KOMERCIJALNA BANKA A .D , · PDF fileKOMERCIJALNA BANKA A.D., BUDVA NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 2016 This version of

KOMERCIJALNA BANKA A.D., BUDVA Financial Statements for the year ended December 31, 2016

and Independent Auditor’s Report

Contents Page INDEPENDENT AUDITORS' REPORT 1-2 Income statements from January 1 to December 31, 2016 3 Statement on other comprehensive income from 1 January to December 31, 2016

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Balance sheet as at December 31, 2016 5 Statement of Changes in Equity from January 1 to December 31, 2016 6 Cash Flow Statement from January 1 to December 31, 2016 7 Notes to the Financial Statements 8-75

KOMERCIJALNA BANKA A.D., BUDVA

NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 2016

This version of the financial statements and the accompanying notes is translation of the original which were published in Montenegrin language.

All possible care has been taken to ensure that the translation is accurate representation of the original. However, in all the matters of interpretation of information, views and opinions, the original language version of the documents takes precedence over this translation

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1. BANK'S FOUNDATION AND ACTIVITY

Komercijalna banka a.d., Budva (hereinafter: the "Bank") has been present in the market of Montenegro since 1992 as a branch, and from 1996 as an affiliate of Komercijalna banka a.d., Beograd.

In accordance with the Law on Banks (Official Gazette of Montenegro no. 17/08, 44/10 and 40/11), prescribing that a bank domiciled outside Montenegro may establish an affiliate as a part of the bank having the capacity of a legal entity, on 7 November 2002, Komercijalna banka a.d., Beograd enacted the Decision on the Branch Shutdown and the Affiliate Establishment. On 7 February 2003, the Central Bank of Montenegro issued an operating license number 0101-9/1-2003 to Komercijalna banka a.d., Budva.

Komercijalna banka a.d., Budva was registered with the Central Registry maintained by the Commercial Court as a shareholding company under the registration number 4 - 0006783. The Bank is included in the Register of Security Issuers maintained by the Securities Commission under the number 372 (Decision number 02/3-29/2-03, as of December 12 2003).

The sole (100%) owner of Komercijalna banka a.d., Budva is Komercijalna banka a.d., Belgrade.

In accordance with the Law on Banks (Official Gazette of Montenegro no. 17/08, 44/10 and 40/11), and the Bank's Articles of Incorporation and Association, the Bank is involved in business of reception of deposits and other assets of private individuals and legal entities and loan and other investment approval form these funds entirely or in part for its own account. In addition to these operations, the Bank is also registered to perform the following activities:

- issue guarantees and undertake other commitments;

- purchase and collect receivables;

- issue, process and record payment instruments;

- perform payment transactions abroad;

- perform finance lease operations;

- trade in its own name for its own account or for the account of a customer with foreign payment instruments;

- collect data, prepare analyses and provide information and advice on the company and entrepreneur creditworthiness;

- perform depositary operations;

- perform custody services over assets and securities; and

- perform other ancillary operations and activities related to the Bank's core operations.

The Bank's governing bodies are the Shareholder Assembly and the Board of Directors. The Shareholder Assembly is the highest body of the Bank. The Executive Board of Komercijalna banka a.d., Beograd acts on behalf of the Shareholder Assembly. Members of the Board of Directors are elected and appointed by the Bank's Shareholders Assembly. The Bank's Board of Directors has five members, two of which are not the Bank's employees. The Board of Directors has two standing committees: the Audit Board and the Asset and Liability Management Committee.

The Chief Executive Officer of the Bank is the Bank's executive manager. The Chief Executive Officer is accountable to the Assembly and to the Board of Directors.

The Bank is headquartered in Budva, no number, BC Podkosljun. As of December 31, 2016, the Bank is comprised of the Central Office located in Budva, 3 branch offices (Podgorica, Niksic, Kotor, Bar, Bijelo Polje and Herceg Novi) and 10 sub-branches (2 in Budva, 2 in Podgorica, and one in Niksic,Tivat, Kotor, Bar, Bijelo Polje and Herceg Novi).

As of December 31, 2016 the Bank has 133 employees (As of December 31, 2015: 120 employees).





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2. BASIS OF PREPARATION AND PRESENTATION OF THE FINANCIAL STATEMENTS

2.1. Basis of Preparation and Presentation of the Financial Statements

The Bank is obligated to maintain its accounting records and prepares its statutory financial statements in conformity with the Law on Accounting of Montenegro (Official Gazette of Montenegro no. 052/16 since August 9 2016) which entails implementation of the International Financial Reporting Standards and Decisions of the Central Bank of Montenegro governing financial reporting of banks. The Bank's financial statements have been prepared in accordance with the Decision On the Content, Deadlines and Manner of Preparation and Submittion of Financial Statements of Banks (Official Gazette of Montenegro no.15/12 and 18/13). Upon preparation of these financial statements, the Bank implemented policies in accordance with the regulations of the Central Bank of Montenegro, which depart from the requirements of IFRS and IAS effective as of December 31, 2016 in respect of recording receivables qualifying for derecognition form the Bank's balance sheet, in respect of format for presentation of the financial statements and the manner ofpresentation and recording loan origination fees. Due to the potentially significant effects of the above described matters on the accuracy and fair presentation of the financial statements, these financial statements cannot be treated as having been prepared in accordance with International Financial Reporting Standards. In the preparation of the accompanying financial statements, the Bank has adhered to the accounting policies described in Note 3, which are in conformity with the accounting, banking and tax regulations prevailing in Montenegro. The official currency in Montenegro and the Bank's functional and presentation currency is Euro (EUR).

2.2. Use of Estimates

Presentation of the financial statements requires the Bank's management to make the best possible estimates and reasonable assumptions that affect the reported amounts of assets and liabilities, as well as disclosures of contingent assets and liabilities as at the financial statements preparation date, and income and expenses arising during the accounting period. These estimations and assumptions are based on historical experience and other information available to us as at the financial statements preparation date that are believed to be reasonable under the circumstances. The estimates and assumptions are the basis of making judgments about the carrying amounts of assets and liabilities that are not readily apparent from other sources. Actual values of assets and liabilities may differ from values estimated in this manner. Estimates and underlying assumptions are reviewed on an ongoing basis. In case that such a review reveals changes in the estimated values of the assets and liabilities, the determined effects thereof are recognized in the financial statements in the period in which a change in the relevant estimate occurred for changes in estimates that affect only the current period, or, in the period in which a change in the relevant estimate occurred as well as the ensuing periods for changes that affect both the current and the future accounting periods.





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2.3. Going concern principle

The financial statements have been prepared in accordance with the going concern concept, which assumes that the Bank will continue to operate over an unlimited period of time in the foreseeable future.

In 2016 the Bank incurred loss of EUR 9,067 thousand (2015: EUR 4,987), which resulted in a capital adequacy ratio of 18.33% at December 31, 2016. The loss was mainly incurred due to additional impairment of the credit potfolio amounting to EUR 4,483 thousand and a portfolio of assets acquired through collection of receivables of EUR 3,905 thousand. The Bank, despite the loss reported at the end of the business year 2016, as well as the fact that short-term liabilities exceeding short-term receivables, profiled it’s role in the market through business strategy for the next three years. The development strategy is based on:

- Stable and sustainable business development;

- Continuous improvement and targeted diversification of the portfolio;

- Continuous strengthening of market share;

- Active problem solving of acquired assets and NPL;

- Sustainability of profitability;

- Reorganization of business in order to increase network efficiency;

- Strengthening the brand.

In addition to clearly defined objectives the Bank has quantified the goals set to be achieved in the future, which are reflected in the growth of credit and deposit potential, profitability growth, reduction of NPL, adjusting pricing policy with the policy of the government in the banking market of Montenegro and other goals which are on the tracks of recovery, strenghtening and development of the Bank in the banking market of Montenegro. In addition, Komercijalna Banka AD, Beograd as the sole shareholder of the Bank and its 100% owner, has issued a Letter of support in which it expressed the readiness to provide adequate financial support to the Bank to continue with the business for a period of one year from the date of preparation of these financial statements. Taking into account the above-mentioned facts, the presented financial statements have been prepared in accordance with the going concern concept.





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2. BASIS OF PREPARATION AND PRESENTATION OF THE FINANCIAL STATEMENTS (continued) 2.4. IFRS 9 "Financial Instruments" (IASB effective date: January 1, 2018)

In July 2014, the IASB issued the final text of the standard IFRS 9 Financial Instruments, which will replace the the existing standard IAS 39 starting from January 1 2018. In 2016, the Bank has established a multi-sectoral implementation team made up of members of risk, finance and other business organizational units to implement IFRS 9 project. The bank has hired consultants for the successful implementation of IFRS 9 standard. The Bank has completed the phase of analysis of the business model of its loan portfolio, which is concluded that its held in order to collect cash flows, while there's an ongoing project analysis of contractual clauses for the needs of SPPI test, within a phase of Classification and measurement. After completion of this phase, the bank will approach the Impairment phase in which they will work the GAP analysis, initial analysis of the impact and development of the methodology for the calculation of impairment. Classification and measurement From the point of classification and measurement the new standards requires that all financial assets other than equity instruments and derivatives, are estimated based on the business model of financial management and the contractual cash flow characteristics of the instrument. The categories of possible estimates in accordance with IAS 39 will be replaced: amortized cost and fair value through the Income Statement (FVPL), the fair value through the other result (FVOCI). In accordance with IFRS 9, it will still be able to continue the valuation of financial instruments based on amortized cost at fair value through other financial result of the income statement, if so eliminates or significantly reduces inconsistencies in measurement and recognition. Equity instruments that are not held for trading may be classified as assets whose value is estimated by the fair value through Other results, without further reclassifying the gains and losses through the income statement. During the initial evaluation, the Bank expects to: • Loans given to clients to still be in valued with the amortized cost method in accordance with IFRS 9 and IAS 39. •Financial instruments that are traded and whose value is estimated according to the fair value of the income statement, to continue the evaluation in the same way; • Debt instruments classified as available for sale in accordance with the IAS 39, valued according to the fair value through the income statement, the amortized cost or fair value through the Other result. As stated above, the Bank is at an early stage of implementation of IFRS 9. The Banks is working with consultants to determine the value method with which the debt securities will be measured. • Debt instruments held to maturity and still evaluated in accordance with the amortized value. Impairment of financial assets In accordance with the IFRS 9, a methodology for impairment is significantly changed. Standard will replace the Realized loss in accordance with IAS 39, with the Principle of future expected loss (ECL). The Bank will be required to calculate the costs of impairment to expected losses for all receivables and other debt instruments that are not valued at fair value through the Income statement, including irrevocable payables and guarantees issued. Impairments are based on the expected loan losses in accordance with the probability of default over the next 12 months, unless there is a significant deterioration in credit risk from the time of initial recognition, when the level of impairment is based on the probability of default for a lifetime period of an instrument.





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2. BASIS OF PREPARATION AND PRESENTATION OF THE FINANCIAL STATEMENTS (continued) 2.5. Reclassification of comparative data of the Balance sheet 2015

The Bank has made certain reclassifications in the balance sheet at December 31, 2015, as shown in the table below:

December 31

2015

Reclassification effects

+/-

December 31 2015

reclassified

ASSETS Cash and deposit accounts held with Central Banks 12,297 - 12,297 Loans and receivables due from banks 15,711 - 15,711 Loans and receivables due from customers 51,641 (380) 51,261 Investment securities - available for sale 15,933 - 15,933 - held to maturity - - - Investment property - - - Property, plant and equipment 1,646 - 1,646 Intangible assets 139 - 139 Deferred tax assets 21 - 21 Other financial receivables 573 224 797 Other operating receivables 12,399 (225) 12,174

TOTAL ASSETS 110,360 (381) 109,979

LIABILITIES Deposits due to banks 35 - 35 Deposits due to clients 76,819 - 76,819 Borrowings from other customers 5,260 (381) 4,879 Issued debt securities - - - Provisions for credit losses on off-balance sheet credit

exposures 520 -

520 Current tax liebilities 6 - 6 Deffered tax liabilities 98 - 98 Other liabilities 225 - 225

TOTAL LIABILITIES 82,963 (381) 82,582

EQUITY Share capital 27,370 - 27,370 Retained earnings 92 - 92 Loss/Profit for the year (4,987) - (4,987) Other reserves 4,922 - 4,922

TOTAL EQUITY 27,397 - 27,397

TOTAL EQUITY AND LIABILITIES 110,360 (381) 109,979

In accordance with the Decision on the Chart of Accounts for Banks ("Official Gazette of Montenegro", no. 55/12), deferred fees for loan approval which at December 31, 2015 were shown at the position Borrowings from clients, are reclassified as the Loans and Receivables from customers. In addition, the Bank's impairment of other financial receivables, which at December 31, 2015 have been shown as Other financial receivables, reclassified to Other operating receivables, in accordance with the Decision on the Chart of Accounts for banks.





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3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

3.1. Interest, Fee and Commission Income and Expense

Interest income and interest expense, including penalty interest and other income and expenses related to interest-bearing assets and liabilities are accounted for on an accrual basis. Fee and commission income and expenses from banking services are determined when due for settlement and/or collection. Origination fees for loans, guarantees and other sureties, as well as fee expenses charged to the Bank based of its borrowings are recognized in accordance with IAS 18 "Revenues" and IAS 39 "Financial Instruments: Recognition and Measurement," loan origination fees are considered to be an integral part of an ongoing involvement with the resultant financial instrument, and are deferred and recognized as an adjustment to the return using effective interest rate method.

3.2. Foreign Exchange Translation Transactions denominated in foreign currencies are translated into EUR at the official exchange rates prevailing on the Interbank Foreign Exchange Market, at each transaction date. Assets and liabilities denominated in foreign currencies are translated into EUR by applying the official middle exchange rates, as determined on the Interbank Foreign Exchange Market that are prevailing at the balance sheet date. Net foreign exchange gains or losses arising upon the translation of transactions, and the assets and liabilities denominated in foreign currencies are credited or charged to the Income statement. Commitments and contingent liabilities denominated in foreign currencies are translated into EUR by applying the official exchange rates prevailing on the Interbank Foreign Exchange Market, at the balance sheet date.

3.3. Taxes and Contributions Income Taxes Current Income Taxes Income taxes are calculated and paid in conformity with the income tax regulations defined under Article 28 of the Montenegrin Corporate Income Tax Law (Official Gazette of Montenegro, no. 65/01, 12/02, 80/04, 40/08, 40/11, 14/12 and 61/13) at the proportional income tax rate of 9% applied to the taxable income. Taxable income is determined based on the profit stated in the Bank's statutory income statement after the adjustments of income and expenses performed in accordance with Montenegro Corporate Income Tax Law (Articles 8 and 9, regarding the adjustment of income and Articles 10 to 20 pertaining to the adjustment of expenses). 100% of the capital gains are included in the tax base in the year in which they are earned. Capital losses may be offset against capital gains earned in the same year. In case there are outstanding capital losses even after the offsetting of capital losses against capital gains earned in the same year, these outstanding losses are available for carryforward during the ensuing 5 years. Montenegro tax regulations do not envisage that any tax losses of the current period be used to recover taxes paid within a specific carryback period. However, any current year losses reported in the annual corporate income tax returns may be carried forward and used to reduce or eliminate taxes to be paid in future accounting periods, but only for duration of no longer than five years.





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3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

3.3. Taxes and Contributions (continued)

Income taxes (continued) Deferred Income Taxes Deferred income tax is determined using the balance sheet liability method, for the temporary differences arising between the tax bases of assets and liabilities, and their carrying values in the financial statements. The currently enacted tax rates at the balance sheet date are used to determine the deferred income tax amount. Deferred tax liabilities are recognized for all taxable temporary differences. Deferred tax assets are recognized for the deductible temporary differences, and the tax effects of income tax losses and credits available for carry forward, to the extent that it is probable that future taxable profit will be available against which deferred tax assets may be utilized. Indirect Taxes, Contributions and Other Duties Payable Indirect taxes, contributions and other duties payable include property and other taxes, contributions and charges payable pursuant to various republic and municipal regulations.

3.4. Cash and Cash Equivalents For purposes of the cash flow statement, cash and cash equivalents include cash on hand, balances on the current account held with the Central Bank of Montenegro, including the obligatory reserve, and balances held on the accounts with other banks in the country and abroad.

3.5. Loans Loans originated by the Bank are recorded in the books of account at the moment of the transfer of funds to the loan beneficiary - borrower. Loans originated by the Bank are stated in the balance sheet in the amount originally approved, net of the principal repaid and an allowance for impairment which is based on the management's estimate of the specifically identified risk exposures and which serves to cover any losses inherent in the Bank's loan portfolio. The Bank's management applies the methodology prescribed by the Central Bank of Montenegro for the estimate of impairment of balance sheet assets and possible loss on off-balance sheet items in accordance with IAS 39, which is described in Note 3.6.

3.6. Provisions and Impairment of Irrecoverable Receivables The Central Bank of Montenegro Decision on the Minimum Standards for Credit Risk Management in Banks (Official Gazette of Montenegro no. 22/12, 55/12 and 57/13) defines elements of credit risk management, minimum criteria and manner of classification of assets and off-balance sheet items in respect of which the Bank is exposed to credit risk and the manner of determining reserves for potential losses arising from the Bank's credit risk exposure. Within the meaning of the aforesaid Decision, the Bank's risk-weighted assets comprise loans, interest, fees and commissions, lease receivables, deposits held with other banks and advances as well as all other asset items where the Bank is exposed to default risk, and, on the other hand, guarantees issued, other sureties, opened letters of credit, approved and unused loans and other off-balance-sheet items representing the Bank's contingent liabilities.





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3.6. Provisions and Impairment of Irrecoverable Receivables (continued)

The Bank is obligated to assess balance sheet assets and off-balance sheet items for impairment at least on a monthly basis, where balance sheet items are assessed for impairment whereas for off- balance sheet items probable losses are estimates. All these items are to be classified in appropriate classification groups in accordance with the effective Decision on the Minimum Standards for Credit Risk Management in Banks (Official Gazette of Montenegro no. 22/12, 55/12 and 57/13). In addition, the Bank is under obligation to determine a methodology for assessment of impairment of balance sheet assets and probable losses per off-balance sheet items in accordance with IAS 39. Pursuant to the Decision on the Minimum Standards for Credit Risk Management in Banks (Official Gazette of Montenegro no. 22/12, 55/12 and 57/13), loans and other assets exposed to risk are classified into the following categories:

- A category ("Good Assets") - including assets assessed as collectable in full and as agreed;

- B category ("Special Mention") - with B1 and B2 subcategories including items for

which there is remote probability of loss, but which, require special attention, as potential risk, if not adequately monitored, could diminish collectability;

- C category ("Substandard assets") - with C1 and C2 subcategories for which there is

high probability of loss, due to the clearly identified collectability issues; - D category ("Doubtful assets") - including items the collection of which is, given the

creditworthiness of borrowers, quality of collaterals, highly unlikely; - E category ("Loss") - including the items which are uncollectable in full, or will be

collectable in an insignificant amount. Impairment Allowance The Bank reviews receivables and other investments in order to determine impairment allowance and provisions/reserves for losses on a monthly basis. In determining whether the impairment losses on receivables and investments should be recognized in the income statement, the Bank assesses whether there is information/evidence indicative of the existence of a measurable decrease in the estimated future cash flows on a portfolio level before such losses can be identified at an individual level. Information indicating impairment losses include: irregularity and default in liability settlement, local market and economic conditions which cause delays in payment etc. Management's estimates of impairment of receivables and other investments using the estimated future cash flows are based on actual historical losses incurred on financial assets with similar risk exposure and similar impairment causes. The methodology and assumptions underlying the process of defining the amounts and periods of cash inflows from investments are reviewed on an ongoing basis in order to minimize the difference between the estimated and actual losses. Impairment assessment is performed on an individual level and on a group level.





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3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

3.6. Provisions and Impairment of Irrecoverable Receivables (Continued) Group-Level Impairment Assessment Impairment assessment is performed on a group (portfolio) level for individually less significant loans and for those individually significant loans where there is no objective evidence of individual impairment. Group-level assessment for impairment is performed in groups formed according to the internally prescribed methodology based on the system of internal loan rating on a monthly basis. Group impairment percentages are calculated based on risk category migrations into default status per type of borrower or type of product. Individual Assessment Impairment assessment is performed on an individual level for each materially significant loan thereby taking into consideration the borrower's financial position, sustainability of the borrower's business plan, borrower's ability to improve performance in instances of financial difficulties, projected revenues, availability of other types of financial support, value of collaterals that may be foreclosed and expected cash flows. If new information becomes available that significantly alter the creditworthiness of the borrower, collateral value and certainty of liability settlement, ad hoc impairment assessment of such loans is performed. Impairment of loans decreases the value of loans and is recognized under expenses within the income statement. Impairment of interest receivables decreases interest income. The amounts of the expected cash inflows from a loan are estimated based on evidence of the borrower's projected revenues, and in instances these are insufficient, cash flows from collateral foreclosure are estimated. Number of days past-due in collection of receivables from a borrower is determined by considering all the relevant information on the timeline of projected revenue realization and historical information of the borrower's default. For the purpose of protection against credit risk, in addition to regular monitoring of the customer business operations, the Bank also acquires security instruments (collaterals) to secure the collection of receivables and minimize credit risk. Depending on the assessment of the ability to settle contractual liabilities, the level of loan coverage is defined so that in case of the debtor default, the Bank could collect its receivables through collateral foreclosure. The quantity and type of collateral depends on the assessed credit risk. For valuation of property or pledges assigned over movable assets, the Bank hires certified appraisers in order to minimize potential risk of unrealistic valuation. Property, goods, equipment and other movables pledged must be insured by an insurance company acceptable to the Bank and insurance policies must be duly endorsed in favour of the Bank. The Bank monitors the market value of collaterals and if necessary, it can demand additional collateral pursuant to the loan/deposit agreement executed.





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3.7. Securities Held to Maturity Held-to-maturity investments are non-derivative financial assets with fixed or payments and fixed maturity that the management has the positive intention and ability to hold to maturity. Securities held to maturity comprise Treasury bills of the Ministry of Finance of the Government of the Republic of Montenegro. All securities are initially recorded at cost. As of the balance sheet date, securities held to maturity are stated at amortized cost.

3.8. Equity Investments in Other Legal Entities and Securities Available For Sale Equity Investments in other legal entities and available-for-sale securities are carried at cost which is believed by the management to approximate the fair value of these instruments. Securities available for sale comprise Treasury bills and bonds of the Republic of Serbia, in which the Bank has invested available funds and which may at any time be sold to the Parent Bank in Belgrade, as a guarantee and secondary source of liquidity in the case the Bank suffers a liquidity crisis. Available-for-sale assets are initially measured at cost and stated at market value if known as of the balance sheet date. Gains and losses incurred upon the change in the market value of these securities are stated as revaluation reserves within equity until such financial assets are sold, collected or disposed of, when revaluation reserves are transferred to income or expenses. The Bank generates its income from interest on securities and interest income is calculated and accrued on a monthly basis.

3.9. Property, Equipment and Intangible Assets Business premises, other fixed assets and intangible assets at 31 December 2015 are stated at cost less accumulated depreciation/amortization and impairment loss, if any. Cost represents the prices billed by suppliers increased by all the costs incurred in bringing the respective asset to the location and condition necessary for its intended use. Depreciation and/or amortization are provided for on a straight-line basis to the cost of assets using the depreciation/amortization rates calculated based on the estimated useful lives of those assets.. Depreciation and/or amortization are calculated using the following prescribed annual rates:

Buildings 2.50% Computers 25.00% Furniture and equipment 10.00 – 25.00% Motor vehicles 15.50% Software 20.00 – 25.00%

The calculation of depreciation and/or amortization commences when an asset is placed into use. Property and equipment are tangible assets that are held for use for business purposes, which the expected future economic benefits are for more than one accounting period The recognition of items of property and equipment is carried out if the following conditions are met: - the existence probability of future economic benefit for a period longer than one year and

-the possibility of obtaining a reliable measurement of costs Initial measurment of property, plant and equipment is at cost, ie. Purchase price plus acquisition costs and the costs of bringing the asset into use, net of discounts and rebates.





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3.9. Property, Equipment and Intangible Assets (continued)

Subsequent investment in property and equipment, which affect the improvement of the state of the asset beyond its initial estimated useful life, increase the purchase value of proper and equipment.The cost of replacing a component of the fixed asset is recognized as par of the book value of the fixed asset if it is probable that future economic benefits associate will come from that replaced part to the Bank and the cost of that part can be measured reliably. The carrying amount of the replaced part is written-off. Spare parts are recorded as inventory and recognized as an expense at the time of consumption. Significant spare parts that can be used only for a single item of property or equipment are recognized as a real estate or equipment if they meet the general requirements for the recognition. When parts of property or equipment have different useful lives, they are accounted for as separate items (major components). Investments based on the current maintenance of property and equipment are recognized as an expense in the income statement in the period in which they arise. After initial recognition, property measured at revaluation amount represents their fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. The revaluation is performed at least once in the period of five years or more often in the case of major disturbances on the market, so as to ensure that book value does not significantly differ from the values to which we would derive using the fair value at the end of the reporting period. The effects of revaluation are recognized proportionally over the cost and written-off the value of the individual properties while presenting: - negative effects as a reduction of the previously established Revaluation reserves and / or reduction of an expense of fixed assets in the income statement and; - positive effects like income from increasing the value of fixed assets to the level of previously recognized losses on the same basis for the same property and/or as an increase of Revaluation reserves. Revaluation reserves as a result of the revaluation of individual property is transferred to retained earnings at the latest on the date of disposal of the property. During the period of use of the property, its revaluation reserves are transferred to retained earnings from previous years, the amount corresponding to the difference between the calculated accounting annual depreciation and depreciation that would have been calculated if for that property applied only cost model of the depreciation (cost model is equal to depreciation for tax purposes). Equipment, after initial recognition, is valued at cost less depreciation, and overall total accumulated losses based on impairment. Depreciation is recognized in the income statement in equal annual amounts over the estimated useful life of each item of property and equipment, since that is the best way to reflect the expected consumption of utility of economic value embodied in the asset. Depreciation is calculated at rates that provide compensation for the value of property and equipment over their useful lives in accordance with the act passed by the Chief Executive Officer.





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3.9. Property, Equipment and Intangible Assets (continued)

The basis for depreciation is the cost or revalued amounts of property and equipment, net of estimated residual (remaining) value. The method of amortization, the useful life and residual values are estimated at the end of the reporting period, and when it is necessary to perform appropriate correction. The Bank keeps records of property and equipment which provide the calculation of depreciation with the above-mentioned method, and the calculation of depreciation at the prescribed rates on the basis of amortization recognized by the applicable tax regulations. The difference between the amount of depreciation calculated in accordance with the accounting policies set out in this Article and the amount of depreciation, which is recognized by tax regulations is entered in the tax balance in a manner determined by tax regulations. Gains or losses on disposal of property and equipment is determined as the difference between the value realized from their sale and their book amount and are recognized within Other income and expenses in the period.

3.10. Investment property

Investment property is property (land, building or part of a building), which the Bank holds for the purpose of earning income from rents or to increase capital or for both, but not for sale in the ordinary course of business or to use for administrative purposes.

When one part of the property is used for business purposes and the other for rent, they are segregated into an investment property and property used for business purposes. Initial evaluation of investment property during acquiring (procurement) is carried at cost or purchase price. Cost of investment property is comprised of the purchase price and all expenses that are directly attributable to the acquisition of the asset.

Subsequent expenditure which relate to the already recognized investment property are attributed to the carrying amount of the investment property when it is probable that future economic benefits will be greater than originally estimated rate of return and investment property. All other subsequent expenditure is recognized as an expense in the period in which they arise. After initial recognition, investment property is carried at fair value which reflects market conditions at the balance sheet date. Fair value is estimated annually by independent certified appraiser. Changes in fair value are recorded in the income statement as part of Other income. Investment property is reclassified to Other assets when there is a change of its purpose, based on bookkeeping documents proving this change. Investment property is removed from the accounts when it comes to its disposal or when no future economic benefits are expected from its use and disposal. The difference between the book value and the sales value of investment properties which are for sale, are recognized in the income statement in the period in which it was made.





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3.11. Provisions

Provisions are recognized when the Bank has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources embodying economic benefits will be required to settle the liability, and a reliable estimate of the amount of the liability can be made.

3.12. Employee Benefits Employee Taxes and Contributions for Social Security Pursuant to the regulations effective in Montenegro, the Bank has an obligation to pay contributions to various state social security funds. These obligations involve the payment of contributions on behalf of an employee, by the employer, in the amounts calculated by applying the specific, legally prescribed rates. The Bank is also legally obligated to withhold contributions from gross salaries to employees, and on their behalf to transfer the withheld portions directly to the appropriate government funds. These contributions payable on behalf of the employee and employer are charged to expenses in the period in which they arise. Retirement Benefits In accordance with the Collective Bargaining Agreement, the Bank is under obligation to pay retirement benefits to an employee upon his/her regular retirement in the amount of 3 average salaries earned by the Bank's employees in the month in which payment is made. Long-term liabilities for provisions for retirement benefits represent the present value of expected future payments to employees determined in an actuarial valuation relying on the following assumptions: annual discount rate of 4 % and salary growth rate of 4,5 %.

3.13. Fair Value In accordance with IAS 32, "Financial Instruments: Disclosures and Presentation," the fair value of financial assets and liabilities should be disclosed in the Notes to the Financial Statements. For these purposes, the fair value is defined as an amount at which an asset can be exchanged, or a liability settled, between knowledgeable willing parties in an arm's-length transaction. The Bank is obligated to disclose the fair value information of those components of assets and liabilities for which published market information is readily available, and for which their fair value is materially different from their recorded amounts. In Montenegro, sufficient market experience, stability and liquidity do not exist for the purchase and sale of receivables, investments and other financial assets or liabilities, for which published market information is presently not readily available. Fair value cannot readily be determined in the absence of active capital and financial markets, as generally required under the provisions of IFRS/IAS. In the opinion of management, the reported carrying amounts are the most valid and useful reporting values under the present market conditions. To the extent of the identified estimated risk that the carrying value will not be realized, a provision is recognized based on the relevant decision of the Bank's management.





21

4. INTEREST INCOME AND EXPENSES

Interest Income In thousand EUR 2016 2015

From loans approved to: - Municipalities 176 542 - Corporate customers 1,857 2,294 - Retail customers 1,833 1,860

3,866 4,696

From securities: - securities available for sale 761 835 - securities held to maturity 26 7

787 842

Impairment allowance of interest receivables (878) (321)

3,775 5,217

Interest Expenses In thousand EUR 2016 2015

Banks and other financial institutions 109 160 Montenegro Government 9 14 Corporate customers 29 65 Retail customers 648 1,161

795 1,400

5. IMPAIRMENT LOSSES AND PROVISION CHARGES Impairment Losses In thousand EUR 2016 2015

Net impairment losses on: - loans 3,360 436 - fees and commissions - (1) - acquired assets 3,905 4,175 - fixed assets 122 - - other assets 172 24

7,559 4,634

Provision charges In thousand EUR 2016 2015

Net impairment losses per: - off-balance sheet items 232 47 - litigations 469 68 - other assets (note 24) 499 -

1,200 115





22

5. IMPAIRMENT LOSSES AND PROVISION CHARGES (continued) Movements on Accounts of Impairment Allowances of Irrecoverable Receivables and Provisions

In thousand EUR

Loans (note15)

Interest and guarantees

Fees and commisions

(note21)

Acquired assets

(note 21)

Employee benefits

andLitigations (note24)

Off-Balance Sheet Items

(note24)

Total

Balance as of January 1,

2015 4,613 1,674 205 2,378 311 128 9,309 Charge for the year , net 436 322 (1) 4,175 34 47 5,013 Other - 1 21 - - - 22

Balance as of December 31, 2015 5,049 1,997 225 6,553 345 175 14,344

Charged for the year, net 3,360 884 1 1,411 407 232 6,295 Other - - 166 - 499 - 665

Balance as of December 31, 2016 8,409 2,881 392 7,964 1,251 407 21,304

6. FEE AND COMMISSION INCOME AND EXPENSES Fee and Commission Income In thousand EUR 2016 2015

Loan fees 194 218 Fee and commission income from off-balance-sheet operations 77 83 Fee and commission income from payment transfers 570 614 Fee and commission income from foreign currency trading 150 148 Other fee and commission income 405 431

1,396 1,494

Fee and Commission Expenses In thousand EUR 2016 2015

Fees and commissions payable to the Central Bank 86 94 Fee and commission expenses arising from deposit insurance premium 394 389 Other fee and commission expenses 298 198

778 681





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7. STAFF COSTS

In thousand EUR 2016 2015

Net salaries 1,137 1,101 Payroll taxes and contributions 985 1,033 Other employee benefits, net 210 211 Remunerations to the members of the Board of Directors (Note 28) 31 78 Employee transport allowance, net 34 38 Business travel expenses and per diems 27 23 Employee professional trainings 2 9 Provisions for retirement benefits and jubilee awards (52) 32 Other staff costs 5 51

2,379

2,576

8. GENERAL AND ADMINISTRATIVE COSTS


Rental costs

200 183

Security services 204 200 Fuel and electricity 64 69 Cleaning 21 20 Taxes payable for business premises 76 66 Maintenance of vehicles 6 11 Insurance costs 59 26 Auditing services 111 111 Court fees 7 14 Other professional fees - 12 Lawyer fees 81 73 Intellectual services 39 67 Money transportation costs 24 31 Telephone bills 37 40 Communication network costs 277 311 Office supplies 48 64 Public utility costs 11 10 Representation costs 10 10 Marketing and advertising 80 135 Maintenance costs of fixed assets 232 244 Miscellaneous other cost 202 184

1,789 1,881

Miscellaneous costs relate to: storing of documentation amounting to EUR 43 thousand (2015: EUR 40 thousand), mediation services of an employment agency EUR 29 thousand (2015: EUR 25 thousand), other non-productive services - EUR 21 thousand (2015: EUR 21 thousand), fuel - EUR 15 thousand (2015: EUR 21 thousand), consumable material EUR 11 thousand (2015: EUR 14 thousand), publications - EUR 4 thousand (2015: EUR 6 thousand) and other costs which are not individually material.





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9. DEPRECIATION/AMORTIZATION CHARGE


Depreciation (Note 17) 159 190 Amortisation (Note 18) 77 90

236 280

10. OTHER INCOME Other income totalling EUR 53 thousand as of December 31, 2016 (December 31, 2015: EUR 45 thousand) mostly relate to the collection per off-balance sheet items (broken-period interest), as well as income from lease of investment property.

11. OTHER EXPENSES

Other expenses for the year ended December 31 2016 in the amount of EUR 226 thousand (December 31 2015: EUR 347 thousand) mostly relate to property tax paid for the property acquired through collection of receivables in the amount of EUR 121 thousand (December 31 2015: EUR 309 thousand) and costs of direct write-offs in the amount of EUR 78 thousand (December 31 2015: EUR 0 thousand).

12. INCOME TAXES

Components of Income Taxes In thousand EUR 2016 2015

Current income tax 61 (6) Deferred income tax 5 2

66 (4)

Numerical Reconciliation between Tax Expense and the Product of Accounting Results Multiplied by the Applicable Tax Rate In thousand EUR 2016 2015

Loss/Profit before tax (9,002) (4,983)

Income tax at the statutory tax rate of 9% (810) (448) Effects of expenses not recognized for tax purposes 12 4 Tax effects of capital gains from the sale of securities 61 11 Unrecognized tax credits on behalf of the transfer of losses for the year 861 455 Other (58) (18)

Tax effect on the income statements 66 4





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12. INCOME TAXES (continued) a) Deferred Tax Assets


Actuarial gains on retirement benefits 6 21

Deferred tax assets stated as of 31 December 2015 in the amount of EUR 21 thousand relate to taxable temporary differences between the tax base of provisions for retirement benefits and litigations recognized within the income tax return and the carrying values thereof as included in the Bank's financial statements. Unused tax losses which the Bank has not recognized as a deferred tax asset as at December 31 2016 are shown in the table below:

Year of beginning

Year of expiry

Tax loss

Years of using

Used amount

2015

2020

455

-

-

2016

2021

861

-

-

According to the Law on Profit Tax losses arising from business relations, excluding those resulting in capital gains and losses may be carried forward to offset profit in future periods, but not longer than five years.

b) Deferred Tax Liabilities


On higher carrying than tax NPV of property, plant and

equipment 49 44 Unrealized gains on securities available for sale 41 54 Gains on revaluation of fixed assets 87 - Other tax liabilities 35 -

Deferred tax liabilities 212 98

Deferred tax liabilities stated as of December 31, 2016 in the amount of EUR 212 thousand, out of which the amount EUR 34 thousand relates to taxable temporary differences between the tax base of business premises and other fixed assets as presented in the income tax return, while EUR 39 thousand refers to the taxable temporary differences between the tax base of available-for-sale securities which are recognized in tax balances and temporary differences arrising from revalorisation in amount of EUR 138 thousand of carrying values included in the Bank's financial statements.





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13. CASH AND DEPOSIT ACCOUNTS HELD WITH CENTRAL BANKS

In thousand EUR

December 31,

2016 December 31,

2015

Cash on hand: - in EUR 2,510 2,526 - in foreign currencies 471 271 Gyro account 10,400 2,126 Obligatory reserves with the Central Bank of Montenegro 6,233 7,374

19,614 12,297

The Bank's obligatory reserve as of December 31, 2016 represents the minimum deposits set aside in accordance with the CBM regulations referred to in the Decision on Obligatory Bank Reserves with the Central Bank of Montenegro (Official Gazette of Montenegro no. 73/15, 78/15 and 3/16). Pursuant to the aforementioned Decision, the required reserve is to be calculated based on demand deposits and time deposits. Deposit accounts held with depository institutions in Montenegro in the amount of EUR 6,233 thousand (2015: EUR 7,374 thousand) pertain to the obligatory reserve allocated at the rate of 9.5% applied to the portion of the basis for reserve calculation comprised of deman deposits and time deposits with maturities of up to a year, i.e. up to 365 days and at the rate of 8.5% applied to the portion of the basis for reserve calculation comprised of deposits with agreed maturities of over a year, i.e. over 365 days. The rate of 9.5% is also applied to deposits with maturities of less than 365 days and contracted early withdrawal clauses. Until December 31, 2016, The Bank may hold up to 25% of the obligatory reserve in the form of Treasury bills issued by Montenegro. The Central Bank of Montenegro calculates interest at the annual rate of 1% to the amount of 15% of the total allocated obligatory reserve funds and pays such interest up to the 8th day in a month for the preceding month. Banks that on the day of application of this Decision set aside and hold more than 25% of obligatory reserve of the form of Treasury bills, may continue to hold the bills as part of their reserve until their maturity. Banks that on December 31, 2016 be set aside and held the reserve requirement in Treasury bills, may continue to hold the bills as part of their reserve until their due date, but not later than March 31, 2017.

14. LOANS AND RECEIVABLES DUE FROM BANKS

In thousand EUR

December 31,

2016 December 31,

2015

Correspondent accounts held with foreign banks 7,475 15,711 Deposits held with foreign banks 10 -

7,485 15,711





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15. LOANS AND RECEIVABLES DUE FROM CUSTOMERS

In thousand EUR

December 31,

2016

December 31, 2015

restated

Matured loans: - corporate customers - private ownership 5,495 5,416 - entrepreneurs 30 27 - municipalities 37 53 - retail customers 1,673 1,681 Short-term loans: - corporate customers - private ownership 5,293 3,145 - entrepreneurs 37 58 - municipalities - - - retail customers 362 401 Long-term loans, including current portions thereof: - corporate customers - private ownership 18,073 21,806 - public companies 45 100 - entrepreneurs 48 34 - municipalities 2,947 3,555 - retail customers 21,850 19,487 Other 38 40

55,928 55,803

Interest receivable: - loans 3,076 2,719 Deferrals: - interest accrued on loans 6 19 -fees accrued on loans (373) (380) Guarantees called on 145 146

2,854 2,504

Total 58,782 58,307

Less: Impairment allowance of loans (note5) (8,409) (5,049) Impairment allowance of interest (note 4) (2,736) (1,858) Impairment allowance of guarantees unsettled (145) (139)

(11,290) (7,046)

47,492 51,261

Short-term loans are approved to legal entities at nominal interest rates from 2.3% to 15% annually. Long-term loans to corporate clients are granted to the maximum period of six years, at the nominal interest rates from 2.2% to 11,90% per annum. As of 31 December 2016 and 2015, all loans were approved to customers domiciled on the territory of Montenegro and Serbia.





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15. LOANS AND RECEIVABLES DUE FROM CUSTOMERS (Continued)

The concentration of total gross loans to customers per industry sector was as follows: In thousand EUR

December 31,

2016 December 31,

2015

Agriculture, hunting and fishing 1,664 1,256 Construction industry 5,226 6,195 Trade 8,801 8,598 Services, tourism, accommodation industry 1,216 1,577 Transport, storage, postal services and telecommunications 656 615 Real estate trade 760 282 Administration and other public services 1,076 606 Retail customers 23,885 21,568 Wireless telecommunications 3,008 2,922 Healthcare 2,929 3,424 Other 6,707 8,760

55,928 55,803

16. INVESTMENT SECURITIES

Securities Available for Sale and Held-to-maturity

In thousand EUR

December 31,

2016 December 31,

2015

Goverment bonds: Republic of Serbia bonds 4,729 12,830 Republic of Montenegro bonds * 16,090 2,708 Treasury bills: Republic of Montenegro bills 2,966 -

23,785 15,538

Invoiced interest receivables per securities 468 395 Invoiced interest per treasury bills 23 -

24,276 15,933

*Purchase on secondary market. Available-for-sale assets are initially measured at cost and stated at market value if known as of the balance sheet date. Gains and losses incurred upon the change in the market value of these securities are stated as revaluation reserves within equity until such financial assets are sold, collected or disposed of, when revaluation reserves are transferred to income or expenses. Held-to-maturity securities totalling EUR 2,966 thousand as of December 31, 2016 (2015: EUR nil).





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17. PROPERTY, PLANT AND EQUIPMENT

Movements on property, equipment and other assets during 2016 and 2015 are presented in the table below: In thousand EUR

Buildings

Equipment and other

assers Total

Cost Balance at January 1, 2015 1,850 1,858 3,708 Additions 9 104 113 Retirement and disposal - (172) (172)

Balance at December 31, 2015 1,859 1,790 3,649

Balance at January 1, 2016 1,859 1,790 3,649 Additions 112 59 171 Retirement and disposal - (162) (162) Transfer from foreclosed assets and adaptation 839 - 839 Revaluation of fixed assets 1,551 - 1,551


Allowance

Balance at January 1, 2015 408 1,575 1,983 Depreciation (note 9) 69 121 190

Retirement and disposal - (170)

(170)

Balance at December 31, 2015 477 1,526 2,003

Balance ar January 1, 2016 477 1,526 2,003 Depreciation (note 9) 70 89 159 Impairment 121 - 121 Revaulation of fixed assets 581 - 581 Transef from acquired assets 528 - 528 Retirement and disposal - (157) (157)


Net Book Value as of:

- December 31, 2016

2,584 229 2,813

- December 31, 2015 1,382 264 1,646

As of 31 December 2016 the Bank had no mortgage or pledge liens instituted over its asset to securitize loan repayment or settlement of other liabilities.





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18. INTANGIBLE ASSETS

Intangible assets mostly comprise licenses and software. Movements on intangible assets in 2016 and 2015 are presented in the table below:


Cost Balance at January 1 669 659 Additions 42 10

Balance December 31 711 669

Accumulated amortization Balance January 1 530 442 Amortization (note 9) 77 90 Other - (2)

Balance December 31 607 530

Net book value at December 31 104 139

19. INVESTMENT PROPERTY/REAL ESTATE In 2016, The Bank recored investment real estate amount of EUR 963 thousand. These are the

business premises by the Bank during 2016 began to leases.

20. OTHER FINANCIAL RECEIVABLES Other financial receivables in the total amount of EUR 584 thousand (December 31, 2015: EUR 797 thousand) relate to receivables arising from damage compensation (EUR 272 thousand), receivables for lawyers' fees (EUR 106 thousand) and other receivables which are not material. Allowance for impairment of fees and commissions in the amount of EUR 392 thousand is presented in Note 20 – Other Trade Receivables.

21. OTHER OPERATING RECEIVABLES

In thousand EUR

December 31, 2016

December 31, 2015

restated

Assets acquired in collection of debt

15,544

18,874

Prepaid expenses 46 78

15,590 18,952 Accumulated depreciation of acquired assets (note 5) (7,964) (6,553) Allowance for impairment of fees and commissions (note 5 and 20)

(392) (225)

7,234 12,174





31

21. OTHER TRADE RECEIVABLES (Continued)

Assets received in lieu of debt collection totalling EUR 15,544 thousand as of December 31, 2016 (December 31, 2015: EUR 18,874 thousand) relates to assets acquired based on the foreclosure of collaterals securing loans (Fiduciaries). Below is a comparative view of proceeds and collection of receivables and the related depreciation.

Per day

Assets received in lieu of

debt collection

Allowance

impairment of acquired assets

Net book value of acquired assets

31.12.2010

8,264

-

8,264

31.12.2011 9,069 28 9,041 31.12.2012 10,551 28 10523 31.12.2013 13,252 887 12,365 31.12.2014 18,675 2,378 16,297 31.12.2015 18,874 6,553 12,321 31.12.2016 15,544 7,964 7,580

These assets are carried at the lower of gross carrying value of receivables or market value of an assets net of costs to sell. In 2016, the Bank acquire assets based on the foreclosure of assets – business premises in (LN 436 KO Hoti) and the value as of the acquisition date amounting to EUR 45 thousand and business premises LN 615 Petrovac valued as of the acquisition date amounting to EUR 232 thousand. Business premises (LN 436 Ko Hoti) The Bank leases and its reclassified as an Investment property.

22. CUSTOMER DEPOSITS

In EUR thousand December 31

2016 December

31 2015

Demand deposits: - municipalities 864 330 - corporate customers - private ownership 10,039 6,923 - entrepreneurs 109 102 - retail-customers 40,289 32,744 - NGOs 518 338 - other customers 312 97

52,131 40,534 Short-term deposits: - corporate customers - private ownership 2,683 2,877 - municipalities 5,500 1,300 - private individuals 19,660 25,941

27,843 30,118 Long-term deposits: - corporate customers - private ownership 613 740 - private individuals 3,299 4,614

3,912 5,354

83,886 76,006

Interest payable and other liabilities Deferrals: deposits 333 813

84,219 76,819





32

22. CUSTOMER DEPOSITS (continued) Demand deposits placed by retail customers in EUR were deposited at an interest rate of 0.05% - 0.10% annually, while retail deposits denominated in other currencies accrued interest at the interest rate of 0.01 %- 0.05% annually. Time deposits of retail customers in EUR falling due within: 3 months were deposited at an interest rate of 0,80%- 1.20% annually 6 months were deposited at an interest rate of 1.10%-1.50% annually 12 months were deposited at an interest rate of 1.60%- 1.80% annually 24 months were deposited at an interest rate of 1.80%- 2.00% annually 36 months were deposited at an interest rate of 2.00%- 2.20% annually. Time deposits of retail customers denominated in foreign currencies falling due within: 3 months were deposited at an interest rate ranging between 0.35% annually 6 months were deposited at an interest rate ranging between 0.80% annually 12 months were deposited at an interest rate ranging between 1.10% annually 24 months were deposited at an interest rate ranging between 1.30% annually 36 months and were deposited at an interest rate ranging between 1.35% annually. On corporate demand deposits the Bank doesn't pay interest. Time deposits of corporate entities placed in EUR falling due within: 3 months were deposited at an interest rate of 0.30% annually 6 months were deposited at an interest rate of 0.80% annually 12 months were deposited at an interest rate of 1.50% annually 24 months were deposited at an interest rate of 1.80% annually 36 months were deposited at an interest rate of 2.00% annually. Time deposits of corporate customer placed in foreign currencies falling due within: 3 months were deposited at an interest rate of 0.10% annually 6 months were deposited at an interest rate of 0.15% do 0.35% annually 12 months were deposited at an interest rate of 0.30% do 0.55% annually 24 months were deposited at an interest rate of 0.40% do 0.65% annually 36 months were deposited at an interest rate of 0.40% do 0.65% annually. At December 31 2016, the Bank had EUR 1,325 thousand (December 31 2015: EUR 1,350 thousand) of earmarked deposits placed as collaterals for loans and advances approved to customers.





33

23. BORROWINGS FROM BANKS AND OTHER CLIENTS

In thousand EUR

December 31 2016

December 31 2015

restated

European Investment Bank 3,268 4,071 Investment and Development Fund of Montenegro 978 160 Directorate for development of small and medium sized enterprises of Montenegro 32 52 Ministry of Finance of Montenegro 456 455

1,466 667

Invoiced interest 3 3 Accruals - Loans 125 138

128 141

4,862 4,879

As of December 31 2016, the Bank has the following borrowings from the European Investment Bank:

In thousand EUR

Period/

Year Annual

Interest Rate

December 31,

2016

December 31,

2015

European Investment Bank 10

3.68% 1,125 1,500

European Investment Bank 10 2.03% 2,143 2,571

3,268 4,071

Borrowings totalling EUR 3,268 thousand as of December 31, 2016 (2015: EUR 4,071 thousand) refer to the liabilities toward the European Investment Bank for repayment of the loan obtained to finance investment projects with a grace period of 2 years. The Bank is not obligated to comply with any covenants on financial indicators in respect of the aforesaid borrowings. The maturities of liabilities arising from borrowings from European Investment Bank are presented in the table below: In thousand EUR

December 31, 2016

up to 1 year

804

from 1 to 2 years

804 from 2 to 3 years

804

from 3 to 4 years

429 from 4 to 5 years

427

over 5 years

0

3,268





34

23. BORROWINGS FROM BANKS AND OTHER CLIENTS (continued)

The liabilities to the Government in the amount of EUR 1,466 thousand (2015: EUR 667 thousand) relate to the liabilities arising from long-term borrowings obtained from the Investment and Development Fund of Montenegro of EUR 978 thousand (2015: EUR 160 thousand) and Directorate for development of small and medium sized enterprises of Montenegro of EUR 32 thousand (2015: EUR 52 thousand) that the Bank uses to extend loans to ultimate beneficiaries for the purposes of funding investment projects. Such loans are approved with repayment periods of 3 years and grace periods ranging from 12 to 24 months. The Bank also has liabilities toward Montenegro Ministry of Finance of EUR 456 thousand (2015: EUR 455 thousand) for the Project 1000+ Apartments addressing the housing issues of the socially underprivileged population categories.

24. PROVISIONS

In EUR thousand December 31,

2016 December 31,

2015

Provisions for losses contigent on off-balance sheet exposures (note 5) 407 175 Provisions for retirement benefits and jubilee awards 130 173 Provision for unused vacations 86 96 Provisions for litigation 536 76 Other provisions-employee benefits 499 -

1,658 520

On the December 31, 2016 The Bank made provision in the amount of EUR 499 thousand for less paid winter allowances, holiday allowances and salaries for the period of 2008 - 2016 according to the analysis and assumptions derived from involved law firms opinion.

25. OTHER LIABILITIES In thousand EUR December 31,

2015 December 31,

2015

Liabilities arising from consignment operations

16

24

Advances received 35 8 Other taxes payable 224 17 Accounts payable 87 129 Other liabilities 155 47

517

225

26. SHARE CAPITAL

a) Share capital

The Bank's share capital as of December 31, 2016 was comprised of 2,737 common shares with the par value of EUR 10,000. The Law on Banks (Official Gazette of Montenegro no. 17/08, 44/10 and 40/11) defines that the minimum cash amount of initial capital may not be less than EUR 5,000 thousand. At December 31, 2016, the Bank's capital complied with the prescribed minimum capital requirements. In 2015 and 2016, dividends were not paid to Komercijalna banka a.d., Beograd. At December 31, 2016, Komercijalna banka a.d., Beograd was the sole (100%) owner of the Bank.





35

26. SHARE CAPITAL (continued) b) Other reserves

At December 31, 2016, other reserves amount to EUR 4,538 thousand (2015: EUR 4,922 thousand).

In thousand EUR

December 31, 2016

December 31, 2015

Effects of changes in fair value of securities available for sale 412

547

Regulatory reserves 3,222

4,287

Actuarial gains in accordance with IAS 19 75

78

Efects of the revaluation of buildings 883

-

Other provisions (54)

10

4,538 4,922

c) Regulatory reserves

Decision of the Assembly of Shareholders No.14 / 2-2 of May 30, 2016 has brought to bear the transfer of more established necessary or missing reserves per regulatory requirement in the amount of EUR 1,065 thousand (at December 31, 2015: EUR 2,591 thousand) on the account of retained accumulated profit from previous years and that will partly serve to cover the losses incurred in the previous year.

27. COMPLIANCE WITH REGULATORY REQUIREMENTS OF THE CENTRAL BANK OF MONTNEGRO The Bank is required to maintain certain ratios pertaining to the scope of its activities and volume and composition of risk-weighted assets in compliance with the Law on Banks and regulations of the Central Bank of Montenegro. The Bank's core capital formed in accordance with the Decision on Capital Adequacy (Official Gazette of Montenegro no. 60/08, 41/09, 38/11 and 55/12), as of December 31, 2016 amounted to EUR 16,277 thousand. The Bank's core capital as of December 31, 2016 comprised the basic elements of the Bank's own assets: paid-in share capital at par value, reserves from prior years' profits after taxes and the current year retained earnings net of amount of intangible assets. The Bank's own assets as of December 31, 2016 totaled EUR 17,247 thousand and represented the sum of the Bank's core capital and supplementary capital. As of December 2015, the Bank stated deductible items reducing the gross own assets of the Bank representing the amount of shortfall reserves of EUR 1,318 thousand. Risk weighted assets and off-balance sheet items formed in accordance with the Decision on Capital Adequacy in Banks amounted to EUR 82,472 thousand.





36

27. COMPLIANCE WITH REGULATORY REQUIREMENTS OF THE CENTRAL BANK OF MONTNEGRO

(continued) The Central Bank of Montenegro Decision on the Minimum Standards for Bank Investments in Immovable Property and Fixed Assets (Official Gazette of Montenegro no. 24/09, 66/10, 58/11, 61/12, 13/13, 51/13 and 16/15), prescribes that the amount of investments in immovable assets and fixed assets in excess of 50% of the Bank's own assets be treated as a deductible item upon calculation of the total aggregate amount of the Bank's own assets. Acquisition of property in lieu of debt collection within the process of NPL restructuring, bankruptcy or liquidation proceedings or execution procedure instigated for debt collection, on condition that no more than 4 years have passed from the property acquisition date. The regulations of the Central Bank of Montenegro do not stipulate the period/deadline within which the Bank must sell the assets acquired in lieu of debt collection. In accordance with the Law on Banks (Official Gazette of Montenegro no.17/08, 44/10 and 40/11), the Bank is obliged to maintain the minimum capital adequacy ratio of 10%. The capital adequacy ratio computed by the Bank as of December 31, 2016 equalled 18,33% (December 31, 2015: 25,32%) and it exceeded the prescribed minimum. The largest exposure towards a single entity as of December 31, 2016 amounted to 27,64% (Republic of Serbia bonds) and is above the prescribed maximum of 25% of the Bank's own assets. Exposure towards the client M-tel amounts to 27.38% and its also above the presribed maximum of 25% of the Bank's own assets. The largest exposure towards a single entity as of December 31, 2015 amounted to 53.56% (The Republic of Serbia bonds) and is above the prescribed maximum of 25% of the Bank's own assets. On March 31, 2016 the Bank has reduced the exposure, towards the above - mentioned client, below the prescribed maximum.

As of December 31, 2016 the Bank had no exposures exceeding 800% of own assets.

28. OFF-BALANCE SHEET ITEMS

In thousand EUR December 31,

2016 December 31,

2015

Irrevocable commitments for loan approval 9,071 9,119 Guarantees issued Payment guarantees 3,570 2,802 Performance guarantees 362 546 Other forms of guarantees - 10 Collaterals securing receivables 124,169 193,827 Other off-balance sheet exposures 587 552

137,759 206,856

Memorandum Broken-period interest 5,053 5,071

Total 142,812 211,927





37

29. RELATED PARTY TRANSACTIONS

The breakdown of receivables and payables arising from transactions with related parties as of December 31, 2016 and 2015 is presented in the following table:

In thousand EUR

December 31,

2016 December 31,

2015

Receivables Foreign currency accounts: : - Komercijalna banka a.d., Beograd 3,553 7,195

Total receivables 3,553 7,195

Payables Borrowings : - Komercijalna banka a.d., Beograd 37 34

Total payables 37 34

Receivables/(payables), net 3,516 7,161

Income

Foreign exchange gains: - Komercijalna banka a.d., Beograd 212 101

Total income 212 101

Fee and commission expenses: - Komercijalna banka a.d., Beograd 21 9

Foreign exchange losses: - Komercijalna banka a.d., Beograd 138 67

Total expenses 159 76

Expenses, net 53 25

Off-balance sheet receivables Principal receivable from consignment operations: - Komercijalna banka a.d., Beograd 18 20 Interest receivable from consignment operations: - Komercijalna banka a.d., Beograd 7 7

25 27

At December 31, 2016 receivables from employees amounting to EUR 1,326 thousand (2015: EUR 528 thousand), related to the loans approved to employees. In 2016, the Bank paid to the key management, including the Chief Executive Officer and executive managers and heads of departments, the amount of EUR 647 thousand as remunerations (2014: EUR 553 thousand). The remunerations paid to the members of the Board of Directors and of the Audit Committee amounted to EUR 31 thousand (2015: EUR 78 thousand) (Note 7). One business property that is classified as Investment property of the Bank, is used for the purpose of housing by one employee.





38

30. RISK MANAGEMENT

The Bank has recognized risk management process as the key element of business management given that risk exposure is an inseparable part of banking and is managed through a process of continued identification, measurement, monitoring, mitigation, control and reporting, i.e. setting of risk limits and through other types of control, including reporting in accordance with adopted strategies and policies. The Bank has established a comprehensive and reliable risk management system that includes: risk management strategies, policies and procedures, appropriate organizational structure, effective and efficient process of managing all risks it is exposed to, adequate system of internal controls, adequate information system and process of internal capital adequacy assessment. Risk management process involves clear determining and documenting risk profile and adjusting risk profile to the Bank's aptitude to assume risks in accordance with the adopted strategies and policies. The basic objectives that the Bank set for the risk management system in its internally adopted acts are the following: minimizing the negative effects on financial result and equity within acceptable risk levels, maintaining the required level of capital adequacy, developing the Bank's activities in accordance with business opportunities and market development with a view to gaining competitive advantage. The Bank implements all the internationally recognized standards and continuously monitors all the announcements of amendments to the effective regulations, analyses the impact thereof on the risk level and undertakes measures for timely adjustment of its operations to the new regulations according to the risk level acceptable to the Bank. Through the clearly defined process of new product introduction the Bank analyses the impact of all new services and products on the future risk exposures in order to optimize its revenues and costs per estimated risk as well as to minimize all potentially adverse effects on the Bank's financial performance. Risk Management System

The risk management system is governed by the following acts:

- Risk Management Strategy and Capital Management Strategy and Plan;

- The strategy of dealing with non-performing loans;

- Risk management policies;

- Risk management procedures;

- Methodologies for managing individual types of risks; - Other enactments.

The Risk Management Strategy includes:

- Overview and definitions of all risks the Bank is exposed to or may be exposed to;

- Objectives to be reached by implementing the Strategy;

- General criteria and methods relevant for creation of the risk management

framework;

- General risk management policy principles;

- Focus on business activities, products and services that will dominate the Bank'

operations with description of the Bank's basic attitude in respect of individual

risk types arising from its operations;





39

30. RISK MANAGEMENT (continued)

- Definition of the bank's risk appetite with expected return relative to risk for the

Bank's portfolio segments and total assets;

- Basic elements of the Bank's process of internal capital adequacy assessment;

- Distribution of competences and responsibilities and comments on the future

development of the Bank's units and departments. Long-term objectives the Bank wants to achieve by implementing the Strategy are as

follows:

- development of activities in accordance with the Business Strategy and market opportunities and developments in order to create competitive advantage;

- avoidance or minimization or risks in order to maintain the business operations within acceptable risk levels;

- minimization of adverse effects on the Bank's capital;

- maintenance of the required capital adequacy ratio;

- diversification of risks the Bank is exposed to.. Policies for managing certain risk types define the following in more detail::

- Manner of organizing risk management processes within the Bank and clear division of personnel responsibilities in all stages of the process;

- Manner of assessing the Bank's risk profile and methodology for identifying, measuring and assessing risks;

- Manners of risk monitoring and control and establishing the system of limits, i.e. types of limits the Bank uses as well as their structure;

- Measures for risk mitigation and rules for implementation thereof;

- Manner and methodology for implementing the process of internal assessment of the Bank's capital adequacy;

- Principles of the system of internal controls; functioning; - Framework and frequency for stress testing and procedure in instances of unfavourable

test results. Procedures for managing certain risk types define, in greater detail, the process of managing risks and competencies and responsibilities of all organizational units of the Bank in the risk management system. Individual methodologies further and in more detail prescribe methods and approaches used in the risk management system.





40


Competences Board of Directors (BoD) determines the objectives and strategies of the Bank and ensures implementation thereof, including the risk management strategy and capital management strategy; establishes and maintains the system for managing risks the Bank is exposed to in its operations; ensures the execution of the process of internal capital adequacy assessment and its compliance with the strategic goals; determines the annual business plan of the Bank, including the financial plan; adopts the annual report on the Bank's business operation with the independent auditor's report and interim reports on the Bank's operations; approves transactions that have significant influence on the structure of the Bank's assets and liabilities and risk level of the Bank's operations in accordance with the risk management policies and procedures; periodically reviews and evaluates exceptional deviations from the risk management policies and procedures; adopts the Internal Audit annual plan and reports; establishes basis for the functioning of the internal system, adequate to the size of the Bank, complexity of its operations and level of risk assumed; enacts general enactments and bylaws, except those enacted by the Shareholder Assembly; adopts the Business Continuity Plan and Disaster Recovery Plan; approves of new product or service introduction, enacts decisions on the organizational structure of the Bank and performs other tasks defined by the Law and Bank's Statute. The Audit Committee analyses and monitors the functioning of the risk management system and offers proposals for improvements to risk management strategies, policies and procedures; analyses and monitors functioning of the internal control system; reviews the program and reports of the Internal Audit and expresses an opinion on the findings of internal audit; monitors the realization of the internal audit recommendations; analyses the Bank's financial statements before their submission to the Board of Directors; evaluates the quality of the statements and information before their submission to the Board of Directors, particularly the following: application of the accounting policies and procedures, decisions requiring high degree of estimation, effects of uncommon transactions on the financial statements, quality of the policies for unification of data, changes resulting from the previously conducted audits, going concern assumptions, compliance with the International Financial Reporting Standards and regulations; expresses an opinion on the selection of the external auditor and proposes the amount of the fee for the auditing services. The Asset and Liability Management Committee (ALCO) monitors risk management in certain areas of the Bank's business, monitors the Bank's risk exposure resulting from the structure of its receivables, payables and off-balance sheet items, and proposes measures for managing interest and liquidity risks, and performs other tasks defined by the BoD Decisions and Bank's bylaws.

The Credit Committee reviews proposals of the Corporate and Retail departments and

opinions and views of the Risk Management Department on the loan proposals - proposals for

loan approval up to the limit amounts for transactions under the remit of the CEO and

executive officers, proposes to the CEO and executive officers enactment of decisions on

loan approval up to the limit amounts for transactions under their remit, proposes to the

executive officer improvements to the practices and policies and procedures for credit risk

management.





41

30. RISK MANAGEMENT (Continued)

Competences (continued)

Executive Officers implement the Bank's determined strategies, including the risk management strategies and policies, and the capital management strategy; ensure that the employees are familiar with the regulations and other Bank's enactments governing their duties and responsibilities; decide on the business transactions in accordance with the Bank's bylaws, particularly decisions related to the transactions within their remit such as procurement and disposal of fixed assets under their remit; implement the Business Continuity Plan and Disaster Recovery Plan, review those plans according to the changes in business and test them; inform without delay the BoD and the Head Office of each deterioration of the Bank's financial position or warn thereof and of other factors that may significantly affect the Bank's financial standing; decide on other matters under their remit and matters that are not within the competence of the Shareholder Assembly and BoD. Risk Management Department is responsible for identification, measurement, assessment and management of risks the Bank is exposed to; it identifies possible causes of certain risk type occurrence; supervises and monitors risks at the Bank level; coordinates, measures and makes projections of the risk exposures; proposes policies, procedures and methodologies for risk management and informs the Bank's competent bodies on risk management.

The Internal Audit Divisionis an independent function that ensures the following: evaluation of the adequacy and effectiveness of the internal control system; identification of the key risk areas of the Bank's business and evaluation of the implementation and effectiveness of risk management policies and risk assessment methodologies; assessment of the IS quality and reliability; analysis of the accuracy, timeliness and reliability of the accounting records and financial statements; assessment of the compliance of the capital and risk levels in the Bank's business operations; testing of transactions and functioning of the special internal control system procedures; evaluation of the compliance function in respect of the laws, regulations and the Bank's defined policies and procedures; recommendations for elimination of the identified irregularities and improvement of the existing procedures and systems.

The Compliance Division is in charge of the Bank's compliance risk identification, measurement, monitoring, control and reporting. In addition, the Compliance Division performs other tasks in accordance with its responsibilities defined by the Law on Banks, Bank's Statute and other bylaws governing compliance. Risk Management Process The Bank regularly measures and evaluates risks identified in its operations. Measurement entails applying qualitative and quantitative measurement methods and models that enable detection of changes in risk profile and assessment of new risks. For all risks identified the Bank determines their significance based on a comprehensive assessment of risks inherent in the Bank's particular operations, products, activities and processes. Risk alleviation or mitigation involves risk diversification, transfer, minimization and or avoidance; the Bank performs risk mitigation in accordance with the Bank's risk profile and risk appetite. Risk monitoring and control is based on limits that are set by the Bank. They in turn depend on business strategy and the business environment, as well as on the level of risk that the Bank is ready and willing to assume.





42


Risk Management Process (continued) Risk management reports are regularly submitted to: the Board of Directors, Executive Board, Audit Committee, Asset Liability Management Committee and CEO and Executive Officers and they contain all the information required for risk assessment and reaching of conclusions about the risks.

Types of Risk In its business operations the Bank is exposed to the following risks in particular: credit risk and related risks, liquidity risk, market risk and operational risk, investment risk, country risk and all other risks that may occur in the course of the Bank's regular operations.

Credit risk

Credit risk represents the risk of negative effects on the Bank's financial result and capital arising from debtors' inability to settle the matured liabilities to the Bank.

The Bank monitors the following risks within the credit risk:

- Default risk – the risk of loss that may arise if a debtor fails to settle liabilities toward the

Bank; - Downgrade risk – the risk of loss that may arise if a risk level of a debtor is downgraded

(deterioration of the customer credit rating); - Concentration risk represents a risk that is a direct or indirect outcome of the Bank's

exposures the same or similar risk factor or type, such as: exposure to a single entity or a group of related parties, industries, geographical regions, types of products and activities, collaterals, financial instruments;

- Exposure risk is a risk that can arise from the Bank's exposure to a single entity, group of related entities or the Bank's related parties;

- Country risk relates to the borrower's country of origin and represents the probability of negative effects on the Bank's financial result and equity due to the inability to collect receivables from abroad and is caused by political, economic and social conditions in the borrower's country of origin.

In addition to the aforelisted risks, the Bank also monitors the following related risks:

- Residual risk is a risk that credit risk mitigation techniques may be less efficient than expected, i.e. that their application is not sufficient to alleviate the risks the Bank is exposed to;

- Settlement/delivery risk - is a risk of possible emergence of negative effects on the Bank's financial results and capital due to counterparty default on free delivery transactions as of contractually defined settlement/delivery date;

- Counterparty risk - is a risk of possible emergence of negative effects on the Bank's financial results and capital due to counterparty failure to settle its liabilities prior to the ultimate settlement of the transaction cash flows, i.e. settlement of cash payment.

According to the volume, type and complexity of its operations, the Bank has organized the credit risk management process and clearly delineated employee responsibilities in all stages of the process. The organizational model of credit risk management system enables adequate communication, information exchange and collaboration at all organizational levels within the Bank as well as clear operational and organizational separation of functions for independent risk management and supporting activities on one hand and the activities of risk assumption on the other, i.e. segregation of duties, competencies and responsibilities. The Bank has also established an adequate information system for full coverage of persons involved in credit risk management system and appropriate management reporting.





43


Credit risk (continued) The objective of credit risk management is to minimize adverse effects of the credit risk on the Bank's financial result and equity based on balance sheet and off-balance sheet investments and operations with counterparties for items carried in the banking book. The level of credit risk exposure acceptable to the Bank is in line with the defined risk management strategy and depends on the Bank's portfolio structure based on which negative effects on the Bank's financial result is limited and capital requirements for credit risk, settlement/delivery and counterparty risk are minimized in order to maintain capital adequacy at an acceptable level. On the other hand, the Bank does not make high-risk investments such as investments in highly profitable projects with significant risk levels. In its effort to manage credit risk the Bank seeks to do business with customers that have good credit rating and to acquire appropriate collaterals to secure repayments. The Bank assesses creditworthiness of each customer upon the submission of a loan application and regularly monitors its debtors, loans and collaterals, in order to be able to undertake appropriate activities for the purpose of collecting its receivables. Credit risk identification involves analysis of all indicators leading to the emergence and increase in credit risk exposure. The Bank determines the causes of the current credit risk exposure in a comprehensive and timely manner and assesses such causes based on the incurred and projected changes in the market, as well as based on the introduction of new products and activities. The Bank's credit risk depends on the debtor creditworthiness, debtor's regularity in settling liabilities due to the Bank and collateral quality. The Bank performs quantitative and/or qualitative measurement, i.e. assessment of the identified credit risk. The credit risk measurement process is based on two parallel approaches:

- Regulatory approach - process of impairing investments and estimating provisions against losses per off-balance sheet as required by IAS 39 and IAS 37 and calculating provisions pursuant to the regulations of the Central Bank of Montenegro (CBM);

- Internal approach - measuring risk level of individual loans and investments based on the internally adopted rating system.

The rating system is not merely an instrument for forming individual decisions and assessing risk levels of individual investments; it is also a basis for portfolio analysis, support in loan approval and loan impairment procedure as well as in estimating provisions against losses per off-balance sheet items for the purpose of loan and investment ranking by risk level and stating realistic value of receivables. The interna rating system is subject to regular review and improvement. In addition to the internal rating system, in credit risk analysis the Bank also uses principles prescribed by the CBM regulations, which require classification of receivables and investments based on the prescribed criteria as well as calculation of the reserve for estimated credit risk losses. Application of these principles allows the Bank to cover unexpected losses due to the customer's inability to settle liabilities as they fall due, in accordance with contractually defined terms. For these purposes, the Bank classifies receivables and assesses the level of necessary reserve using the regular analysis of portfolio. The analysis includes the measurement of adequacy of reserves formed against individual borrowers, risk categories, portion of portfolio and at overall portfolio level. Reserves for estimated losses represent a certain form of hedge against potential adverse effects in case invested funds are not repaid when due and in full.





44


Credit risk (continued) Prior to loan approval, the Bank assesses the creditworthiness of the borrower based on internally defined criteria as a primary and offered collateral as a secondary source of collection/loan repayment. Based on the identified and measured credit risk level (assessed financial situation and credit worthiness of the borrower, value and legal security of the credit hedge and other relevant factors), and independent risk assessment, the Bank's competent bodies enact a loan approval decision in accordance with the defined decision making system.

In decision making related to areas of crediting, irrespective of the decision making level, the principle of double control, the so-called "four eyes principle," is observed which ensures that there is always a party that proposes and a party that approves a particular loan/investment.

Alleviating credit risk entails maintaining the risk at the level acceptable to the Bank's risk profile, i.e. maintaining acceptable level of the Bank's loan portfolio. The basic techniques for credit risk mitigation are as follows:

- Exposure limits - concentration risk; - Investment diversification; - Collaterals; - Residual risk.

The Bank's exposure limits per individual debtor are based on the assessment of the debtor's creditworthiness, whereas the exposure limits at the portfolio level are focused on restricting exposure concentration within the portfolio. The Bank continuously controls credit risk movements within a defined risk profile.

Concentration risk includes: large exposure (exposure to a single entity or a group of related entities and the Bank's related parties), group exposures with the same or similar risk factors such as industry sectors, types of products, geographical areas and the like, county risk and credit risk hedges.

Investment diversification is aimed at alleviating credit risk through reduction portfolio concentrations in certain segments of assets. Monitoring loan investment quality at the individual debtor level is primarily based on obtaining updated information on the financial situation and creditworthiness of the debtor as well as on the market value of collateral, whereas credit risk monitoring at the portfolio level is performed through identification of changes at the level of client groups with certain pre-set levels of risk, investment, collateral and required reserves for estimated and unexpected losses for the purpose of establishing management of the asset balances and quality. For protection against credit risk exposure, in addition to the regular monitoring of the customers' business operations, the Bank contractually defines security instruments (collaterals), which reduce credit risk. In order to protect itself from changes in the market value of collaterals (mortgages, pledges, securities etc.), the Bank adjusts the appraised collateral value for a defined percentage depending on the collateral type and location, which percentage is reviewed at least annually or more frequently as appropriate. In this way, the Bank protects itself from potential losses arising from the impossibility of collection of receivables through security instrument activation.





45


Credit risk (continued)

Credit risk control entails a process of continuous reconciling business operations with the defined system of limits, both on a daily and monthly bases, as well as under conditions of large credit exposure approaching the upper risk profile limit, i.e. upon introduction of new products and business activities.

The Bank reschedules and restructures receivables from customers experiencing certain difficulties in operations. If the undertaken measures for regulating collection, i.e. enforced collection and court proceedings fail to provide expected results, i.e. when receivables cannot be collected in full, the Bank initiates write-off of the remaining receivables.

Apart from credit risk exposure, the Bank also has off-balance sheet exposures (various types of payment and performance guarantees, acceptances and letters of credit) based on which the Bank has contingent liabilities to make payments on behalf of third parties. For off-balance sheet exposures the Bank uses the same control processes and procedures that are used for credit risk. Credit risk reporting includes internal and external reporting systems executed on a monthly basis according to a pre-set schedule and in conformity with the define reporting system. Downgrade Risk The quality of the Bank's assets is measured by the level of exposure to individual risk categories according to internal rating system criteria. The internal rating system focuses on quantitative and qualitative parameters for assigning customer ratings. The rating scale consists of 5 risk categories that are subdivided into 17 subcategories. The rating scale is used as a uniform method for assigning ratings which ensures that customers with the same rating have the same credit characteristics and the same probability of default, in part or in full, over the period of one year. The basic parameters of credit risk used in determining a risk subcategory are calculated and monitored on a monthly basis.

A low level of risk implies doing business with customers with a high credit rating (risk rating categories 1 and 2), increased level of risk implies doing business with customers with operating difficulties that could have a negative impact on the settlement of liabilities (risk rating category 3), and a high level of risk characterizes customers with negative operating results and poor credit rating (risk rating categories 4 and 5). The Bank guards against downgrade risk through continuous monitoring of customers' business operations and by identifying changes that could arise through: deterioration of a borrower's financial standing, delays in repayment and changes in the business environment, as well as by securing appropriate collaterals.

Risk of Change in the Value of Assets

Allowance for impairment of loan investments is intended to ensure reasonable, prudent and timely registering of losses on loan impairment, as well as to intervene in respect of contingent liabilities with a view to protect the Bank in the period when the loss occurs and is definitely confirmed (realized), due to inability to collect contracted amounts or through outflow of assets to settle contingent liabilities.





46


Risk of Change in the Value of Assets (continued)

Allowance for impairment of loans and provisions are made when there is justification and objective evidence of impairment arising as the result of events that occurred after initial recognition of a loan, that have a negative effect on future cash flows from a loan. Key elements in assessing impairment of investments are as follows: overdue payments on principal or interest, cash flow difficulties on the part of the borrower, the borrower's credit rating deterioration or changes in the initial terms of the loan contract etc.

Allowance for impairment is based on estimated future cash flows from the borrower's business or collateral foreclosure if it is assessed that a loan can be realistically settled from such assets. The Bank assesses allowance for impairment of receivables on an individual and on a group basis. Individual Assessment The Bank estimates the correction value on an individual basis (individual assessments) for each client, which does not belong to the group of small claims, wherein the exposure is more than 50,000 and EUR and having a default status:

The borrower under this claim is more than 90 days due

The Bank, based on the assessment of the financial condition and credit worthiness of the debtor, estimated that the borrower will not be able to meet its obligations in full without realization of collateral, regardless of whether the borrower settles his obligations on time or not;

The Bank is consideres unlikely that the borrower will fully meet its obligations to the Bank without taking into account the possibility of implementation of the instrument of credit protection;

commitments - if the withdrawal from the borrower would lead to emergence of claims which Bank considers uncollectible in its entirety without collateral activation, on the basis of the estimated financial status or creditworthiness.

given guarantees - if it is probable that they will be activated, especially if the guarantee of the claim fulfills the conditions tro be considered problematic,

the process of making pre-prepared plan of reorganization has began;

The consensual financial restructuring is started

the procedure of bankruptcy / liquidation is started

principal and interest write-off

implementation of the collateral except bills of exhange by other creditors

continuous blockade longer than 60 days

in accordance with the definition of the default .

Group-Level Assessment

Impairment is assessed on a group basis for each client in which is identified:which belong to the group of small claims (MMZK), whose total claims (before reduction of the amount of the impairment of balance assets) is less than EUR 50.000 in the case of legal entities (banks, commercial clients and micro clients), and in individuals, farmers and entrepreneurs less than EUR 20,000, on the day of calculation,





47


Risk of Change in the Value of Assets (continued)

that does not belong to the group of small claims (SC), and don't have default status,claims according to which the borrower is the Bank or some other financial institution, as well as the investments in securities (HOV) that are not listed on the official market (exchange) and securities which are kept to maturity but don't belong to group of non-small claims (NSC), which in accordance with the definition don't have default status

where the amount of the assets is not determined by the calculation on an individual basisbased on commisions on payments, fees and other receivables that don't have elements NPV (discounting)

Impairment of loans decreases the value of loans and is recognized as an expense in the income statement.

Determining the probable loss on off-balance sheet items

Assessment of probable losses arising from off-balance sheet items is a procedure which includes the assessment of the recoverability of future cash outflows for each acquired off-balance sheet liability and the calculation of the amount of probable losses for each off-balance sheet item.

A provision is recognized when all the following conditions, namely: When there is a present liability (legal or customary) as a result of a past transaction. The current liability exists if it is probable that an obligation exists or where it is not certain that it exists, but it is more likely than not that the liability exists. Only those obligations arising from past events, whose existence is uncertain based on future operations of Banks (e.g., a binding event is the delivery of a guarantee, or other form of warranties, which cause the formation of legal obligations) are recognized as provisions; If it is probable that an outflow of resources will be required to settle the obligation. Outflow of resources is treated as probable when it is more certain that the event will occur than not (e.g., due to deterioration in the financial position of the individual or legal entity to whom a guarantee was given, the outflow of resources for the settlement of liability is likely); When the amount of the liability can be reliably assessed. The provision is based on the best estimates, it being possible to use previous experience on the same or similar basis, taking into consideration all other known circumstances and available information that may affect the formation of future liabilities. The calculated amount of probable loss on off-balance sheet items ais recorded as an expense, and as provision for losses on off-balance sheet items.

Maximum Credit Risk Exposure

Maximum credit risk exposure as of December 31 2016 and 2015 is presented in the table below without taking into account any collateral or any other sort of credit risk hedge. The stated values are presented in gross and net carrying amounts (after impairment effects).





48


Maximum Credit Risk Exposure (continued) In EUR thousand December 31 2016 December 31 2015-reclassified Gross Net Gross Net I. Assets 110,742 99,085 103,045 95,999

Cash and deposit accounts held with depository institutions 19,614 19,614 12,297 12,297 Loans and receivables due from banks 7,485 7,118 15,711 15,711 Loans and receivables due from customers 58,782 47,492 58,307 51,261 Investment securities - available for sale 21,287 21,287 15,933 15,933 - held to maturity 2,989 2,989 Other financial receivables 585 585 797 797 II. Off-balance sheet items 4,519 4,340 3,910 3,814

Payment guarantees issued 3,570 3,419 2,802 2,735 Performance guarantees 362 334 546 517 Other off-balance sheet exposures 587 587 552 552 Other types of guarantees - - 10 10

Total (I+II) 115,261 103,425 106,955 99,813

The largest credit risk is associated with the executed loan arrangements; however, the Bank is also exposed to risk based on investment securities and off-balance sheet items resulting from commitments and contingent liabilities.



This version of the financial statements and the accompanying notes is translation of the original which were published in Montenegrin language. All possible care has been taken to ensure that the translation is accurate

representation of the original. However, in all the matters of interpretation of information, views and opinions, the original language version of the documents takes precedence over this translation 49

30. RISK MANAGEMENT (continued) Maximum Credit Risk Exposure (continued)

Loans and advances and receivables from banks In thousand EUR December 31, 2016

Housing

Cash

Agricultural

Other

Micro businesses Total retail

Total corporate

Total

Due from banks

Not overdue and not impaired 1 2 1 1 5 - 45 40 Overdue and not impaired 7 6 1 - - 14 - 14 - Group-level impaired 12,521 8,893 76 559 5,681 27,730 20,393 48,123 - Individually impaired 2,067 211 - 21 3,226 5,525 5,075 10,600 -

Total 14,596 9,200 79 581 8,908 33,274 25,468 58,782 40 Allowance for impairment 1,474 1,101 - 160 3,464 6,199 5,091 11,290 - Group-level allowance 117 913 - 138 602 1,770 659 2,429 - Individual impairment allowance 1,357 188 - 22 2.862 4,429 4,432 8,861 -

Net carrying amount 13,122 8,099 79 421 5,444 27,075 20,377 47,492 40






In thousand EUR December 31, 2015

Housing

Cash

Agricultural

Other Micro

businesses Total retail Total

corporate

Total Due from

banks

Not overdue and not impaired - 155 - 6 128 289 2,180 2,469 40 Overdue and not impaired - 1 - 4 16 21 - 21 - Group-level impaired 13,051 6,330 10 1,408 5,798 26,597 19,228 45,825 - Individually impaired 1,224 - - - 1,669 2,893 7,059 9,952 -

Total 14,275 6,486 10 1,418 7,611 29,800 28,467 58,267 40 Allowance for impairment (934)

(806)

(8) (272)

(2,662)

(4,682)

(2,365)

(7.047)

-

Group-level allowance (601) (806)

(8)

(272)

(1,981)

(3,668)

(1,138)

(4,805)

- Individual impairment allowance (333)

- - - (681)

(1,014)

(1,227) (2,241) -

Net carrying amount 13,341 5,680 2 1,146 4,949 25,118 26,102 51,221 40





51

30. CREDIT RISK (Continued) Maximum Credit Risk Exposure (Continued)

Impaired Loans and Advances Impaired deposits and loans are loans for which the carrying amount is greater than its estimated recoverable amount, where the recoverable amount is estimated based on such events documented in the past, but at the same time based on estimates of expected events that may occur in the future.

Impairment Allowance Of impairment of assets represents the amount of impaired assets of the Bank, calculated in accordance with the requirements of International Accounting Standard 39. Receivables Overdue but not Impaired Loans and advances matured but not impaired represent those loans and advances where there is default in settling liabilities for contractually agreed interest or principal outstanding. Yet the Bank believes that it is not appropriate to make impairment allowances for such loan investments given the probability of default status occurrence for certain types of customers (migrations), the value of instruments securitizing such loans and/or certainty of debt collection on the part of the Bank. Receivables not overdue and not Impaired Loans and advances not matured and not impaired extended to corporate customers and banks relate to the loans approved and disbursed to state-owned companies, local self-governments, municipalities, and to deposits placed with other banks for which it is determined that it is not appropriate to make impairment allowances for such loan investments given the probability of default status occurrence for certain types of customers (migrations) and/or certainty of debt collection on the part of the Bank.





30. RISK MANAGEMENT (continued)) Maximum Credit Risk Exposure (continued)

Loans and advances to customers and due from banks, not matured and not impaired

In thousand EUR

December 31, 2016 Housing Cash Agricultural Other Micro

businesses Total retail Total

corporate Total Due from

banks

Low (IR 1,2) 1 - 1 - 1 3 - 43 40 Medium (IR 3) - - - - - - - - - High (IR 4,5) - - - - - - - - -

1 - 1 - 1 3 - 43 40

December 31, 2015 Housing Cash Agricultural Other

Micro businesses Total retail

Total corporate Total

Due from banks

Low (IR 1,2) - 155 - 6 118 279 609 889 40 Medium (IR 3) - - - - 10 10 - 10 - High (IR 4,5) - - - - - - 1,570 1,570 -

-

155 - 6 128 289 2,179 2,469 40






Loans and advances to customers and due from banks, matured but not impaired In In thousand EUR

December 31, 2016 Housing Cash Agriculture Other Micro

bussineses Total retail Total Due from

banks

Up to 30 days overdue 5 5 - - - 10 10 - 31 – 90 days overdue 2 1 1 - - 4 4 - Over 90 days overdue - - - - - - - -

7 6 1 - - 14 14 -

In thousand EUR

December 31, 2015 Housing Cash Agriculture Other

Micro bussineses Total retail Total

Due from banks

Up to 30 days overdue - - - 4 13 17 17 - 31 – 90 days overdue - 1 - - 3 4 4 - Over 90 days overdue - - - - - - - -

- 1 -

4 16 21 21 -

Review does not include interest and fees on the due loans and deposits of corporate clients at December 31 2015 and December 31 2016.



This version of the financial statements and the accompanying notes is translation of the original which were published in Montenegrin language. All possible care has been taken to ensure that the translation is accurate representation of the original. However, in all the matters of interpretation of information, views and opinions, the original language version of the documents takes precedence over this

translation 54


Loans with Altered Initially Agreed Terms Loans with altered initially agreed terms are those loans that are rescheduled or restructured due to the difficulties in the borrower's servicing the liabilities when due. Receivables are rescheduled if due from borrowers up to 90 days in default, most commonly per individual loan subaccount, i.e. not including all the receivables due from the same borrower (not all loan subaccounts). In accordance with the regulations of CBM, the Bank restructures/reschedules borrower loans if, due to the deterioration of the borrower creditworthiness, it performs the following: 1) Extends principal or interest repayment periods for; 2) Reduces interest rate applied to the loan approved; 3) Assumes borrower's receivables due from third party for full or partial loan repayment; 4) Reduces the amount of debt, principal or interest; 5) Capitalizes interest accrued on the loan approved; 6) Replaces the existing loan(s) with a new loan (loan renewal); or 7) Provides other similar incentives to facilitate the financial position of the borrower.

Not considered to be a restructuring of loans:

1) changing of the conditions for repayment of principal due to unforeseen circumstances beyond the debtor's control (e.g. the delay in the completion of the project), if the effective interest rate remains unchanged in relation to the contractual terms, as long as the interest is paid on time; 2) reducing the interest rate or capitalization of interest, which are not caused by deterioration of the creditworthiness of the debtor.

In EUR thousand Restructured December 31 2016 December 31 2015

Gross Net Gross Net

Retail Housing 1,538 1,537 505 479 Cash loans 596 573 101 8 Other - - 9 3 Micro businesses 700 695 787 595

2,834 2,805 1,402 1,085

Corporate customers 2,404 2,395 4,245 3,532

5,238 5,200 5,647 4,617

Concentration Risk

The Bank controls concentration risk by establishing a system of limits to the exposure with the same or similar risk factors (industry sectors/activities, product types, geographical regions, single entities or groups of related parties, collaterals...). Establishment of appropriate exposure limits is the basis for concentration risk control with the aim of loan portfolio diversification. Depending on the general economic trends and of trends in different industrial sectors Bank diversifies investments in industrial sectors which are resistant to the impact of advers economic trends.




translation 55


Concetration Risk (Continued)

An analysis of credit risk concentration depending on the geographic region, based on placements to customers, is presented in the table:

In EUR thousand Loans and advances to customers Off-balance sheet items December 31, 2016 December 31, 2015 December 31, 2016 December 31, 2015

Gross Net Gross Net Gross Net Gross Net

Serbia 17 12 932 931 - - - - Monetengro 58,725 47,440 57,335 50,290 3,932 3,752 3,358 3,262 Europian Union 40 40 40 40 - - - -

Total: 58,782 47,492 58,307 51,261 3,932 3,752 3,358 3,262

Securities

In EUR thousand December 31, 2016 December 31, 2015 Gross Net Gross net

Investment securities: - available for sale 21,287 21,287 15,933 15,933 - held to maturity 2,989 2,989 - -

Total 24,276 24,276 15,933 15,933

Available-for-sale financial assets represent financial instruments which are intended to be held over an indefinite time period and which may be sold for liquidity purposes, due to the movements in interest rates, exchange rates or prices of capital. They mostly comprise Treasury bills and bonds issued by the Republic of Serbia and bonds of other banks. Available-for-sale assets are initially measured at cost, and on a quarterly basis fair value thereof is determined based on the market prices for securities traded in active stock exchange (mark to market). Internally developed valuation models (mark to model) are used in instances that for certain financial instruments independent sources of market information are not available, and are based on the maturity of the security and the risk-free interest rate level. The Bank has no securities carried at fair value through profit and loss in its portfolio. Held-to-maturity securities entirely relate to the Treasury bills of the Government of Montenegro.

Credit Risk Hedges (collaterals)

For the purpose of protection against credit risk, in addition to regular monitoring of the customer business operations, the Bank also acquires security instruments (collaterals) to secure the collection of receivables and minimize credit risk. Depending on the assessment of the ability to settle contractual liabilities, the level of loan coverage is defined so that in case of the debtor default, the Bank could collect its receivables through collateral foreclosure. The quantity and type of collateral depends on the assessed credit risk. As a standard type of loan security instrument, the Bank demands and receives from clients contractual authorizations for account withdrawals and bills of exchange, whereas, depending on the credit risk assessment and loan type, additional collaterals agreed upon include the following:

• for commercial loans - pledge over movable and immovable property (mortgages),

deposits, banking, corporate and state-issued guarantees, sureties, pledge over securities, equity interests, receivables and livestock;

• for retail loans - mortgages, deposits and co-sureties.




translation 56


Credit Risk Hedges (collaterals) (Continued)

For valuation of property or pledges assigned over movable assets, the bank hires certified appraisers in order to minimize potential risk of unrealistic valuation. Property, goods, equipment and other movables pledged must be insured by an insurance company acceptable to the Bank and insurance policies must be duly endorsed in favour of the Bank. The Bank monitors the market value of collaterals and if necessary, it can demand additional collateral pursuant to the loan/deposit agreement executed. It is the Bank's policy to ensure collection from collateral foreclosure and use the proceeds therefrom to reduce or repay debt. Collaterals securitizing loan repayments repossessed by the Bank in the process of debt collection are provided below:

In EUR thousand

December 31, 2016 December 31, 2015

Properties 15,544 18,894

Total: 15,544 18,894

The Bank's policy is to ensure the sale of collaterals.




translation 57

30. RISK MANAGEMENT (continued) Liquidity risk Limit prescribed by the Central Bank of Montenegro:

Regulatory limit

Coefficient of daily

liquidity

For one work day min 0.9 Average indicators for all work days in a month min 1 Realised value: 2016. 2015.

As of 31 December 1.46 1.76 Average indicators for all work days in a month 1.35 1.62

Realised value: Liquidity

ratio

Narrow liquidity

ratio

For one work day min 0.8 min 0.5 For three consecutive days min 0.9 min 0.6 Average indicators for all work days in a month min 1 min 0.7 Liquidity ratio Narrow liquidity ratio Realised values: 2016 2015 2016 2015

As of 31 December 3.19 3.74 2.20 3.01 Average for the period 2.89 3.55 2.01 3.21 Maximum for the period

3.31 4.92

2.45 3.98

Minimum for the period 2.56 2.86 1.78 2.26 Limits 2016 2015

Gap to 1 month / total assets Маx (10%i) 9.91% 12.51% Cumulative Gap to 3 months / total assets Маx (20%)

11.14 % 11.64%



This version of the financial statements and the accompanying notes is translation of the original which were published in Montenegrin language. All possible care has been taken to ensure that the translation is accurate representation of the original. However, in all the matters of interpretation of information, views and opinions, the original language version of the documents takes precedence over this translation

58


Liquidity risk (continued) Maturity structure of monetary assets and monetary liabilities as of December 31, 2015 is presented below:

In thousand EUR

Up to 1 month

From 1 to 3 months

From 3 to 6 months

From 1 to 5 years

Over 5 years Total

Financial assets

Cash and deposit accounts held with depository institutions

19,614 - - - - 19,614

Loans and receivables due from banks

7,485 - - - - 7,485

Loans and receivables due from customers

2,256 2,216 10,930 23,210 8,880 47,492

Investment securities - available for sale 21,287 - - - - 21,287 - held to maturity 2,989 - - - - 2,989 Other financial receivables 585 - - - - 585

54,216

2,216

10,930

23,210

8,880

99,452

Financial liabilities - - - - - - Deposits due to banks - - - 37 - 37 Deposits due to customers 52,464 6,717 21,126 3,912 - 84,219 Borrowings from customers

62

56

1,015

3,328

401

4,862

Other liabilities 517 - - - - 517

Total

53,043

6,773

22,141

7,277

401

89,635

Net GAP 1,173 (4,557) (11,211) 15,933 8,479 9,817

Cumulative GAP 1,173 (3,384) (14,595) 1,338 9,817




59


Liquidity risk (continued) Maturity structure of monetary assets and monetary liabilities as of December 31 2015 is presented below:

In thousand EUR

Up to 1 month

From 1 to 3 months

From 3 to 6 months

From 1 to 5 years

Over 5 years Total

Financial assets

Cash and deposit accounts held with depository institutions 12,297 - - - - 12,297 Loans and receivables due from banks 15,711 - - - - 15,711 Loans and receivables due from customers 2,976 2,093 9,750 26,317 10,125 51,261 Investment securities - available for sale 15,933 - - - - 15,933 - held to maturity - - - - - - Other financial receivables 797 - - - - 797

47,714 2,093 9,750 26,317 10,125 95,999

Financial liabilities

Deposits due to banks - - - 35 - 35

Deposits due to customers 41,347 7,608 22,510 5,284 70 76,819 Borrowings from customers 41 43 2,587 711 1,497 4,879 Other liabilities 225 - - - - 225

Total 41,613 7,651 25,097 6,030 1,567 81,958

Net GAP 6,101 (5,558) (15,347) 20,287 8,558 14,041

Cumulative GAP 6,101 543 (14,804) 5,483 14,041




translation 60


Liquidity risk (continued) The Bank collects deposits of corporate and retail customers which commonly have shorter maturity periods and can be withdrawn at the client request. Short-term nature of such deposits increases the Bank's liquidity risk and requires active liquidity risk management and constant monitoring of market trends. In near term, the Bank manages liquidity risk by monitoring and controlling items in all major currencies in order to identify the needs for additional funding in a timely manner in case of maturities of certain items, i.e. in the long term, the Bank plans the structure of its funding sources and investments in order to provide sufficient stable funding sources and liquidity reserves. The Bank tests the Plans for Liquidity Management in Crisis Situations which are intended for testing potential crisis, checks the survival period and solvency, availability of funding for liabilities that could arise and assesses the support under the assumed crisis conditions. Market risk Market risk represents the possibility of occurrence of negative effects on the Bank' financial result and equity due to changes in market variables and comprises interest rate risk in the banking book and foreign exchange risk for all business operations. The Bank has no trading book. The Bank has established appropriate organizational structure, which allows for clear differentiation between the process of assuming market risks and the process of managing those risks. Interest Rate Risk Interest rate risk represents the probability of negative effects on the Bank's financial result and equity through items of the banking general ledger due to adverse interest rate fluctuations. The exposure to this risk depends on the relation between the interest rate sensitive assets and liabilities. The Bank is exposed to interest rate risk inherent in the items within the banking general ledger, which is reflected in the possible negative effects on the Bank's financial result and equity through due to adverse interest rate fluctuations.

The Bank manages the following types of interest rate risk:

- Repricing risk of temporal mismatch between maturity and repricing (repricing risk);

- Yield curve risk - to which the Bank is exposed due to changes in yield curve shape;

- Basic risk - to which the Bank is exposed due to different reference interest rates

for interest rate sensitive items with similar maturity or repricing characteristics;

- Optionality risk - to which the Bank is exposed due to contractually agreed optional terms - loans with an option of early repayment, deposits with an option

of early withdrawal, etc.




translation 61


Interest Rate Risk (continued) Basic objective of interest rate risk management is maintaining the acceptable level of interest rate risk exposure from the aspect of the effect on the financial result, by conducting adequate policy of matching periods of interest rate repricing, matching adequate sources to investments per interest rate type and maturity, as well as projecting movements in the yield curve in both foreign and domestic markets. The Bank particularly considers the effects of interest rate changes and changes in the structure of interest-bearing assets and liabilities from the perspective of maturity, interest rate repricing and currency structure and manages the effect thereof on the economic value of equity. The process of interest rate risk management consists of identification, measurement, minimizing, monitoring, control and interest rate risk reporting. Identification of interest rate risk consists of comprehensive and timely identification of the causes and factors that lead to the occurrence of interest rate risk, which includes determining current interest rate risk exposure, as well as interest rate risk exposure arising from new business products and activities. Measurement and assessment of interest rate risk at the Bank is performed through quantitative and/or qualitative assessment of identified interest rate risk by using the following techniques:

- GAP analysis;

- Ratio analysis;

- Duration;

- Economic value of equity; - Stress test.

Minimizing interest rate risk means maintaining this risk at a level that is acceptable for the Bank's risk profile. Alleviating interest rate risk refers to the process of defining the systems of limited exposure of the Bank to the interest rate risk and implementing measures for interest rate risk mitigation. Control and monitoring of interest rate risk entails the process of monitoring compliance with the established system of limits as well as monitoring defined measures for reducing the Bank's exposure to the interest rate risk. Control of interest rate risk refers to control on all management levels as well as an independent control system implemented by the organizational units responsible for internal audit and compliance monitoring. Interest rate risk reporting consists of an internal system of reporting to competent boards/committees and the Bank's interest rate risk management bodies. Internal limits are determined based on the internal reporting on the interest GAP that includes all balance sheet items.

Internal

limit 2016 2015

Gap up to 1 month / total assets Min 0.8 1.13 1.06 Group limit 2016 2015

Relative Gap Маx 15% (9.18%) (5.92%) Coefficient of disparity 0.75-1.25 0.89 0.92




62


Interest rate risk (continued) Overview of the exposure to interest rates on December 31 2015 is presented in the following table:

In thousand EUR

Up to 1 month

From 1 - 3 months

From 3 – 12 months

From 1 – 5 years

Over 5 years

Interest - bearing

Non – interest bearing Total

Financial assets Cash and deposit accounts held with depository institutions

- - - - - - 19,614 19,614

Loans and receivables due from banks

7,485 - - - - 7,485 - 7,485

Loans and receivables due from customers

4,394 2,096 25,311 11,960 3,572 47,333 159 47,492

Investment securities - available for sale 21,287 - - - - 21,287 - 21,287 - held to maturity 2,989

2,989 2,989 Other financial receivables 585 - - - - 585 - 585

Total 36,740 2,096 25,311 11,960 3,572 79,679 19,773 99,452

Financial liabilities - - - 37 - 37 0 37 Deposits due to banks 52,464 6,717 21,126 3,912 0 84,219 0 84,219 Borrowings from customers 62 56 1,015 3,328 401 4,862 0 4,862 Other liabilities

517 517

Total 52,526 6,773 22,141 7,277 401 89,118 517 89,635

Interest rate GAP (15,786) (4,677) 3,170 4,683 3,171 (9,439) 19,256 9,817




63


Interest rate risk (continued) Overview of the exposure to interest rates on December 31 2015 is presented in the following table:

In thousand EUR

Up to 1 month

From 1 - 3 months

From 3 – 12 months

From 1 – 5 years

Over 5 years

Interest - bearing

Non – interest bearing Total

Financial assets

Cash and deposit accounts held with depository institutions

- - - - - 12,297 12,297

Loans and receivables due from banks 15,711 - - - - 15,711 - 15,711 Loans and receivables due from customers 2,244 2,094 23,149 16,620 6,806 50,913 348 51,261 Investment securities - available for sale 15,933 - - - - 15,933 - 15,933 - held to maturity

Other financial receivables 797 - - - - 797 - 797

Total 34,685 2,094 23,149 16,620 6,806 83,354 12,645 95,999


Deposits due to banks - - - 35 - 35 35

Deposits due to customers 41,347 7,608 22,510 5,284 70 76,819 - 76,819 Borrowings from customers 41 43 2,587 711 1,497 4,879 - 4,879 Other liabilities 225 225

Total 41,388 7,651 25,097 6,030 1,567 81,733 225 81,958

Interest rate GAP (6,703) (5,557) (1,948) 10,590 5,239 1,621 12,420 14,041



This version of the financial statements and the accompanying notes is translation of the original which were published in Montenegrin language. All

possible care has been taken to ensure that the translation is accurate representation of the original. However, in all the matters of interpretation of information, views and opinions, the original language version of the documents takes precedence over this translation

64

30. RISK MANAGEMENT (continued) Interest rate risk (continued) Interest rate risk GAP report of monetary sub-balance includes monetary balance items distributed according to the shorter of period of interest rate repricing and maturity outstanding. The Bank's management believes that appropriate compliance of positions per interest rate type and interest rate repricing period constitutes a solid prerequisite for existence with required financial results achieved and maintenance of economic value of equity. The Bank monitors the risk of interest rate changes. To that end, the Bank observes the regulatory and internally defined methodologies. In accordance with the regulations of CBM, the standard shock scenario implies a parallel change (increase or decrease) in interest rates by 200 basis points (b.p.). Regulatory approach: Sensitivity analysis of the Bank to the increase or decrease in interest rates - impact on the financial result: In thousand EUR

Parallel increase of

200 bp

Parallel decrease of

200 bp

As of December 31 2016 44

(44)

As of December 31 2015 57 (57)

Sensitivity analysis of the Bank to the increase or decrease in interest rates - impact on the economic value of equity:


200 bp

As of December 31 2016 0.23% As of December 31 2015 0.21%





65

30. RISK MANAGEMENT (continued) Interest rate risk (continued) Internal approach: Sensitivity analysis of the Bank to the increase or decrease in interest rates - impact on the financial result: In EUR thousand


200 bp

Parallel decrease of

200 bp

2016 As of December 31 16 (16) Average for the period 23 (23) Maximum for the period 33 (33) Minimum for the period 16 (16) 2015 As of December 31 31 (31) Average for the period 26 (26) Maximum for the period 31 (31) Minimum for the period 20 (20) Sensitivity analysis of the Bank to the increase or decrease in interest rates - impact on the economic value of equity:


200 bp

2016 As of December 31 0.09% Average for the period 0.09% Maximum for the period 0.13% Minimum for the period 0.07% 2015 As of December 31 0.11% Average for the period 0.08% Maximum for the period 0.11% Minimum for the period 0.06%





66


Foreign Exchange Risk

Foreign exchange (currency) risk represents the possibility of negative effects on the Bank's financial result and equity due to fluctuations in exchange rates between currencies, fluctuations in the domestic currency with respect to foreign currencies or changes in the value of gold and other precious metals.

In order to minimize the currency risk exposure, the Bank diversifies the currency structure of its portfolio and currency structure of liabilities, reconciling open positions in certain currencies pursuant to the principles of asset maturity transformation.

The Bank has established appropriate organizational structure, which allows for clear differentiation between the process of assuming currency risk and the process of managing currency risk.

The process of currency risk management entails identifying, measuring, minimizing, monitoring, control and currency risk reporting.

In identifying currency risks, the Bank identifies in a comprehensive and timely manner the causes that lead to emergence of currency risk and includes the determination of current currency risk exposure, as well as currency risk exposure resulting from new business products and activities, within items carried in the banking book.

Measurement and assessment of currency risk in the Bank is performed through quantitative and/or qualitative assessment of identified currency risk by using the following techniques:

- GAP analysis and currency risk ratio; - Stress test; - Back testing.

Relieving foreign currency risk entails maintenance of risk at an acceptable level for the Bank's risk profile through the establishment of a transparent system of limits and defining measures used to mitigate foreign currency risk.

Control and monitoring of the currency risk consists of observation and supervision of compliance with internally and externally defined limits as well as monitoring of defined and implemented measures. Continuous monitoring and control of foreign currency risk during the day ensures timely undertaking measures for the purpose of maintaining the currency risk within defined limits. Foreign currency risk control means control at all management levels as well as independent control system implemented by the organizational units responsible for internal audit and compliance monitoring. Reporting on currency risk includes internal and external reporting systems. It is performed on a daily basis and according to set schedules and in accordance with the defined system.

The Bank adjusts its business activities with internal and regulatory prescribed indicator of foreign exchange risk.

Overview of the total risk foreign currency position and regulatory and internally defined indicator of foreign exchange risk as of 31 December is presented as follows:

Regulatory

limit

2016

2015

Total risk foreign currency position - (193,000) 125,000 Foreign exchange risk 2% (0.94%) 0.38%

Internal limit

2016

2015

Total risk foreign currency position - 50,671 121,257 Foreign exchange risk 2% 0.29% 0.57%





67

30. RISK MANAGEMENT (continued) Foreign Exchange Risk (continued) Exposure to foreign currency risk at December 31 2016

RSD position USD CHF

Other currenci

es Total in

currency EUR Total

Financial assets

Cash and deposit accounts held with depository institutions 8 1,690 212 145 2,055 17,559 19,614 Loans and receivables due from banks - - - - - 7,485 7,485 Loans and receivables due from customers - - - - - 47,492 47,492 Investment securities

- available for sale - 4,495 - - 4,495 16,792 21,287 - held to maturity - - - - - 2,989 2,989 Other financial receivables - - - - - 585 585

Total 8 6,185 212 145 6,550 92,902 99,452


Deposits due to banks - - - - - 37 37 Deposits due to customers - 6,390 210 126 6,726 77,493 84,219 Borrowings from customers - - - - - 4,862 4,862 Other liabilities - - - - - 517 517

Total - 6,390 210 126 6,726 82,909 89,635

Net GAP 8 (205) ) 2 19 (176) 9,993 9,817





68

30. RISK MANAGEMENT (continued) Foreign Exchange Risk (continued) Exposure to foreign currency risk at December 31 2015

RSD position

USD

CHF

Other curren

cies

Total in currenc

y

EUR

Total

Financial assets

Cash and deposit accounts held

with depository institutions 21 6,325 233 152 6,731 5,566 12,297 Loans and receivables due

from banks - - - - - 15,711 15,711 Loans and receivables due

from customers - - - - - 51,261 51,261 Investment securities

- available for sale - - - - - 15,933 15,933 - held to maturity - - - - - - - Other financial receivables - - - - - 797 797

Total 21 6,325 233 152 6,731 89,268 95,999


Deposits due to banks - - - - - 35 35 Deposits due to customers - 6,250 225 114 6,589 70,230 76,819 Borrowings from customers - - - - - 4,879 4,879 Other liabilities - - - - - 225 225

Total - 6,250 225 114 6,589 75,369 81,958

Net GAP 21 75 8 38 142 13,899 14,041





69

30. RISK MANAGEMENT (continued) Foreign Exchange Risk (continued)

Scenario Value and changes Decription Impact on the financial result (net)

Effect to the change of the capital requiremen t in EUR

Foreign exchange risk indicator

Scenario no.1

8,492

1,019

0.65%

10.01%

↘

Strengthening of currency - USD

9.19%

↘

Strengthening of currency - CHF

Scenario no.2

(3,567)

(428)

0.58%

(3.95)% ↗

Weakening of currency - USD

(14.40)% ↗

Weakening of currency - CHF

Scenario no.3

5,589 671 0.63% 6.66% ↘


8.12% ↘


Scenario no.4

7,401 888 0.64% 9.12% ↘


12,08% ↘


Scenario no.5

10,989 1,319 0.66% 13.70% ↘


8.12% ↘


The Bank also performs stress testing of foreign exchange risk. Stress testing of foreign currency exchange risk starts from the assumption of changes in foreign currency exchange rates for the currencies in which the Bank has the largest exposure, then simulates the impact of the change on the financial result, capital requirement and foreign currency risk indicator:





70

30. RISK MANAGEMENT (continued) Operational risk Operational risk represents the possibility of negative effects on the Bank's financial result and equity due to employee errors (intentional or accidental), inadequate procedures and processes in the Bank, inadequate management of information and other systems in the Bank, as well as occurrence of unforeseen external events. Operational risk includes legal risk. Operational risk is defined as an event that occurred as the result of inappropriate or unsuccessful internal processes, employee and system actions or system and other external events, internal and external abuses, hiring and security practices at the workplace, customer receivables, product distribution, fines and penalties for infractions, damage incurred to property, disruptions in operations and system errors and process management. The Bank monitors operational risk events according to the following business lines: corporate financing, trade and sales, retail brokerage services, corporate banking, retail banking, payment transfers, agency services and treasury. The process of operational risk management represents an integral part of the Bank's activities conducted on all levels and ensures identification, measuring, relieving, monitoring and reporting continually on operational risks ahead of their realization, as in accordance with the legal requirements and deadlines. The existing process relies on known methods of measuring operational risk exposures, database on operating losses, an updated control and reporting system.

The Bank monitors operational risk events daily and manages operating risks. For the purpose of efficient operational risk monitoring, the Bank appoints employees who are in charge of operational risk with the objective of monitoring operational risk in its every organizational part, where such employees are responsible for accuracy and timeliness of information about all operational risk events that occur in their organizational unit, as well as for keeping records about all such events in the operational risk database. The organizational part of the Bank which is responsible for risk management monitors and reports on operational risks.

Measurement and assessment of operational risk at the Bank is done through quantitative and/or qualitative assessment of identified operational risk. The Bank measures operational risk exposure through event records, self-assessment and stress testing. Self-assessment consists of assessment of risk exposure by organizational units based on the roadmap for identifying operating risks, through measurement of potential ranges and frequencies of events that can result in losses, identification of levels of control that business areas must maintain over these risks and measures of improvement.

The Bank cannot eliminate all operational risks, but by introducing a rigorous framework of control, monitoring and response to potential risks it is capable of managing these risks. The Bank takes measures in order to relieve operational risks and ensure proactive response to events potentially creating operational risks through continued monitoring of all activities, application of adequate and reliable information system and by applying project approach orientation, the implementation of which helps improve the business practice and optimize the Bank's business processes.

Through reliable reporting on the implementation of measures undertaken to mitigate operational risks, the Bank has established a system for monitoring the activities undertaken by the Bank's organizational parts in order to reduce arising operational risks. The Bank assess the risk of entrusting third parties with activities related to the Bank's operations and based on the service contracts executed with such third parties which clearly define terms, rights, obligations and responsibilities of the contracting parties.

With the objective of smooth and continued operation of all significant systems and processes in the Bank, and to limit losses that could be incurred in extraordinary circumstances, the Bank adopted the Business Continuity Plan, in order to ensure the restoration and recovery of the information technology systems in the event of interruption or stoppage of operations, the Bank adopted the Disaster Recovery Plan.





71


Exposure risk The total Bank's exposure to a single entity or a group of related entities must not exceed 25% of the Bank's own assets. The Bank's exposure to a single entity or a group of related entities that exceeds 10% of Bank's own assets is considered a large exposure. The sum of all large exposures of the Bank must not exceed 800% of the Bank's own assets. In respect of the exposures to its own related parties, the banks implements the following limits:

- Aggregate exposure of the Bank to all of its related parties must not exceed 200% of the Bank's own assets;

- Total exposure of the Bank to a member of the Board of Directors, Audit Committee or an Executive Officer and members of their immediate families can equal maximum 2% of the Bank's own assets;

- Total exposure of the Bank to the legal entities controlled by the persons referred to in the line above and/or members of their immediate families may equal maximum 10% of the Bank's own assets;

- Total exposure of the Bank to an employee who is not a member of the Board of Directors, Audit Committee or an Executive Officer and members of their immediate families may equal maximum 1% of the Bank's own assets;

- Total exposure of the Bank a shareholder without a qualified interest in the Bank, including exposures to legal entities controlled by the shareholder, may not exceed 10% of the Bank's own assets;

- The sum of aggregate exposures of the Bank toward the following persons/entities: shareholders with qualified interest in the Bank, including exposures to the legal entities controlled by such shareholders, legal entities controlled by the person/entity controlling the Bank and legal entities controlled by the Bank must not exceed 20% the Bank's own assets.

The Bank's exposure to a single entity or a group of related entities, as well as to the parties related to the Bank was within the prescribed limits. . The maximum exposure to a single entity as at December 31 2016 amounted to 27.64% (Bonds of the Republic of Serbia) and above the prescribed maximum of 25% of its own funds. Exposure to the client M-tel is 27.38% and is also higher than the prescribed maximum of 25% of its own resources (note 27).

Country risk

Country risk relates to the risk of the country of origin of the entity the Bank is exposed to, i.e. the possibility of negative effects on the Bank's financial result and equity due to inability to collect receivables from abroad and is caused by political, economic and social conditions in the borrower's country of origin. Country risk includes the following risks:

- Political and economic risk relates to the likelihood of losses due to the inability to collect the Bank's receivables because of deterioration in macroeconomic stability, due to limitations prescribed by government regulations or due to other structural changes in the economy of the given country;

- Transfer risk relates to the probability of losses due to the inability to collect receivables in a currency which is not the official currency in the borrower's country of origin, due to limitations to liability settlement toward creditors from other countries in specific currency that is predetermined by the official state regulations and bylaws of state and other bodies of the borrower's country of origin.

Measurement of country risk is made per individual loans and advances and at the Bank's portfolio level. Measurement of exposure of an individual receivable to country risk is based on the country rating of the Bank's borrower's country of origin as defined by internationally recognized agencies, while measurement of portfolio exposure to country risk is based on setting limits to exposure in terms of a percentage of the Bank's equity, depending on the internal country rating category. The Bank measures and controls portfolio exposure to country risk by grouping receivables per default level of risk of the borrower countries of origin.





72

30. RISK MANAGEMENT (continued) Capital management The Bank manages capital on an ongoing basis. As part of the capital management system, the Capital Management Strategy and Capital Management Plan include the following: - principles of capital management; - strategic goals and schedule for realization thereof; - manner of organizing the process of available internal capital management with clearly defined

segregation of duties and responsibilities; - procedures for planning adequate levels of available internal capital; - manner of achieving and maintaining adequate levels of available internal capital in the future; - allocation of capital; - relevant limits pertaining to capital; - general Business Continuity Plan in case of unforeseen events. Through its Capital Management Strategy and Capital Management Plan the Bank maintains the level and structure of the internal capital that adequately supports the growth of loans and advances, future sources of financing and their deployment, dividend policy and response to changes in regulatory requirements. Strategic goals of capital management are as follows:

- to comply with the internally defined target capital adequacy ratio set above the regulatory required minimum and to comply with the minimum capital adequacy ratio per Group-level internal approach (12%);

- to maintain customer trust in the safety and stability of the Bank's operations;

- to realize business and financial plans;

- to support the expected growth of loans and advances to customers;

- to ensure optimum future sources of funds and deployment thereof, bearing in mind the fact that capital represents the most expensive source of financing.

Capital requirements and the capital adequacy ratio of the Bank comply with the regulations of the CBM (in EUR thousand):

Capital requirement and capital adequacy ratio December 31

2016 December 31

2015

Bank's own assets 17,247 24,044

Core capital 16,277 23,418

Supplementary capital 970 626

Deductible items Total 17,247 24,044

Total risk-weighted assets 82,473 81,749

Risk weighted balance sheet assets 77,998 79,727

Risk weighted off-balance sheet items 4,475 2,022

Capital required for market risks - -

Capital required for operational risk 1,092 1,190

Capital required for country risk 460 1,047

Capital required for other risks 236 262

Capital adequacy ratio (min. 10%)

18.33 25.32%

During 2016 the Bank's capital adequacy ratio was significantly above the prescribed regulatory minimum of 10%.





73

30. RISK MANAGEMENT (continued) Capital management (continued) The Bank continuously implements processes of internal assessment of capital adequacy in accordance with the nature, volume and complexity of its business operations and in compliance with the adopted Risk Management Strategy, individual risk management policies and Capital Management Strategy..

The process of planning the adequate level of available internal capital involves:the internal capital adequacy assessment process (ICAAP);planning the adequate level of available internal capital. The internal capital adequacy assessment process includes the following stages:

Determination of materially significant risks. All materially significant risks the Bank is or may be exposed to are included in the internal capital adequacy assessment.Identification of all risks the Bank is exposed to and determination of their materiality is based on the comprehensive assessment of the existing actual and potential risk areas (products, activities, processes and systems), financial position of the Bank and assessment of the environment where the Bank operates.

Quantification of risks, i.e. calculation of internal capital requirements for certain risks entails risk measuring and methodologies for assessing internal capital requirements including stress testing. Risk measurement is the process of quantifying potential losses arising from operations, activities, processes and systems of the Bank. Upon quantification of potential losses 13arising from the risks the Bank is exposed to, the Bank complies with the minimum standards defined by the regulations of the Central bank of Montenegro and Group standards, taking care of the volume and complexity of its activities..

After the identification of all risks and quantification of exposures to the risks resulting therefrom, the Bank assesses the amount of the available internal capital required to absorb the quantified level of risks, including the results of stress testing.

Stress testing is the basic instrument for assessing the future Bank's capital adequacy. The Bank implements stress testing for these purposes at least annually.

Upon determining the amount of the available internal capital required for the absorption of the quantified risk level, for risks subject to the methodology prescribed by the Central Bank of Montenegro the Bank applies the prescribed methodologies for calculation of the minimum capital requirement, whilst for risks where the Central Bank has not prescribed the respective methodologies, the Bank uses its own methodologies to compute the required capital amounts. In accordance with the Bank's risk profile and complexity of the banking business it performs, the bank may develop its own methodology for calculation of the capital requirements for the risks for which CBM has prescribed methodologies.

In addition, the Bank calculates the amounts of capital required for individual types of risks in accordance with the internal approach applied at the Group level.

Determination of the aggregate internal capital requirement, i.e. the required capital amount. After identifying the risks the Bank is exposed to or may be exposed to in the course of its business operation, determining their materiality and quantification of the Bank's exposure to the risks identified and determining the amount of capital required for the absorption thereof, the Bank aggregates risks and defines the total internal capital requirement. Comparison of the following elements of capital:

- capital calculated in accordance with the Decision on the Capital Adequacy to the available internal capital;

- minimum capital requirements computed in accordance with the Decision on the Capital Adequacy to the internal capital requirements for individual risks;

- the sum of minimum capital requirements computed in accordance with the Decision on the Capital Adequacy to the total internal capital requirements.

Reporting on the results obtained based on the performed Bank's internal capital adequacy assessment.





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31. LITIGATION As of December 31 2016, there were 34 legal suits filed against the Bank totalling EUR 3,563 thousand. The aforesaid amount does not include potential penalty interest that may be assigned upon completion of the proceedings. The Bank's management, Legal Department and attorneys do not anticipate unfavourable outcome of these legal suits that might have adverse material effects on the financial statements of the Bank. As of December 31 2016, the Bank formed provisions for potential litigation losses per lawsuits involving the Bank as a defendant in the amount of EUR 536 thousand (December 31 2015: EUR 76 thousand) (Note 24).

32. EVENTS AFTER THE REPORTING PERIOD There have been no significant events subsequent to the reporting date, which would affect the stand-alone financial statements of the Company as of and for the year ended December 31 2016.

33. TAXATION RISKS

Montenegro tax legislation is subject to varying interpretations, and legislative changes occur frequently. The interpretation of tax legislation by tax authorities as applied to the transactions and activities of the Bank may not concur with the views of the Bank's management. Consequently, transactions may be challenged by the relevant tax authorities and the Bank could be assessed additional taxes, penalties and interest, which can be significant. The fiscal periods remain open for review by the tax and customs' authorities with regard to the tax-paying entity's tax liabilities for a period of five years. The Bank's management holds that tax liabilities recorded in the financial statements are fairly stated.

34. EXCHANGE RATES The official exchange rates for major currencies used in the translation of the balance sheet components denominated in foreign currencies into EUR as at December 31 2016 and 2015 were as follows:

Parity

December 31, 2016

December 31, 2015

USD 1 0.9487 0.9152 CHF 1 0.9312 0.9247 GBP 1 1.1680 1.3550 RSD 100 0.8070 0.8222

Documents

KOMERCIJALNA BANKA A .D , · PDF fileKOMERCIJALNA BANKA A.D., BUDVA NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 2016 This version of