KOMERCIJALNA BANKA A.D. BANJA LUKA Financial …Komercijalna banka a.d., Banja Luka (hereinafter: the “Bank”) was founded in September 2006 and entered into the Court Register

"KOMERCIJALNA BANKA" A.D. BANJA LUKA

Financial Statements For year ended December 31, 2016 And Independent Auditors´ Report

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''KOMERCIJALNA BANKA'' A.D. BANJA LUKA

Contents

Page

Responsibilities of the Management Board and Supervisory Board for the preparation and approval of the annual financial statements

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Independent Auditors' Report 3 Financial Statements:

Income Statement 5

Balance Sheet 6

Statement of Changes in Equity 7

Statement of Cash Flows 8

Notes to the Financial Statements 9-67

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Ernst & Young d.o.o. Sarajevo Fra Anđela Zvizdovića 1 71000 Sarajevo Bosna i Hercegovina

Tel: +387 33 296 308 Fax: +387 33 296 309 www.ey.com

ID : 4201625380006 PDV : 201625380006

Independent auditor’s report to the shareholder of Komercijalna banka a.d. Banja Luka We have audited the accompanying financial statements of Komercijalna banka a.d. Banja Luka (hereinafter the “Bank"), which comprise the statement of financial position as at 31 December 2016, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and a summary of significant accounting policies and other explanatory information (as set out on pages 4 to 66). Management’s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with Law on Accounting and Auditing of the Republic of Srpska and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s Responsibility Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with Standards on Auditing applicable in Republic of Srpska. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.


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BALANCE SHEET As of December 31, 2016 (Thousands of BAM)

December 31. 2016

December 31. 2015 Note

ASSETS Cash and cash funds held with the Central Bank 13 68,746 62,294 Loans and receivables from banks 14 36,434 9,886 Loans and receivables from customers 16 161,989 167,341 Securities 17 16,440 19,141 Investment properties 18 4,299 2,506 Equipment, investment property and intangible assets 18 1,055 1,133 Accrued interest and other assets 15 5,147 4,946

Total assets 294,110 267,247

LIABILITIES AND EQUITY Current accounts and deposits from banks 19 - 5,000 Current accounts and deposits from customers 20 209,953 170,257 Borrowings 21 17,255 25,828 Other liabilities 22 3,260 3,033 Provisions for liabilities and charges 23 454 639 Deferred tax liabilities 12 70 41

Total liabilities 230,992 204,798

Equity 24 Share capital 60,000 60,000 Legal reserves 281 281 Regulatory reserves for estimated losses 1,797 4,231 Revaluation reserves 630 371 (Loss)/profit for the year 410 (2,434)

Total equity 63,118 62,449

Total liabilities and equity 294,110 267,247

Commitments and contingent liabilities 25 13,883 21,197

Notes on the following pages form an integral part of these financial statements.


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STATEMENT OF CHANGES IN EQUITY For the year ended December 2016 (Thousands of BAM)

Share

Capital

Regulatory Reserves for

Estimated Losses

Legal Reserves

Revaluation Reserves

Retained Earnings/

Accumulated Losses Total

Balance of January 1 2015 60,000 4,231 256 86 25 64,598 Profit distribution - - 25 - (25) - Loss for the year - - - - (2,434) (2,434)

Other comprehensive income: - Actuarial loss (IAS 19) - - - (10) - (10) - Deferred tax effects - - - (32) - (32) - Effect of available-for-sale

securities valuation - - - 327 - 327

Total comprehensive income for the year - - - 285 (2,434) (2,149)

Balance at December 31, 2015 60,000 4,231 281 371 (2,434) 62,449 Profit distribution - (2,434) 2,434 - - - Loss coverage - - (2,434) - 2,434 - Profit for the year - - - - 410 410

Other comprehensive income: - Actuarial gains (IAS 19) - - - 26 - 26

- Deferred tax effects - - - (3) - (3) - Effect of available-for-sale

securities valuation - - - 236 - 236

Total comprehensive income for the year - - - 259 410 669

Balance at December 31, 2016 60,000 1,797 281 630 410 63,118



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STATEMENT OF CASH FLOWS For the year ended December 31, 2016 (Thousands of BAM)

Year Ended December 31,

2016


2015

Cash flows from operating activities Interest received 12,174 12,568 Interest paid (2,563) (3,362) Fees and commissions received 3,702 3,686 Fees and commissions paid (1,181) (1,077) Other receipts from operations 325 59 Payments to, and on behalf of employees and trade payables (9,470) (9,441) Income taxes paid (501) (122)

Net cash flow from operating activities 2,486 2,311

Cash flow changes in operating assets and liabilities Net increase in loans from customers 1,397 21,944 Net increase in securities 2,547 (18) Net increase/(decrease) in deposits from customers 34,696 4,416

Net cash generated from operating activities 41,126 28,653

Cash flows from investing activities Purchases of equipment and intangible assets (223) (261) Proceeds from investments in securities 731 142

Net cash used in investing activities 508 (119)

Cash flows from financing activities (Decrease)/increase in borrowings (8,574) (2,590)

Net cash (used in)/generated from financing activities (8,574) (2,590)

Foreign exchange (losses)/gains on translation of cash and cash equivalents (60) (97)

Net increase/(decrease) in cash and cash equivalents 33,000 25,847 Cash and cash equivalents, beginning of year 72,180 46,333

Cash and cash equivalents, end of year 105,180 72,180

Cash and cash equivalents comprise the following balance sheet components: Cash and cash funds held with the Central Bank and other banks 105,180 72,180


"KOMERCIJALNA BANKA" A.D. BANJA LUKA NOTES TO FINANCIAL STATEMENTS for the year ended December 31, 2016

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1. BANK´S ESTABLISHMENT AND ACTIVITY

Komercijalna banka a.d., Banja Luka (hereinafter: the “Bank”) was founded in September 2006 and entered into the Court Register based on a relevant Decision issued by the Basic Court in Banja Luka no. 071-0-REG-06-001693.

Within the process of the Bank’s registration for performance of its core activities, all conditions required

by the regulatory bodies were fulfilled. Under Decision no. 03-870-4/2006 dated August 28, 2006, the Banking Agency of the Republic of Srpska (“BARS”) issued an operating license to the Bank, whereas under Decision no. 03-983-1/2006 dated September 25, 2006 it issued the Bank a license to perform international payment transactions. In Bosnia and Herzegovina the Bank is licensed to perform payment transfers, credit and depositary operations in the country and abroad, and in accordance with the Republic of Srpska banking legislation, the Bank is to operate based upon the principles of liquidity, solvency and profitability.

As of December 31, 2016, the Bank was comprised of the Head Office located in Banja Luka at no. 6,

Veselina Masleše Street, 8 branches and 10 agencies in the territory of Bosnia and Herzegovina.

As of December 31, 2016, the Bank had 157 employees (December 31, 2015: 147 employees).

The Bank’s tax identification number is 4402503100008. The major shareholder of the Bank is Komercijalna banka a.d. Belgrade, which has a participation of 99.998%, and is the ultimate owner. Management Board of Komercijalna Banka AD Banja Luka from 15.9.2014 to 31.07.2016 consisted of the following members:

Srđan Šuput, Chairman of the Management Board; Boško Mekinjić, board member; Dragan Vučić, board member. Management Board of Komercijalna Banka AD Banja Luka from 01.08.2016 to 31.12.2016 consisted of the following members:

Boško Mekinjić, Chairman of the Board; Dragan Vučić, board member. Supervisory Board of Komercijalna Banka AD Banja Luka in the period from 15.09.2014 to 15.04.2016 Consisted of the following members:

Lidija Sklopić, president; Dragana Romandić, member; Ivan Dimitrijević, member; Una Sikimić, member; Ljiljana Milošević, member.

Supervisory Board of Komercijalna Banka AD Banja Luka in the period from 16.04.2016 to 29.06.2016 consisted of the following membersi:

Marko Schneider, president; Dragana Romandić, member; Ivan Dimitrijević, member; Una Sikimić, member; Ljiljana Milošević, member.

Supervisory Board of Komercijalna Banka AD Banja Luka in the period from 30.06.2016 to 31.12.2016 consisted of the following membersi:

Marko Schneider, president; Petar Stefanović, member; Mihajlo Kosanović, member; Aleksandar Grabovac, member; Savo Petrović, member.

Audit Board of Komercijala Banka AD Banja Luka in the period from 26.10.2014 to 06.07.2016 consisted of the following members::

Snežana Pejčić, president; Živorad Radovanović, member; Mišo Topić, member; Marija Bogdanović, member; Slaviša Jovanović, member.

Audit Board of Komercijala Banka AD Banja Luka in the period 07.07.2016 to 31.12.2016 consisted of the following membersnili su sledeći članovi:

Dragana Romandić, prezident; Gordana Zorić, member; Una Sikimić, member; Igor Krsmanović, član; Miloš Kolović, member.

"KOMERCIJALNA BANKA" A.D. BANJA LUKA NOTES TO THE FINANCIAL STATEMENTS for the year ended December 31, 2016

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2. BASIS FOR PREPARATION AND PRESENTATION OF THE FINANCIAL STATEMENTS 2.1. Statement of Compliance, Basis of Measurement and Basis for Preparation of the Financial 2.2. Statements

The accompanying financial statements of the Bank have been prepared in accordance with the accounting regulations effective in the Republic of Srpska. Accounting regulations applicable in the Republic of Srpska are based on the regulations of the Law on Accounting and Auditing ( "Law") (Official Gazette of the Republic of Srpska number 94/15). Bank produces and publishes its financial statements in accordance with International Accounting Standards ( "IAS"), including their amendments and interpretations ( "Interpretation standards") and International Financial Reporting Standards ( "IFRS") and their amendments and interpretations ( "Interpretation of international standards financial reporting ") as issued by the International Accounting Standards Board ("IASB"), and which have been translated and published by the Association of Accountants and auditors of the Republic of Srpska (under the authority of the Accounting Committee of Bosnia and Herzegovina. No. 2-11 / 06). The decision on publication is obligatory for periods beginning from January 1, 2009. All subsequently published standards of the Board are not translated or published, and therefore have not been applied in the preparation of these financial statements. Accordingly, these financial statements are not prepared in accordance with all the IFRS requirements. The financial statements have been prepared under the method of historical cost except for those financial assets and liabilities carried at fair value.

2.2. Functional and Presentation Currency

The Bank’s financial statements are stated in thousands of convertible marks (BAM). The convertible mark represents the official reporting currency in the Republic of Srpska and the Bank’s functional currency.

2.3. Use of Estimates

Preparation and presentation of financial statements requires the Bank’s management to make the best possible accounting estimates and assumptions that affect the stated amounts of assets and liabilities, as well as disclosures of contingent receivables and liabilities as of the financial statements’ preparation date and of income and expenses during the reporting period. These estimations and assumptions are based on historical experience and other information available as of the financial statements preparation date, which seem realistic and reasonable under the circumstances. Based on such information, assumptions are made on the value of assets or liabilities where other sources result in uncertainties. The actual values of assets and liabilities may vary from these estimates. The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period or in the period of the revision and future periods if the revision affects both current and future periods


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SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND KEY ACCOUNTING ESTIMATES AND ASSUMPTIONS

3.1. Interest Income and Expenses

Interest income and expense are recognized in the income statement (profit and loss) using the effective interest method. The effective interest rate is the rate that exactly discounts the estimated future cash payments and receipts through the expected life of the financial asset or liability (or, where appropriate, a shorter period) to the carrying amount of the financial asset or liability. When calculating the effective interest rate, the Bank estimates future cash flows considering all contractual terms of the financial instrument but not future credit losses The calculation of the effective interest rate includes all fees and transaction costs paid or received that are an integral part of the effective interest rate. Transaction costs include incremental costs that are directly attributable to the acquisition or issue of a financial asset or liability. Income from non-performing loans for accrued interest not collected is recognized within the income statement. The Bank makes impairment allowance for uncollected interest receivables arising from NPLs on a regular basis in accordance with the adopted methodology for impairment allowance of receivables in accordance with IAS 39. Loan origination fees are deferred, included in the interest income and amortized on a straight-line basis over the loan repayment period, which, in the opinion of the Bank’s management, is close to the effective interest method. Interest income and expenses included in the statement of comprehensive income include:

Interest accrued on the financial assets and financial liabilities measured at amortized cost using effective interest rates; and

Interest on investment securities available for sale..


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3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND KEY ACCOUNTING ESTIMATES AND

ASSUMPTIONS (Continued)

3.2. Fee and Commission Income and Expenses

Fee and commission income and expenses that are an integral part of the effective interest rate applied to a financial asset or liability are included in the measurement of the effective interest rate.

Other fee and commission income are recognized upon performance of the relevant service. Such fees and commissions relate to domestic and foreign transactions, credit card issuance and usage, issuance of guarantees and letters of credit and other banking services. Other fee and commission expenses relate mainly to transaction and service fees, which are recognized upon performance of the relevant service. Other fees and commission are recognized in the income statement as incurred or when they mature for collection. Guarantee approval fees and income from fees per other contingent liabilities are deferred i.e., recognized on a straight-line basis over the commitment period within the income statement.

3.3. Net trading income

Net trading income comprises gains less losses, related to trading assets and liabilities, and includes all realized and unrealized fair value changes and foreign exchange difference.

3.4. Net income from Other Financial Instruments at Fair Value through Profit or Loss

Net income from other financial instruments at fair value through Profit or Loss, relates to financial assets and liabilities designated at fair value through Profit or Loss and includes all realized and unrealized fair value changes

3.5 Operating and Finance Leases

Payments made during the year under operating leases are charged to the income statement on a straight-line basis over the period of the lease.

3.6. Tax Expenses

Tax expenses comprise current taxes and deferred taxes. Current taxes and deferred taxes are recognized in profit or loss except to the extent that they relate to items recognized directly in equity or in other comprehensive income. Current income tax is the amount of tax payable on the taxable profit reported in the annual tax return in accordance with the effective tax regulations. Current tax liabilities are measured at the amount expected to be paid to the competent tax authority (or refunded by the tax authority. The Bank presents in its income statement as the tax expense the amount arrived at by applying the legally prescribed tax rate to the amount of profit before taxation adjusted for the effects of permanent differences, i.e., tax effects of expenses not recognized for tax purposes and tax effects of tax holidays. Deferred taxes are amounts refundable or payable in the future periods that arose as a result of transactions and events from the prior periods. Such taxes are based on the differences between the carrying amounts of assets and liabilities recognized within the balance sheet and tax bases of those assets and liabilities recognized by the tax authorities, as well as on the carryforward of unused tax losses and tax credits. Deferred tax assets are generally recognized for all deductible temporary differences and effects of tax losses and tax credits available for carryforward to the ensuing financial periods to the extent that it is probable that taxable profits will be available against which those unused tax credits and unused tax losses can be utilized. Deferred tax assets are reviewed at the end of each reporting period and are reduced to the extent that it is no longer probable that sufficient taxable profit will be realized. Deferred tax assets and liabilities are determined by applying the currently effective (or expected to be effective) tax rate to the taxable temporary differences.


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ASSUMPTIONS (Continued) 3.7. Financial Assets and Liabilities

3.7.1. Recognition The Bank initially recognizes loans and receivables, deposits, borrowings and subordinated liabilities as they occur. All other financial assets and liabilities are initially recognized on the trade date at which the Bank becomes a party to the contractual provisions of the instrument. A financial asset or liability is measured initially at fair value of equivalents given upon their acquisition including transaction costs that are directly attributable to the acquisition, yet without transaction costs that may be incurred upon disposal. Exceptionally, transaction costs attributable to the acquisition of trading financial assets are immediately recognized in the income statement. 3.7.2. Classification The Bank classifies its financial assets into the following categories: financial assets held for trading, loans and receivables and investment securities (which are further classified as securities held to maturity, securities at fair value through profit and loss and securities available for sale).

The Bank classifies its financial liabilities as measured at amortized cost or held for trading.

3.7.3. Derecognition The Bank derecognizes a financial asset when the contractual rights to the cash flows from the financial asset expire, or when it transfers the financial asset in a transaction in which substantially all the risks and rewards of ownership of the financial asset are transferred or in which the Bank neither transfers nor retains substantially all the risk and rewards of ownership and it does not retain control of the financial asset. Any interest in transferred financial assets that qualifies for derecognition that is created or retained by the Bank is recognized as a separate asset or liability in the balance sheet. On derecognition of a financial asset, the difference between the book value (or book value of part of the assets that is transferred) and the sum of fee received (including new assets which are purchased less any new commitments), as well as the cumulative gain or loss that are previously recognized in the balance sheet are also recognized in the income statement. The Bank enters in transactions whereby it transfers assets recognized on its balance sheet, but retains either all or substantially all of the risks and rewards of the transferred assets or a portion of them. If all or substantially all risks and rewards are retained, then the transferred assets are not derecognized. Transfers of assets with retention of all or substantially all risks and rewards include, for example, repurchase transactions. In transactions in which the Bank neither retains nor transfers substantially all the risk and rewards of ownership of a financial asset and it retains control over the asset, the Bank continues to recognize the asset to the extent of its continuing involvement, determined by the extent to which it is exposed to changes in the value of the transferred asset. The Bank derecognizes a liability when it is settled, cancelled or ceded. 3.7.4 Offsetting Financial assets and liabilities are offset and the net amount presented in the balance sheet when, and only when, the Bank has a legal right to set off the recognized amounts and it intends either to settle on a net basis or to realize the asset and settle the liability simultaneously . Income and expenses are presented on net basis only when permitted under IFRSs, or for gains and losses arising from a group of similar transactions such as in the Bank’s trading activity.


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ASSUMPTIONS (Continued)) 3.7. Financial Assets and Liabilities (Continued)

3.7.5. Amortized Cost Measurement

The amortized cost of a financial asset or liability is the amount at which the financial asset or liability is measured at initial recognition, minus principal repayments, plus or minus the cumulative amortization using the effective interest method of any difference between the initial amount recognized and the nominal maturity amount, less any impairment. 3.7.6. Fair Value Measurement

The fair values stated for financial instruments are the amounts for which the asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. Whenever possible, the Bank measures the fair value of an instrument using quoted prices in an active market for that instrument. A market is regarded as active if quoted prices are readily and regularly available and represent actual and regularly occurring market transactions on an arm’s length basis. If a market for a financial instrument is not active, the Bank establishes fair value using a valuation technique. Valuation techniques include using recent arm’s length transactions between knowledgeable, willing parties (if available), reference to the current fair value of other instruments that are substantially the same, discounted cash flow analyses and other optional models. The chosen valuation technique makes maximum use of market inputs, relies as little as possible on estimates specific to the Bank, incorporates all factors that market participants would consider in setting a price, and is consistent with accepted economic methodologies for pricing financial instruments. Inputs to valuation techniques reasonably represent market expectations and measures of the risk-return factors inherent in the financial instrument. Valuation methods are calibrated and tested for validity using prices from observable current market transactions in the same instrument of based on other available observable market data. The best evidence of the fair value of a financial instrument at initial recognition is the transaction price, i.e. the fair value of the consideration given or received, unless the fair value of that instrument is evidenced by comparison with other observable current market transactions in the same instrument (i.e., without modification or repackaging) or based on a valuation technique whose variables include only data from observable markets. When transaction price provides the best evidence of fair value at initial recognition, the financial instrument is initially measured at the transaction price and any difference between this price and the value initially obtained from a valuation model is subsequently recognized in profit or loss depending on the individual facts and circumstances of the transaction but not later than when the valuation is supported wholly by observable market data or the transaction is closed out. Any difference between the fair value at initial recognition and the amount that would be determined at that date using a valuation technique in a situation in which the valuation is dependent on unobservable parameters is not recognized in profit or loss immediately but is recognized over the life of the instrument on an appropriate basis or when the instrument is redeemed, transferred or sold, or the fair value becomes observable. Fair values reflect the credit risk of the instrument and include adjustments to take account of the credit risk of the Bank and counterparty where appropriate. Fair value estimates obtained from models are adjusted for any other factors, such as liquidity risk or model uncertainties to the extent that the Bank believes a third-party market participant would take them into account in pricing a transaction.

3.7.7. Identification and Measurement of Impairment

At reporting date the Bank assesses whether there is objective evidence that financial assets not carried at fair value through profit or loss are impaired. A financial asset or a group of financial assets are impaired when objective evidence demonstrates that a loss event has occurred after the initial recognition of the assets, and that the loss event has an impact on the future cash flows of the assets that can be estimated reliably.


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3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND KEY ACCOUNTING ESTIMATES AND ASSUMPTIONS (Continued)

3.7. Financial Assets and Liabilities (Continued)

3.7.7. Identification and Measurement of Impairment

Objective evidence that financial assets (including equity securities) are impaired can include significant financial difficulty of the borrower or issuer, default or delinquency by a borrower, restructuring of a loan or advance by the Bank on terms that the Bank would not otherwise consider, indications that a borrower or issuer will enter bankruptcy, the disappearance of an active market for a security, or other observable data relating to a group of assets such as adverse changes in the payment status of borrowers or issuers in the group, or economic conditions that correlate with defaults in the group. In addition, for an investment in an equity security, a significant or prolonged decline in its fair value below its cost is objective evidence of impairment. The Bank considers evidence of impairment for loans and receivables and held-to-maturity investment securities at both a specific asset and collective level. All individually significant loans and receivables and held-to-maturity investment securities are assessed for specific impairment. All individually significant loans and receivables and held-to-maturity investment securities found not to be specifically impaired are then collectively assessed for any impairment that has been incurred but not yet identified. Loans and receivables and held-to-maturity investment securities that are not individually significant are collectively assessed for impairment by grouping together loans and receivables and held-to-maturity investment securities with similar risk characteristics. In assessing collective impairment the Bank uses statistical modeling of historical trends of the probability of default, timing of recoveries and the amount of loss incurred, adjusted for management’s judgment as to whether current economic and credit conditions are such that the actual losses are likely to be greater or less than suggested by historical modeling. Default rates, loss rates and the expected timing of future recoveries are regularly benchmarked against actual outcomes to ensure that they remain appropriate. Impairment losses on assets carried at amortized cost are measured as the difference between the carrying amount of the financial asset and the present value of estimated future cash flows discounted at the asset’s original effective interest rate. Losses are recognized in profit or loss and reflected in an allowance account against loans and receivables. When a subsequent event causes the amount of impairment loss to decrease, the decrease in impairment loss is reversed through profit or loss. Impairment losses on available-for-sale investment securities are recognized by transferring the cumulative loss that has been recognized in other comprehensive income to profit or loss as a reclassification adjustment. The cumulative loss that is reclassified from other comprehensive income to profit or loss is the difference between the acquisition costs, net of any principal repayment and amortization, and the current fair value, less any impairment loss previously recognized in profit or loss. Changes in impairment provisions attributable to time value are reflected as a component of interest income. If, in a subsequent period, the fair value of an impaired available-for-sale debt security increases and the increase can be objectively related to an event occurring after the impairment loss was recognized in profit or loss, the impairment loss is reversed, with the amount of the reversal recognized in profit or loss. However, any subsequent recovery in the fair value of an impaired available-for-sale equity security is recognized in other comprehensive income.

3.8. Cash and Cash Equivalents

Cash and cash equivalents include cash balances on gyro accounts in BAM and foreign currencies, cash on hand in BAM and foreign currencies, deposits held with the Central Bank, revocable deposits held with other banks, other cash funds if eligible for recognition as cash equivalents and precious metals if directly cashable in the near term.


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3.9. Derivatives

Financial derivatives comprise forward and swap transactions. Financial derivatives are initially recognized at cost and are subsequently measured at market value. Market values are ascertained by using different valuation techniques, including discounted cash flows. Financial derivatives are accounted for under assets if their market value is positive and under liabilities if their market value is negative. Fluctuations in market value of financial assets are reported in the income statement, under net trading income.

3.10. Loans and Receivables

Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market and that the Bank does not intend to sell immediately or in the near term. They arise when the Bank provides money or services directly to a debtor with no intention of trading the receivable. Loans and receivables comprise loans and receivables to banks and customers. Loans and receivables are initially recognized at fair value.. After initial recognition, loans and receivables are measured at amortized cost using the effective interest method.

Loans approved in BAM that are hedged using a contractual currency clause linked to the BAM to EUR exchange rate, BAM to another currency rate or a retail price index are translated into BAM as at the reporting date in accordance with the provisions of the relevant loan agreements.

Loans and receivables are presented net of individual and collective allowances for impairment. Individual and collective allowances are made against the carrying amount of loans and receivables that are identified as being impaired in order to reduce their value to recoverable amount. If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognized (such as an improvement in the debtor’s credit rating), the previously recognized impairment loss is reversed by adjusting the allowance account. The amount of the reversal is recognized in the income statement.

3.11. Investment Securities

Investment securities are initially measured at fair value plus, in case of investment securities other than at fair value through profit or loss, incremental direct transaction costs, and subsequently accounted for depending on their classification as either held-to-maturity, at fair value through profit or loss, or available-for-sale.

3.11.1. Available-for-Sale Financial Assets and Equity Investments Available for sale financial assets are those non-derivative financial assets that are designated as available for sale or are not classified as another category of financial asset. Available-for-sale investments are those intended to be held for an indefinite period of time, which may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices. Financial assets available for sale are all other financial assets, including equity investments in legal entities, except for the assets acquired to be sold promptly or in the near term, which should be classified as financial assets held for trading.


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3.11. Investment Securities (continued)

3.11.1. Available- for- Sale Financial Assets and Equity Investments (Continued)

Financial assets available for sale are measured at fair value. If there is no active market for the financial assets available for sale, they are measured at cost. After initial recognition, measurement of available for-sale financial assets depends on whether they have quoted market prices. Available-for-sale financial assets that have quoted market prices are measured at market value, and equity investments without quoted market prices are measured at amortized cost using the effective interest method.

Other fair value changes are recognized in other comprehensive income until the investment is sold or impaired, whereupon the cumulative gains and losses previously recognized in other comprehensive income are reclassified to profit or loss as a reclassification adjustment.

When a decline in the fair value of an available-for-sale financial asset has been recognized in other comprehensive income and there is objective evidence that the asset is impaired (long and continuing decline in the fair value in the period longer than twelve months, as well as decline above 30% of cost), the cumulative loss that had been recognized within equity shall be reclassified from equity to profit or loss and recognized as an impairment loss although the Bank has not ceased to recognize the financial asset. A non-derivative financial asset may be reclassified from the available-for-sale category to the loans and receivables category if it otherwise would have met the definition of loans and receivables and if the Bank has the intention and ability to hold such financial assets for the foreseeable future or until maturity.

3.12. Property and Equipment

Items of property and equipment are initially measured at cost or purchase price. Cost includes expenditures that are directly attributable to the acquisition of the asset. Following initial recognition items of equipment are measured at cost less accumulated depreciation and accumulated impairment losses. Following initial recognition, property is measured at a revalued amount which represents its fair value at valuation date less subsequent accumulated depreciation and subsequent accumulated impairment losses. Valuation is performed at least once every five years or more frequently in the event of major market disorders, in order to ensure that net book value does not differ significantly from the amount that would result from using the fair value approach at the end of reporting period.

When parts of an item of property or equipment have different useful lives, they are accounted for as separate items (major components) of property and equipment. The gain or loss on disposal of an item of property and equipment is determined by comparing the proceeds from disposal with the carrying amount of the item or property and equipment, and are recognized within other income or other expenses in profit or loss. 3.12.1. Subsequent Expenses

The cost of replacing part of an item of property or equipment is recognized in the carrying amount of the item if it is probable that the future economic benefits embodied within the part will flow to the Bank and its cost can be measured reliably. The carrying amount of the replaced part is derecognized. The costs of the day-to-day servicing of property and equipment are recognized in profit or loss as incurred. .


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ASSUMPTION (Continued)

3.12. Property and Equipment (Continued)

3.12.2. Depreciation

Depreciation is recognized in profit or loss on a straight-line basis over the estimated useful lives of each part of an item of property and equipment since this most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset. Leased assets are depreciated over the shorter of the lease term and their useful lives. The estimated useful lives and depreciation rates for the current and comparative periods were as follows:

Depreciation rate

Estimated useful life (in years)

Computer equipment 25% 4 Vehicles 15.5% 6.5 Furniture and other equipment 10% - 33.33% 3 - 10 Leasehold improvements 10% - 33.34% 3 - 10 Buildings 2.5 % 40

Depreciation methods, useful lives and residual values are reassessed at each financial year-end and adjusted if appropriate.

3.13. Intangible Assets

Intangible assets are initially measured at cost comprised of the purchase price increased by direct costs incurred in placing the assets in use. After initial recognition, intangible assets are measured at cost less accumulated amortization and accumulated impairment losses. Subsequent expenditure on intangible assets is capitalized only when it increases the originally estimated useful life or the future economic benefits embodied in the specific asset to which it relates. Amortization is recognized in profit or loss on a straight-line basis over the estimated useful life of each item of intangible assets, since this most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset. The estimated useful life of intangible assets is 3 to 5 years and amortization rates used range 20.00% and 33.33 %. Amortization methods, useful lives and residual values are reassessed at each financial year-end and adjusted if appropriate.

3.14. Investment property

Investment property (land, a building or part(s) of a building) held by the Bank either to earn rental income or for capital appreciation or for both, but not for sale in the ordinary course of business, use in the production or supply of goods or services or for administrative purposes. Investment property is initially measured at cost. Cost of acquired investment property comprises the purchase price and all expenses that can be directly attributed to the acquisition of the asset. For subsequent measurement of investment property the Bank uses the cost model, such that investment property is measured at cost less accumulated depreciation and impairment losses. Estimated useful life of investment property amounts to 40 years, while the depreciation rate used equals 2.5%. Depreciation is provided for in profit or loss on a straight line basis over the useful life of a given item of property, given that it reflects best the expected exploitation of the useful economic value embodied in the asset. Investment property is subject to revaluation once every five years or more frequently in the event of major market disruptions.


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3.15. Assets Acquired in Lieu of Debt Collection

Collection of receivables through foreclosure of movable and immovable assets when the Bank's receivables are securitized with mortgage or pledge liens over such assets or another sort of collateral is performed based on the relevant court ruling and/or purchase/sale agreements arising from out-of-court settlement arrangements or auction purchase.

Tangible movable and immovable assets received in lieu of debt collection are recognized in the Bank's books as inventories of assets acquired in lieu of debt collection and are intended to be sold within a year. Such assets are initially measured at the lower of the following:

appraised value of the assets acquired (appraisal up to a year old) less costs to sell,

when assets are acquired under the relevant court ruling at the amount below the gross value of receivables (secured with the said assets), such assets are measured at the amount stated in the court ruling.

After the initial recognition, the carrying values of the assets acquired in lieu of debt collection are adjusted to their fair values, as well as for impairment should impairment occur in the assets in terms of decline of their recoverable amounts in accordance with the relevant decision made by the Bank's Executive Board. Effects of value adjustment are recognized within expenses.

3.16. Non-Current Assets Held for Sale

Non-current assets held for sale are assets whose carrying amounts can primarily be recovered through a sale transaction and not through further use. Non-current assets held for sale are measured at the lower of the carrying value and fair value less costs to sell. In the event that such an asset is not sold within a year from the initial recognition as an asset held for sale, the carrying amount of the assets is adjusted to the fair value thereof, as well as in the event of impairment of such assets in terms of decline of their recoverable values, in accordance with the relevant decision enacted by the Bank’s management. The effects of value adjustment are recognized within the expenses of the period.

Non-current assets held for sale are not depreciated.

3.17. Leases

The Bank classifies leases (of property and equipment) as financial leasing when the lease agreement stipulates that the basic risks and benefits of ownership over the leased assets are transferred to the lessee. All other leasing agreements are classified as operating leases.

Lease agreements that relate to lease of office space in which the Bank’s branches are located primarily relate to operating leases. All payments made during the year for operating leases are reported as expenses in the statement of comprehensive income on a straight line basis over the duration of the lease period.

Assets that are held under finance lease agreements are recognized as the Bank’s assets at the lower of their fair value and the present value of minimum lease payments specified at the start of the lease agreement. The corresponding liability toward the lessor is reported in the balance sheet as a finance lease liability. Lease payments are apportioned between the finance expense and the reduction of the outstanding finance lease liability, such that a constant interest rate is achieved on the outstanding portion of the liability. The related financial expense is reported directly as an expense of the period.


20

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND KEY ACCONTING ESTIMATES AND ASSUMPTIONS (Continued)

3.18. Impairment of Non-Financial Assets

The carrying amounts of the Bank’s non-financial assets, other than investment property and deferred tax assets are reviewed at each reporting date to determine whether there is any indication of impairment. If any such indication exists then the asset’s recoverable amount is estimated. An impairment loss is recognized if the carrying amount of an asset exceeds its estimated recoverable amount.

The recoverable amount of an asset is the greater of its value in use and its fair value less costs to sell. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset.

An impairment loss is recognized when the carrying amount of an asset exceeds its recoverable amount. Impairment losses are recognized in the income statement (profit or loss).

Impairment losses recognized in prior periods are assessed at each reporting date for any indications that the loss has decreased or no longer exists. An impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortization, if no impairment loss had been recognized.

3.19. Deposits, Borrowings and Subordinated Liabilities

Deposits, debt securities, borrowings and subordinated liabilities are the Bank’s main sources of financing (finance instruments). The Bank classifies capital instruments as financial liabilities or equity instruments in accordance with the substance of the contractual terms of the instruments.

Deposits, debt securities, borrowings and subordinated liabilities are initially measured at fair value increased for all directly attributable transaction costs, while they are subsequently measured at amortized cost using the effective interest rate method.

3.20. Provisions

A provision is recognized if, as a result of a past event, the Bank has a present legal or constructive obligation that can be estimated reliably, and it is probable that an outflow of economic benefits will be required to settle the obligation. Provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and, where appropriate, the risks specific to the liability.


21


3.21. Employee Benefits

In accordance with regulatory requirements effective in Bosnia and Herzegovina, the Bank is obligated to pay contributions to various state social security funds, which guarantee social security insurance benefits to employees. These obligations involve the payment of taxes and contributions on behalf of the employee, by the employer, in the amounts computed by applying the specific, legally prescribed rates. The Bank is also legally obligated to withhold contributions from gross salaries to employees, and on behalf of its employees, to transfer the withheld portions directly to government funds. These taxes and contributions payable on behalf of the employee and employer are charged to personnel expenses in the period in which they arise. The Bank has no defined benefit plans of its own or share-based remuneration options to employees and had no identified liabilities in this respect as at December 31, 2016. In 2016, the Bank made provisions for long-term liabilities for employee retirement benefits and benefits for unused annual leaves (vacations) in accordance with IAS 19. The Bank hired a certified actuary to perform evaluation and calculation of provisions for the aforesaid purpose

3.22. Equity and Reserves

The Bank’s equity consists of: share capital, special reserves for estimated losses, profit/loss for the year, prior years’ retained earnings and revaluation reserves. The Bank’s core capital was formed from the monetary contributions of the Bank’s founders. A founder cannot withdraw assets contributed to the Bank’s core capital.

3.23. Earnings per Share

The Bank presents basic earnings per share (EPS) data for its ordinary shares. Basic EPS is calculated by dividing the profit or loss attributable to ordinary shareholders of the Bank by the weighted average number of ordinary shares outstanding during the period.

3.24. Foreign Exchange Translation

Transactions denominated in foreign currencies are translated into BAM at official middle exchange rates effective at the date of each transaction.

Monetary assets and liabilities denominated in foreign currencies and stated at cost are translated into BAM at official middle exchange rates effective at the reporting date. Net foreign exchange positive or negative effects arising upon translation of foreign currency assets and liabilities are recognized in the income statement. Non-monetary assets denominated in foreign currencies and stated at cost are translated into BAM at official middle exchange rates effective the date of each transaction.

The official exchange rates for major currencies used in the translation of balance sheet components denominated in foreign currencies are as follows:

In BAM

December 31,

2016 December 31,

2015

USD 1.855450 1.790285 CHF 1.821240 1.807781 EUR 1.955830 1.955830


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4. INTEREST INCOME

In thousands of BAM


2016 2015

Interest income from:

Corporate customers, public and state agencies 8,280 9,656

Retail customers 2,478 2,631

Securities 803 746

Bank and other financial institutions 1 1

11,562 13,034

5. INTEREST EXPENSES

6. FEE AND COMMISSION INCOME

In thousands BAM


` 2016 2015

Fee and commission income from payment transactions 2,291 2,299

Commission income from currency conversions 565 615

Fees and commissions arising on payment card operations 493 456

Fees for issued guarantees and other securities 214 223

Other fee and commission income 135 140

3,698

3,733

7. FEE AND COMMISSION EXPENSES

In thousands BAM


2016 2015

Fees and commissions arising on payment card operations 512 409

Fees and commissions charged by the RS Banking Agency 209 193

Fees and commissions charged by the Central Bank for domestic payment transactions 184 155

Fee and commission expenses for foreign payment transactions 136 160

Fee and commission expenses for currency conversions 118 135

Other fee and commission expenses 27 27

1,186 1,079

In thousands of BAM Year Ended December

2016 2015

Interest expenses from : Deposits from retail customers 1,086 1,246 Deposits and borrowings from banks and financial institutions 808 853 Deposits from corporate customers, public and state agencies 635 1,223

2,529 3,322


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8. (LOSSES)/GAINS ON VALUATION OF ASSETS AND LIABILITIES, NET

In thousands of BAM


2016 2015

Foreign exchange gains 5,272

8,614

Foreign exchange losses (5,331)

(8,710)

Losses on value adjustment of Repossessed assets (466)

(251) Net income on valuation of assets (525)

(347)

Assets and liabilities denominated in foreign currencies are translated into BAM at the balance sheet date by applying the official rates of exchange in effect on that date. Foreign exchange gains or losses arising upon translation are credited or charged to the income statement. Losses from changes in value of the material acquired assets held for resale are arising based on:

the impairment of fixed assets held for sale (property and equipment) in the amount of BAM 208 thousands reducing the amount of the estimated market value or the subsequent evaluation by applying internally defined rate of impairment, depending of the applicable method of impairment in the case of specific asset held for sale,

impairment of investment property and land in the total amount of BAM 236 thousands reducing

the amount of the estimated market value

Impairment of equipment leased and which is calculated by subsequent evaluation by applying internally defined rate of impairment in the amount of BAM 22 thousands.

9. PROVISIONS a) Provisions for Impairment, Commitments and Contingent liabilities

In thousands of BAM


2016 2015

PROVISION EXPENSES

Impairment of loans and receivables from customers 8,801 10,150

Provisions for losses per off-balance sheet items 636 415

Impairment allowance of other assets 58 12

Impairment allowance of other liabilities 11 66

9,506 10,643

REVERSAL OF PROVISIONS

Reversal of impairment of loans and receivables due from customers 8,058 5,884

Reversal of provisions for losses per off-balance sheet items 666 463

Reversal of provisions for other liabilities 140 -

8,864 6,347

PROVISIONS FOR POTENTIAL LOSSES, NET 642 4,296

Provisions for other liabilities in the total amount of BAM 11 thousands are related to provisions for litigations. Reversal of provisions for other liabilities relate to cancellation of provisions for litigations in the amount of BAM 17 thousands, provisions for employee retirement benefits and unused annual leaves (vacations) of BAM 123 thousands.


24

9. PROVISIONS (Continued) b) Movements on the long-term provisions for Commitments and Contingent liabilities

In thousands of BAM

Loans and Receivable

s from Customers

(Note 16)

Accrued Interest and

Other Assets

(Note 15)

Commitme

nts and Contingent

Liabilities (Note 23)

Provisions for

Litigation (Note 23)

Provisions for

Employee Retirement

Benefits and Annual Leaves

(Note 23) Total

Balance, January 1, 2015 10,333 1,447 274 8 329 12,391 Charge for the year 9,423 739 415 4 62 10,643 Reversal of provisions (5,665) (219) (463) - - (6,347) Actuarial losses charged to revaluation reserves - - - - 10 10

Balance, December 31, 2015 14,091 1,967 226 12 401 16,697

Charge for the year 8,333 526 636 11 - 9,506 Reversal of provisions (7,610) (448) (666) (17) (123) (8,864) Actuarial gains credited to revaluation reserves - - - - (26) (26)

Balance, December 31, 2015 14,814 2,045 196 6 252 17,313


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10. OTHER OPERATING EXPENSES

In thousands of BAM


2016 2015

Net salaries and benefits 2,807 2,612

Payroll taxes and contributions 1,883 1,819

Rental costs 1,409 1,496

Other non-material expenses 757 677

Current and investment maintenance of property and equipment 698 657

Security services 555 568

Depreciation and amortization 554 565

Materials, fuel and energy 356 325

Deposit insurance premiums 288 325

Lawyer fees and administrative fees 196 185

Telecommunication and postage services 185 178

Other insurance premium costs 158 189

Marketing and advertising 147 126

Other taxes and contributions 130 152

Other staff costs 117 192

Costs of legal judgments and tax settlement 89 -

Receivables write-off 88 -

Other expenses 44 5

10,461

10,071

11. OTHER OPERATING INCOME

In thousands of BAM

Year Ended December 31, 2016 2015

Gains on sales of securities available-for-sale 298 200 Revenues from rent of investment property 95 44 Income from previous years from corporate business 87 - Income from previous years from operations with securities 87 - Other income from litigations payments 72 6 Other income 59 8

698 258

Gains on the sale of securities available for sale of BAM 298 thousand relate to the gains on the sale and collection upon maturity of coupon bonds issued by the Government of the Republic of Srpska (Ministry of Finance, Public Debt Management Office), realized in the secondary trade.


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12. INCOME TAXES

In thousands of BAM


(Loss)Profit before taxes 615 (2,090)

Tax calculated at the rate of 10% 62 (209) Previous period tax loss carried forward - - Effects of income recognized for tax purposes - 120 Provisioning charges and other costs not recognized for tax purposes 287 453 Non-taxable income (144) (20)

Effective income tax expense 205 344

Effective tax rate 33,33% not applicable

In accordance with applicable laws, the Tax Administration has the discretionary right to determine the tax treatment of business activities and transactions of any taxpayer. Therefore, changes in the business activities can be differently treated by the Tax Administration. As a result, the Bank may be charged additional taxes, penalties and interest, which may be significant.

In thousands BAM


Deferred tax liabilities Revalorization reserves from securities and actuarial assessment at

the beginning of the year 41 9 Change during the year 29 32

Revalorization reserves from securities and actuarial assessment at the end of the year 70 41

Deferred tax liabilities on the December 31, 2016 in the amount of BAM 70 thousand refer to effects based on revaluation reserves for investment in securities available for sale and revaluation reserve based on actuarial valuation. The same had the effect on the balance of revaluation reserves.


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13. CASH AND CASH EQUIVALENTS HELD WITH THE CENTRAL BANK

In thousands BAM

December 31, 2016

December 31, 2015

Cash funds: - in BAM 4,078 2,883 - in foreign currencies 2,633 1,912 Cash funds held with the Central Bank in BAM: - Current account 38,904 41,882 - Obligatory reserves 22,499 15,617 - Other reserves 632 -

68,746

62,294

The reported amounts of cash funds held with the Central Bank of Bosnia and Herzegovina include the obligatory reserve held with the Central Bank of Bosnia and Herzegovina, which represents the minimum amount of reserves calculated in domestic currency in accordance with the Decision on the Obligatory Reserve Held with the Central Bank of Bosnia and Herzegovina and surplus liquid assets deposited with the Central Bank.

As of May 1, 2015, the fees for the obligatory reserve maintenance have been charged using the average EIONIA rate recorded in the market in the same period, less 10 basis points or it could be minimum zero, while the fee for the funds exceeding the obligatory reserve equals zero. The zero rate is applied to the obligatory reserve in the event that the average EIONIA rate decreased by 10 basis points is negative. As of July1, 2016, the mandatory reserve rate applied by the Central Bank on the base for calculation the mandatory reserve requirement is 10%. The basis for calculation of required reserves consists of deposits and borrowed funds, regardless of currency asset recognized on the balance of funds at the end of each working day of the accounting period preceding the period of maintenance. The Central bank does not charge fee on obligatory reserves, and the amount of funds above the obligatory reserve fee is charged at a rate equal to the 50% rate applied by the European Central Bank to commercial banks' deposits (Deposit Facility Rate). If during the maintenance period, Deposit Facility Rate changes, it shall apply the rate that applied on the first day of the maintenance period during which change of Deposit Facility Rate occurred.

14. LOANS AND RECEIVABLES FROM BANKS

In thousands of BAM

December 31, 2016

December 31, 2015,

Loans and receivables from: Foreign banks 36,370 9,854 Domestic banks 64 32

36,434

9,886


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15. ACCRUED INTEREST AND OTHER ASSETS

In thousands BAM

December 31, 2016

December 31, 2015

In BAM: Due interest receivables - from loans 2,692 3,193 Repossessed assets 2,635 1,726 Other receivables 506 505 Deferred other expenses 208 183 Interest receivables arising from securities available for sale 193 40 Accrued interest receivables 191 190 Fee and commission receivables 123 116 Inventories of materials 62 70 Deferred expenses - at the effective interest rate 31 47 Receivables for prepaid taxes and contributions 15 - In foreign currencies:

Other foreign currency receivables 362 341 Interest receivables arising from securities available for sale 102 424 Receivables from accrued interest in foreign currency - loans 72 56 Accrued interest - 22 Impairment allowance off:

- Due nterest (1,852) (1,843) - fees and other assets (193) (124)

5,147 4,946

Repossessed assets Properties:

In thousands of BAM Acquisition date Property/location

December 31, 2016

December 31, 2015

30/08./2016. Prijedor, commercial buildings and land 1,029 - 12/12/2014. Business premises, Posušje 406 421 24/06/2015. Gradiška, Kočićevo, commercial building and

land 332 355 23/12/2015. Hadžići, commercial buildings and land 325 337 30/11/2015. Mrkonjić Grad, commercial buildings and land 241 350 28/10/2015. Prijedor, family house 106 110 28/11/2016. Gradiška, Rovine, commercial building and land 87 -

2,526

1,573

Equipment:

In thousands of BAM Acquisition date Assets

December 31, 2016

December 31, 2015

24.11.2015. Equipment - construction and other machinery 59 78 29.01.2015. Machinery for dairy industry 31 54 16.12.2015. Equipment - printing and other machinery 19 21

109

153

After initial recognition, subsequent valuation of assets held for sale is performed no later than the expiration of a period of 12 months from the date of acquisition. In cases where the estimated market value is determined to be lower than the carrying amount, the Bank made impairment of assets by reducing the carrying value to the amount of the estimated market value, and in cases where the assessment of an independent appraiser determined the market value in a higher amount than the carrying amount, the impairment of these assets was made in accordance with internal policies.


29

16. LOANS AND RECEIVABLES FROM CUSTOMERS

Loans and receivables from customers are presented within the balance sheet in the outstanding and unpaidamounts of the loans approved. Loans were approved to retail customers at interest rates ranging from 2.75% to 12.50% whereas the annual interest rates for other types of loans were between 3.00% to 11.00%. The maximum period for which retail loans were approved lasts 25 years. Short-term loans approved to corporate customers accrued interest at the rates of 2.90% to 9,35% annually. Long-term loans were extended at interest rates between 3.25% and 11.00% annually. By its decisions on amendments and supplements to the Decision on the Minimum Standards for Credit Risk Management and Classification of Banks’ Assets (Official Gazette of RS no 49/13 and 01/14) the Banking Agency of the Republic of Srpska proscribed for the banks to implement adequate methodology for measuring impairment of loans and other financial assets in accordance with IAS/IFRS (whose application has been obligatory from January 1, 2010) as well as pursuant to the accounting and auditing regulations prevailing in the Republic of Srpska. The Bank’s management made provisions for potential credit losses based on all known and anticipated risks as at the financial statements’ preparation date. Classification of the loan portfolio receivables was made based on the most recent financial information available.

In thousands of BAM

December 31, 2016

December 31, 2015

In BAM : OUTSTANDING LOANS

Up to a year Short-term loans to corporate customers 29,045 21,536 Short-term loans to retail customers 1,338 1,540 Short-term loans to public sector and public companies 200 2,290 Over a year Long-term loans to public sector and public companies 53,787 62,314 Long-term loans to retail customers 37,487 35,931 Long-term loans to corporate customers 28,822 27,508 In foreign currencies: Long-term loans to corporate customers 5,867 5,714 Impairment allowance of loans and receivables (2,318) (2,317)

TOTAL LOANS AND RECEIVABLES 154,228 154,516

MATURED LOANS Matured loans in BAM 20,154 24,496 Impairment allowance of loans and receivables in BAM (12,393) (11,671) Matured loans in foreign currencies 103 103 impairment allowance of loans and receivables in foreign currencies (103) (103)

TOTAL MATURED LOANS: 7,761 12,825

TOTAL LOANS AND RECEIVABLES FROM CUSTOMERS 161,989 167,341


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17. SECURITIES

In thousands of BAM

December 31, 2016

December 31, 2015

Securities available for sale: In BAM:

- war damaged bonds 12,909 3,230 - Treasury bills - 1,969

In foreign currencies: - bonds issued by the Government of the Republic of Serbia 3,531 13,942

16,440 19,141

Securities available for sale in local currency relate to the investments in bonds issued by the Government of the Republic of Srpska for the purpose of settlement liabilities for old foreign currency savings at an interest rate of 2.5 % and war reparations and non-material damage at an interest rate of up to 1.5% which are traded in Banja Luka Stock Exchange. Securities available for sale in foreign currencies refer to investments in bonds issued by the Government of the Republic of Serbia at the interest rates from 4.0% annually. Bonds are classified as financial assets available for sale.

"KOMERCIJALNA BANKA" A.D. BANJA LUKA NOTES TO FINANCIAL STATEMENTS for the year ended December 31, 2016

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18. EQUIPMENT, INVESTMENT PROPERTY AND INTANGIBLE ASSETS In thousands of BAM

Equipment and

Other Assets Assets under Construction

Leasehold Investments

Investment properties

Intangible Assets

(Licenses and Programs)

Intangible Assets under Construction

Total

Cost Balance, January 1, 2015 4,929 83 674 2,199 2,604 52 10,541 Additions 136 143 6 435 102 119 941 Transfers - (142) - - - (102) (244) Disposals (12) - - - - - (12)

Balance, December 31, 2015 5,053 84 680 2,634 2,706 69 11,226

Balance, January 1, 2016 5,053 84 680 2,634 2,706 69 11,226 Additions - 242 - - - 196 438 Transfers 241 (292) 51 2,305 242 (242) 2,305 Disposals (81) - (14) - - - (95) Sales - - - (233) - - (233)

Balance, December 31, 2016 5,213 34 717 4,706 2,948 23 13,641

Impairment allowances Balance, January 1, 2015 4,064 - 526 96 2,347 - 7,033 Depreciation for the year 364 - 34 32 135 - 565 Disposals (11) - - - - - (11)

Balance December 31, 2015 4,417 - 560 128 2,482 - 7,587

Balance January 1, 2016 4,417 - 560 128 2,482 - 7,587 Depreciation for the year 284 - 39 46 185 - 554 Disposals (81) - (6) - - - (87) Sales - - - (3) - - (3) Impairment - - - 236 - - 236

Balance December 31, 2016 4,620 - 593 407 2,667 - 8,287

Net Book Value December 31, 2015 636 84 120 2,506 224 69 3,639

December 31, 2016 593 34 124 4,299 281 23 5,354


NOTES TO THE FINANCIAL STATEMENTS For the year ended December 31, 2016

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18. EQUIPMENT, INVESTMENT PROPERTY AND INTANGIBLE ASSETS (Continued)

As of December 31, 2016, the Bank had investment property stated as totaling BAM 4,299 thousand mostly comprised of leased out properties (December 31, 2015: BAM 2,506 thousand). On the basis of the contract on long-term lease, the Bank in 2016 carried out the transfer of the investment real estate from the position of fixed assets held for sale (business-catering facility located in Nova Topola and land with commercial and catering facility located in Nova Topola) in amount of BAM 2,305 thousand. During 2016, certified appraisers engaged by the Bank appraised the amount investment property by BAM 236 thousand. . During 2016 the Bank sold the office building-warehouse and associated land to the mentioned object in Tišći, Šekovici Municipality and on that basis made the impairment of investment real estate the present value of BAM 230 thousand The total selling price of real estate amounted to BAM 216 thousand.

19. CURRENT ACCOUNTS AND DEPOSITS FROM BANKS

In thousands of BAM

December 31, 2016

December 31, 2015

Short-term deposits due to banks - 5,000

- 5,000

20. CURRENT ACCOUNTS AND DEPOSITS FROM CUSTOMERS

In thousands of BAM

December 31, 2016

December 31, 2015

In BAM: Corporate customers current accounts 76,474 62,483 Retail customers current accounts 18,691 15,977 Current accounts Public sector and public companies current accounts 14,375 13,877 Short-term deposits from corporate customers 26,227 2,889 Short-term deposits from retail customers 2,137 4,902 Short-term deposits from public sector and public companies 1,150 1,350 Long-term deposits from corporate customers 16,834 19,211 Long-term deposits from retail customers 10,483 6,058 Long-term deposits from public sector and public companies 3,473 2,663

169,844 129,410

In foreign currencies: Retail customers current accounts 7,235 5,517 Corporate customers retail accounts 1,585 2,411 Public sector and public companies current accounts 583 2,162 Short-term deposits from retail customers 3,061 16,133 Short-term deposits from corporate customers 117 117 Short-term deposits from public sector and public companies - 6 Long-term deposits from retail customers 27,393 14,367 Long-term deposits from public sector and public companies 101 101 Long-term deposits from corporate customers 34 33

40,109 40,847

TOTAL CURRENT ACCOUNTS AND DEPOSTIS FROM CUSTOMERS 209,953 170,257



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20. CURRENT ACCOUNTS AND DEPOSITS FROM CUSTOMERS (Continued)

Short-term deposits of corporate customers, public sector and public companies in local currency (BAM) were placed at interest rates ranging from 0.00 % to 3.10 % annually whereas long-term deposits of corporate customers, public sector and public companies accrued interest at the annual rates from 2.00% to 5.00 %. Demand deposits of corporate clients, public sector and public companies in local currency (BAM) accrued interest at the rates ranging from 0.00% to 3.10% whereas demand deposits in foreign currencies were placed at interest rates between 0.00% to 2.50% annually. Short-term retail BAM deposits were placed at interest rates ranging between 0.00 % to 2.90 % annually and long-term ones at rates ranging from 0.05 % to 4.80%.

Earmarked deposits accrue interest at the rates ranging from 0.00% to 5.00% annually.

21. BORROWINGS

In thousands of BAM

December 31, 2016

December 31, 2015

In BAM: IRB RS - Housing Funds 6,269 5,176 IRB RS - Funds for Development of the Eastern Part of the Republic of Srpska 3,550 3,857 IRB RS - Development and Employment Fund 2,295 4,054

12,114 13,087

In foreign currencies: Komercijalna banka a.d., Beograd 2,794 9,220 European Fund For Southeast Europe 2,347 3,521

5,141 12,741

17,255 25,828

Interest rates applied to borrowings obtained in BAM ranged from 1.2% to 3.4% annually. Local currency borrowings relate to the line of credit the Bank uses based on the investment made by the Investment and Development Bank of the Republic of Srpska. Interest rates applied to borrowings obtained in foreign currencies ranged from 2.56 % to 3.50%. Interest rates applied to borrowings in foreign currencies are linked to 3-month or 6-month EURIBOR. 22. OTHER LIABILITIES

In thousands of BAM

December 31, 2016

December 31, 2015

Interest payable in BAM, not due 349 612 Deferred collected loan fees and interests 634 681 Interest payable in foreign currencies, not due 786 693 Advances received 549 376 Trade payables in BAM 442 262 Trade payables in foreign currencies 193 27 Matured interest and fees payable in BAM 183 47 Deferred tax liabilities 70 41 Taxes and contributions payable 20 50 Income tax payable 12 180 Other liabilities payable in BAM 85 90 Other liabilities payable in foreign currencies 7 15

3,330 3,074



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23. PROVISIONS FOR LIABILITIES AND CHARGES In thousands of BAM

December 31, 2016

December 31, 2015

Provisions for employee benefits under IAS 19 252 402 Provisions for potential losses for off-balance sheet items 196 225 Provisions for litigations 6 12

454 639

24. EQUITY

The total share capital of the Bank as of December 31, 2016 amounted to BAM 60,000,000 and comprised 60,000 ordinary shares carrying voting rights with the par individual value of BAM 1,000. The Bank’s majority shareholder is Komercijalna banka a.d., Beograd holding an equity interest of 99.998%.

In thousands of BAM

December 31, 2016

December 31, 2015

Share capital 60,000 60,000 Reserves from profit 281 281 Revaluation reserves 630 371 Regulatory reserves for estimated losses 1,797 4,231 (Loss)/Profit for the year 410 (2,434)

63,118 62,449

As of December 31, 2016 revaluation reserves totaling BAM 630 thousand were formed based on the subsequent measurement of financial assets available for sale at their fair value and the actuarial gains/losses in accordance with IAS 19, with gains on value adjustment recognized under revaluation reserves within equity.

25. COMMITMENTS AND CONTINGENT LIABILITIES

In thousands of BAM

December 31, 2016

December 31, 2015

Irrevocable undrawn loan commitments in BAM 6,959 11,528 Guarantees issued in BAM 5,366 6,020 Guarantees issued in foreign currencies 1,558 1,693 Irrevocable undrawn loan commitments in foreign currencies - 1,956

13,883 21,197



35

26. RELATED PARTY TRANSACTIONS

In thousands of BAM

December 2016

December 31, 2015

Balance Sheet Assets Loans and receivables from banks - Komercijalna Banka a.d. Beograd 2,213 1,678 Loans and receivables from customers - Related parties-private individuals 131 177

Total assets 2,344 1,855

Liabilities Deposits and liabilities from customers - Related parties – private individuals 219 258 Borrowings - Komercijalna Banka a.d. Beograd 2,794 9,220 Accrued interest liabilities - Komercijalna Banka a.d. Beograd 25 42 Accounts payables - Komercijalna Banka a.d. Beograd 1 -

Total liabilities 3,039 9,520

Off-balance sheet items: - Related parties-private individuals 11 21 - Komercijalna Banka a.d. Beograd 5,867 - Income statement Year ended

December 31, 2016

December 31, 2015

Income Interest income - Related parties – private individuals 8 13 Fee and commission income - Komercijalna Banka a.d. Beograd 23 37 Net foreign exchange gains - Komercijalna Banka a.d. Beograd - 122 Revenues from securities sale - Komercijalna Banka a.d. Beograd 298 -

Total income 329 172

Expenses Interest expenses -Komercijalna banka a.d. Beograd 81 147 - Related parties - private individuals 1 4 Fee and commission expenses -Komercijalna banka a.d. Beograd 41 46 Net foreign exchange loss - Komercijalna Banka a.d. Beograd 5 - Total expenses 128 197

Income/(expenses), net 201 (25)



36

26. RELATED PARTY TRANSACTIONS (Continued)

The gross and net remunerations to the Executive Board* of the Bank, Supervisory Board and Audit Committee members in 2016 and 2015 were as follows:

In thousands of BAM


2016 2015

Gross remunerations - Executive Board* 299 344 Net remunerations - Executive Board* 174 208 Gross remunerations - Supervisory Board and Audit

Committee 50 172 Net remunerations - Supervisory Board and Audit

Committee 30 104 (*)Remunerations to the Bank’s Executive Board only the gross and net remunerations to the Director General and Executive Directors (without salaries and benefits to the department heads).

27. RISK MANAGEMENT

The Bank is exposed to the following risks:

Credit risk,

Liquidity risk,

Market risk (including interest rate risk, currency risk and other market risks), Country risk, and

Operational risk.

This Note presents information on the Bank’s exposure to each of the above listed risks, objectives, policies and processes for risk measurement and management and for capital management.

Risk Management Framework

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 Basel II standards and permanently monitors all the announcement and amendments to the effective regulations, analyses the risk levels and undertakes measures for timely reconciliation of its operations with newly enacted regulations in accordance with the risk level acceptable to the Bank.



37

27. RISK MANAGEMENT ( continued)

Risk Management Objectives and Principles

Risk Management System

The risk management system is governed by the following internal regulations:

Risk management strategy and Capital management strategy; Risk management policies; Risk management procedures; Methodologies for individual risk management; and Other enactments.

Risk Management Strategy sets out: Long-term objectives, defined by the Bank’s business policy and strategy and its aptitude to

assume risk determined in accordance with those objectives; Basic principles of risk assumption and management; Basic principles of the process of internal assessment of the Bank’s capital adequacy; and Overview and definitions of all types of risk the Bank is exposed to or may be exposed to.

The Bank specified the basic principles of risk management for meeting its long-term objectives: Organizing operation of a separate organizational unit for risk management; Functional and organizational separation of risk management activities from the regular operating

activities of the Bank; Comprehensive risk management; Effective risk management; Cyclic risk management; Developing risk management as a strategic orientation; and Risk management as part of corporate culture.

Policies for managing certain risk types define following: Manner of organizing risk management processes within the Bank and clear demarcations 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; 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; Framework and frequency for stress testing and procedure in instances of unfavorable 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.

Methodologies for managing certain risk types define, in greater detail, methods and approaches used in the risk management system.

Competencies

The Supevisory Board is authorized and responsible for establishing a uniform risk management system and for monitoring such system, adopting the strategy and policies for risk management and capital management strategy, establishment of internal control system, supervision of the work of the Executive Board and execution of the process of internal capital adequacy assessment, as well as other activities defined with legislation and internal regulations of the Bank.

ngand policies, capital management strategy adoption, risk management guidelines and methodology

adoption and efficiency analysis of risk management procedure implementation, which procedures define processes of identifying, measuring, minimizing, monitoring, controlling reporting risk the Bank is exposed to. It reports to the Supervisory Board on the efficiency of risk management procedure implementation

The Audit Committee is authorized and responsible for continued analysis and monitoring of the adequate implementation of the adopted risk management strategies and policies and internal control system. At least monthly, the Audit Committee reports to the Supervisory Board on its activities and identified irregularities and proposes how to eliminate them.



38

27. RISK MANAGEMENT (Continued)

The Asset and Liability Management Committee is authorized and responsible for monitoring 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.

The Credit Committee decides on loan approval requests within framework determined by the Bank’s enactments, analyses the Bank’s exposure credit, interest rate and currency risk, analyzes loan portfolio and executes Internal Audit recommendations under its remit and proposes measures to be taken to the Supervisory Board and Executive Board.

The Risk Management Department defines and proposes the risk management objectives and principles to the Supervisory board for adoption, i.e. risk management strategy, policies and procedures, defines and proposes the risk management guidelines and methodologies to the Executive Board for adoption, identifies, measures, mitigates, monitors, controls and reports on the risks the Bank is exposed to. It is also in charge of developing models and methodologies for all stages of risk management and reporting to the competent Bank’s bodies

The Internal Audit Division performs independent evaluation of the risk management system and continually assesses adequacy, reliability and efficiency of the internal control system. 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 as 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 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 to accept.

Risk management reports are regularly submitted to: the Bank’s Supervisory Board, Executive Board, Audit Committee and Asset Liability Management Committee, and they contain all the information required for risk assessment and reaching of conclusions about the Bank’s risks.

27.1. 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. Credit risk includes the following:

Default risk - the risk of loss that may arise if a debtor fails to settle liabilities toward the Bank i; Downgrade risk - the risk of loss that may arise if a risk level of a debtor is downgraded

(deterioration of the customer credit rating); Risk of change in the value of assets - the risk of loss that may arise on assets in the event of

a decline in their market value as compared to the price at which assets were acquired; 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.

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

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;

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;



39

27. RISK MANAGEMENT (continued)

27.1. Credit Risk (continued)

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.

Credit Risk Management

According to the volume, type and complexity of its operations, the Bank has organized the credit risk management process and clearly segregated 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. 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. The Bank approves loans to (corporate and retail clients) which are estimated as creditworthy. On the other hand, the Bank does not make high-risk investments such as investments in highly profitable projects or investment funds with significant risk levels.

The basic principles of credit risk management are as follows: Managing credit risk at the individual loan level as well as the Bank’s entire portfolio level; Maintaining credit risk level that minimizes the negative effects on the Bank’s financial result and

capital; Loan/investment rating according to risk; Operating in accordance with best banking practices of loan approval; i Ensuring adequate credit risk management controls.

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 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 placements and estimating provisions against

losses per off-balance sheet as required by IAS 39 and IAS 37 and calculating provisions pursuant to the regulations;

Internal approach – measuring risk level of individual loans and investments based on the

internally adopted rating system.

The rating system does not serve only as 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 ranking by risk level and stating realistic value of receivables. The internal rating system is subject to regular review and improvement.



40

27. RISK MANAGEMENT ( continued)

27.1. Credit Risk (continued)

In addition to the internal rating system, in credit risk analysis the Bank also uses principles prescribed by the RS Banking Agency, 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.

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. Decisions on credit risk exposure are defined through the decision of the Supervisory Board on the limits for transaction approval as well as through credit risk management procedures.

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. With the aim of minimizing credit risk, internal regulations have defined the competence of organizational units who take the risk and who manage credit risk, and the competence of the Risk Management Department, in terms of giving an independent attitude in the extension of new loans, rescheduling / restructuring loans ie. regulation of high-risk investments.

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; and Collaterals.

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 preset 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.

The Bank performed adequate and detailed reviews of all reports on valuation of collaterals prepared by external appraisers hired by the Bank, which all confirmed the Bank's independence and that of the customers whose properties were subject to appraisal. The aforesaid valuation reports were used in calculating the net value of receivables per loans extended to customers.



41


27.1. Credit Risk (Continued)

Credit Risk Management (Continued)

Based on the internal analyses performed, we believe that the results of the collateral value appraisals fairly reflect the selling value of collaterals calculated in accordance with the Bank's Methodology, i.e., that in instances of collateral foreclosure the Bank may collect the minimum amounts we used in estimating the future cash flows for individually classified loan accounts for the purposes of impairment allowance calculation in accordance with IAS 39. 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.

As a measure of protection against counterparty default risk, the Bank undertakes the following steps in respect to collection of due receivables:

Rescheduling or restructuring; Out-of-court settlement; Seizure of goods or properties in order to collect receivables; Sale of receivables; Executing agreements with interested third parties; and Instigating court proceedings and other measures.,

The Bank reschedules and restructures receivables from customers experiencing certain difficulties in operations.

Apart from credit risk exposure, the Bank also has off-balance sheet exposures (various types of payment and performance guarantees, unsecured letters of credit, irrevocable approved yet undrawn loans and all other items representing the Bank's contingent liabilities) based on which the Bank has potential obligation 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 preset schedule and in conformity with the defined 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 rating assignment that ensures that all customers with the same rating actually have the same characteristic and the same probability of default, partial or full, within a year. The basic credit risk parameters indicative of the rating 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 history (risk rating categories 4 and 5). The Bank protects itself 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 loans is intended to ensure reasonable, cautious 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. 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 associated with a loan.



42



Risk of Change in the Value of Assets (Continued)

Key elements in assessing impairment of loans 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 contract etc. Allowance for impairment is based on estimated future cash flows from the borrower’s operations or from 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 assesses impairment of each individually significant loan whose status is „default“, as well as receivables for which the debtor is a bank or other financial institution, investments in securities that are not listed at the official market (stock exchange) and the securities that are held to maturity but that are materially significant and have the status of "default". In such case are considered the financial position of the loan beneficiary, sustainability of its business plan, its ability to improve performance in the event of financial difficulties, income projections, availability of other financial support and collateral value which can be realized, as well as scheduling of expected cash flows. In the event of new information coming to light that significantly alters the customer’s creditworthiness, value of collateral and likelihood that liabilities toward the Bank will be settled, ad hoc assessment of loan impairment is performed.

Group Assessment

Impairment is assessed on a group basis for loans that are not individually significant and for individually significant loans that do not have a „default“ status. Group assessment is performed monthly within groups that are determined based on internal methodology and internal rating system. Group impairment percentages are calculated based on migration of risk rating categories, more precisely on the basis of a three year average probability of default status per type of borrower or product. For each party of loans is determined net basis which is calculated so that the total carrying amount is reduced by the amount of collateral corrected by corrective factor (hair cut ) Party with a delay of over 180 days are not reduced by the amount of collateral, so that the net basis equals the book value. Depreciation of loans decreases the value of the loan and recognized as an expense in the income statement.

Assessment of Provisions for Losses on Off-Balance Sheet Items

Assessment of provisions for losses on off-balance sheet items (contingent liabilities) is performed when it is estimated that it is fairly certain that an outflow of assets will be required to settle contingent liabilities. In assessing provisions for contingent losses on off-balance sheet items, funds obtained by activating collaterals are recognized if it is completely certain that cash outflows for contingent liabilities will be settled from collaterals.



43


27.1. Credit Risk (Continued) 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).

Breakdown of Assets-Gross/Net

In thousands of BAM

December 31, 2016

December 31, 2015

Gross Net Gross Net

Breakdown of Assets

Cash and cash balances held with the Central Bank

68,746 68,746

62,294 62,294

Loans and receivables from Banks 36,434 36,434 9,886 9,886 Loans and receivables from customers

176,803 161,989

181,432 167,341

Securities 16,440 16,440 19,141 19,141 Equipment, investment property and intangible assets

13,641 5,354

11,225 3,639

Interest accrued and other assets 7,803 5,147 7,292 4,946 I. Total assets 319,867 294,110 291,270 267,247 Payment guarantees 4,114 3,967 4,719 4,535 Performance bonds 2,810 2,765 2,995 2,954 Irrevocable commitments 6,959 6,955 13,483 13,483

II. Off-balance sheet items 13,883 13,687 21,197 20,972

Total (I+II) 333,750 307,797 312,467 288,219



44


27.1. CREDIT RISK (Continued)

The following table presents loans and receivables due from customers as well as classification for individual loan assessment/group portfolio:

In thousands of BAM

December 31, 2016 Housing Loans

Cash Loans

Agricultu-re Loans

Other Loans

Micro Business

Total Retail

Public Sector Loans

Corporate loans

Total Due from

Banks

Loans neither due nor impaired 67 424 10 179 2,010 2,690 26,400 9 29,099 - Loans due and impaired 66 17 7 79 345 514 82 - 596 - Collectively impaired 22,179 12,508 1,834 4,418 9,830 50,769 22,999 57,315 131,083 - Individually impaired 588 142 - 410 6,911 8,051 - 7,974 16,025 -

Total 22,900 13,091 1,851 5,086 19,096 62,024 49,481 65,298 176,803 - Impairment allowance 179 2,109 217 1,628 4,844 8,977 - 5,837 14,814 -

Group-level impairment allowance 119 2,085 217 1,380 965 4,766 - 1,393 6,159 - Individual impairment allowance 60 24 - 248 3,879 4,211 - 4,444 8,655 -

Net carrying amount 22,721 10,982 1,634 3,458 14,252 53,047 49,481 59,461 161,989 -

In thousands of BAM


Cash Loans

Agricultu-re Loans

Other Loans

Micro Business

Total Retail

Public Sector Loans

Corporate loans

Total Due from

Banks

Loans neither due nor impaired - - - - - - - - - - Loans due and impaired - - - - - - - - - - Collectively impaired 21,946 10,222 2,785 4,720 8,976 48,649 58,540 24,454 131,643 - Individually impaired 870 820 - 531 10,942 13,163 - 36,626 49,789 -

Total 22,816 11,042 2,785 5,251 19,918 61,812 58,540 61,080 181,432 - Impairment allowance 299 2,373 212 1,528 4,696 9,108 - 4,983 14,091 -

Collective impairment allowance 137 2,237 212 1,307 741 4,634 - 510 5,144 - Individual impairment allowance 162 136 - 221 3,955 4,474 - 4,473 8,947 -

Net carrying amount 22,517 8,669 2,573 3,723 15,222 52,704 58,540 56,097 167,341 -



45



Impaired Loans

Impaired loans and advances are those for which the Bank has determined the existence of objective evidence of impairment and does not expect them to be collected in full amounts of principal and interest matured pursuant to the relevant loan agreements. Materially significant loans are those loans whose total exposure (based on receivables or potential liabilities) is equal to or greater than BAM 100 thousand in case of legal entities (banks, commercial clients and micro clients), and for individuals, farmers and entrepreneurs it is equal or greater than BAM 40 thousand at the day of calculation. For loans that are not individually significant, and for loans that are individually significant, or do not have the status of "default", impairment is determined on a group basis, depending on the group affiliation of receivables with a similar level of risk, for all categories of rating. Group impairment percentages are applied to all credit groups, except for materially significant placements with the status of "default", which is devaluing individually. If during individual placement of impairment receives a percentage of 0%, then percentage that is applied is group percentage of impairment at lowest risk category (credit rating group I) for this category of clients, products for individuals. Group percentage of impairment least risky categories applied to gross base placement, without any deduction for asset impairment. Impairment Allowance

The Bank makes impairment allowance for loan arrangements based on the assessment of impairment. The key components of impairment allowance made in this manner are: impairment allowance related to individually significant credit risk exposures that have „default“ ˝status and group-level impairment allowance made for groups, formed for less materially significant loans and materially significant loans which do not have a „default“ status, as well as for those materially significant loans that were subject to individual assessment of impairment yet no impairment was identified on an individual basis.

Loans and Receivables Matured but not Impaired Loans and receivables matured but not impaired represent a) loans and receivables for which in the process of an individual determination of impaired allowances is determined impairment allowance value of 0% (as the expected discounted flow covers the whole receivable) and in the percentage of migration of at least a credit groups for the type of exposure is 0%, which is in this case is applied to loans and receivables for which are in the process of individual assessment determined impairment of 0%, and b) loans and receivables who are group deprived of rights and not in the ˝default˝ status, for which the calculated percentage of migration 0%. Loans and Receivables not matured and not impaired

Loans and receivables not matured and not impaired are: state loans and loans to other customers that are impaired in a group and for which is found that are not adequately impaired, because calculated percentage of migration risk categories is 0%. According to the methodology for determining the allowance for impairment of balance sheet assets and provisions for losses on off-balance sheet items when the matrix migration to a certain segment of the client equals to zero (0%), the impairment allowance is equal to zero (0%).



46



Loans and receivables due from customers, neither due nor impaired In thousands of BAM


Cash Loans

Agricultural Loans

Other Loans

Micro Business

Total Retail Public Sector

Corporate Loans

Total Due from

Banks

Low (IR 1.02) 67 425 10 178 2,010 2,690 21,323 - 24,013 - Medium (IR 3) - - - - - - 4,484 - 4,484 - High (IR 4.5) - - - - - - 593 - 593 -

Total 67 425 10 178 2,010 2,690 26,400 - 29,090 -


Cash Loans

Agricultural Loans

Other Loans

Micro Business


Corporate Loans

Total Due from

Banks

Low (IR 1.02) - - - - - - - - - - Medium (IR 3) - - - - - - - - - - High (IR 4.5) - - - - - - - - - - Total - - - - - - - - - -

Loans and receivables due from customers, due but not impaired

In thousands of BAM


Cash Loans

Agricultural Loans

Other Loans

Micro Business


Corporate Loans

Total Due from

Banks

Up to 30 days past due 66 17 5 78 54 220 62 - 282 - 31 - 90 days past due - - 2 1 - 3 20 - 23 - Over 90 days past due - - - - 291 291 - - 291 -

Total 66 17 7 79 345 514 82 - 596 -


Cash Loans

Agricultural Loans

Other Loans

Micro Business


Corporate Loans

Total Due from

Banks

Up to 30 days past due - - - - - - - - - - 31 - 90 days past due - - - - - - - - - - Over 90 days past due - - - - - - - - - - Total - - - - - - - - - -



47


27.1. Credit risk (Continued)

Loans with Modified Initially Agreed Terms Loans with altered initially agreed terms are those loans that are rescheduled or restructured due to the difficulties in the debtor servicing the liabilities when due. Rescheduling of receivables is performed for debtors with currently mismatching cash inflows and outflows, yet whose financial indicators have not deteriorated suggesting that the debtor will be able to settle the rescheduled liabilities according to the subsequently agreed repayment terms. Receivables are rescheduled if due from debtors up to 90 days in default, most commonly per individual loan subaccount, i.e. not including all the receivables due from the same debtor (all loan subaccounts).

Restructuring is performed for loans due from debtors with significant problems in business where financial indicators are substantially deteriorating. Upon restructuring

All balance sheet receivables due from the debtor or a greater portion thereof are replaced;

Terms where under the relevant receivable was approved are essentially altered (which particularly entails extension of the period for repayment of principal or interest,);

Interest rate applied or the amount receivable and other modifications of terms which are to facilitate the position of a debtor.

Loans with Modified Initially Agreed Terms In thousands of BAM

Rescheduled

Restructured

December 31, 2016

December 31, 2015

December 31, 2016

December 31, 2015

Gross Net Gross Net

Gross Net Gross Net

Housing loans - - - - 66 66 70 70 Cash loans 325 309 189 178 64 53 33 29 Agricultural loans 15 15 19 19 - - - - Other loans 284 173 394 291 6 - 7 7 Micro Business 1,962 785 2,919 1,628 - - - - Total retail 2,586 1,282 3,521 2,116 136 119 110 106

Corporate loans 4,830 3,654 5,421 4,325 - - - -

Total 7,416 4,936 8,942 6,441 136 119 110 106

Concentration Risk

The Bank controls concentration risk by establishing a system of limits to the exposures 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 .



48


27.1. Credit risk (Continued)

An analysis of credit risk concentration depending on the sector, based on loans to customers, is shown in the following table:

In thousands of BAM

Loans and receivables due from 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

Finance and insurance sector 2,082 2,048 237 235 1,000 1,000 4 3 Corporate sector 76,256 65,861 75,042 65,379 11,682 11,498 18,094 17,885 Agriculture 1,338 1,090 1,772 1,521 - - - - Manufacture 27,280 24,486 26,688 24,129 192 191 220 225 Power industry 3,766 3,655 7,868 7,767 1,065 1,051 1,930 1,930 Construction works 3,692 3,233 2,499 2,206 2,224 2,212 1,744 1,712 Wholesale and retail 28,610 22,908 25,230 20,231 4,287 4,229 10,997 10,901 Services industries 10,536 9,464 9,115 7,698 3,914 3,815 3,203 3,117 Real estate activities 1,034 1,025 1,870 1,827 - - - - Entrepreneur sector 2,689 2,145 2,452 2,058 12 5 46 31 Public sector 49,635 49,635 58,541 58,541 4 4 110 110 Retail sector 40,240 36,651 39,444 35,425 960 960 984 984 Non-residents sector 5,867 5,631 5,714 5,701 - - 1,956 1,956 Other customers sector 34 18 2 2 225 220 3

3

Total 176,803 161,989 181,432 167,341 13,883 13,687 21,197 20,972

Depending on general economic trends and individual industry sector trends, the Bank diversifies investments into the industry sectors that are resistant to the impact of adverse economic trends.

An analysis of credit risk concentration depending on the geographic region, based on loans to customers, is shown in the following table:

Loans and receivables due from 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

Bosnia and Herzegovina 170,936 156,358 175,718 161,640 13,883 13,687 19,241 19,016 Republic of Srpska 155,639 143,907 161,568 150,216 11,457 11,261 16,872 16,666 Federation of Bosnia and Herzegovina 5,487 3,589 3,969 2,047 2,012 2,012 98 97 Brčko District 9,810 8,862 10,181 9,377 414 414 2,271 2,253 European Union - - - - - - - - Other 5,867 5,631 5,714 5,701 - - 1,956 1,956

Total 176,803 161,989 181,432 167,341 13,883 13,687 21,197 20,972



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27. Risk Management (Continued)


Investment securities and unpledged assets held for trading

In thousands of BAM

December 31, 2016

December 31, 2015

Gross Net Gross Net

Unpledged assets held for trading - - - - Investment securities: Available for sale 16,440 16,440 19,141 19,141 Held to maturity - - - -

Total 16,440 16,440 19,141 19,141

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 bonds issued by the Republic of Srpska and the Republic of Serbia. Available-for-sale assets are initially measured at cost, and their fair value is calculated afterwards. The Bank had no securities held to maturity in its possession.

Credit risk protection instruments (Collateral) 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, and guarantees of the Brčko District Government (particularly for agricultural loan facilities),

For retail loans – mortgages, deposits and co-sureties.

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 favor 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.

Breakdown of financial and non-financial collaterals taken over by the Bank in the process of loan collection during the year is provided in the table below:

In thousands of BAM

December 31, 2016

December 31, 2015

Properties 2,526 1,573 Other 109 153

Total 2,635 1,726



50

27. RISK MANAGEMENT (Continued) 27.1. Credit risk (Continued)

Credit Risk Hedges (Collateral) (Continued) Assets acquired to securitize/in lieu of receivable collection are not used for the Bank's regular operating purposes. It is the Bank’s policy to ensure sale of the acquired collaterals.

27.2. Liquidity Risk

Liquidity risk represents the risk of negative effects on the Bank’s financial result and equity resulting from the Bank’s difficulty or inability to settle its matured liabilities in instances of insufficient liquidity reserves and inability to cover for unexpected outflows and other liabilities. The Bank operates in accordance with the basic principles of liquidity, maintaining a sufficient level of funds to cover liabilities incurred in the short term, i.e. it observes the principle of solvency by establishing the optimal financial leverage and sufficient liquidity reserves which do not compromise realization of the projected return on equity. Liquidity risk represents the Bank’s inability to settle its liabilities as they fall due. Liquidity risk may be manifest as the risk related to sources of funds and market liquidity risk. The problem of liquidity in respect of the sources of funds relates to the structure of liabilities and is expressed through potential significant share of unstable and short-term sources of funds or their concentration. On the other hand, liquidity risk is reflected in reserves deficiency and difficulty or inability to obtain liquid assets at reasonable market prices. The Bank has established appropriate organizational structure, which allows for clear differentiation between the process of assuming and the process of managing liquidity risk. The Asset and Liability Management Committee and Liquidity Committee have the most significant role therein as well as other competent boards/committees, whose decisions can impact the Bank's exposure to this risk.

In order to minimize liquidity risk, the Bank:

Diversifies sources of assets in respect to their currencies and maturities;

Forms sufficient liquidity reserves;

Manages monetary funds;

Monitors future cash flows and liquidity levels on a daily basis;

Limits principal sources of credit risk with most significant impact on liquidity; and

Defines and periodically tests Plans for Liquidity Management in Crisis Situations, The liquidity management process comprises identification, measurement, minimizing, monitoring, control and liquidity risk reporting. In identifying liquidity risk, the Bank identifies in a comprehensive and timely manner the causes that lead to the occurrence of liquidity risk determines current liquidity risk exposure as well as liquidity risk exposure arising from new business products and activities. Measurement and assessment of liquidity risk in the Bank is performed through quantitative and/or qualitative assessment of identified liquidity risk by using the following techniques: GAP analysis, Ratio analysis, Stress test.

Minimizing liquidity risk consists of maintaining this risk at a level that is acceptable to the Bank’s risk profile through definition of the system of exposure limits including both internal and statutory limits and timely implementation of measures to mitigate the risk and operation within the set internal and external limits. Control and monitoring of liquidity risk includes the process of monitoring compliance with internally defined limits, and monitoring of defined measures for reducing the bank's exposure to liquidity risk. Liquidity risk control involves the control at all liquidity risk management levels as well as the independent control system implemented by the bank's organizational units responsible for internal audit and compliance monitoring. Liquidity risk reporting consists of internal and external reporting systems and is performed on a daily basis and a set schedule according to the defined system..



51


27.2. Liquidity risk (Continued)

Liquidity Risk Exposure

The Bank’s operations are aligned daily with internally prescribed liquidity ratio and narrow liquidity ratio for which minimum values are defined for one working day, three consecutive working days and average for all working days within a month. During 2016, the Bank’s liquidity and narrow liquidity ratios were significantly in excess of the prescribed limits. The narrow liquidity ratio represents first rank liquid receivables ratio to the sum of the appropriate portion of the liabilities without defined maturity and the total liabilities with defined maturities (maturing within a month). The liquidity ratio in broader sense includes second rank liquid receivables (maturing within a month mostly related to loan receivables).

Internally prescribed limits

Liquidity ratio Narow liquidity

Ratio

For one working day Min 0.8 Min 0.5 For 3 consecutive working days Min 0.9 Min 0.6 Average for all working days in a

month Min 1 Min 0.7

Compliance with the internally defined liquidity ratio limits: Liquidity ratio Rigid/Cash Liquidity Ratio

2016 2015 2016 2015

As at December 31 3.48 1.70 3.15 1.55

Average for the period 2.35 2.27 2.14 1.99

Maximum for the period 3.48 3.82 3.17 2.47

Minimum for the period 1.57 1.21 1.40 1.35

The Bank collects deposits of retail and corporate customers with commonly shorter maturities, which can be withdrawn at request. The Bank manages liquidity risk on a short-term basis by monitoring and controlling items in all major currencies in order to identify in a timely manner needs for additional sources of funding in case certain items mature, and, on a long-term basis, plans the structure of its sources and loans in such a manner as to ensure sufficient stable sources and sufficient liquidity reserves. Management believes that appropriate deposit portfolio diversification per number and type of depositors as well as the Bank’s historical experience, form a good prerequisite for a stable and long term deposit base. In order words, no significant outflows of resources are expected in this respect. The Bank tests the Plans for Liquidity Management in Crisis Situations, testing potential crisis, survivorship period and solvency of the Bank, availability of sources to cover any liabilities that would arise and evaluates support in the assumed crisis conditions.

The Bank defines internal limits based on the internal liquidity GAP. Compliance with the internally defined last day liquidity ratios was as follows:

Limits 2016 2015

GAP up to 1 month / Total assets Max (10%) 19.36% 10.38% Cumulative GAP up to 3 months / Total assets Max (20%)

15.91%

7.82%

In addition, the Bank limits and coordinates its operations with the limits defined for maturity per major foreign currencies.



52


27.2. Liquidity Risk (Continued)

Maturity structure of monetary assets and monetary liabilities per outstanding maturity:

December 31, 2016 Up to 1 month

From 1 – 3 months

From 3 - 12 months

From 1 - 5 years

Over 5 years

Total

Assets Cash and cash balances held with

the Central Bank 48,776 1,697 7,635 10,638 - 68,746 Loans and receivables from banks 36,434 - - - - 36,434

Loans and receivables from customers 4,659 9,922 43,880 75,658 27,870 161,989

Securities 67 54 410 14,717 1,192 16,440 Interest accrued and other assets 1,548 - 216 - 337 2,101

Total Assets 91,484 11,673 52,141 101,013 29,399 285,710

Liabilities Current accounts and deposits from banks - - - - - - Current accounts and deposits from customers 33,550 21,224 86,654 68,086 439 209,953 Borrowings 147 577 2,578 8,368 5,585 17,255 Other liabilities 1,295 - 1,093 - - 2,388

Total liabilities 34,992 21,801 90,325 76,454 6,024 229,596

Net liquidity gap 56,492 (10,128) (38,184) 24,559 23,375 56,114

December 31, 2016 Up to 1 month

From 1 – 3 months

From 3 - 12 months

From 1 - 5 years

Over 5 years

Total


the Central Bank 48,811 1,146 5,155 7,182 - 62,294 Loans and receivables from banks 9,886 - - - - 9,886

Loans and receivables from customers 4,757 7,454 43,915 83,484 27,731 167,341

Securities 66 2,021 5,161 10,565 1,328 19,141 Interest accrued and other assets 1,796 143 655 - 325 2,919

Total Assets 65,316 10,764 54,886 101,231 29,384 261,581

Liabilities Current accounts and deposits from banks 5,000 - - - - 5,000 Current accounts and deposits from customers 33,971 14,902 51,840 68,959 585 170,257 Borrowings 150 579 2,844 16,004 6,251 25,828 Other liabilities 780 - 1,256 - - 2,036

Total liabilities 39,901 15,481 55,940 84,963 6,836 203,121

Net liquidity gap 25,415 (4,717) (1,054) 16,268 22,548 58,460

The table above presents the maturity structure of the monetary assets and liabilities, where the monetary balance sheet items are distributed according to maturities outstanding, with transaction and demand deposits classified according to the Bank’s internal methodology, which is based on historical and statistical analyses at the Banking Group level.

The Bank has continuously improved the liquidity risk management with a software solution implemented in order to advance the asset and liability management. The aforesaid software solution enabled review of the undiscounted cash flows from principal and future interest. The undiscounted cash flows arising from the items of monetary assets and monetary liabilities include future cash flows per balance sheet items and future interest.



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27.3. Market Risks

Market risk represents the possibility of occurrence of negative effects on the Bank’s financial result and equity due to changes in market variables and comprises interest rate risk, currency risk for all the Bank’s business operations 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. The Asset and Liability Management Committee (ALCO) have the most significant role therein as well as other competent boards/committees, whose decisions can impact the Bank's exposure to this risk.

(I) 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 manages the following types of interest rate risk:

Repricing risk of temporal mismatch between maturity and repricing; Yield curve risk - to which the Bank is exposed due to changes in yield curve shape; Basis risk - to which the Bank is exposed due to different reference interest rates for interest rate

sensitive items with similar maturity or repricing characteristics; and 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.

The 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. Primarily, the Bank manages the internal yield margin through the prices of loans and deposits, focusing on the interest rate margin. 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.



54

27. RISK MANAGEMENT (Continued) 27.3. Market Risk (Continued)

(I) Interest Rate Risk (Continued)

Interest rate risk reporting consists of an internal system of reporting to competent boards/committees and the Bank’s interest rate risk management bodies. In identifying the interest rate risk exposure limits, the Bank takes into consideration several aspects of interest rate risk, restricting the adverse effects thereof on the financial result and economic value of equity. The Bank has defined limits for interest-bearing items, limits for gaps per currency up to a year to restrict the adverse effects on the financial result and limits for the changes in the economic value of equity to restrict the adverse effects on equity. Compliance with internally defined interest rate risk limits at the last day of the financial year was as follows:

Limits 2016 2015

Relative GAP - (2.55%) (4.36%) Mismatch ratio - 0.97 0.94 Cumulative GAP up to 3 months +30%/-30% 6.79% (10.11%)

Interest rate risk is monitored by calculating mismatch between the interest rate-sensitive assets and interest rate-sensitive liabilities. Report on the exposure to changes in interest rates has balance positions allocated to the period of interest rate repricing or the remaining period of maturity, depending on which period is shorter.



55


27.3. Market Risks (Continued)


Breakdown of net interest rate exposure as at December 31, 2016 is provided in the table below:

In thousands of BAM

Carrying Value Up to 3 Months From 3 to 6

Months From 6 to 12

Months From 1 to 5

Years Over

5 years Non-Interest

Bearing


the Central Bank 68,746 38,904 - - - - 29,842 Loans and receivables due from banks 36,434 64 - - - - 36,370

Loans and receivables due from customers 161,989 50,487 35,452 15,219 48,503 12,328 -

Securities 16,440 121 107 303 14,717 1,192 - Interest accrued and other assets 2,101 133 - - 337 1,631

Total Assets 285,710 89,709 35,559 15,522 63,220 13,857 67,843

Liabilities Deposits and other liabilities due to banks - - - - - - - Deposits and other liabilities due to customers 209,953 54,872 33,287 53,949 65,644 343 1,858

Borrowings 17,255 14,908 2,347 - - - - Other liabilities 2,388 - - - - - 2,388

Total liabilities 229,596 69,780 35,634 53,949 65,644 343 4,246 Net interest rate gap 56,114 19,929 (75) (38,427) (2,424) 13,514 63,597



56




Breakdown of net interest rate risk exposures as at December 31, 2015 is provided in the table below:

In thousands of BAM

Carrying Value Up to 3 Months From 3 to 6

Months From 6 to 12

Months From 1 to 5

Years Over

5 years Non-Interest

Bearing


the Central Bank 62,294 - - - - - 62,294 Loans and receivables from banks 9,886 32 - - - - 9,854

Loans and receivables from customers 167,341 47,501 36,571 15,720 54,245 13,304 -

Securities 19,141 2,086 4,980 182 10,565 1,328 - Accrued interest and other assets 2,919 256 315 2 325 2,021

Total Assets 261,581 49,875 41,866 15,904 64,810 14,957 74,169

Liabilities Current accounts and deposits from banks 5,000 5,000 - - - - - Current accounts and deposits from customers 170,257 49,374 17,837 35,877 64,889 491 1,789

Borrowings 25,828 25,828 - - - - - Other liabilities 2,036 - - - - - 2,036

Total liabilities 203,121 80,202 17,837 35,877 64,889 491 3,825 Net interest rate gap 58,460 (30,327) 24,029 (19,973) (79) 14,466 70,344



57




In addition to the GAP analyses, interest rate risk management also entails monitoring the sensitivity of the Bank’s assets and liabilities to different scenarios of changes in interest rates. The Bank performs regular interest rate risk stress testing to assess the estimated impact of the changes in the key factors on the Bank’s interest rate risk. In scenario modelling, in addition to the changes in interest rates, particular consideration is given to the impact of early deposit withdrawal and early loan repayment, which the Bank estimates based on historical trends and expert estimates. The Bank estimated trends with regard to transaction deposits, demand deposits and savings deposits of retail customers using time series statistical modeling. The standard scenario entails parallel changes (increases and decreases) in the interest rate by 100 basis points (b.p.). The Bank’s sensitivity analysis, i.e. impact on the Bank’s financial performance of the increase/decrease in the interest rates assuming symmetrical movement in yield curves and constant financial position is presented in the table below:

Impact on the financial result In thousands of BAM

Parallel increases Parallel decreases

2016. As at December 31 By 100 basis points 215 (215) By 200 basis points 430 (430) By 400 basis points 859 (859) 2015. As at December 31 By 100 basis points (118) 118 By 200 basis points (236) 236 By 400 basis points (472) 472

Based on the mismatch between the interest rate-sensitive assets and interest rate-sensitive liabilities sensitivity of the Bank’s economic value of equity to changes in interest rates is calculated. Short and long positions per all intervals (periods) are weighted by factors reflecting the sensitivity of items in different maturity baskets to the assumed change in interest rates of 200 b.p. and the estimates of their modified duration. Breakdown of the Bank’s sensitivity to increases and decreases in interest changes - impact on the economic value of equity:

In thousands of BAM

Parallel increases

by 200 b.p.

2016. As at December 31 2,376 4.21%

2015. As at December 31 3,523 6.72%



58




The applied model entails the following:

A simplified approach to the calculation of economic value of equity; Standardized interest shock of 200 b.p.; Calculation relates to interest-bearing items only; Estimated modified duration for each time basket; Assumptions on the maturity in the middle of the time basket; Arrangement of items with variable market interest rates according to the repricing period; Arrangement of items with fixed interest rates and items with interest rates defined under the Bank’s business policy according to the maturity periods;

The Parent Bank limited the impact on the economic value of equity up to 20% and developed an internal model for calculating the capital adequacy requirements for interest rate risk at the Group level.

(II) Currency risk

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. All items in the banking book and the trading book that are denominated in a foreign currency and gold, including domestic items indexed to foreign currency clause are exposed to currency risk. 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 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 Asset and Liability Management Committee has the most significant role therein as well as other competent boards/committees, whose decisions can impact the Bank's exposure to this 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. 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; VaR analysis; Stress test; Back testing.



59



(II) Currency Risk (Continued) Reducing 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. The Bank reconciles its business operations with the prescribed foreign currency risk ratio, which represents the ratio between the total net foreign currency balances relative to the Bank’s regulatory capital. Reporting on currency risk includes clearly determined external and internal systems of reporting to the competent committees and bodies of the Bank on the currency risk management. Currency risk is expressed and measured by means of open currency position. Open currency position represents a difference between the Bank’s receivables and liabilities in foreign currencies as well as between the receivables and liabilities in local currency with currency clause index.

Foreign exchange (currency) risk ratio represents the ratio between the total open currency position and the regulatory capital of the Bank. The foreign currency risk ratio is defined in accordance with the Bank’s internal policies, and potential exchange rate fluctuations. The Bank adjusts its operations to the regulatory foreign exchange risk ratio prescribed under the Decision on the Minimum Standards for Foreign Exchange Risk Management of Banks and is obligated to ensure that its total net open currency position does not exceed 30% of its core capital, or individual foreign exchange exposure by currency (for EUR maximum 30%, for other currencies maximum 20% of core capital).

The Bank has also defined an internal limit to restrict the total net open currency position relative to the capital.

Breakdown of the total currency risk position and legally defined currency risk ratio at December 31:

Limit 2016 2015

Total currency risk position - 1,411 3,835 Currency risk ratio 30% 2% 7%

In addition to reconciliation with the limits prescribed by the regulator, the Bank monitors currency risk ratio according to its internal approach, where the open currency position (the larger of long and short positions) is related to the net capital.



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(II) Currency risk (Continued)

Breakdown of monetary assets and monetary liabilities per currencies as of December 31, 2016:

In thousands of BAM

EUR USD CHF Other

currencies FX Total

Currency Clause (EUR) BAM Total


the Central Bank 2,041 175 173 244 2,633 - 66,113 68,746 Loans and receivables from banks 34,648 713 945 63 36,369 - 65 36,434

Loans and receivablesfrom customers 5,631 - - - 5,631 112,998 43,360 161,989

Securities 3,531 - - - 3,531 9,997 2,912 16,440 Accrued interest and other assets 141 338 - - 479 169 1,453 2,101

Total Assets 45,992 1,226 1,118 307 48,643 123,164 113,903 285,710

Liabilities - - - - - - - - Current accounts and deposits from banks 38,205 838 965 102 40,110 114,869 54,974 209,953 Current accounts and deposits from customers 5,141 - - - 5,141 12,114 - 17,255 Borrowings 846 14 1 8 869 - 1,519 2,388 Other liabilities 44,192 852 966 110 46,120 126,983 56,493 229,596

Net currency position December 31, 2016 1,800 374 152 197 2,523 (3,819) 57,410 56,114



61



(II) Currency Risk (Continued)

Breakdown of monetary assets and monetary liabilities per currencies as of December 31, 2015:

EUR USD CHF

Other Currencies FX Total

Currency Clause (EUR)

In thousands of BAM

BAM Total

Assets Cash and cash balances held with the Central Bank 1,367 120 226 198 1,911 - 60,383 62,294 Loans and receivables from banks 8,674 99 1,035 46 9,854 - 32 9,886 Loans and receivablesfrom customers 5,702 - - - 5,702 122,766 38,873 167,341

Securities 13,942 - - - 13,942 1,969 3,230 19,141 Accrued interest and other assets 461 325 - - 786 - 2,133 2,919

Total Assets 30,146 544 1,261 244 32,195 124,735 104,651 261,581

Liabilities - - - - - 5,000 - 5,000 Current accounts and deposits from banks 39,023 864 895 66 40,848 88,356 41,053 170,257 Current accounts and deposits from customers 12,741 - - - 12,741 13,087 - 25,828 Borrowings 706 13 - - 719 - 1,317 2,036

Other liabilities 52,470 877 895 66 54,299 106,443 42,370 203,121

Net currency position December 31, 2015 (22,324) (333) 366 178 (22,113) 18,292 62,281 58,460



62



(II) Currency Risk (Continued)

The Bank also conducts currency risk stress testing to estimate the potential effects of specific events and/or changes in more than one financial variable on the Bank’s financial result, capital and the currency risk ratio. The VaR represents the highest possible loss in the Bank’s portfolio during a specified period with a predefined confidence interval. (one day and a ten day VaR is calculated, with a 99% confidence interval for foreign currency positions). The Bank calculates the VaR by using the generalized autoregressive-conditional heteroskedastic (GARCH) model Currency VaR is calculated for foreign currency items as well as domestic currency clause-indexed BAM items. Analysis of Bank's sensitivity to rate change is shown in table below:

The impact of change in

exchange rate on the financial result

Parallel increase of exchange rate

USD and CHF

Parallel decrease of

exchange rate USD and CHF

2016 As at December 31 By 100 basis points 4 (4) By 200 basis points 8 (8) By 400 basis points 17 (17) 2015 As at December 31 As at December 31 - - By 100 basis points 1 (1) By 200 basis points 1 (1)

27.4 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 performed 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 by level of risk of the borrower’s country of origin.



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27.4 Country Risk (Continued)

The level of the Bank’s exposure to a certain country is determined by country limits depending on the default risk for a certain country. For the purpose of adequate country risk management, the Bank defines exposure limits per borrower country of origin, and in instances of risk concentrations for certain geographic regions, it defines exposure limits per region. The Bank’s investments approved to the borrowers domiciled outside of the Bosnia and Herzegovina for financing businesses in the Bosnia and Herzegovina, whose financial obligations to the Bank are expected to be settled from the operating results achieved in Bosnia and Herzegovina, represent the Bank’s receivables without exposure to the risk of the borrower’s country of origin.

27.5. 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 frauds, 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 or failures 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 asset management. 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.



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27.5. Operational Risk (Continued)

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 each organizational part, where those 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 operational risks to the Bank’s Board of Directors, the Bank’s Executive Board and the Audit Committee.

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 of operational risk (stress testing of operational risk is performed on the Group level). Self-assessment consists of assessment of risk exposure by organizational units based on the roadmap for identifying operating risks, through measurement of potential ranges, importance for business activities and frequencies of events that can result in losses, identification of levels of control those business areas must maintain over these risks and measures of improvement. Stress test represents an operational risk management technique which is used to assess potential effects of specific events and/or changes in several financial variables on the Bank’s exposure to operational risk.

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 has adopted the Business Continuity Plan and in order to ensure the restoration and recovery of the information technology systems in the event of interruption or stoppage of operations, the Bank has adopted the Disaster Recovery Plan.



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27.6. Capital Management

The Bank develops internal approach activities (standardized approach) in calculation of capital requirements for each risk type it monitors (credit, market and operational risks) in accordance with regulations of the Basel II Standard. The Bank’s capital represents the sum of the core capital and supplementary capital, while the net capital is the aforesaid capital amount reduced for deductible items. Risk-weighted assets are all balance sheet and off-balance sheet items exposed to risk, which are multiplied by appropriate standard risk weights prescribed for all types of assets and asset exposures to inherent risks. The capital adequacy ratio represents the Bank’s net capital relative to the i total risk-weighted assets of the Bank, which comprise the sum of the total risk-weighted balance sheet assets and off-balance sheet items, weighted operational risk and weighted market risk. Risk-weighted balance sheet and off-balance sheet items represent the sum of the appropriate risk rates (weights) and items of the balance sheet assets and credit equivalents of off-balance sheet items exposed to risk. Based on exposure to operational risk, the Bank forms and maintains MACROR (the minimum adequate capital requirement for operational risk, i.e. for protection from loss incurred based on operational risks), which is calculated using the “basic indicator method” comprising 15% of the recent three year-average gross profit. Annual gross profit for MACROR calculation is a sum of the net interest and similar income and the total operating income less other operating expenses and direct costs. MACROR obtained in the aforedescribed manner is multiplied by the reciprocal value of the minimum rate of net capital to arrive at WOR (weighted operational risk) which is then added to the amount of the risk-weighted assets and credit equivalents in calculating net capital gain rate (capital adequacy). The Banking Agency of the Republic of Srpska has extended the implementation of the Decision on the Minimum Standards for Market Risk Management, which is the reason that WMR (weighted market risk) affecting the capital adequacy is not yet calculated. The period during which the Bank is required to coordinate the management of market risks with the regulations of this decision will be subsequently determined.

Capital adequacy ratio In thousands of BAM

Core capital

2016

2015

59,112 57,325 Supplementary capital 3,542 3,417 Deductible items (6,292) (8,338)

Capital

56,362 52,404

Credit risk-weighted assets 160,539 171,084 Weighted operational risk exposure 15,724 15,819 Weighted market risk exposure - -

Capital adequacy ratio

32.0% 28.0%

The data presented on December 31, 2016 related to the calculation of the capital adequacy ratio at the time of release of these financial statements, have not been audited, and their audit will be included in the audit report on the performed economic - financial audit of the Bank in accordance with regulatory requirements The Bank has been operating in accordance with the prescribed limits:

The minimum amount of the core capital and the lowest amount of the net capital the Bank is to maintain totals BAM 15 million;

The minimum prescribed capital adequacy ratio equals 12%.



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27.6. Capital Management (Continued)

In thousands of BAM

Breakdown of reserves as per regulatory requirements used for capital adequacy ratio calculation

December 31, 2016

December 31, 2015

Total reserves as per regulatory requirements for balance sheet assets and off-balance sheet items

25,144 28,854

Total impairment allowance as per IAS 39 and IAS 37 (for balance sheet assets and off-balance sheet items)

17,055 16,285

Special reserves for estimated losses - account 812 1,797 4,231

Amount of shortfall reserves for estimated credit losses according to BARS

6,292 8,338

The Bank’s management formed provisions for potential credit losses based on all the known and predictable risks as of the financial statements preparation date.

27.7. Fair Values of financial Assets and Financial Liabilities

27.7.1. Breakdown of the carrying values and fair values of financial assets and liabilities measured at other than fair value

The fair value of investment securities held to maturity is estimated using market prices or using discounted cash flows model based on current market interest rates offered for instruments of similar products.

In thousands of BAM

December, 31 2016 December 31, 2015

Carrying value

Fair value

Level 1 Level 2 Level 3

Carrying value

Fair value

Financial assets

Loans and receivables from customers

161,989 162,291 - - 162,291 167,341 167,997

Investment securities held to maturity

- - - - - - -

Financial liabilities Current accounts and deposits to customers

209,953

210,978

- -

210,978

170,257

170,541

Due to changes in the methodological approach of expressing the fair value of financial assets and

liabilities not carried at fair value in 2016, and to achievement of consistency in the presentation of the previous reporting period, comparative information for the previous year have been stated according to changes in the methodology of presenting fair value. These changes in the presentation of comparative data have no impact on the result and equity of the Bank. Fair values of loans and receivables due from customers were estimated using the method of discounted cash flows for loans at fixed interest rates. Discount rates applied are based on the current market interest rates applied to similar instruments under similar terms for borrowers with approximately the same credit quality. In addition, deposits and other liabilities due to customers with specified maturities and fixed interest rates agreed were discounted taking into account the prevailing terms and conditions according to the deposit type, placement period and currency.



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27.7. Fair Values of Financial Assets and Financial Liabilities (Continued)

27.7.2 Financial instruments measured at fair value (Continued) Level 1 includes financial instruments that are traded on the stock exchange, while Level 2 contains securities whose fair value is estimated on internally developed models that are based on information from the auction in the secondary securities market (auctions). The fair value of the assets determined by the price of the banking market is distributed in Level 3. Level 3 category includes all instruments whose assessment is based on inputs that are not available and visible and as such have a significant effect on the assessment of the value of the instruments. December 31, 2016 In thousands of BAM

Level 1 Level 2

Level 3 Total assets /

liabilities at fair value

Assets

Financial assets at fair value through profit and loss

- - - -

Securities available for sale (in BAM)

13,102 - - 13,102

Securities available for sale (in foreign currencies)

- 3,633 - 3,633

December 31, 2015 In thousands of BAM

Level 1 Level 2

Level 3 Total assets /

liabilities at fair value

Assets

Financial assets at fair value through profit and loss

- - - -

Securities available for sale (in BAM)

5,239 - - 5,239

Securities available for sale (in foreign currencies)

- 14,366 - 14,366

30. EVENTS AFTER THE BALANCE SHEET DATE

There have been no events from the balance sheet date up to these financial statements’ issue date that would require any adjustments to or additional disclosures in the Bank’s financial statements.

Documents

KOMERCIJALNA BANKA A.D. BANJA LUKA Financial …Komercijalna banka a.d., Banja Luka (hereinafter: the “Bank”) was founded in September 2006 and entered into the Court Register