation in 2014-2015. In the period 2016-2017 the Bank started to value the equity based on the quoted prices from the Mongolian Stock Exchange.

6.8. Translation exposures of securities portfolio

The Bank invested into government bonds denominated in USD currency (USD 115 mln) during

the period 2014-2015. The funding of the Bank was also provided in USD currency at the same

time. Thus, there was no foreign currency risk associated to those bonds (perfect hedging).

6.9. Adequacy, effectiveness and efficiency of hedging strategy

The investment into USD denominated Mongolian government bonds in 2014-2015 was fully

hedged by USD denominated liabilities.

6.10. Impact of FX denominated securities

The investment into USD denominated Mongolian government bonds had no impact on the

open FX position.



4 8

7. Foreign exchange risk

7.1. Market risk management framework and market risk strategy concerning FX

risk

In y ears 2012-2016 the management of the market risk (specifically FX risk) was subject to the

Government decisions for all operational and strategic decisions which made process inefficient.

However, we observed since 2017 when a new law on DBM was revised a positive progress in

improving FX risk management. The bank focuses primarily on open FX position; however,

there is lack of the comprehensive and integral FX risk management across the bank.

The Bank’s approach for measuring and monitoring FX risk currently does not meet the good

practices in this area as shown in the table below. The below mentioned analysis was based on

the following documents received during the project.

T able 10: List of procedures, policies and strategies in previous years.


What is included in the policy

Asset and Liability Management Policy

8/21/2012 8.3.2 The bank can reduce FX risk by swap agreement and hedge accounting


5/30/2017 Section 4. Open position on Foreign Currency

Resolution on capital adequacy requirement and monitoring

9/7/2017 3. Each or total open position amount should not be exceeding 50% of equity

Risk Management Policy 4/20/2017 5.3.1 Definition of FX risk

Risk Management Policy 1/10/2012 6.2.1.2 Definition of FX risk (superseded)

T able 11: Components of FX risk management subject to review

Areas Comment Risk Appetite Statement (RAS)/Risk Appetite Framework (RAF)

There is no RAS/RAF in place since 2012 for FX risk. RAS/RAF, however, is one of the main components in risk management (including FX risk) described under international good practice.

Robust FX risk m anagement Framework

There is no such FX management framework in place since 2012. The provided documents describe the framework only in a very general manner.

Identifying, m easuring, m onitoring and controlling liquidity risk

There was no active identification, measurement, monitoring and controlling of the FX risk since 2012. In 2015 the Bank established a new division responsible for the financial risk. In terms of FX risk management the only activity was to prepare a report on open bank’s FX position from 2015. The only FX limit in place is the limit approved by BoD DBM stating the open position cannot exceed 50 % of the equity for each currency and total open position of the Bank. This limit requirement comes from the Bank of Mongolia recommendation.

FX Stress Testing There is no FX stress testing in place since 2012 performed by the Bank even though the Bank states in its documents that such an FX stress test is an integral part of the FX risk management.



4 9

Nevertheless, the bank discloses the stress test results on a yearly basis in the annual report,

Granting FCY loans to clients

There is no bank’s policy in place that would prevent granting FCY loans to clients without the ability to hedge the FX risk (in cases where the loan is not a natural hedge)

Disclose information on a regular basis

The bank discloses the information about FX risk since 2012. This is in a line with good practice.

7.2. Integration of market risk management into management and decision-making

processes

The Bank’s risk management department produces on a weekly basis the report about open FX

position. This report is submitted to the Bank’s top management and regularly discussed by the

ALCO committee. The treasury department produces its own report about open FX position. Both

reports after our verification provide the same information. The Bank started to produce such

reports from 2015. Based on risk reports the Bank makes final decisions about FX hedging of the

FX open positions. There are no internal limits in place for open FX position. The only limit the

bank is following is a limit set by BoD DBM . (Bank of Mongolia recommendation)

7.3. Accounting methodology for FX transactions

The Bank’s FX accounting methodology is written in the accounting policy approved in 2012 and

in line with good practice. Bank of Mongolia official rates are used in calculating of realised and

unrealised gain/losses.

7.4. FX Risk exposure

We have reviewed the information about the open FX position the bank carries out since 2012.

Based on our analysis the Bank is operating with a significant open FX position in USD (-71 mln)

and JPY (-9.7 bln) totalling MNT (-381 bln) as of Dec 2017. The maximum open FX position was

in 2016 in USD (-447 mln), EUR (-22 mln) and JPY (-26 bln) making total of MNT(-1,71 tln). The

bank commenced to reduce its open FX position in 2017.

The reason for the open FX position is the absence of the FX hedging strategy in the Bank. As

stated above a long-term funding consists fully from the FCY denominated long-term debt (loans,

issued bonds). There is a very limited/no use of cross currency swaps used by the Bank to hedge

the FX risk. Due to the size and maturity of the local market, DBM can transfer its FX exposure

only to Bank of Mongolia, Ministry of Finance of Mongolia, agencies of Government of Mongolia

or to the Mongolian private sector as there are not liquid hedging instruments available

internationally. Only other reasonable alternative would have to be to reduce balance sheet of the

DBM itself.

The standard approach by the Bank management was to convert the obtained FCY proceeds from

the bond issuance (loan obtained) into local currency at FX spot rate in the given date without

hedging FX risk thus increasing its net open FX position.

Other very important reason that does not enable the bank to manage properly the FX risk is the

absence of any convenient FX hedging instruments (namely FX cross-currency swap) in the

Mongolian banking sector. The only entity that can provide in a limited way a long term cross-

currency swap is the Bank of Mongolia. On the other hand the cost of such hedging is very high

and often removes the advantage of the issuance a long term funding in FCY on the foreign

markets.



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T able 11: FX positions at y ear end (2012-2017)

Currency (‘000)

2012 2013 2014 2015 2016 2017

USD (280,303) (1 ,042) (101,332) (108,919) (447,962) (71,898) EUR - 9 158 (25,187) (22,327) (61) JPY - - (11,919,254) (20,047,137) (26,470,981) (9,739,828)

CNY - - 215 215 215 5 Total (USD) (280,303) (1 ,030) (200,991) (302,859) (697,961) (158,553)

We recommend the following improvement:

When accepting a FCY debt, the Bank should make sure that also a proper cross-currency

swap is also pre-agreed

7.5. Analysis of methodology for credit granting and loan monitoring

We were provided with no methodology for granting loans denominated in FCY and loan

monitoring as such policy does not exist. Based on the interviews we had the Bank does not

require from its clients to hedge the FX risk in case the credits are provided in FCY. Thus, the

Bank is exposed to the credit risk due to significant movement of FX rate.

7.6. FX lending risk management

As stated above the clients accepting a credit denominated in FCY, convert these proceeds into

local currency at an FX spot rate. The clients have no access to any FX hedging products due to

its absence in the Mongolian banking sector. Nevertheless, some companies are able to generate

the FCY cash flow to reduce the FX risk.

T able 12: Volumes of provided credits to clients that are able to generate a FCY cash flow

Currency FX rate Total amount Credit volumes to generate FCY cash flow

USD 2,427.13 540,431,662 294,341,031 54.46%

EUR 2,897.87 13,620,311 428,788 3.15%

JPY 21.53 4,267,481,973 3,597,625,514 84.30%

Total (MNT)

1 ,443,046,677,306.320 7 93,103,395,769.010 54.96%

Only 44%/58%/84% of clients that were provided the USD/EUR/JPY loans, respectively, are able

to generate FCY cash flow. In case of a significant FX rate movement against MNT, there is a

material credit risk the Bank is exposed to that the clients that do not generate FCY cash flow will

not be able to repay its FCY debt.

Our recommendations are as follows:

When providing a FCY credit(s) to its client, the Bank should make sure that the client

has the access to cross-currency swap to hedge his FX risk or the client is able to generate



5 1

the FCY income in a sufficient amount to accumulate and cover future repayments of the

FCY debt.

The clients that are not able to generate FCY cash flow or have no access to FX hedging

products at reasonable cost, should not be provided the FCY credits

8. Accounts receivable

In general, the main purpose of the strategy of the use of receivables in the past (mainly from MoF) was to manage and offset the FX risk. This approach (the agreement between DBM and Ministry of finance allowed the Bank to ask for compensation in case there are FX losses on DBM side when providing SME loans to clients) eliminated the FX losses on the Bank’s balance sheet, however, the FX risk was passed to the MoF. The FX losses were covered by the state budget.

8.1. Regulation on asset classification for assessing accounts receivables

The Bank has implemented into its internal procedures/policies the following policies and regulations related to accounts receivable during the period 2012-2017.

T able 13: List of policies related to accounts receivable

Document name A pproved date

2012 2013 2014 2015 2016 2017

A ccounting policy 7 /23/2012

Reg u lation on a sset cla ssification, pr ov isioning a n d its disbursement for DBM, a pprov ed by CEO

4 /3 /2012 Replaced

Reg u lation on a sset cla ssification, pr ov isioning a n d its disbursement for DBM, a pprov ed by BoM

1 0/3/2017 A bsent A bsent A bsent A bsent A bsent

Asset classification and provisioning are regulated by Bank of Mongolia’s regulation as per accounting policy. However, between Apr 2012 and Oct 2017, the Bank has approved regulation on classification and provisioning. Due to revised Law on DBM, BoM specifically approved asset classification and provisioning regulation for the Bank. In this policy, receivables from Ministry of Finance and state owned organisations are not subject to impairment.

8.2. Asset quality of accounts receivables

During the year 2012-2017, significant part of accounts receivable was from Ministry of Finance.

T able 14: Accounts receivables outstanding balances each year-end.

Financial year

Amount (‘000 MNT) Percentage

Receivable from Ministry of Finance

Other receivables

Total

Receivable from Ministry of Finance

Other receivables

2012 2,168,468 251 2,168,719 99.99% 0.01%

2013 5,097,610 530 5,098,140 99.99% 0.01% 2014 9,635,697 12,183 9,647,880 99.87% 0.13%

2015 8,447,858 611 8,448,469 99.99% 0.01% 2016 481,651,152.0 114,671 481,765,823 99.98% 0.02%

2017 - 107,686 107,686 0.00% 100.00%



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Receivable from Ministry of Finance in 2012-2015 and 2016 (MNT 7.3 bln) relates to SME loan agreement made among the Ministry of Finance, the Ministry of Food and Agriculture and the Bank. The Ministry of Finance agreed to cover any losses in MNT denominated loans due to the fact that these loans are financed through USD denominated bonds. Significant increase in 2016 is related to repaid loans by a state budget that were transferred to Government of Mongolia based on the Parliament of Mongolia resolution from 28 December 2016. As a result, the Bank had MNT 3.1 trillion receivables while the Bank had payable to MoF amounting MNT 2.7 trillion in its balance sheet. Therefore, the Bank and MoF signed a reconciliation act to offset those receivables and payables and the bank booked receivables of MNT 474 bln in addition to those FX receivable. As of end of 2017 there were no accounts receivables from MoF.

8.3. Gaps/Pro-forma Provisions

The bank did not create any provisions for accounts receivables in 2012-2016. In 2017, due to newly approved asset classification regulation by BoM, the bank had MNT 18 mln provisions on outstanding receivables. These provisions relate to the private sector companies.

8.4. Inventory of clear titles to accounts receivables

See the table and comments above.

8.5. Adequacy and efficiency of reconciliation procedures

The Bank does not have any policy to perform a reconciliation with customers. However, reconciliation was performed with Ministry of Finance during 2012-2016 due to material outstanding receivables mentioned in chapter 8.2.

8.6. Outstanding items

There are no outstanding material items of receivables identified.



5 3

9. Liabilities

9.1. Funding risk with focus on currency and maturity mismatches

The liability side consists of short-term and long-term funding. The short-term funding consists

of MNT money market deposits and capital injection provided by the Government of Mongolia.

The long-term part consists fully from the FCY long-term debt (loans, issued bonds). Based on

the cumulative liquidity gap report as of end 2017 we observed the following:

USD: The mismatch between assets and liabilities requires ensuring funding to cover a

short position in 2018 USD 230.3 mln and USD 317 mln by the end of 2019. This short

position represents a liquidity risk in case the bank will not be able to acquire and repay

USD funding.

EUR: There is no immediate need to acquire additional long term EUR funding in a

short-term horizon for 2018 as the Bank is able to repay its EUR liabilities from its own

sources. Nevertheless, starting from 2019 the Bank will need to cover its short position,

measured cumulatively, about EUR 4.8, by 2019 the short position will decrease to EUR

10.2. Overall, the total short Bank position in EUR is about EUR 17.6.

JPY : There is no need to ensure funding for JPY debt in the coming years as the Bank has

a long JPY position. Nevertheless, the Bank will be forced to repay its JPY debt after

2022.

T able 15: Estimated future liquidity position of the Bank as at Dec 2017

T able 16: List of all funding sources (issued bonds, accepted loans).

Counterparty Date of funding obtained

Currency Maturity Interest Amount Matured as at 31/12/2017

Bonds

EMTN 3/21/2012 USD 5 year 5.75% 580 mln Y es

Samurai bond 12/16/2013 JPY 10 year 1.52% 30,000 mln N o

A CEM 2015 MN T 7 year 4% 233,400 mln N o

Borrowing

Government 1 4/30/2013 USD 5 year 4.79% 1,000 mln Y es

Government 2 4/30/2013 USD 10 year 4.79% 0,5 mln Y es

Syndicated loan 1 9/8/2014 USD 3 year 4.5% + 6M Libor

30 mln Y es

Syndicated loan 2 9/8/2014 USD 5 year 4.625% + 6M Libor

270 mln N o

All in mln MNT

As of Dec 15, 2017

2017

2018 2019 2020 2021 >2022 Total

Net di fference / MNT /

279,523 210,173 169,543 32,604 217,228 85,845 (533,591) 461,325 MN T 24,213 254,500 586,006 252,449 211,514 34,893 9,200 1,372,775 USD 44 (15) (259) (88) 4 22 50 (242) EUR 7 (2) (3) (7) (5) (4) (4) (18) JPY 5,947 (185) 10,398 621 504 325 (30,205) (12,594)

Net i ncrease i n gross amount (MNT)

279,523 489,696

659,240 691,844 909,071 994,917 461,325 461,325

MN T 24,213 278,713 864,719 1,117,169 1,328,682 1,363,575 1,372,775 1,372,775 USD 44 29 (230) (318) (314) (291) (242) (242) EUR 7 5 2 (5) (10) (14) (18) (18) JPY 5,947 5,763 16,160 16,781 17,285 17,611 (12,594) (12,594)



5 4

Bank 1 9/4/2014 USD 8 year 6% 162 mln N o

Bank 2 6/29/2015 USD 8 year 2.88% 19.9 mln N o

Bank 2 10/4/2017 USD 5 year 2.5% and 7.16%

10 mln N o

Bank 3 9/15/2015 EUR 7 year 6.00% + 6М Еu ribor

20 mln N o

Bank 4 4/11/2014 EUR 6 year 1.90% + 6M Eu ribor

13 mln N o

Bank 5 4/10/2016 USD 2 year 9.50% 75 mln N o



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10. Quality of earnings

10.1. Sustainability and accuracy of historical earnings generated from related

parties transactions

We have performed assessment based on the audited financial statement as at each snapshot date and

relied on the information on it. Our scope was solely based on the audited financial statements and

detailed breakdown provided by the Bank.

As per IAS 24, a related party transaction is a transfer of resources, services or obligations between the

Bank and a related party, regardless of whether a price is charged.

The Bank is 100% owned by the Government of Mongolia and its operations include the financing of

projects within Mongolia, which include projects undertaken by governmental entities. According to

IAS24, related parties of the Bank comprise national companies and other organisations controlled,

jointly controlled or under significant influence of the Government.

We understand that related parties and transactions with related parties are assessed in accordance with

IAS 24 and disclosed in the financial statement.

The Bank has balances and transactions with the following related parties:

Government Common control entities Other

Government (which includes organisations, such as Ministry of Finance and other Ministries, of which management is appointed by the central government);

Entities controlled by the Government, which include state organisations (i.e. corporate entities), local commercial bank (State Bank) and central bank of Mongolia (Bank of Mongolia); these entities represent entities under common control in relation to the Bank;

Other related party MIK (which is an entity over which Government has significant influence). The Bank’s balance to MIK relates to investment securities available for sale.

Given the nature of its operations, the Bank has significant volume of transactions with the Government

and other related parties, including guarantees received from the Government. Loans and advances given

to projects either to be repaid from the State budget or the debtor’s own operating cash flow (loans to

related parties) refer to socially beneficial projects such as, improvement of rural and city roads, civil

engineering construction, development of the air transport, extension and improvement of power and

heat plant, building of a new railways and mortgage financing through commercial banks for middle

income families and individuals.

Significant transactions with related parties

The Bank’s financial position and performance was highly dependent on the recoverability of the loans

and advances to be repaid by the State budget during 2012-2016 and other loans and receivables

guaranteed by the Government, as well as the Government’s execution of other guarantees and

contractual obligations. As a result, the sustainability of the Bank’s growth and profitability depends on

the continuing support from the Government, and sufficiency of the State budget revenue, which could

be substantially influenced by developments in the operating environment until the end of 2016.

Parliament resolution No.81 dates 28 December 2016 and following Government resolution No.42 and

No.210 dated 1 February 2017 and 28 December 2016 directed DBM to transfer its loan portfolio to be

repaid from State budget to Ministry of Finance. Pursuant to the resolution loan and advance to be repaid



5 6

from state budget in the amount of MNT 3.3 trillion was transferred on 31 December 2016 and remaining

MNT 249,616 mln was reclassified from “state budget” to “corporates” portfolio. The reason for this is

described in greater detail in section related to loans to be repaid from state budged on page 74.

Sustainability of the income generated from the related party transactions is summarised below.

T able 17: Summary of interest income from related parties

In mlns of MNT 2017 2016 2015 2014 2013 2012

Tota l in terest income

for the year 285,564 427,448 410,176 330,080 131,060 12,878

In terest in come from

r elated parties total 123,978 301,055 262,533 177,802 84,075 4,170

- Loa ns and

a dv ances 8 2 ,377 2 7 7,543 2 36,691 1 57,092 7 9,506 4 ,057

- Sh ort term

in v estment 3 6 ,200 1 4,994 1 0,877 4 ,246 - -

- Cu stomer

a ccount 4 ,520 8 ,517 1 4,965 1 6,463 4 ,569 1 13

- Du e from

g ov ernment 8 81 - - - - -

Com position of interest

in come fr om related

pa r ties

100% 100% 100% 100% 100% 100%

- Loa ns and

a dv ances 6 6 % 9 2 % 9 0% 8 8 % 9 4 .57% 9 7 %

- Sh ort term

in v estment 2 9 % 5 % 4 % 2 % - -

- Cu stomer

a ccount 4 % 3 % 6 % 9 % 5 .43% 3 %

- Du e from

g ov ernment 1 % - 0% - - -

Per centage of income

g en erated fr om related

pa r ties in total income

43% 67% 62% 53% 61% 47%

The share of interest income from transactions with related parties vary from year to year and it has been

a significant part of earnings from interest income. Majority of the interest income from related parties is

from loans and advances.

T able 18: Interest expense summary to related parties

In mlns of MNT 2017 2016 2015 2014 2013 2012

Interest expense for the y ear

167 ,702

334,689

279,101

216,855

89,058

13,695

Interest expense to related parties

310 133,401 125,778 128,17 6 31,168 -

- Financing from government

2 124,581 122,326 122,137 31,168 -

- Promissory notes Bank of Mongolia

- - 2,730 6,039 - -



5 7

- Bond issued in local market

309 8,820 7 23 - - -

Percentage of interest expense to related parties

0% 40% 45% 59% 35% 0%

The share of interest expense from transactions with related parties vary from year to year and being a

significant part of interest expense until 2016.

The share of interest expense from transactions with related parties was relatively high during 2014 to

2016. Initial financing from Government of Mongolia to the Bank was on 30 April 2013 in order to fund

projects and programs. The Government has provided this funding from proceeds of the Chinggis Bond.

Interest is charged at 4.7917% p.a. on this loan. One third of this funding has a 5 year maturity ending

January 2018 and two thirds of this funding have a 10 y ear maturity ending December 2022.

In 2017, the interest expense decreased significantly due to both financing from government and loans to

be repaid from the State Budget as of 31 December 2016 was transferred to the Government pursuant to

Parliament Resolution No.81 dated 28 December 2016.

Due to majority of the income from related party is from loans and advances, interest rates for related

parties are compared in table below:

T able 19: Rates for non-related parties (nominal rates)

Yea r 2 017 2 016 2 015 2 014 2 013 2 012

Ra nge m in m ax m in m ax m in m ax m in m ax m in m ax m in m ax

MNT Rela ted pa r ty 4 .50% 1 6% 4 .50% 1 0% 4 .7 9% 1 0% 4 .25% 1 0% 6 % 9 .60% 6 .7 5% 7 .38% Non -r elated pa r ty 4 .50% 17 % 4 .50% 1 6% 4 .50% 1 2% 5 % 1 2% 5 .7 0% 1 2%

USD Rela ted pa r ty 6 .13% 9 .7 5% 5 .13% 8 .45% 5 .13% 8 .45% 5 .13% 8 .30% 5 .13% 7 .80% 7 .35% 7 .90% Non -r elated pa r ty 3 .60% 1 0.28% 7 .79% 8 .45% 7 .79% 8 .45% 8 % 8 .10% 8 % 8 .10% 8 .10% 8.10%

JPY Rela ted pa r ty 6 .25% 6 .25% - - - - - - - - - -

Non -r elated pa r ty 5 .95% 7 .50% - - - - - - - - - -

MNT lending rate.

In general, rates on loans issued in MNT to related parties are not lower than the rates to non-related

parties between 2012 to 2017. There is only one case observed in 2014 and the minimum lending rate to

non-related party in 2014 is 0.75% higher than the lending rate to related party. It is related to the loan

to Debtor 1 , in the balance of MNT 6,416 mln as of 31 December 2014. It was initiated from the

Government resolution No.299 dated on the 16 August 2013 pertaining to enhancement of coal exports

of Mongolia. The Resolution states the road and basic infrastructure building to enhance Port 1 capacity

are to be purchased and ownership of the assets transferred to Debtor 1 . Pursuant to Government

resolution No.449 rate dated 16 November 2015, the loan was restructured so that principle and interest



5 8

amount are due for repayment by state budget within the period of 2019-2020, and interest rate is

increased from 4.25% p.a to 6.06.% p.a.

USD lending rate. Generally, rates on loans issued in USD to related parties are lower than the rates to

non-related parties between 2012 to 2016. At that period, lending to related parties were funded by

Chinggis bond, rate of which (4.79% p.a.) is relatively lower from other funding.

10.2. Earnings generated from accrued but uncollected interest, fees and FX

revaluations

In this section we have summarised the impact of recognised but not collected interest income (accrued

interest receivables), fees and FX revaluation gain/ (loss) at each snapshot. Please refer to table 20 and

table 21 for accrued interest receivables for each snapshot and table 22 for commission income and FX

revaluation summary.

In table 20, we have performed movement schedule on interest income in order to identify how much of

interest income recognised was not collected yet at each snapshot. We have broken down the result into

“Performing and Non- performing” classifications per Bank.

T able 20: Interest income accrued/recognised but not collected from loan and advances according to credit quality disclosure under IAS 39.

In m lns of MNT 2 017 2 016 2 015 2 014 2 013 2 012

Performing loan portfolio

Loa n portfolio 2 ,438,259 2 ,835,697 4 ,400,952 3 ,642,647 2 ,059,453 4 93,556

Tota l r ecognised in terest in come for th e year

1 89,432 3 46,077 2 63,848 1 80,628 8 5 ,604 7 ,543

Repay ment during th e year

17 9,744 3 38,797 2 36,700 1 55,839 5 7 ,690 4 24

FX g a in/(losses) (8 ,265) (6 5,092) 6 ,160 (6 ,311) (2 91) 1

A ccrued interest r eceivables

17 7,390 1 59,437 8 7 ,064 6 6 ,077 3 4 ,976 6 ,7 71

Non -performing loan portfolio

Loa n portfolio 1 99,472 2 92,710 5 85,639 1 91,627 1 26,362 -


1 2,599 1 0,985 2 9 ,741 1 2,372 8 ,419 -

Repay ment during th e year

1 21 1 5 1 1 ,446 2 ,389 7 ,755 -

FX g a in/(losses) 5 ,170 5 ,919 (8 ,032) (4 32) (1 ,476)


5 1 ,241 4 3 ,933 3 8 ,882 1 2,555 2 ,140 -

In table 21, we have performed movement schedule on interest income in order to identify how much of

interest income recognised was not collected y et at each snapshot. We have broken down the result into

two classifications “Performing and Non- performing” per revised classification by us.

T able 21: Interest income accrued / recognised but not collected from loan and advances according to revised classification of reviewed loan portfolio

In mlns of MNT 2017 2016 2015 2014 2013 2012

Performing loan portfolio

Loa n portfolio 8 15,443 1 ,061,977 3 ,558,680 2 ,699,461 1 ,659,632 2 58,139


6 3 ,117 2 44,900 2 06,444 1 37,629 6 2 ,039 3 ,291



5 9

Repay ment during the y ear

6 7 ,554 2 7 8,854 2 03,295 1 37,977 4 0,705 4 24

FX g a in/(losses) 5 ,301 (8 ,226) (5 ,554) (4 ,238) (1 ,430) 0


2 ,7 23 1 2,461 3 8 ,189 2 9 ,486 2 5,596 2 ,832

Non -performing loan portfolio

Loa n portfolio 1 ,822,288 2 ,066,430 1 ,427,911 1 ,134,814 5 26,183 2 35,417


1 38,914 1 12,161 8 7 ,144 5 5,371 3 1 ,984 4 ,251

Repay ment during the y ear

1 12,311 5 9,957 4 4 ,851 2 0,251 2 4 ,740 0.2

FX g a in/(losses) (8 ,395) (5 0,947) 3 ,682 (2 ,505) (3 37) 1


2 25,907 1 90,908 8 7 ,757 4 9 ,146 1 1 ,520 3 ,939

When loans become doubtful of collection, they are written down to the present value of expected cash

inflows and interest income was thereafter recorded for the unwinding of the present value discount based

on the loans’ effective interest rate which was used to measure the impairment loss.

Repayment of the interest income during the year was recomputed based on accrued interest balance and

interest income recognised during the year. (opening balance of accrued interest receivables of + total

recognised interest income during the year – closing balance of accrued interest receivables)

T able 22: Earnings recognised in statement of profit and loss from fees and commission income and foreign exchange translation gain/losses based on audited financial statements as at each reporting date.

In mlns of MNT 2017 2016 2015 2014 2013 2012

FX revaluation gain/(losses) (17 ,934) (391,218) (45,315) 1 ,089 1 ,914 (5,771)

Fee and commission income - 124 907 815 - -

It can be seen that FX revaluation losses reached MNT 391,218 mln in 2016 (main driver is significant

fluctuation in foreign currency rate in 2016 while the Bank has negative foreign currency position for both

y ears).

T able 23: Foreign currency positions as at 31 December 2017, 2016 and 2015 based on the audited financial statements and fluctuation in percentage of each currency (official rate in the end of the year and official rate in the beginning of the year).

In mln MNT USD EUR JPY

Net ba lance sheet positions as at 31 December 2017 (160,613) (177) (2 00,627)

Net ba lance sheet positions as at 31 December 2016 (1 ,115,215) (5 8,179) (5 60,920)

Net ba lance sheet positions as at 31 December 2015 (217,399) (5 4,976) (3 32,382)

Flu ctuation in 2017 (2 .51%) 1 1 .21% 1 .60%

Flu ctuation in 2016 2 4 .73% 1 9.38% 2 7 .80%

Flu ctuation in 2015 5 .53% (5 .07%) 5 .07%

Ga ins / (losses) in 2017 4 ,031 (2 0) (3 ,210)



6 0

Ga ins / (losses) in 2016 (27 5,793) (11 ,275) (155,936)

Ga ins / (losses) in 2015 (12,022) 2 ,7 87 (16,852)

It can be seen that foreign currency fluctuation heavily influenced profit or loss of the Bank through FX

revaluation gains/losses as the Bank has a significant outstanding balances of funding denominated in

foreign currency.

JPY exposure is due to Samurai bond issued at Japanese bond market in January 2014 in the amount of

JPY 30 bln with fixed interest rate of 1.52% p.a. and 10 years maturity.

USD exposure has arisen from net position between loans and advances denominated in USD and bonds

and borrowings denominated in USD. The bond is related to USD 600 mln Euro Medium Term Notes

programme, started in November 2011 and second series was issued in March 2012 amounting to USD

580 mln. The borrowings in USD were obtained from various parties, e.g. in form of as syndicated loan

facility.

Since the Bank is exposed to foreign currency risk due to its nature of the operation, we recommend the

Bank to consider applying hedge accounting under IFRS 9 and applying foreign currency hedging

instruments such as foreign currency swaps, forward etc.

Fee and commission income is recognised during the normal course of business and mainly from the

guarantees provided to the third parties.

10.3. Criteria for decision to capitalise interest and roll-over extension of credit

Purpose of this section is to identify and analyse the extent to which collateral values (rather than operating cash flows) are the basis for decisions to:

criteria for decision to capitalise interest criteria for decision to roll-over extension of credit decision making process

During our review we were not able to identify clear criteria used to capitalise interest or roll-over extension of credit. The Bank seeks to restructure loans rather than to take possession of collateral. This may involve extending the payment arrangements and the agreement of new loan conditions. Once the terms have been renegotiated, the loan is no longer considered past due but restructured. The Bank does not have in place a forbearance definition in line with international standards.

We have reviewed the loan policy and loan operation policy effective for the periods between 2012-2017

and obtained understanding from responsible Bank personnel. There is no formal policy and regulation

which regulates to restructure through capitalisation of accrued interest based on the collateral value.

Process for restructuring the facility is initiated by the debtor’s official request and approved by the head

of respective loan department. Once the approval for the assessment of restructure is granted, loan officer

reviews the debtor’s financial ability, presents to the credit committee and final decision is made by the

either credit committee or BoD where necessary. Please refer to corporate governance section for more

details.



6 1

10.4. Adequacy of income recognition policies

T able 24: Income recognised on statement of profit or loss during 2012 to 2017 based on audited financial statements (accounting policy of each stream has been outlined accordingly)

In mlns of MNT 2017 2016 2015 2014 2013 2012

In terest income 285,564 427,448 410,175 330,079 131,059 12,878

Fee a n d commission income - 124 907 815 - -

Div idend income 1453 743 539 - - -

Interest income is recorded for all debt instruments on an accrual basis using the effective interest method.

This method defers, as part of interest income all fees received between the parties to the contract that are an

integral part of the effective interest rate.

Fees integral to the effective interest rate include o rigination fees received by the entity relating to the

creation of a financial asset. Commitment fees received by the Bank to originate loans at market interest

rates are integral to the effective interest rate if it is probable that the Bank will enter into a specific lending

arrangement and does not expect to sell the resulting loan shortly after origination.

When loans and other debt instruments become doubtful of collection, they are written down to the present

value of expected cash inflows and interest income is thereafter recorded for the unwinding of the present

value discount based on the asset’s effective interest rate which was used to measure the impairment loss.

Commissions and fees arising from negotiating, or participating in the negotiation of a transaction for a

third party, such as the acquisition of loans, shares or other securities or the purchase or sale of

businesses, and which are earned on execution of the underlying transaction, are recorded on its

completion.

Dividends on financial instruments are recognised in profit or loss for the y ear when the Bank’s right to

receive payment is established and it is probable that the dividends will be collected.

Based on the review of accounting policy of the Bank, principles of income recognition are in line with

IFRS.

10.5. Deferred expenses and derivative trading and their impact on P/L

We have reviewed the audited financial statements as at each snapshot dates and balances of deferred

expenses are shown below.

T able 25: Balances of prepayments based on audited financial statements.

In mln MNT 2017 2016 2015 2014 2013 2012

Pr epaid employ ee benefit 5 39 5 91 6 43 6 94 7 46 -

Oth er prepayments 6 45 5 63 1 57 2 50 1 83 1 14

The Bank offers its employees below market rates on mortgage loans. The Bank has arranged this benefit

by providing other commercial banks with interest free funding for a period of 15 to 20 y ears. The

commercial banks, in return, issue loans to the Bank’s employees at below market rates. This scheme

began in June 2013 with a MNT 1 bln deposit. It was recognised by fair value at initial recognition and

subsequently, it is amortised as employee benefit on profit or loss over the lifetime of the deposit which

is not expected to exceed the service period of the employees.



6 2

Interest expense is recorded on an accrual basis using the effective interest method. This method defers,

as part of interest expense, all fees paid between the parties to the contract that are an integral part of the

effective interest rate, transaction costs and all other premiums or discounts. Therefore, deferred

expenses related to bonds and borrowings are disclosed as part of the outstanding balances as at each

snapshot dates.

T able 26: Impact on statement of profit or loss from derivative valuation based on audited financial statements.

In mlns of MNT 2017 2016 2015 2014 2013 2012

Gains/(losses) from financial derivative 354 (303) (6,434) (1 ,404) - -

On 4 December 2017, the Bank entered forward contract to sell USD 10 mln notional amount on 4 June

2018 at rate of MNT 2,523.1/USD. The Bank marks to market its derivative exposures and recorded a

gain of MNT 354 mln.

On 2 December 2014, the Bank entered into a swap arrangement with Trade and Development Bank of

Mongolia. The first leg was to receive USD 20,086 thousand on 3 December 2014 and in return receive

EUR 21,000 thousand on 3 March 2015. The swap arrangement has been prolonged to 3 June 2015, 3

September 2015, 3 December 2015 and to 29 January 2016 based on both parties’ agreement.

The fair valuation of the swap agreement resulted in a loss of MNT 1,404 mln and MNT 6,434 mln to the

Bank for the period ended 31 December 2014 and 31 December 2015, respectively.

The swaps are fair valued through interest rate parity analysis using inter-bank rates of each currencies.

The Bank estimated the forward rates as at each snapshot dates and according to the Bank’s estimate,

USD rate is expected to depreciated against EUR rate and it resulted loses in profit or losses.

When the second leg of the swap is exercised in January 2016, recognised losses from the swap

arrangement in profit or losses was amounted to MNT 303 thousand as at 31 December 2016.



6 3

11. Review of financial statements

11.1.Comparative information on methodologies and techniques for data compilation

The data compilation of standalone and consolidated financial statements is prepared by the reporting

specialist of Finance, Accounting and Reporting Division ("FARD"), and reviewed and approved by the

senior reporting specialist and head of FARD. Standalone financial statements are prepared, reviewed

and approved on monthly, quarterly, semi-annual, and annual basis, while the consolidated financial

statements are prepared, reviewed and approved on semi-annual basis. CEO reviews and approves

consolidated financial statements before issuing to third parties.

Reporting specialist receives inter-department note for financial statements line items (FSLIs) which

require valuation experts.

T able 27: FSLIs and valuation techniques

No. FSLI na me Met h odologies and valuation t echniques

Respon sible department

1 Loa n and advances im pairment

- Specific assessment for corporate por t folios are assessed by the credit depa rtment; - Colletaral items are internally valued by the r isk management department;

- Pr oject financing and credit depa rtment; - Risk ev aluation and m anagement department;

2 In v estment available for sa les

Qu oted share price in Mongolian stock exchange

A sset , liability and treasury m anagement department

3 Der iv ative instruments

2 017: Forward - Ma r k to market using in terest rate parity analysis 2 016: Swap - In terest rate parity a n alysis using inter-bank rates of each cu rrency

A sset , liability and treasury m anagement department

4 Recov erability of deferred tax asset (DTA )

Recov erability of DTA is a ssessed with con sideration of business plan

Fin ance, accounting and r eporting div ision

These techniques are commonly applied methodologies in preparation of financial statements and it is

in line with the IFRS 13 Fair Value Measurement.

We summarised data compilation of Bank’s standalone financial statements for the years ended 31

December 2016 and 2017 below. Our scope was limited to presentation and disclosures related to

standalone financial statements, only.

T able 28: Data compilation of comparative information

Report name A pplicable st a ndard

Frequ ency Prepared by Rev iewed by

A u dited Financial Sta tements 2016

In a ccordance w ith IFRS

Sem i-annually

Repor ting specialist of fin ance, a ccounting and r eporting division

Sen ior r eporting specialist a n d head of finance, a ccounting and reporting div ision

A u dited Financial Sta tements 2017

In a ccordance w ith IFRS

Sem i-annually

Repor ting specialist of fin ance, a ccounting and r eporting division

Sen ior r eporting specialist a n d head of finance, a ccounting and reporting div ision

Manual transactions are obtained with supporting documents alongside with approval from relevant

departments including the project financing and credit department, the risk evaluation and

management department, and the asset, liability and treasury management department etc. The

specialist of FARD records the manual transaction into core banking system and the transaction is

approved by senior specialist on paper (memo). At the end of the day, daily report is printed and



6 4

reviewed by senior specialist by reconciling it to the supporting documents, which is then reviewed and

approved by the head of FARD.

Automated transactions are reviewed by senior specialist and head of FARD on monthly and semi-

annual basis depending on the type of transaction. Automated transactions are foreign exchange

translation, interest accrual, depreciation of property and equipment and amortisation of intangible

assets in 2016 and 2017.

All manual adjustments are approved by head of FARD based on decision given from relevant

departments, and posted by specialist in the core banking system before period-end financial reporting.

We summarised control scheme of the standalone bank financial statements for the years ended 31

December 2016 and 2017 below.

T able 29: Control scheme of comparative information

Jou rnal entries Frequ ency of con t rol

Post ed by Rev iewed by

A u tomated journal en tries

Mon th ly Sem i-annually

Gr apeBank sy stem Sen ior specialist and head of fin ance, a ccounting and r eporting div ision

Ma n ual journal entries Da ily Specialist of finance, a ccounting and reporting div ision

Sen ior specialist and head of fin ance, a ccounting and r eporting div ision

A djustment/correction of er r ors

A d-h oc basis Specialist of finance, a ccounting and reporting div ision

Hea d of finance, a ccounting and r eporting division

11.2. Missing items in notes to the financial statements

We reviewed audited consolidated financial statements for the y ears ended 31 December 2016 and 2017

for the completeness and quality of disclosures presented in accordance with the applicable International

Financial Reporting Standards. We summarised a list of missing disclosures in Bank’s standalone

financial statements for the years ended 31 December 2016 and 2017 below. Our scope was limited to

presentation and disclosures related to standalone financial statements, only.

We have assessed individual provision requirements – according to ECB AQR manual – for loan portfolios of the Bank. Our assessment resulted in under-provisioning for corporate and on-lending portfolio as at 31 December 2016 and 31 December 2017. We summarised additional provisions requirement of corporate and on-lending loan portfolios in the section 12.1.

For the financial year 2016, the Bank was not subject to any externally imposed capital requirements as it was not regulated by the Bank of Mongolia. Therefore, the Bank adopted the standardised internal approach, which takes into consideration of credit risk exposure by risk weighting on on-balance sheet exposures to credit risk according to broad categories of relative credit risk. For the financial year 2017, the Bank evaluates its capital adequacy ratio in accordance with the Bank of Mongolia’s Regulation on capital adequacy requirement and monitoring approved on 30 May 2017. The Bank’s capital adequacy ratio is overstated with consideration of additional provision requirement under our review for the years ended 31 December 2016 and 2017. We summarised potential impact on the capital adequacy ratio in the section 12.3.

T able 30: List of missing disclosures

No. List of m issing disclosures in a udited financial st atements for the y ears ended 31 December 2016 a nd 2017

2016 FS Not e/Page

2017 FS Not e/Page

A pplicable st a ndard

ref.

1

Oth er a ssets and other financial a ssets a re n ot disclosed sepa rately in the face of statement of financial position and n ote 11 of audited financial statements for the years ended 3 1 December 2016 and 2017. Prov isions for other financial a ssets should be disclosed by classes in audited financial sta tements for the year ended 31 December 2017.

SFP 1 1 pg31

SFP 1 1 pg30

IFRS 7 . 36-3 7



6 5

2 Disclosure of staff costs paid is missing in the statement of ca sh flows in a udited financial statements for the y ears en ded 31 December 2016 and 2017.

SCF SCF IA S 7

3

Not a ll critical a ccounting est imates a nd judgments are qu a ntified in notes 4 of audited financial statements for the y ears ended 31 December 2016 and 2017 including indirect g u arantee and gov ernment guarantee.

4 pg17 4 pg17 IA S 1 .125

4

Cr edit qu a lity a n alysis of u nrated ba lances r elates to Mon g olian commercial banks are not presented separately in n otes 6 and n otes 7 of audited financial statements for th e y ears ended 31 December 2016 a nd 2017. It should be disclosed separately to differentiate and enable the user of fin ancial statements to compare the quality.

6 -7 pg21-22 6 -7 pg21-22 IFRS 7 .36-

3 7

5

Cr edit qu ality a nalysis of sh or t term investment is not disclosed in n otes 8 of a udited financial statements for the y ear ended 31 December 2017 while it has balance in 2016 a n d it was disclosed in the note. It is disclosed in the notes 8 of a u dited financial statements for th e y ear ended 31 December 2016.

n /a 8 pg 22 IFRS 7 .36-

3 7

6

No disclosure is pr esented for u nder-collateralised loan ba lance for the pu rpose of IFRS im pairment prov ision a ssessment in notes 9 of audited financial statements for th e years ended 31 December 2016 and 2017.

9 pg 27-28 9 pg 27-28 IA S 3 9

7

Ba la nces a nd transactions w ith r elated parties are not disclosed by classes of related parties in notes 19 and notes 2 1 of a udited financial statements for the years ended 31 December 2016 and 2017.

1 9 p38 2 1 p38 IA S 2 4

8

Com pensation prov ided to key management personnel is n ot disclosed by type in n otes 19 and n otes 21 of audited fin ancial statements for the years ended 31 December 2016 a n d 2017.

1 9 p40 2 1 p39 IA S 2 4

9

Th e nature of n on-deductible expense is n ot specified in th e reconciliation table of theoretical income tax expense in n otes 26 and notes 29 of audited financial statements for th e years ended 31 December 2016 and 2017.

2 6 p43 2 9 p44 IA S 12

1 0

Fin ancial r isk policy is not disclosed in sufficient details in th e financial r isk m anagement disclosure in n otes 27 of a u dited fin ancial sta tements for th e y ear en ded 31 December 2016 (i.e. short position in USD, JPY, EUR).

2 7 p47 n /a IFRS 7

1 1 Ex pected m aturity of a ssets/liabilities disclosure is om itted in Notes 27 of audited financial statements for the y ear ended 31 December 2016 in or der of liquidity.

2 7 p51 n /a IA S 1

1 2

Th e effect of the changes of interest rates on equity is not disclosed in Notes 27 a n d 3 1 of a u dited financial sta tements for the y ears ended 31 December 2016 and 2 017. Sensitivity of the changes of in terest rates must be disclosed separately on profit/loss and equity.

2 7 pg57 3 1 pg64 IFRS 7 . 39,

4 0-41

1 3

Th e effect of the changes of for eign currencies on equity is n ot disclosed in Notes 27 a nd 31 of a u dited financial sta tements for the y ears ended 31 December 2016 and 2 017. Sensitivity of the changes of foreign currencies must be disclosed separately on profit/loss and equity.

2 7 pg58 3 1 pg66 IFRS 7 . 39,

4 0-41



6 6

12. Loan portfolio and off-balance sheet

transactions review

12.1. Review of classification and provisioning

The bank’s loan portfolio consist of loans to be repaid from state budget and loans to be repaid from

corporates. Further, loan portfolio to be repaid from corporates divided into 2 portfolios corporate loan

and on-lending loan. The We have conducted loan portfolio analysis based on total loans and advances

balance before impairment.

T able 31: Breakdown of loan exposure

In m lns of MNT

2017 2016 2015 2014 2013 2012

Loans to be repaid from corporates

Loans to corporates

On balance 1 ,976,978 2,101,536 1 ,461,111 1 ,218,114 555,729 235,417

Off balance exposures

41 ,553 17 ,174 22,071 68,762 6,801 0

Number of debtors

40 16 15 14 7 3

On lending loans to corporates

On balance 660,753 1 ,026,872 7 81,494 564,503 308,993 1 ,979


12,870 12,920 93,242 57,490 7 ,606 23,971

Number of debtors

13 12 12 11 2 1

T otal loans to be repaid from corporates

2,692,154 3,158,502 2,357,918 1,908,869 87 9,129 261,367

Loans to be repaid from state budget

On balance - - 2,743,986 2,051,683 1 ,321,251 256,216


- - 238,190 181,431 299,040 68,574

Number of debtors

- - 4 3 4 1

T otal loans to be repaid from State budget

-

-

2,982,176 2,233,114 1,620,291 324,790

T otal loans and advances balances before im pairment

2,692,154 3,158,502 5,340,094 4,141,983 2,499,420 586,157

Total Bank impairment provision

(213,818) (192,747) (77,347) (30,893) (6,225) -

Net loans and advances balance

2,478,336 2,965,755 5,262,747 4,111,090 2,493,195 586,157

Loans and advances given to corporate projects are to be repaid from the project’s or borrower’s future

cash flow generation and the Bank also holds collateral. The Bank provides lending to corporate projects

which the Government considers priority commercial activities (air transport development, support of



6 7

mining industry, railway, infrastructure, Small and Medium Enterprises (SME), housing and

manufacturing projects).

Loans and advances given to projects to be repaid from the State budget refer to socially beneficial

projects that do not create cash flows of their own, these loans cover areas such as, improvement of rural

and city roads, civil engineering construction, extension and improvement of power and heat plant,

building of a new railways and mortgage financing through commercial banks for public servant.

Classification review - Corporate

We summarised overview of performing exposure (“PE”) and non-performing exposure (“NPE”)

classification of corporate debtors of the Bank according to simplified EBA definition in Table 31 and 32

for the period 2012 to 2017. The main purpose of majority of loans were investment, so we have

considered cash flow projection for the review of classification of debtor. Off balance sheet exposure is

included in total value of exposure using credit conversion factor as per agreement with the Bank.

T able 32: Summary of corporate debtors classified as PE

In mlns of MNT 2017 2016 2015 2014 2013 2012

Bank classification

Number of debtors 21 3 4 8 4 3

Total exposure 2,018,531 2,118,710 1 ,483,182 1 ,286,875 562,529 235,417

Value of exposures 292,113 107,551 34,541 444,980 97 ,007 235,417

% of total debtors 52% 19% 27% 57% 57% 100%

% of total exposure 14% 5% 2% 35% 17% 100%

Our classification


Value of exposures 232,776 107,551 34,315 113,483 36,347 227,974

Reclassifications

Number of exposures (11) - (1) (4) (1) (1)

Value of exposures (59,337) - (226) (331,498) (60,660) (7 ,443)

T able 33: Summary of corporate debtors classified as NPE

In mlns of MNT 2017 2016 2015 2014 2013 2012

Bank classification

Number of debtors 19 13 11 6 3 -

Total exposure 2,018,531 2,118,710 1 ,483,182 1 ,286,875 562,529 235,417

Value of exposures 1,726,418 2,011,159 1 ,448,641 841,895 465,522 -

% of total debtors 48% 81% 7 3% 43% 43% 0%

% of total exposure 86% 95% 98% 65% 83% 0%

Our classification




6 8

Value of exposures 1,785,755 2,011,159 1 ,448,868 1 ,173,393 526,183 7 ,443

Reclassifications

Number of exposures 11 - 1 4 1 1

Value of exposures 59,337 - 226 331,498 60,660 7 ,443

Reclassification drivers

Table 34 lists the corporate debtors reclassified from PE to NPE for the period 2012 to 2017. The most

common impairment triggers on which reclassification of these debtors are based on:

1) Debt Service Coverage Ratio (“DSCR”) below 1.1; and 2) A material decrease in cash flows over the last 12 months.

In addition, the total valuation of reclassified debtors’ estimated future cash flows is insufficient to cover

the Bank's exposure, and the debtors’ guarantors do not have sufficient cash flows to cover the debtors’

liabilities.

Important commentary on financial statements

Our review of loan classification included an assessment of debtors’ financial performance as reported in

the financial statements provided by the Bank. For several debtors audited financial statements were not

available, so Format A (tax) statements were provided by the Bank and reviewed by us to assess reliability

of the provided financial information.

Table 34 also indicates that impairment triggers based on which exposures are reclassified from PE to

NPE generally include impairment triggers directly based on debtors’ financial statements. This implies

that the insufficient assurance on the reliability of debtors’ financial statements might have affected the

results of our classification assessment for several debtors.

T able 34: List of reclassified corporate debtors in 2012 to 2017 (in mln of MNT)

Debtor ID On-balance exposure

Off-balance exposure

T otal exposure

Description of rationale for reclassification

2017

3600002408 14,705 - 14,705 The debtor's DSCR is below 1 .1.

3600002340 12,787 1 ,643 14,430

The debtor's equity reduced by more than 50% over the last 12 months, and the debtor has a negative DSCR, as debtor is loss making and uncertainty in product demand exists as of 31 December 2017.

3600002539 10,098 2,500 12,598

The debtor experienced a material decrease in cash flows over the last 12 months, and the debtor has a negative DSCR, as debtor is loss making and timing to complete of construction is uncertain as of 31 December 2017.

3600002312 5,305 - 5,305

The debtor's equity reduced by more than 50%, and it experienced a material decrease in cash flows over the last 12 months. In addition, the debtor has a negative DSCR as debtor is a loss making and has material unexpected expenses as of 31 December 2017. The



6 9

debtor is subsequently forborne in 2018 due to the financial difficulty.

3600000230 4,054 - 4,054

The debtor has 68 days of overdue as of 31 December 2017 since the sales revenue of the debtor has been transferred directly to the Ministry of Energy since June 2017. Both the bank and debtor have no control over the cash management from its sales revenue.

3600002465 1 ,591 694 2,285

The debtor has a material amount past due to public creditors/employees, and it experienced a material decrease in cash flows over the last 12 months. In addition, the debtor's DSCR is below 1 .1.

3600002363 1 ,510 - 1 ,510

The debtor's DSCR is below 1.1, and modification of repayment terms has been granted, hence the debtor is classified forborne in 2017.

3600002456 1 ,247 - 1 ,247 The debtor's DSCR is below 1 .1.

3600002472 1 ,216 - 1 ,216

The debtor's turnover reduced by more than 50%, and it experienced a material decrease in cash flows over the last 12 months. In addition, the debtor's DSCR is below 1 .1.

3600002233 427 7 01 1 ,127

The debtor experienced a material decrease in cash flows over the last 12 months, and the debtor has a negative DSCR as debtor is a loss making and has a negative cash flow projection as of 31 December 2017.

3600002444 860 - 860

The debtor's turnover reduced by more than 50%, and it experienced a material decrease in cash flows over the last 12 months. In addition, the debtor has a negative DSCR as debtor is a loss making. Required mining equipment to explore the gold (main product) was absent as of 31 December 2017.

2015

3600000955 226 - 226

Although the loan was fully repaid in 2017, the debtor experienced a material decrease in cash flows over the last 12 months, and the debtor's DSCR is below 1.1. as of snapshot date.

2014

3600000773 177,012 - 177,012

The debtor's equity reduced by more than 50%, and it experienced a material decrease in cash flows over the last 12 months. In addition, the debtor's DSCR is below 1 .1.



7 0

3600001198 134,940 - 134,940 The debtor's equity reduced by more than 50% over the last 12 months, and DSCR is below 1.1.

3600000479 19,192 - 19,192

The debtor's turnover reduced by more than 50% over the last 12 months, and DSCR is below 1 .1. In addition, the debtor has requested the extension of loan maturity by one y ear and the additional funding as of snapshot date in order to implement project successfully.

3600000955 354 - 354

Although the loan was fully repaid in 2017, the debtor experienced a material decrease in cash flows over the last 12 months, and the debtor's DSCR is below 1.1. as of snapshot date.

2013

3600000551 60,660 - 60,660 The debtor's DSCR is below 1 .1.

2012

3600000043 7 ,443 - 7 ,443

Although the loan was fully repaid in 2013, the debtor has a negative DSCR as debtor is loss making as of snapshot date.

Classification review - On-lending portfolio

Overview

The Bank regularly entered into on-lending program in order to create new jobs and support SMEs

pursuant to parliament resolution N.138 dated 25 April 2012. The nature of on-lending projects ran

during 2012 to 2017 is outlined in turn below. Terms and conditions differ for each programs.

1. SME support program,

2. Mongol 888 project,

a. Loan amount up to MNT 2 bln through SME fund

b. Loan amount above MNT 2 bln through commercial banks

3. Other on-lending projects through Commercial banks

4. On-lending project through DBM leasing LLC

1. SME support program

The Bank signed on the tri-party agreement of “General financing term and condition” with Ministry of

finance (“MoF”) and Ministry of food and agriculture (MoFA) on 5 July 2012 pursuant to Government

resolution no.138 and no.208.

According to the agreement, MoF is responsible for interest repayment at 7.38% p.a and foreign currency

exchange loss arising from funding the project. The loan currency to SME Fund is in MNT while the

funding is denominated in foreign currency. These exposures are included in the loan to be repaid from

State Budget and assessed as part of the portfolio.

MoFA is responsible for project implementation and monitoring of principal repayment.

Tri-party agreement between the Bank, SME fund and commercial banks was signed on 10 July 2012. In

this agreement, commercial banks are responsible for principal repayment to SME fund and provide



7 1

guarantees at 110% of the total contractual amount. SME fund is responsible for announcing projects to

the public and selecting the projects that meet the certain criteria determined in the operation manual

approved by the Ministry of Labour.

Commercial banks issue loans to SMEs at interest rate of 7% p.a. and are responsible for transferring the

principal repayment into account of SME fund, placed at the Bank. Since ultimate credit risk is born by

commercial banks, assessment is performed at commercial banks’ level.

2.a. Mongol 888 project loan amount up to MNT 2 bln through SME fund

The Bank signed on the quadripartite agreement of “General financing term and condition” with Ministry

of finance (“MoF”), Ministry of Economic Development and Ministry of Labour (on behalf of SME fund)

on 4 July 2014 pursuant to Parliament resolution No.52 in 2012, Government resolution No. 239 in 2013

and No.176 in 2014.

Ministry of Economic Development (currently MoF) is responsible for providing funding to the Bank from

proceeds of government securities traded in the international stock exchange and monitoring the project

implementation.

Further, tri-party agreement between the Bank, SME fund and the selected commercial banks were signed

on August 2014.

Loan issued at 5% interest p.a to SME fund where SME fund collects 3% interest p.a from the commercial

banks and 2% interest p.a from State Budget. MoF is responsible for including the income and expenses

related to SME fund into the state budget via proposal initiated by Ministry of Labour. The due from State

Budget of 2% p.a. is included on the loans to be repaid from State budget and assessed as part of the loans

to be repaid from State Budget.

SME fund is in charge of centralising/collecting repayments from commercial banks and MoF and to

transfer to the Bank according to the repayment schedule. Simultaneously, SME fund is responsible for

announcing projects to the public and selecting the projects that meet the criteria, determined in the

operation manual approved by the Minister of Labour. Commercial banks guarantee SME fund at 110%

of the total contract amount to the Bank.

Therefore, assessment of classification has been performed at commercial banks’ level since the ultimate

credit risk is born by commercial banks.

2.b Mongol 888 project loan amount above MNT 2 bln through commercial bank

Sub-lending agreement is signed with commercial banks to support SMEs with preferential rate loans on

23 April 2014 where initial loan request is analysed by commercial banks and reviewed by the Bank’s

credit committee. The credit committee ensures if the project is in line with targeted group/SMEs.

The Bank issues loan to commercial banks at 5% p.a and sub-lending rate shall not exceed 9% p.a. and

commercial banks are responsible for the interest and principle repayment. Commercial banks issues

promissory notes as guarantees.

Guarantees shall be exercised if commercial bank fails to repay the loan on time. DBM has right request

the Bank of Mongolia to transfer the loan repayment from commercial bank’s current account to DBM

account, which outlined in “Law on Promissory note”.

3. Other on-lending projects through commercial banks

The Bank financed below projects through commercials banks.



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T able 35: On-lending projects through commercial banks

Project name Project finance bu dget

Interest rate t o com m ercia l ba nks (p.a)

Su b-lending interest ra te t o end-borrower (p.a .)

Fu nding of t h e project

Gu a rantee Undertaken period

Lea ther project MNT 1 40.4 bln

5 % 7 % Gov ernment securities a n d Gov ernment bon d

Pr omissory n ote from commer cia l ba n k

2 014-2020

A g riculture Up to

MNT 25 bln

9 .0% 1 2.5% Fu n d from Cr edit Swiss

Pr omissory

n ote from commer cia l ba n k

2 016-2018

Mea t project Up to MNT 100 bln

9 .5% 1 2.5% Not specified Pr omissory n ote from commer cia l ba n k

2 016-2020

Pr omote export a n d substitute im port project

MNT3 00 bln

6 % 9 % Not specified Pr omissory n ote from commer cia l ba n k

2 015-2021

Ca shmere pr oject

Up to MNT 100 bln

6 % 9 % Un u sed fu n ds from g ov ernmen t r esolution No.165 dated 2 014.


2 015-2018

V illa project MNT 125 bln

4 .5% 4 .5%+Bank’s m argin

Un qu oted Bon d issued to th e local m arket


2 015-2021

Hotels MNT 150 bln

4 .5% 4 .5%+Bank’s m argin

Un qu oted Bon d issued to th e local m arket


2 015-2019

SME 7 0 bln MNT 7 0 bln

6 % 9 % Fu n d from Cr edit Swiss


2 015-2019

Ma n ufacturin g , agriculture, milk a n d w ool and ca shmere

MNT 269 bln

5 .125% 8 % Ch inggis bon d


2 013-2016

4. On-lending project through DBM leasing LLC

DBM leasing LLC was established in 2017 pursuant to the Bank’s BOD resolution No.42 dated 19 May

2017. DBM Leasing LLC is 100% subsidiary of the Bank and provides finance lease to Mongolian



7 3

economic policy-oriented projects including priority sectors such as agriculture, mining, and

transportation.

DBM leasing LLC obtained a loan from the Bank for agricultural projects pursuant to Government

resolution No.212 dated 28 December 2016. The loan bears interest rate of 6%, 3.6% and 5.95% p.a.

depending on the funding and mark up of 2% is made by DBM leasing LLC.

Finance lease contract is signed between DBM leasing LLC and project unit of MoFA to promote farming

industry. The Fund is responsible for providing list of the equipment needed and list of the lessee to DBM

leasing LLC and DBM leasing LLC acts a lessor.

DBM leasing LLC is responsible for the repayment of the interest and principle of the loans. Therefore,

the classification is analysed for DBM leasing LLC.

Approach summary of on-lending portfolio

Classification assessment is performed at the commercial bank level for the period between 2012-2017

since either credit risk is born by commercials banks or guaranteed by the commercial banks. In 2017,

DBM Leasing LLC is additionally assessed. We summarised overview of PE and NPE classification of on-

lending debtors according to simplified EBA approach on tables 36, 37 and 38 for the period 2012 to 2017.

T able 36: Bank’s classification of debtors

In mlns MNT 2017 2016 2015 2014 2013 2012

Bank classification performing


Value of on-balance exposures 605,509 968,942 781,494 564,503 308,993 1 ,979

Value of off-balance exposures 25,739 25,839 186,484 114,980 15,213 47,942

Bank classification non-performing

Number of debtors 1 1 - - - -

Value of on-balance exposures 55,243 57,929 - - - -

Value of off-balance exposures - - - - - -

T otals


Value of on balance exposures 660,753 1,026,872 781,494 564,503 308,993 1 ,979

Value of off balance exposures 25,739 25,839 186,484 114,980 15,213 47,942

T able 37: On balance exposure breakdown – All on lending projects

In mlns of MNT 2017 2016 2015 2014 2013 2012

Bank classification

Number of debtors/guarantors 12 11 12 11 2 1

Value of exposures 605,509 968,942 7 81,494 564,503 308,993 1 ,979

- Villa project 125,063 125,062 60,030 - - -



7 4

- Mongol 888 above MNT 2 bln 115,871 150,815 178,997 123,635 - -

- Promote export and substitute import project 111,922 119,948 6,004 - - -

- Hotels 87 ,835 107,274 36,384 - - -

- Leather 55,663 68,894 7 5,925 60,638 - - - Mongol 888 up to MNT

2 bln 48,161 7 2,592 92,239 96,648 - -

- SME 7 0 bln 42,510 63,631 44,633 - - - - On-lending project

through DBM leasing LLC 30,384 - - - - -

- Cashmere project 15,456 46,884 36,543 - - -

- Meat project 15,399 16,200 - - - -

- Agriculture 11 ,644 22,203 - - - - - SME support

programme 847 16,362 29,278 41,330 36,247 1 ,979 - Manufacturing,

agriculture, milk and wool and cashmere - 217 ,006 221,461 242,252 272,745 -

Our classification


Value of exposures 605,509 968,942 7 81,494 564,503 308,993 1 ,979

Reclassifications

Number of exposures - - - - - -

Value of exposures - - - - - -

T able 38: Summary of on-lending debtors classified as NPE

In mlns of MNT 2017 2016 2015 2014 2013 2012

Bank classification


Value of exposures 55,243 57 ,929 - - - -

Our classification


Value of exposures 55,243 57,929 - - - -

Reclassifications

Number of exposures - - - - - -

Value of exposures - - - - - -


Overview

We have reviewed the loans to be repaid from state budget during the period of 2012-2016. This loan

portfolio was transferred to the Government of Mongolia as of 31 December 2016 pursuant to the

parliament resolution #81 dated 28 December 2016, Government Resolution #219 dated 28 December

2016 and Government Resolution #42 dated 1 February 2017.



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Loans to be repaid from the state budget (or “budget loans”) are loans given to beneficiaries for socially

beneficial projects (which cannot be repaid from project revenue ). Government guaranteed the

repayment of the loans and was included in the state budget on annual basis.

The loan portfolio was classified as PE loans as it was repaid from state budget during 2012 to 2016.

Approach summary

We have obtained understanding of the process of this loan portfolio as follows:

1) The project is initially discussed at government level and government issues the resolution for approval. The resolution assigns the Bank to finance specific project and directs the Ministry of

Finance and BoD of the Bank to disburse loan. 2) According to the government resolution, the credit committee holds a meeting and approves the

loan in the case of supports.

3) BoD of the Bank holds a meeting and declares a resolution according to Credit Committee decision. The BoD resolution approves to process the loan agreement and to take necessary actions for the disbursement.

4) Once decisions are finalised, the loan agreement is made between DBM, Ministry of Finance, relevant Ministry who is in charge of the implementation and the executing company. Contractual amount is set at the total financing amount, approved by the government, while the

disbursements are made partially based on the completion rate of the project. Repayments are proposed to be included in the state budget annually. General term is to repay the principal in bulk on the maturity date and to repay the interest on quarterly or semi-annually basis.

Loans to be repaid from the State budget are comprised of four debtors (varying from year to year). Please refer to Table 30 for overview of the portfolio.

We have selected 27 samples (facilities) from these debtors in the state budget loan portfolio based on

their disbursement periods. For the selected samples, we have reviewed the below mentioned documents in order (1) to verify the loan agreement and actual disbursements are in line with resolutions and (2) credit risk is born by Government of Mongolia:

Government resolution

Board of directors resolution

Credit committee decision

Loan agreement (or project financing and repayment settling agreement)



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T able 39: Summary of selected samples from the State budget loan

In mln MNT 2015 2014 2013 2012


2,743,986 2,051,683 1 ,321,251 256,216

Number of newly disbursed facilities

88 95 195 1

Number of sample (from newly disbursed facilities)

3 9 14 1

Exposure amount of samples

153,852 158,339 7 83,021 119,160

Cumulative exposure amount of samples

1 ,214,372 1 ,060,520 902,181 119,160

Sample coverage (cumulative basis)

44% 52% 68% 47%

Proposal of inclusion into the state budget is collected by Ministry of Finance and the budget is approved

by the Parliament in November. The Bank sends budget proposal of total amount due from the State

budget for the following year with the details of projects. In case of exclusion from the State budget, it is

informed to the Bank by the Ministry of Finance. As the Bank started its operation in June 2012, no

repayment was scheduled and accordingly, no payment was received from the State Budget for the year

2012.

Summary of due amount from State budget as per proposal and repayment from the State budget is shown

below.

T able 40: Summary of repayment received from the State

In mln MNT 2015 2014 2013 2012

Due from the state budget per proposal amount

435,449 157,600 52,500 -

Total receivable from the Ministry of Finance after reconciliation act

170,946 166,965 No reconciliation act was performed for this y ear

-

- Offset against the payable to Ministry of Finance

121,991 60,541 -

- Cash consideration 48,955 106,425 24,229 -

Difference between the proposed amount and receivable amount per reconciliation act

(264,503) 9,365 28,271 -

Certain amount is offset against the Chinggis Bond funding’s interest payables to Ministry of Finance

every year. The funding from proceeds of the Chinggis Bond was provided to the Bank on 30 April 2013.

Difference between proposal amount and the amount per reconciliation act with Ministry of Finance is

explained by the Bank as follows:



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- 2015: Principal due in 2015 from the following debtors were delayed according to restructuring. Thus, the proposed principals were excluded from the reconciliation act.

Principal 1 (USD 25 mln=MNT 49.9 bln) Principal 2 (USD 1 .5 mln=2.9 bln) Principal 3 (MNT 46.2 bln) Principal 4 (MNT 170.6 bln) Principal 5 (MNT 992 mln)

The above principals are amounting to MNT 270 bln while the difference is MNT 264 bln which

is due to FX fluctuation between the date of proposal (Nov 2014) and the date of reconciliation

act (Dec 2015).

- 2014: Total receivable per reconciliation act is higher than the proposed amount due to the FX fluctuation. Proposal for 2014 was sent in November 2013 by translating USD repayments into MNT and the reconciliation act was made in the end of 2014. The average MNT/USD rate in 2013 was 1 ,523.5 while it was 1,817 in 2014, which is 16% of increase.

- 2013: It was the first y ear when the Bank sent proposal. At that time, the Bank assumed to disburse loan commitments according to the project completion rate. In reality, the project did not complete as it was projected. Therefore, projected and proposed amount differed from the actual consideration.

The loans to be repaid from the State Budget as of 31 December 2016 was transferred to the Government

pursuant to Parliament Resolution No.81 dated 28 December 2016, Government Resolution #219 dated

28 December 2016 and Government Resolution No.42 dated 1 February 2017, (except 3 loans). The below

table summarises the final reconciliation act made for the transfer.

T able 41: Summary of final reconciliation act

Reconciliation act (in mln MNT)

T otal receivable from the Ministry of Finance 3,17 6,782

Principal due from loans to be repaid from state Budget 3,117,052

Interest due from loans to be repaid from state Budget 51 ,625

FX revaluation from SME fund 8,105

T otal payable to the Ministry of Finance (2,702,468)

Financing from Chinggis bond (2,693,148)

Interest due to financing from Chinggis bond (9,320)

Amount due from Ministry of Finance to the Bank 47 4,314

As of 31 December 2017, there are no outstanding loans to be repaid from the State Budget and the receipt

of cash payment due from the Ministry of Finance as per above reconciliation was verified.

Provisioning Impacts

We have assessed individual provision requirements – according to ECB AQR manual – for all loans

classified as NPE at the snapshot dates of each period (2012-2017). The individual provision assessment

was made using the going- and gone-concern approaches in line with agreed methodology. The

assessment of provision requirements was initially based on a going-concern approach if the debtor is

expected to continue to generate cash flows in the future, and a gone-concern approach if the assets of

the debtor need to be foreclosed to cover the Bank’s exposure.



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Under going-concern approach, provision requirements are based on the difference between the present

value of a debtor’s expected future cash flows and the Bank’s exposure amount. Under gone-concern

approach, provision requirements are based on the difference between the present value of a debtor’s

collateral and the Bank’s exposure amount.

In order to identify the present value of a debtor’s collateral, first we determined whether a Bank has

proper valuations in place for collateralised items. Such proper valuations are generally external,

independent valuations from reputable companies and suppliers. Such external, independent valuations

can be updated by an internal, independent review under certain conditions. In the event that a Bank has

credible, external, independent valuations from a reputable company, we review the valuation and its

assumptions to ensure that they appear reasonable based on knowledge of the market and similar

transactions. Subsequently, we adjust the valuation of the collateral to a net, discounted value reflecting

the costs and time.

For specific asset types (real estate and equipment), our subcontractor performed the valuation of the

real estate collateral held against loans in accordance with IVS as required by Mongolian law and the

Consultant will then review that valuation as part of the project. To ensure that the subcontractor’s

valuations are of the same quality as other external valuations performed by other valuers in accordance

with IVS, our independent valuation review team was established. This team reviewed whether the

methodology as described below has been followed by subcontracted valuers correctly.

In addition, valuation indices were applied to adjust the valuation to snapshot dates of review periods

(2012 to 2017). This index adjustment was applied for the valuation based on market comparative

approach. For assets valued by income approach or discounted cash flow approach and for collateral types

of vehicles and heavy machinery, these have been kept unchanged for y ears where the collateral was

available.

In case the present value of a debtor’s expected future cash flows is insufficient to cover the Bank’s

exposure under going concern approach, provision requirements are also assessed under gone-concern

approach, and the final provisions are based on the approach that results in the lowest provision

requirements.

Table 42 provides an overview of our assessment and aggregate additional provision levels for the

portfolio of loans to be repaid from corporates. For the loans to be repaid from state budget, no provision

is considered as all debtors within this portfolio were classified as PE.

T able 42: Provisioning assessment – Loans to be repaid from corporates

In mlns of MNT 2017 2016 2015 2014 2013 2012

Loans to corporates

Total exposure 2,018,531 2,118,710 1 ,483,182 1 ,286,876 562,530 235,417

- Bank provision 199,138 177,343 7 5,577 30,893 6,225 -

% of total exposure 9.87% 8.37% 5.10% 2.40% 1.11% 0.00%

- Our provision 375,651 367,402 264,707 241,745 25,388 7 ,443

% of total exposure 18.61% 17 .34% 17 .85% 18.79% 4.51% 3.16%

Additional provision amount

176,513 190,059 189,130 210,852 19,163 7 ,443

On lending loans to corporates

Total exposure 673,623 1 ,039,792 87 4,736 621,993 316,599 25,950

- Bank provision 14,680 15,404 - - - -

% of total exposure 2.18% 1 .48% 0.00% 0.00% 0.00% 0.00%

- Our provision 55,243 57,929 - - - -

% of total exposure 8.20% 5.57% 0.00% 0.00% 0.00% 0.00%



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Additional provision amount

40,563 42,525 - - - -

T otal additional provision am ount

217 ,076 232,584 189,130 210,852 19,163 7 ,443

Additional provision was calculated for on-lending loans to corporate in 2017 and 2016 which is

associated with one debtor classified as NPE from 2016. Main trigger was that the debtor was over 90

day s past due and required capital adequacy ratio per Bank of Mongolia regulation was not met for these

2 y ears. We have assessed the provisioning under going concern approach since the collateral of the loan

was a promissory note issued by the debtor (zero collateral was assigned to collateral). Absence of

financial statements as at 31 December 2017 and loss making performance as at 31 December 2017 led to

the full provision for the debtor.

As for loans to corporates, additional provisions was calculated by netting off the over-provisioned

amounts of PE debtors (for all PE debtors is assumed zero provision) against under-provision amount of

NPE debtors. Table 43 provides an overview of under or (over) provisions reported by the Bank

distinguished by our classification.

T able 43: Provisions by classification – Loans to corporates

In mlns of MNT 2017 2016 2015 2014 2013 2012

PE debtors per our classification


- Bank provision 3,155 1 ,399 155 833 - -

- Our provision - - - - - -

Under/(over) provision (3,155) (1 ,399) (155) (833) - -

NPE debtors per our classification


- Bank provision 195,983 175,944 7 5,422 30,060 6,225 -

- Our provision 375,651 367,402 264,707 241,745 25,388 7 ,443

Under/(over) provision 179,668 191,458 189,285 211,685 19,163 7 ,443

T otal impact 17 6,513 190,059 189,130 210,852 19,163 7 ,443

Table 44 lists all NPE debtors in Loans to Corporate portfolio for all y ears on individual debtor level,

according to our provisioning assessment. Additional provision for each year is mainly driven from three

debtors of which impacts are MNT 213 bln in 2017, MNT 257 bln in 2016, MNT 202 bln in 2015 and MNT

207 bln in 2014, respectively. These three debtors are as follows:

- Debtor 1– The loan was issued in 2014 and reclassified from the same y ear. - Debtor 2 – The loan was issued in 2012 and reclassified from 2013. - Debtor 3 - First loan was issued in 2013, while the other 3 loans were issued in 2014 and 2015.

These three debtors are listed first in the below table.



8 0

T able 44: Provisions on individual debtor level – Loans to corporates

Facility IDs per Debtor

T otal exposure (m ln. MNT)

Bank provisions (m ln. MNT)

Our provisions (m ln. MNT)

Under/ (over) provision

Going/ Gone concern

Key -driver of our assessment

Loans issued before 2017

Debtor 1

2017 174,165 2,613 83,734 81,121 Going

The loan was issued in 2014 and reclassified from the same y ear. Main collateral of the debtor is the future income which has no value per agreed methodology. Thus the provision assessment was made under going concern approach.

2016 178,461 2,680 114,796 112,116 Going

2015 143,134 2,135 141,111 138,976 Going

2014 134,940 1 ,349 133,032 131,683 Going

Debtor 2

2017 192,855 7 9,416 147,808 68,392 Going The debtor reports small amount of cash flow being generated which is higher than valuation amount of collaterals securing the exposure. Thus, going concern approach was applied.

2016 185,724 52,805 114,583 61,778 Going

2015 140,929 32,567 56,771 24,204 Going

2014 125,874 13,720 65,687 51 ,966 Going

2013 102,814 5,067 23,982 18,915 Going

Debtor 3

2017 110,069 22,599 86,061 63,462 Gone The estimated future cashflow was insufficient to cover the Bank’s exposure. Thus, the provisioning assessment was made under gone concern approach. Bank's valuation of collaterals were adjusted downward.

2016 101,124 42,616 77 ,116 34,500 Gone

2015 77,892 15,209 53,884 38,675 Gone

2014 52,451 5,156 28,170 23,014 Gone

2013 23,548 1 ,158 1 ,406 248 Gone

Debtor 4

2017 7 6,713 1 ,153 12,524 11 ,371 Going

The valuation of collaterals were lower than the estimated future cash flow. Thus, the provisioning assessment was made under going concern approach.



8 1

2016 161,619 2,429 51,428 48,999 Gone

The provisioning assessment was made under gone concern approach as the valuation of collaterals were higher than the estimated future cash flow.

2015 129,431 1 ,946 - (1 ,946) Going

The provisioning assessment was made under going-concern approach, and is concluded with no additional provision as future cash flow is sufficient to cover the Bank’s exposure.

Debtor 5

2017 97,656 9,415 20,548 11 ,132 Gone

The estimated future cashflow was insufficient to cover the exposure. Thus, the provisioning assessment was made under gone concern approach. Bank's valuation of collaterals were adjusted downward.

2016 60,130 2,551 - (2,551) Going

Provision requirements are assessed under going-concern approach, and is concluded with no provision as future cash flow valuation is sufficient to cover the loan exposure.

2015 42,247 551 - (551) Going

Debtor 6

2017 6,617 7 ,447 6,617 (830) Going The debtor is fully provisioned by the Bank. The provisioning assessment was made under going concern approach due to absence of collateral information. As the debtor reports losses and estimated future cash flow was insufficient, the debtor is full provisioned.

2016 5,950 6,906 5,950 (956) Going

2015 5,945 3,727 5,945 2,218 Going

2014 5,708 571 5,708 5,137 Going

Debtor 7

2017 285,327 54,829 - (54,829) Gone

The debtor reports losses and the estimated future cash flow was insufficient to cover the Bank's



8 2

2016 318,010 25,579 3,418 (22,161) Gone

exposure. Thus, the provisioning assessment was made under gone-concern approach. There is an indirect Government Guarantee to repay the principal and interest amount of facilities except one, hence no provision is created for these guaranteed facilities. For the non-guaranteed facility, gone concern approach was applied.

2015 278,265 4,142 6,770 2,627 Gone

2014 113,775 1 ,138 - (1 ,138) Gone

2013 60,660 - - - Gone

Debtor 8

2016 110 2 110 108 Going

The provisioning assessment was made under going concern approach due to absence of collateral information. As the debtor reports losses and estimated future cash flow was insufficient, the debtor is fully provisioned.

2015 226 3 226 223 Going

2014 354 4 - (4) Going

Going-concern approach was applied and the estimated cash flow is sufficient to cover the Bank’s exposure.

Debtor 9

2017 5,493 82 - (82) Going As the loan was fully repaid in 2018, collateral information was not provided. Thus, the provisioning assessment was made under going-concern approach. The estimated future cashflow is sufficient to cover the Bank’s exposure.

2016 19,631 295 - (295) Going

2015 24,021 361 - (361) Going

2014 19,192 192 9,148 8,956 Going

As the loan was fully repaid in 2018, collateral information was not provided. Thus, the provisioning assessment was made under going-concern approach.

Debtor 10



8 3

2017 24,961 374 - (374) Going Going-concern approach was applied and the estimated cashflow is sufficient to cover the Bank’s exposure. 2016 31,534 3,846 - (3,846) Going

2015 30,263 3,912 - (3,912) Gone

The estimated future cashflow was insufficient to cover the exposure. Thus, gone concern approach was applied. The exposure has an indirect Government guarantee to repay whole outstanding loan amount, hence no provision is created.

2014 13,175 1 ,181 - (1 ,181) Gone

2012 7 ,443 - 7 ,443 7 ,443 Gone

The estimated future cash flow was insufficient to cover the Bank's exposure. Thus, gone concern approach was applied. Due to absence of collateral information, full provision is created.

Debtor 11

2017 172,890 2,593 - (2,593) Going The provisioning assessment was made under going-concern approach, and the estimated cash flow is sufficient to cover the Bank’s exposure.

2016 183,529 2,756 - (2,756) Going

2014 177,012 1 ,770 - (1 ,770) Going

Debtor 12

2017 4,054 61 - (61) Gone

The estimated cashflow is insufficient to cover the exposure. Thus, gone concern approach was applied and valuation of the collateral is sufficient to cover the Bank’s exposure.

Debtor 13



8 4

2017 336,817.00 5,052.00 - (5,052) Going

The provisioning assessment was made under going-concern approach, and the estimated cashflow is sufficient to cover the Bank’s exposure. In addition, the loan has an indirect Government Guarantee.

2016 592,860.00 8,907.00 - (8,907) Gone The debtor reports losses, so provision requirements are assessed under gone-concern approach, however, it has an indirect Government Guarantee.

2015 461,836.00 5,988.00 - (5,988) Gone

2014 530,912.00 4,979.00 - (4,979) Gone

2013 339,161.00 - - - Gone

Debtor 14

2017 182,481 6,923 - (6,923) Going Provision requirements are assessed under going-concern approach, and is concluded with no additional provision as future cash flow valuation is sufficient to cover the loan exposure.

2016 172,476 24,572 - (24,572) Going

2015 114,677 4,881 - (4,881) Going

Loans issued in 2017

Debtor 15

2017 14,430 192 11 ,048 10,856 Gone

Gone approach was used as due to reported losses debtor has insufficient future CF. Bank's valuation of collaterals were adjusted downward.

Debtor 16

2017 5,305 239 2,438 2,198 Gone

The debtor reports losses and the estimated future cash flow was insufficient to cover the Bank's exposure. Thus, the provisioning assessment was made under gone concern approach. Bank's valuation of collaterals were adjusted downward.

Debtor 17

2017 2,368 577 2,368 1 ,791 Going The debtor was fully provisioned by the Bank in 2018 as it went to court. Our assessment confirmed this amount.

Debtor 18

2017 860 215 860 645 Gone



8 5

Debtor 19

2017 1 ,216 304 1 ,216 912 Going

As the debtor was fully repaid in 2018, financial statements and collateral information were not provided. It resulted into full provision.

Debtor 20

2017 7 05 32 208 176 Gone The debtor reports losses and the estimated future cash flow was insufficient to cover the Bank's exposure. Thus, the provisioning assessment was made under gone-concern approach. Bank's valuation of collaterals were adjusted downward.

Debtor 22

2017 1 ,247 19 194 175 Gone

Debtor 23

2017 12,598 152 30 (122) Gone

Debtor 24

2017 2,285 24 - (24) Going Going concern approach was applied and future cash flow is sufficient to cover the Bank’s exposure. Thus, no additional provision is needed.

Debtor 25

2017 7 18 32 - (32) Going

Debtor 26

2017 1 ,510 68 - (68) Gone The debtor reports losses and the estimated future cash flow was insufficient to cover the Bank's exposure. Thus, the provisioning assessment was made under gone concern approach. Valuation of collaterals is sufficient to fully cover the Bank’s exposure.

Debtor 27

2017 2,326 105 - (105) Gone

Debtor 28

2017 13,333 518 - (518) Gone

Debtor 29

2017 37,394 562 - (562) Gone

Debtor 30

2017 1 ,127 6 - (6) Gone

Collateral values also affect the amount of additional provision for non-performing debtors. In our review we have identified that market value of collaterals recorded in Bank’s system is consistently lower than corresponding market value our subcontractor have estimated for same collaterals. The results of the review of collateral and real estate valuation suggest that the value of collateral recorded in the Bank’s sy stems is not compliant with BoM’s requirements on collateral valuation, i.e. not performed according to IVSC International Valuation Standards. Further, in our review we have discounted market value of collaterals using time to sell, cost to sell and effective interest rates as agreed in the methodology. This discounted collateral value was consistently lower than value recorded in Bank’s system. Please note, number of collaterals revalued were always minimum of 70% of total monetary collateral value for each debtor. Remaining part of collaterals was prorated based on the revaluation data. Diffe rences in values are described above are summarised in following table.



8 6

T able 45: Overview of Bank’s collateral value and collateral value after our review

In mln MNT Bank’s m arket value

Market value after review

Discounted m arket value after review

% change to our m arket valuation

% change to our discounted valuation

2017 7 81,543 1 ,196,813 579,795 153.1% 7 4.2%

2016 604,534 871,925 450,635 144.2% 7 4.5%

2015 311,650 535,762 274,703 171.9% 88.1%

2014 248,732 291,642 148,688 117.3% 59.8%

2013 32,859 45,058 23,524 137 .1% 7 1.6%

2012 0 0 0 0% 0%

Classification under Bank of Mongolia regulation

Overview

The Bank of Mongolia (“BoM”) approved Asset classification and provisioning regulation for the Bank on

3 October 2017 pursuant to official letter from MoF No.8-1/5473 dated 18 September 2017. DBM law was

revised in February 2017 and it directed BoM to issue a regulation on asset classification and provisioning

for the Bank.

Core requirements for establishing loss provision under BoM regulation

The Bank assesses loan loss provision following categories:

- Specific provisioning

- Collective provisioning.

Specific provisioning: The banks performs qualitative and quantitative assessment at debtor level and,

the debtor shall be assessed individually through specific assessment in the case of any trigger hit from

below. Those qualitative and quantitative criteria are specifically defined in the regulation as follow:

1. Economic conditions that correlate with defaults on the assets; 2. Adverse change in laws and regulation environment and adverse legal opinion that might affect

value of financial asset;

3. It becomes probable that the borrower will enter bankruptcy or increase in probability of default 4. Deterioration on debtor’s financial ratio 5. The debtor requests to restructure the facility and to update repayment schedule and it is

accepted by the Bank 6. A breach of contract, such as a default or delinquency in interest or principal payments; 7 . Identified impairment indicator in the debtor in prior period

8. Decrease in the collateral value 9. Identified any material difference

Collective provisioning: If none of above trigger hit debtor shall be assessed collectively. Assets can be

pooled based on the quality, type, location, repayment period and risk profile, and other conditions of

assets shall be similar.

The Bank calculates the provision using the impairment model outlined in the above-mentioned

regulation and which is inline with IFRS. Impairment provision model is defined as follow:



8 7

Impairment provision = Net present Value of future cash flow – Total loan exposure

Net present Value of future cash flow = Present value of the future cash flow discounted at original

effective interest at the reporting date.

Total loan exposure = Outstanding balance of loan + acc. interest receivables + penalty income –

deduction

(guarantees provided by government, central bank and other international financial institutions).

Classification

In order to identify the classification of the asset, the Bank shall calculate the provision and determine

the classification based on the loan loss provision rate under IFRS. BoM classification is determined based

on the IFRS provision rate. The scale of the classification of the asset based on the loan loss provision rate

is outlined in the regulation as follows:

Classification Performing Special m ention

Sub-standard

Doubtful Loss

Provision loss rate Up to 5% 5%-25% 25%-50% 50%-75% over 75%

Reporting

Project financing and credit department calculates loan loss provision under IFRS semi-annually and

submits to risk evaluation and management department for review. After risk evaluation and

management department’s review, loan loss provision is discussed at Credit Committee and credit

committee decision is issued. Based on the credit committee resolution, financing and credit reporting

div ision classify the debtors based on the approved loan loss provision and reports to BoM semi-annual

basis.

Summary

The Bank started to follow the BoM regulation starting from 2017 pursuant to the approved regulation

dated October 2017. Provision amount is equal to our provision per AQR ECB manual and the

classification is allocated according to the loan loss provision rate.

T able 46: Overview of Bank’s and our BOM provisions

In mlns of MNT 2017 2016 2015 2014 2013 2012

T he Bank provision under IFRS and BoM

213,818 192,747 7 5,577 30,893 6,225 -

Loans to be repaid from corporate

213,818 192,747 7 5,577 30,893 6,225 -


- - - - - -

Our provision under BoM 430,894 425,331 264,707 241,745 25,388 7,443

Loans to be repaid from corporate

430,894 425,331 264,707 241,745 25,388 7,443


- - - - - -

Loans to be repaid from the state budget



8 8

BoM regulation states that debtor will be classified as PE with no provision if the debtor is guaranteed by

government. As the portfolio is repaid from the state Budget, the portfolio is classified as PE with no

provision.

Loans to be repaid from corporates - corporates

T able 47: Classification analysis of the total portfolio under BoM regulation

Exposure amounts, In

m lns of MNT 2017 2016 2015 2014 2013 2012

Per bank classification

Performing 1 ,939,942 2,285,754 2,102,889 1 ,711,661 87 9,128 261,367

Special mention 552,739 579,948 249,084 197,208 - -

Substandard 192,855 286,848 - - - -

Doubtful - - 5,945 - - -

Loss 6,617 5,950 - - - -

T otal loans to be repaid

from corporates including

off balance exposure

2,692,153 3,158,501 2,357,918 1,908,869 87 9,128 261,367

Per our classification

Performing 1 ,952,704 2,467,672 1 ,989,792 1 ,550,314 7 52,766 253,924

Special mention 175,617 - - - 126,362 -

Substandard 180,175 161,619 140,929 39,583 - -

Doubtful - 364,185 77 ,892 178,325 - -

Loss 383,657 165,025 149,306 140,648 - 7 ,443

T otal loans to be repaid from corporates including

off balance exposure

2,692,153 3,158,501 2,357,918 1,908,869 87 9,128 261,367

12.2. Credit risk concentrations

T able 48: Concentration risk from the economic sector point of view

In mlns of MNT 2017 2016 2015 2014 2013 2012

Manufacturing 807,270 1 ,034,831 1 ,193,148 814,931 440,446 88,440

Construction 670,885 629,844 398,700 132,968 67,365 -

Financial and insurance activities

660,753 335,829 - - - -



8 9

Mining and quarrying

377,460 624,789 612,604 653,770 357,223 141,512

Electricity, gas, steam and air conditioning supply

77 ,434 262,409 387,876 - 127,700 2,774

Transportation and storage

24,961 240,705 30,004 - 4,779 7 ,443

Health and social work

17 ,720 - - - - -

Agriculture, forestry and fishing

1 ,247 - - - - -

Mortgage - - 117,018 - - -

Railway - - 442,728 417,897 301,953 -

Roads - - - - - -

Utility - - - 227,580 94,614 -

Other - - 32,427 - - -

Transportation and communication

- - - 13,175 - -

Real estate and housing loans

- - - 110,547 101,318 50,774

Utility - - 406,443 - - 428

Road - - 1 ,365,643 1 ,189,527 690,416 202,184

Finance - - - 2,938 - -

Power plant - - - 270,942 - -

T otal loan and advances (before im pairment)

2,637,730 3,128,407 4,986,591 3,834,274 2,185,815 493,556

T able 49: Concentration risk from the economic sector point of v iew by percentage:

By percent 2017 2016 2015 2014 2013 2012

Manufacturing 31% 33% 10% 21% 20% 18%

Construction 25% 20% 13% 3% 3% -

Financial and insurance activities 25% 11% 16% - - -

Mining and quarrying 14% 20% 9% 17% 16% 29% Electricity, gas, steam and air conditioning supply 3% 8% 8% - 6% 1%

Transportation and storage 1% 8% 1% - 0% 2%

Health and social work 1% - - - - -

Agriculture, forestry and fishing 0% - - - - -

Mortgage - - 2% - - -

Railway - - 9% 11% 14% -

Roads - - - - - -

Utility - - - 6% 4% -

Other - - 1% - - -

Transportation and communication - - - 0% - -

Real estate and housing loans - - - 3% 5% 10%

Utility - - 8% - - 0%

Road - - 24% 31% 32% 41%



9 0

Finance - - - 0% - -

Power plant - - - 7 % - - T otal loan and advances (before im pairment) 100% 100% 100% 100% 100% 100%

Credit risk concentration from single debtor

As at each snapshot dates, the aggregated amount of the top 5 largest corporate debtors before

impairment is presented in below table. The amount did not consider on-lending loans and loans to be

repaid from state budget.

T able 50: Top 5 debtors of corporate portfolio (excluding on-lending portfolio)

in mlns of MNT

Industry 2017 2016 2015 2014 2013 2012

Debtor 1 Mining and quarrying 336,817 592,860 447,163 497,914 339,161 141,512

Debtor 2 Manufacturing 192,855 185,724 140,929 125,874 102,814 86,462

Debtor 3 Construction 285,327 318,010 278,265 113,775 60,660 -

Debtor 4 Construction 174,165 178,461 143,134 134,940 - -

Debtor 5 Manufacturing 182,481 - - - - -

Debtor 6 Construction - 183,529 - 177,012 - -

Debtor 7 Manufacturing - - 129,431 - - -

Debtor 8 Manufacturing - - - - 23,548 -

Debtor 9 Mining and quarrying - - - - 18,062 -

Debtor 10 Transportation and storage - - - - - 7 ,443

Total loan portfolio to corporates excluding corporates

1,976,978 2,101,535 1 ,458,271 1 ,218,114 555,728 235,417

Exposure to Top 5 largest corporate debtors

1 ,171,645 1,458,585 1,138,922 1,049,514 544,245 235,417

Percentage of top 5 debtor in total corporate loan portfolio excluding on-lending

59% 69% 7 8% 86% 98% 100%

only one debtor exists as at 31 December 2012.

As at each snapshot dates, the aggregated amount of the top 3 largest on-lending borrowers before

impairment is presented in below table.

T able 51: Top 3 debtors of on-lending loans

In mlns of MNT

Industry 2017 2016 2015 2014 2013 2012

Debtor 1

Financial and insurance activities, manufacturing

63,807 307,081 279,892 278,405 272,745 -

Debtor 2


264,739 300,494 178,136 38,934 - -

Debtor 3


- 88,954 121,517 137,978 36,247 1 ,979

Debtor 4 Financial and insurance

7 0,753 - - - - -



9 1

activities, manufacturing

Exposure to Top 3 largest on-lending debtors

399,299 696,529 579,546 455,317 308,993 1,97 9

T otal on lending exposure as at each snapshot before im pairment

660,753

1,026,872 781,494 564,503 308,993 1,979

Percentage of top 3 debtors in total Corporate on-lending loan portfolio excluding corporate loan

60% 68% 7 4% 81% 100% 100%

There were only 1 and 2 debtors as at 31 December 2012 and 2013, respectively.

Concentration of the group of connected debtors

Connected clients as defined in CRR article 4 paragraph 39. If a debtor belongs to multiple groups of

connected clients the major connection should be specified. If there is no major connection then a control

dependence takes priority over an economic dependence and should be reported as such.

T able 52: Summary of connected debtors (information provided by the bank)

Group of connected debtors

2017 2016 2015 2014 2013 2012

Group of connected debtor 1 513,761 7 82,955 457,676 688,756 357,223 -

Group of connected debtor 2 317 ,607 378,982 226,357 32,006 - -

Group of connected debtor 3 55,243 - - - - -

Group of connected debtor 4 23,678 - - - - - T otal exposure from connected clients

910,289 1,161,936 684,034 7 20,762 357,223 -

T otal loan and advances balances from corporates (before impairment)

2,637,730 3,128,407 2,242,605 1,7 82,591 864,565 237,340

Percentage of the group of connected debtors

35% 37 % 31% 40% 41% 0%

Excluding loans and advances to be repaid from the state budget

12.3. Off-balance sheet items and the potential impact on the capital adequacy

under Basel rules

Guarantees

The Bank issued a guarantee on behalf of a housing projects amounting to USD 84 mln on the 13

September 2012 with the maturity of 6 y ears from the loan disbursement. To date the counterparty have

not y et provided any funding to the housing project.

The Bank has issued three-year guarantee to a debtor with the amount of USD 7 6 mln in May 2013. The

guarantee is finalised in 2016 as the construction of a object that was subject to the guarantee is completed

and full settlement is made by the project implementing companies.

The Bank issued a two year guarantee to a local commercial bank in the amount of USD 35 mln in January

2014. The guarantee is fully settled in 2016 as the debtor fully repaid the loan received from local

commercial bank.



9 2

We have concluded that no provision is necessary as guarantees 3600000272 and 3600000735 are

settled with no activation while the other guarantee Client 1 is still inactive. We summarised the

exposure from the issued guarantees on Table 61.

T able 53: List of guarantees in 2012 to 2017

2017 2016 2015 2014 2013 2012

Client 1

In mlns of USD 84 84 84 84 84 84

In mlns of MNT 203,879 209,121 167,662 158,390 138,944 116,936

Client 2

In mlns of USD - - 13 54 7 6 -

In mlns of MNT 25,848 101,822 125,546 -

Client 3

In mlns of USD - - 5 35 - -

In mlns of MNT 10,379 65,996 - -

As a result of additional provision identified during our review, the potential impact on capital adequacy

ratio is show in table below.

T able 54: Potential impact on capital adequacy

Ca pital Impact

T ot al ca pital

prior t o rev iew (m ln. MNT )

T ot al ca pital

a dequacy ra tio prior t o review

(%)

Identified a djustments du ring ou r

rev iew

(m ln. MNT)

T ot al ca pital

following ou r review

(m ln. MNT)

T ot al ca pital

a dequacy ra tio a fter ou r review

(%)

Ca pital su rplus or

deficit over regulatory m inimum

of 10%

(%)

2 017 1 ,038,823 3 3.60% -2 17,056 8 21 ,747 2 6 .58% 1 6.58%

2 016 9 53,557 3 0.50% -2 32,584 7 20,973 2 3.06% 1 3.06%

2 015 2 87 ,402 1 4.22% -1 89,130 9 8 ,272 4 .86% (5 .14%)

2 014 2 46,536 1 3.66% -2 10,852 3 5,684 1 .98% (8 .02%)

2 013 1 43,879 17 .76% -1 9,163 1 24,716 1 5.39% 5 .39%

2 012 6 6 ,992 1 3.65% -7 ,443 5 9,549 1 2.14% 2 .14%



9 3

13. Fixed assets

13.1. Review of valuation of fixed assets through desktop review process

This section summarises findings from our review of the Bank’s fixed assets. Fixed assets in this case

encompasses DBM’s own use property.

T able 55: Fixed assets overview (2012 – 2017)

Year 2012 2013 2014 2015 2016 2017

Balance sheet value (mln. MNT)

961 1 ,361 2,111 28,249 28,999 28,488

Significant increase in 2015 is due to acquisition of 11 th and 12th floor in TDB tower, which currently serves as a DBM headquarters.

T able 56: Comparison of Bank’s and our valuation of fixed assets

Asset class Valuation method Bank’s

valuation (m ln. MNT)

Consultant’s valuation

(m ln. MNT)

Difference in valuation

(m ln. MNT)

Bank’s own use property

Market approach -Comparable Valuation

Method based on unit of area

28,488 23,400 - 5,088

For Bank’s own use properties, our valuation is lower than the Bank’s valuation. This difference is due to

different valuation approaches applied by the Bank and us. The Bank is valuing their fixed assets at cost

whereas our valuation is using a market approach.

Approach applied by the Bank creates no issue in relation to valuing fixed assets.



9 4

List of abbreviations

Abbreviation Full description

BCBS Banking Committee on Banking Supervision

DPD Day s past due

FCY Foreign currency

FX Foreign exchange currency

IA Internal Audit

ICS Internal Control System

IFRS International Financial Reporting Standard

IVS International Valuation Standards

LCR Liquidity Coverage Ratio

MIK Mongolian Mortgage Corporation

MNT Mongolian Tugrik

NPE Non-performing exposure

NPL Non-performing loan

NSFR Net Stable Funding Ratio

PE Performing exposure

RAF Risk Appetite Framework

RAS Risk Appetite Statement

RM Risk Management



9 5

T able of tables

Table 1: Findings and recommendation related to corporate governance framework......................... 15

Table 2: List of findings and recommendation related to risk management framework, credit granting

and monitoring process, and classification of loans and other assets .............................................. 24

Table 3: List of findings and recommendations to Credit Risk Management Framework: .................. 27

Table 4: List of findings and recommendation to internal control system and audit function ............. 37

Table 5: List of provided documents that were obtained and reviewed............................................ 39

Table 6: Components of liquidity risk management subject to review ............................................. 39

Table 7 : Information on the Government support. ...................................................................... 43

Table 8: Summary of funding structure ..................................................................................... 44

Table 9: Overview of investment structure ................................................................................. 45

Table 10: List of procedures, policies and strategies in previous years............................................. 48

Table 11: FX positions at year end (2012-2017) ...........................................................................50

Table 12: Volumes of provided credits to clients that are able to generate a FCY cash flow .................50

Table 13: List of policies related to accounts receivable ................................................................ 51

Table 14: Accounts receivables outstanding balances each year-end. .............................................. 51

Table 15: Estimated future liquidity position of the Bank as at Dec 2017 ......................................... 53

Table 16: List of all funding sources (issued bonds, accepted loans). .............................................. 53

Table 17: Summary of interest income from related parties........................................................... 56

Table 18: Interest expense summary to related parties ................................................................. 56

Table 19: Rates for non-related parties (nominal rates) ................................................................ 57

Table 20: Interest income accrued/recognised but not collected from loan and advances according to

credit quality disclosure under IAS 39. ...................................................................................... 58

Table 21: Interest income accrued / recognised but not collected from loan and advances according to

revised classification of reviewed loan portfolio .......................................................................... 58

Table 22: Earnings recognised in statement of profit and loss from fees and commission income and

foreign exchange translation gain/losses based on audited financial statements as at each reporting

date. .................................................................................................................................... 59

Table 23: Foreign currency positions as at 31 December 2017, 2016 and 2015 based on the audited

financial statements and fluctuation in percentage of each currency (official rate in the end of the year

and official rate in the beginning of the year).............................................................................. 59

Table 24: Income recognised on statement of profit or loss during 2012 to 2017 based on audited

financial statements (accounting policy of each stream has been outlined accordingly) ..................... 61

Table 25: Balances of prepayments based on audited financial statements. ..................................... 61



9 6

Table 26: Impact on statement of profit or loss from derivative valuation based on audited financial statements. ........................................................................................................................... 62

Table 27: FSLIs and valuation techniques .................................................................................. 63

Table 28: Data compilation of comparative information............................................................... 63

Table 29: Control scheme of comparative information ................................................................. 64

Table 30: List of missing disclosures ......................................................................................... 64

Table 31: Breakdown of loan exposure ...................................................................................... 66

Table 32: Summary of corporate debtors classified as PE ............................................................. 67

Table 33: Summary of corporate debtors classified as NPE ........................................................... 67

Table 34: List of reclassified corporate debtors in 2012 to 2017 (in mln of MNT).............................. 68

Table 35: On-lending projects through commercial banks ............................................................ 7 2

Table 36: Bank’s classification of debtors................................................................................... 7 3

Table 37: On balance exposure breakdown – All on lending projects .............................................. 7 3

Table 38: Summary of on-lending debtors classified as NPE ......................................................... 7 4

Table 39: Summary of selected samples from the State budget loan ............................................... 7 6

Table 40: Summary of repayment received from the State ............................................................ 7 6

Table 41: Summary of final reconciliation act ............................................................................. 77

Table 42: Provisioning assessment – Loans to be repaid from corporates .......................................7 8

Table 43: Provisions by classification – Loans to corporates ......................................................... 7 9

Table 44: Provisions on individual debtor level – Loans to corporates ............................................80

Table 45: Overview of Bank’s collateral value and collateral value after our review ........................... 86

Table 46: Overview of Bank’s and our BOM provisions ................................................................87

Table 47: Classification analysis of the total portfolio under BoM regulation ................................... 88

Table 48: Concentration risk from the economic sector point of view ............................................. 88

Table 49: Concentration risk from the economic sector point of view by percentage: ........................ 89

Table 50: Top 5 debtors of corporate portfolio (excluding on-lending portfolio) ...............................90

Table 51: Top 3 debtors of on-lending loans ...............................................................................90

Table 52: Summary of connected debtors (information provided by the bank) ................................. 91

Table 53: List of guarantees in 2012 to 2017 ............................................................................... 92

Table 54: Potential impact on capital adequacy........................................................................... 92

Table 55: Fixed assets overview (2012 – 2017) ............................................................................ 93

Table 56: Comparison of Bank’s and our valuation of fixed assets .................................................. 93



9 7

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Documents

Financial Diagnostic of the Development Bank of Mongolia Final … · 2019. 4. 5. · Investment Portfolio 0 3 FX risk 2 3 (1 replacement) Accounts Receivable 2 1 (replacement) There