KOMERCIJALNA BANKA A.D., BANJA LUKA Financial ......KOMERCIJALNA BANKA A.D., BANJA LUKA Translation of the Independent Auditors’ Report Issued in the Serbian language 3 BALANCE SHEET

Translation of the Independent Auditors’ Report Iss ued in the Serbian language

KOMERCIJALNA BANKA A.D., BANJA LUKA

Financial Statements Year Ended December 31, 2013 and Independent Auditors’ Report

Translation of the Independent Auditors’ Report Iss ued in the Serbian language


CONTENTS Page Independent Auditors' Report 1 Financial Statements:

Income Statement 2

Balance Sheet 3

Statement of Changes in Equity 4

Cash Flow Statement 5

Notes to the Financial Statements 6 - 56


Translation of the Independent Auditors’ Report Iss ued in the Serbian language 3

BALANCE SHEET As of December 31, 2013 (Thousands of BAM) December 31,

2013 December 31, 2012 Note

ASSETS Cash and balances held with the Central Bank 14 44,343 44,806 Due from other banks 15 6,704 3,754 Loans and advances to customers 17 187,520 183,777 Securities 18 16,526 - Equipment and intangible assets 19 4,108 4,358 Interest accrued and other assets 16 3,645 2,439 Total assets 262,846 239,134 LIABILITIES AND EQUITY Due to other banks 20 51 9,941 Customer deposits 21 170,991 151,134 Borrowings 22 23,739 10,596 Other liabilities 23 3,067 2,731 Provisions for potential losses 24 435 501 Total liabilities 198,283 174,903 Equity 25 Share capital 60,000 60,000 Special reserve for estimated losses 4,231 3,181 Revaluation reserves 76 - Profit for the year 256 1,050 Total equity 64,563 64,231 Total liabilities and equity 262,846 239,134 Commitments and contingent liabilities 26 256,832 303,062

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



STATEMENT OF CHANGES IN EQUITY Year Ended December 31, 2013 (Thousands of BAM)

Share Capital

Special Reserves for

Estimated Losses

Revaluation reserves

Retained Earnings Total

Balance at January 1, 2012 60,000 1,891 - 1,290 63,181 Prior years’ profit distribution - 1,290 - (1,290) - Profit for the year - - - 1,050 1,050 Balance at December 31, 2012 60,000 3,181 - 1,050 64,231 2012 profit distribution - 1,050 - (1,050) - Revaluation of assets performed during the year

- - -

- 76

Profit for the year - - 76 256 256 Balance at December 31, 2013

60,000

4,231

76 256

64,563




CASH FLOW STATEMENT Year Ended December 31, 2013 (Thousands of BAM)

2013 2012 Cash flows from operating activities Interest received 14,407 14,773 Interest paid (3,998) (3,703)Fees and commissions received 2,150 3,323 Fees and commissions paid (764) (716)Other receipts from operations 137 56 Payments to, and on behalf of employees and accounts payable (9,840) (10,419) Receipts for prepaid income taxes / Income taxes (paid) (459) 264 Net cash generated by operating activities prior to

increases or decreases in assets and liabilities 1,633 3,578 Increases or decreases in assets and liabilities: Net increase in loans and advances to customers (5,250) (34,505)Net (increase)/decrease in securities (2,396) 14,781 Net decrease/(increase) in customer deposits 9,991 (8,581) Net cash generated by/(used in) operating activities 3,978 (24,727) Cash flows from investing activities Purchase of equipment and intangible assets (669) (450)Investments in long-term securities, outflows (14,084) - Net cash used in investing activities (14,753) (450) Cash flows from financing activities Increase in borrowings 13,144 1,168 Net cash generated by financing activities 13,144 1,168 Foreign exchange gains on translation of cash and

cash equivalents 118 105 Net increase/(decrease) in cash and cash equivalent s 2,487 (23,904) Cash and cash equivalents, beginning of year 48,560 72,464 Cash and cash equivalents, end of year 51,047 48,560 Cash and cash equivalents comprise the following

balance sheet components: Cash and balances held with the Central Bank 51,047 48,560



NOTES TO THE FINANCIAL STATEMENTS Year Ended December 31, 2013

6 Translation of the Independent Auditors’ Report Iss ued in the Serbian language

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 the operating license to the Bank, whereas under Decision no. 03-983-1/2006 dated September 25, 2006 it issued the Bank license to perform international payment transactions. In Bosnia and Herzegovina the Bank is licensed to perform a broad range of banking activities that include payment transfers, credit and deposit operations in the country and abroad, and as 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, 2013, the Bank was comprised of the Head Office located in Banja Luka at no.

6, Veselina Masleše Street, 10 branches and 7 agencies in the territory of Bosnia and Herzegovina.

As of December 31, 2013, the Bank had 143 employees (December 31, 2012: 144 employees).

The Bank’s tax identification number is 4402503100008.

2. BASIS FOR PREPARATION AND PRESENTATION OF THE FI NANCIAL STATEMENTS

2.1. Statement of Compliance

The accompanying financial statements of the Bank have been prepared in accordance with the accounting regulations effective in the Republic of Srpska. These financial statements have been prepared at cost principle except for revaluation of certain financial instruments measured at fair value as explained in the accounting policies provided in the following passages. The accompanying financial statements have been prepared by applying International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS) which were in effect at January 1, 2009 and in accordance with accounting regulations of the Republic of Srpska based on these standards. Namely, in accordance with the provisions of the Law on Accounting and Auditing of the Republic of Srpska, currently in force, (Official Gazette of RS numbered 36/09 and 52/11), all legal entities situated on the territory of the Republic of Srpska are under an obligation to fully apply IAS, IFRS and International Standards on Auditing (ISA), as well as the Code of Ethics for Professional Accountants and the pronouncements, interpretations and guidelines of the International Accounting Standards Board (IASB) and all pronouncements, interpretations and guidelines of the International Federation of Accountants (IFAC) to its financial statements prepared for the periods commencing on or after January 1, 2010. The accompanying financial statements have been presented in the format adapted to the requirements of IAS 1 – “Presentation of Financial Statements.”

2.2. Basis of Measurement

These financial statements have been prepared at cost principle except for the following: • Financial instruments carried at fair value through profit and loss, which are measured at fair

value; • Financial instruments available for sale, which are measured at fair value; and • Property and equipment in instances of significant differences between their net book value

and fair value.




2. BASIS FOR PREPARATION AND PRESENTATION OF THE FI NANCIAL STATEMENTS

(Continued) 2.3. Going Concern

The Bank’s financial statements have been prepared on a going concern assumption, which means that the Bank will continue its business operations in the foreseeable future.

2.4. 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.

2.5. Use of Accounting Estimates and Assumptions

The preparation and presentation of financial statements requires the Bank’s management to make the best possible accounting estimates and assumptions that influence 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. Estimates and assumptions are made based on historical experience as well as on various information available as at the financial statements’ preparation date that are deemed reasonable in the circumstances, where the results present a solid basis for assessment of the carrying value of assets and liabilities and where other sources result in uncertainties. Actual values of assets and liabilities may vary from these estimates. Estimates and underlying assumptions are subject to constant review. In case the review reveals that there have been changes in the estimates carrying values of assets and liabilities, the determined effects thereof are recognized in the financial statements for the period wherein the change in the relevant estimate occurred if the change affects the current period only, or for both the period wherein the change in the relevant estimate occurred and the ensuing periods, if the change affects both the current and the ensuing periods.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND K EY ACCOUNTING ESTIMATES AND ASSUMPTIONS

3.1. Interest Income and Expenses

Interest income and expenses, including penalty interest and other income and other expenses arising from interest-bearing assets and interest-bearing liabilities, are recognized in the income statement on an accrual basis and pursuant to the contractual terms agreed upon by and between the Bank and its clients. Income from loan origination fees is deferred and amortized on a straight-line basis over the loan repayment period, which, in the opinion of the Bank’ management, approximates the effective interest method. Interest income also includes income from hedging financial instruments, mostly based on indexing repayment annuities to the BAM/EUR exchange rate or another currency exchange rate, or consumer price index and is calculated at each month-end over the repayment period and as at the repayment annuity maturity date.

3.2. Fee and Commission Income and Expenses

Fee and commission income and expenses are recognized as per “matching principle.” Fee and commission income from banking services and fee and commission expenses are determined and recognized within the income statement. Fees and commission charged for guarantees and other contingent liabilities are deferred and recognized as income within the income statement proportionately over their maturity periods.




3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND K EY ACCOUNTING ESTIMATES

AND ASSUMPTIONS (Continued)

3.3. Income and Expenses from Securities

Gains and losses arising from changes in amortized cost of securities held to maturity are recognized as income and expenses. Realized and unrealized gains and losses arising from the change in market value of trading securities are recognized within income statement. Unrealized gains and losses arising on securities available-for-sale are recognized within revaluation reserves included in the Bank’s equity. Upon sales or permanent impairment of these securities adequate amounts of previously formed revaluation reserves are stated in the income statement as gains or losses on the sale of securities, i.e. as impairment losses on securities. Gains/losses based on the contractually agreed currency clause and changes in exchange rates of securities available for sale as well as interest income from securities available for sale are included in the income statement.

Impairment allowances for estimated risk effects on all types of securities are recognized in the Bank’s income statement.

3.4. Foreign Exchange Translation

Transactions denominated in foreign currencies are translated into BAM at official middle exchange rates as determined in the Interbank Foreign exchange Market and effective at the date of each transaction. Assets and liabilities denominated in foreign currencies are translated into BAM by applying the official middle exchange rates as determined in the Interbank Foreign exchange Market and prevailing at the balance sheet date. Net foreign exchange positive or negative effects arising upon the translation of transactions, and the assets and liabilities denominated in foreign currencies are credited or charged to the income statement as foreign exchange gains or losses. Commitments and contingent liabilities denominated in foreign currencies are translated into BAM by applying the official middle exchange rates as determined in the Interbank Foreign exchange Market and prevailing at the balance sheet date.

3.5. Property, Investment Property, Equipment and I ntangible Assets 3.5.1. Intangible Assets

The Bank’s intangible assets are recognized at cost or purchase price. Subsequent to the initial recognition, intangible assets are stated at cost less accumulated amortization and impairment losses. Calculation of amortization of intangible assets commences in the month following the one in which a relevant intangible assets was placed into use or became available for use. Amortization of intangible assets is charged to the base comprised of cost net of residual value. If the residual value of an asset is immaterial, it is not taken into consideration, i.e. it does not reduce the amortization base. Intangible assets are amortized on straight-line basis using the annual amortization rate of 20%.

3.5.2. Property and Equipment a) Recognition and Measurement

Fixed assets other than property are measured at cost less accumulated depreciation and impairment losses. Items of fixed assets are initially measured at cost or purchase price. Cost includes all acquisition-related expenses. Purchased software necessary for the functioning of equipment is capitalized as part of such equipment. When different parts of the same asset have different respective useful lives, they are carried as separate items (basic components) of equipment.




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

3.5.2. Property and Equipment (Continued)

b) Subsequent Expenditure Cost of spare part replacement is recognized at carrying value if it is probable that the future economic benefits associated with the respective spare part will flow to the Bank and if the spare part purchase price can be measured reliably. Spare parts and servicing equipment are recorded within the income statement when used up. c) Investment Property The Bank’s investment property comprise buildings and land the Bank leases out, which are measured at cost less accumulated depreciation and impairment losses, if any, in accordance with IAS 40 – “Investment Property.”

d) Depreciation Depreciation is calculated on a straight-line basis to the cost or revalued amount of property and equipment by applying the following annual depreciation rates in order to write the cost or revalued amount less residual value of those assets down in equal annual amounts over useful lives of assets. Annual depreciation rates applied are as follows: Computer equipment 25% Vehicles 15.5% Furniture and other equipment 10% - 33.33% Leasehold improvements 10% - 33.34% Buildings 2.5 %

3.6. Inventories 3.6.1. Inventories

Inventories are stated at the lower of cost and net realizable value. The Bank includes in inventories assets acquired in lieu of debt collection (receivables arising from loans).

3.6.2. Non-Current Assets Held for Sale

Non-current assets held for sale are assets whose carrying amounts can primarily be recovered through a sales transaction and not through further utilization. A non-current asset is classified as non-current asset held for sale if the following criteria are met: • An asset (or a group of assets) is available for immediate sale in the condition as is; • There is an adopted plan for sales of non-current assets and activities have already commenced

to achieve the sales plan; • There is an active market for such assets and the relevant asset is actively present on the

market; • The likelihood of prospective sales is high, i.e. it is expected that the sales will be realized within

a year from the date of classification of the relevant item as a non-current asset held for sale. Non-current assets held for sale are initially measured at the lower of the net book value (carrying amount) and the market value (fair value) net of costs to sell. From the initial classification of such assets as non-current assets held for sale, the Bank ceases to depreciate those assets. In case of changes to the sales plan, a non-current asset ceases to be classified as a non-current asset held for sale and is measured at the lower of the following two amounts:




3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND KEY ACCOUNTING ESTIMATES


3.6. Inventories (Continued) 3.6.2. Non-Current Assets Held for Sale (Continued )

Carrying amount of the relevant asset prior to its classification as a non-current asset held for sale allowing for the accumulated depreciation and impairment that would be recognized had the relevant asset not been classified as a non-current asset held for sale; and Recoverable amount as at the date of subsequent decision not to sell the relevant asset.

3.7. Financial Instruments

a) Classification

The Bank classifies its financial assets into the following categories: financial assets carried at fair value through profit and loss, loans and receivables, financial assets available for sale and financial assets held to maturity. Classification depends on the intended purpose for which the financial assets were acquired. The Bank’s management classifies financial investments upon initial recognition.

b) Recognition

All regular way purchases or sales of financial assets or liabilities are recognized and derecognized on a trade date basis.

c) Measurement

Financial instruments are initially measured at fair value, which includes transaction costs in all financial assets or liabilities except for those carried at fair value through profit and loss. Financial assets carried at fair value through profit and loss are initially recognized at fair value whereas the transaction costs are charged to the operating expenses within the income statement. Available-for-sale financial and assets carried at fair value through profit and loss are subsequently stated at fair value. Loans and receivables as well as financial assets held to maturity are measured at amortized cost by applying the effective interest method. Subsequent to initial recognition, financial liabilities are stated at amortized cost using the effective interest method, except for financial liabilities carried at fair value through profit and loss.

d) Derecognition

Financial assets cease to be recognized when the rights to cash inflows from such assets have been realized, expired, abandoned, and/or ceded. Any right to ceded financial assets, created or retained by the Bank is recognized as a separate financial asset or liability. Financial liabilities cease to be recognized when the Bank fulfills the obligations, or when the contractual repayment obligation has either been cancelled, ceded or has expired. e) Amortized Cost Measurement

Amortized cost of a financial asset or a liability is the amount at which an asset or a liability is initially measured decreased by principal repayments made and increased or decreased by accumulated amortization by applying the effective interest method on the difference between the initial value and the nominal value at the instrument’s maturity date, less any impairment.




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

3.7. Financial Instruments (Continued)

f) Fair Value Measurement

Fair value of financial instruments is an amount for which an asset can be exchanged or a liability settled between knowledgeable and willing parties in an arm’s length transaction. Fair value is determined by applying the market information available at the reporting date and other valuation models used by the Bank. Fair values of certain financial instruments stated at nominal values approximate their respective carrying values. Such instruments include cash and receivables and liabilities without contractually defined maturities or fixed interest rates. Other receivables and liabilities are reduced to the net present value by discounting the expected future cash flows by using current interest rates. In the opinion of the management, due to the nature of the Bank’s operations and its generally adopted policies, there are no significant differences between the carrying value and fair value of the financial assets and liabilities. Fair value of irrevocable loans and off-balance sheet items is equal to their carrying amounts.

e) Impairment

As at the balance sheet date the Bank reviews financial assets in order to determine whether there is indication of impairment. If there is objective evidence of impairment, the recoverable amount of the investment is determined. For the purpose of adequate and efficient credit risk management, the Bank has adopted internal bylaws prescribing special policies and procedures for identifying and managing bad assets. The Bank’s management assesses recoverability of receivables, i.e. allowance for impairment of investments based on individual assessment of risk-weighted receivables. Risk-weighted receivables are all past-due receivables. The Bank assesses the recoverable amount of receivables and investments taking into consideration regularity in repayment, financial situation of the debtors and quality of collaterals securitizing the repayment as well as the contractually defined cash flows and historical credit losses. The Bank charges allowance for the assessed impairment to the expenses of the period in which the impairment occurred. If in a subsequent period, the management determines that conditions have changed and the impairment no longer exists or decreases, the previously formed allowance for impairment is reversed to income in profit and loss. Reversal of impairment allowance cannot result in the carrying amount of the relevant asset in excess of what the carrying amount of the asset would have been had the impairment not been recognized.

3.8. Loans

Loans originated by the Bank are stated within the balance sheet at the amount of principal outstanding, less allowance for impairment, which is based on the assessment of specifically-identified exposures and losses that are inherent in the Bank’s loan portfolio. The Bank’s management applies the internally adopted methodology in the evaluation thereof based on the fully adopted and implemented IAS 39. Loans that are disbursed in BAM and index-linked to the BAM-EUR exchange rates, other currency exchange rates or to the consumer price index are revalued in accordance with the specific individual loan agreements in question. The difference between the nominal value of the principal outstanding and the revalued amount is stated within receivables from loans and advances to customers. The effects of such revaluation are included under gains and losses on the valuation of assets and liabilities.





3.9. Financial Assets

3.9.1. Financial Assets Carried At Fair Value throu gh Profit and Loss

Financial assets carried at fair value through profit and loss are financial assets held for trading. A financial asset is classified into this category if acquired primarily for sale in the near term.

3.9.2. Financial Assets Held to Maturity

Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturity that the Bank has the positive intention and ability to hold to maturity. This category of securities includes commercial papers issued by legal entities. If the Bank decides to sell a substantial portion of the financial assets held to maturity, the entire category is reclassified to assets available for sale. Financial assets held to maturity are classified as non-current assets unless their maturities are due in less than 12 months after the balance sheet date, in which case such assets are classified as current assets.

Financial assets held to maturity are initially recognized at cost. As at the balance sheet date, such instruments are stated at amortized cost, i.e. the present value of the future cash flows determined by applying the effective interest rate inherent in the instrument.

Financial Assets Available for Sale

Financial assets available for sale are non-derivative financial assets that are designated as available for sale or not classified as loans and receivables, financial assets held to maturity and financial assets carried at fair value through profit and loss. 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. Securities available-for-sale with fixed maturities for which an active market and quoted prices do not exist are measured at amortized cost using the effective interest method. Financial assets available for sale comprise bonds issued by the Republic of Serbia and the Republic of Srpska. Available-for-sale assets are initially measured cost and stated at market value if known as the balance sheet date. Unrealized gains and losses incurred upon the change in the market value are stated as revaluation reserves within equity until this financial asset is sold, collected or disposed of, when revaluation reserves are transferred to income or expenses. In instances of decrease in value of financial assets available for sale due to objective evidence of impairment (long-term and continuous decrease in fair value over a period longer than 12 months, or decrease in value of more than 30% of the assets’ cost), accumulated losses recognized within equity is derecognized from equity and recognized as impairment loss within expenses, although such financial assets do not cease to be recognized.

3.10. Cash and cash Equivalents

For the purpose of cash flow statement, cash and cash equivalents comprise cash on hand, balances on the accounts held with other banks and cheques in the course of collection.




3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND KEY ACCOUNTING ESTIMATES


3.11. Managed Funds

The Bank manages funds on behalf of and for the account of third parties, and charges fees for these services. These items are not included in the Bank’s balance sheet but presented within off-balance sheet items.

3.12. Taxes and Contributions 3.12.1. Income Taxes

Income tax represents an amount arrived at by applying the legally prescribed tax rate to the amount of profit before taxation stated in accordance with IAS/IFRS as adjusted for effects of permanent differences that reduce the prescribed tax rate to the effective tax rate. The ultimate amount of income tax payable is determined by applying the tax rate of 10% to the taxable base reported in the annual tax return. Tax effects related to temporary differences between the tax bases of certain assets and liabilities and the amounts of such assets and liabilities stated in the balance sheet prepared in accordance with IAS/IFRS are presented as deferred tax assets or deferred tax liabilities.

3.12.2. Indirect Taxes and Contributions

Indirect taxes and contributions include property taxes, value added tax, taxes and contributions to salaries charged to employer and various other taxes and contributions paid pursuant to effective republic and local tax regulations. These taxes and contributions are included within other operating expenses.

3.13. Deposits

Deposits are stated at the amounts of placed funds which may be increased by the interest accrued, depending on the contractual terms agreed between the depositors and the Bank. The Bank agrees on interest rates depending on the amount of funds deposited.

Foreign currency deposits are stated in BAM at the official middle exchange rates prevailing as at the balance sheet date. Deposits are presented as transaction and other deposits within the Bank’s balance sheet.

3.14. Equity

The Bank’s equity is comprised of the share capital, special reserve for potential losses, profit for the year, retained earnings from prior years 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.

3.15. Key Accounting Estimates and Assumptions

The management makes estimates and assumptions that influence the amounts of assets and liabilities of the forthcoming financial year. The estimated values often differ from the actually achieved results. What follows are the key estimates and assumptions which represent risk from material adjustments to the amounts of balance sheet items in the following fiscal year.

a) Impairment Allowance

The Bank reviews receivables and other investments in order to determine impairment allowance and provisions on a monthly basis. The Bank acts prudently and promptly in order to determine the probable losses arising from loan impairment and intervenes based on contingent liabilities in order to protect the Bank’s operating profit in the period when such losses are definitely confirmed (incurred) through inability to collect the contractually defined amounts or through the outflow of assets for contingent liability settlement. Impairment of balance sheet assets and provisions for off-balance sheet items are performed only when there are justified grounds therefor.





3.15. Key Accounting Estimates and Assumptions (Co ntinued)

a) Impairment Allowance (Continued)

A loan is impaired when its carrying amount exceeds its estimated recoverable amount, whereby the recoverable amount is assessed based on both documented past events and estimates of the expected events that may occur in the future. Impairment of a loan decreasing the carrying value thereof is recorded on the impairment allowance account within the balance sheet and is recognized as expense within the income statement.

Information indicating impairment losses include: irregularity and default in liability settlement, financial standing of the debtor indicating substantial difficulties in the debtor’s operations, information of the debtor transaction account being blocked, local market and economic conditions which cause delays in payment etc. The methodology and assumptions underlying the process of defining the amounts and periods of cash inflows from investments are reviewed on an ongoing basis in order to minimize the difference between the estimated and actual losses. Impairment assessment is performed on an individual level for each materially significant loan and on a portfolio level for materially less significant loans. The amount of impairment is individually assessed as the difference between the carrying amount and the present value of the expected future cash flows determined by discounting the relevant loan at the effective interest rate thereof. Impairment of materially less significant loans is assessed on a portfolio basis for each credit rating group separately, given their similar characteristics in respect of credit risk, as the percentage of migration of the relevant credit rating group into the V credit rating group adjusted for the percentage of collected loans previously classified into V credit rating group. The methodology and assumptions underlying the process of defining the amounts and periods of cash inflows from investments are reviewed on an ongoing basis in order to minimize the difference between the estimated and actual losses. The amounts of inflows expected from a loan are assessed based on evidence of the debtor’s planned earnings or based on the expected cash flows from collateral foreclosure. The number of days in default against certain receivables from debtors is determined by considering all relevant evidence about the timeline of debtors’ planned earnings inflow as well as historical default of those debtors.

b) Fair Value The fair value of financial instruments for which an active market does not exist is determined by applying different valuation methods and techniques. For financial instruments with less trading volume, whose market prices are therefore less transparent, determination of fair value is more subjective and requires a higher degree of estimation depending on the instrument liquidity, risk concentration, market volatility, assumptions about the prices and other factors affecting the particular financial instrument.

3.16. Employee Benefits

In accordance with regulatory requirements effective in Bosnia and Herzegovina and the Republic of Srpska, the Bank is obligated to pay contributions to government pension funds and social security funds. These obligations involve the payment of taxes and contributions on behalf of employees, by the employer, in the amounts calculated applying the rates prescribed by the statutory regulations. 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 the applicable government funds. These taxes and contributions payable on behalf of the employees and employer are charged as expenses in the period in which they arise. The Bank does not have defined benefit plans or share-based remuneration options and there were no identified liabilities thereof as of December 31, 2013. In 2013, the Bank made provisions for long-term liabilities for employee retirement benefits and benefits for unused annual leaves (vacations). The Bank hired a certified actuary to perform evaluation and calculation of provisions for the aforesaid purpose.





3.17. Segment Information

The Bank monitors and discloses information on its operating segments – lines of business. The major portion of the Bank’s business operations is conducted in the territory of Bosnia and Herzegovina and the Republic of Srpska and, therefore, the information on geographical segments is not disclosed.

4. INTEREST INCOME In thousands of BAM

Year Ended December 31, 2013 2012

Interest income from: Balances held with the Central Bank of Bosnia and Herzegovina 15 8 Balances held with other banks 7 21 Corporate customers, public and state agencies and institutions 11,042 12,017 Securities 554 154 Retail customers 2,685 3,080

14,303 15,280 5. INTEREST EXPENSES

In thousands of BAM Year Ended December 31,

2013 2012 Interest expenses from: Deposits and borrowings from banks and financial institutions 739 293 Deposits from corporate customers, public and state

agencies and institutions 2,166 2,113 Deposits from retail customers 1,487 1,370

4,392 3,776 6. FEE AND COMMISSION INCOME


2013 2012

Fee and commission income from payment transfers 1,905 1,924 Fees for issued guarantees and other sureties 248 546 Commission income from currency conversions 438 341 Fees and commissions arising on payment card operations 303 308 Other fee and commission income 158 175

3,052

3,294




7. FEE AND COMMISSION EXPENSES


2013 2012

Fee and commission expenses for currency conversions 99 62 Fees and commissions charged by the Central Bank for

domestic payment transfers

205

227 Fee and commission expenses for foreign payment transfers 98 77 Fees and commissions charged by the RS Banking Agency 193 196 Fees and commissions arising on payment card operations 157 148 Other fee and commission expenses 12 6

764

716

8. GAINS ON VALUATION OF ASSETS AND LIABILITIES, N ET In thousands of BAM


Foreign exchange gains 4,455 4,189 Foreign exchange losses (4,337) (4,084)Losses on revaluation of property and equipment - (63)

118 42

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

9. FIXED ASSET IMPAIRMENT LOSSES Fixed asset impairment losses incurred in 2012 in the amount of BAM 63 thousand resulted from the reduction of equipment (a machine acquired through bankruptcy procedure over the company “Šipad 10 avgust“ a.d., Vlasenica) the Bank acquired in lieu of collection of loan repayment receivables to its technical value. The reduction to the technical value was performed in accordance with the regulations of the banking Agency of the Republic of Srpska. The equipment was sold in 2013.




10. А) PROVISIONS FOR POTENTIAL LOSSES, CONTRACTED LIABI LITIES AND WRITE-OFFS


2013 2012 IMPAIRMENT ALLOWANCE EXPENSES Impairment of loans and advances to customers 5,803 4,666 Provisions for losses per off-balance sheet items 212 145 Provisions for other liabilities 30 131 6,045 4,942 INCOME FROM REVERSAL OF IMPAIRMENT ALLOWANCES Reversal of impairment of loans and advances to customers 4,569 3,318 Reversal of provisions for losses per off-balance sheet items 251 52 Reversal of provisions for other liabilities 58 16 4,878 3,386 PROVISIONS FOR POTENTIAL LOSSES, NET 1,167 1,556

In thousands of BAM


Total reserves in accordance with the regulatory requirements

for balance sheet assets and off-balance sheet items 24,161

20,325 Total impairment allowance per IAS 39 and IAS 37

(for balance sheet assets and off-balance sheet items) 9,656

8,461 Special reserves for estimated losses – account 812 4,231 3,181 Additional required reserves for potential losses as per BARS 10,274 8,683

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




10. B) MOVEMENTS ON THE LONG-TERM PROVISIONS FOR POTENTIA L LOSSES AND CONTRCTED LIABILITIES In thousands of BAM

Loans and Advances to

Customers Accrued Interest

and Other Assets

Contracted and Contingent

Liabilities Provisions

for Litigations

Provisions for Employee

Retirement Benefits and Annual Leaves Total

Balance, January 1, 2012 6,067 904 49 6 251 7,277 Charge for the year 4,302 364 145 13 118 4,942 Release of provisions – retirement benefit

disbursement - - - - (12) (12)Reversal of provisions (3,071) (246) (53) - (16) (3,386) Balance, December 31, 2012 7,298 1,022 141 19 341 8,821 Balance, January 1, 2013 7,298 1,022 141 19 341 8,821 Charge for the year 5,517 286 212 5 25 6,045 Reversal of provisions (4,380) (189) (251) (19) (39) (4,878) Balance, December 31, 2013 8,435 1,119 102 5 327 9,988




11. OTHER OPERATING EXPENSES


2013 2012

Net salaries and benefits 2,764 2,889 Payroll taxes and contributions 1,881 1,952 Other staff costs 198 150 Materials, fuel and energy 346 357 Current and investment maintenance of property and equipment 625 593 Rentals (business premises, telecommunication lines and other) 1,665 1,821 Marketing and advertising 150 127 Depreciation and amortization charge 936 962 Telecommunication and postage services 187 204 Security services 559 515 Deposit insurance premiums 386 362 Other insurance premiums 222 213 Other taxes and contributions 120 103 Lawyer fees and administrative fees 178 73 Other non-material expenses 685 704 Other expenses 29 297

10,931

11,322 12. OTHER OPERATING INCOME

In th ousands of BAM Year Ended December 31,

2013 2012

Other income 154 59

154 59

13. INCOME TAXES In thousands of BAM


Profit before taxes 373 1,304 Income tax at the statutory tax rate of 10% 37 130 Adjustment for permanent differences: - Capital gains/losses 18 1 - Expenses recognized in the tax balance 62 123 Effective income tax expense 117 254 Effective tax rate 31,37 % 19,47%




14. CASH AND BALANCES HELD WITH THE CENTRAL BANK In thousands of BAM

December 31,

2013 December 31,

2012 Cash on hand: - in BAM 2,923 2,830 - in foreign currencies 1,701 2,177 Balances with the Central Bank in BAM: - Obligatory reserve 16,451 13,215 - Assets in excess of obligatory reserve – gyro account 23,268 26,584

44,343 44,806

Cash and cash equivalents include surplus liquid assets deposited with the Central Bank of Bosnia and Herzegovina in accordance with the requirements of IAS/IFRS and amended regulations of the Central Bank of Bosnia and Herzegovina.

The obligatory reserve held with the Central Bank of Bosnia and Herzegovina represents the minimum amount of reserves calculated in accordance with the Decision on the Obligatory Reserve Held with the Central Bank of Bosnia and Herzegovina.

Since August 1, 2011, the Central Bank of Bosnia and Herzegovina has calculated and charged banks fees for the obligatory reserve funds held with the Central Bank as follows: the fee for the amount of obligatory reserves equals 70% whereas the fee for the amounts in excess of the obligatory reserves equals 90% of the rate determined based on the weighted interest rate average the Central Bank of Bosnia and Herzegovina applied on the deposits placed up to a month in the same period.

15. DUE FROM OTHER BANKS

In thousands of BAM

December 31,

2013 December 31,

2012

Funds held with foreign banks 6,704 3.754

6.704 3,754




16. INTEREST ACCRUED AND OTHER ASSETS

In thousands of BAM

December 31,

2013 December 31,

2012In BAM: Matured interest receivables – from loans 2,676 2,463 Interest receivables arising from securities available for sale 29 - Non-current assets held for sale 74 - Fee and commission receivables 81 79 Receivables for prepaid taxes and contributions 215 - Deferred interest receivables 193 186 Deferred other expenses 187 213 Inventories of materials 81 96 Other receivables 352 228 In foreign currencies: Matured interest receivables – loans and advances 56 56 Interest receivables arising from securities available for sale 451 - Deferred interest receivables 65 95 Other foreign currency receivables 304 45 Less: Allowance for impairment of interest accrued (1,026) (926)Less: Allowance for impairment of fees and other assets (93) (96)

3,645 2,439

Non-current assets held for sale as of December 31, 2013 comprised a building property situated in Banja Luka, which was acquired in lieu of debt collection for a loan disbursed.

17. LOANS AND ADVANCES TO CUSTOMERS Loans and advances to customers are presented within the balance sheet in the outstanding amounts of the loans and advances approved. Loans were approved to retail customers at interest rates ranging from 2.98% to 9% annually for housing loans, whereas the annual interest rates for other types of loans were between 2% and 13%. 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 5.9 % to 14.45% annually, while the long-term loans were extended at interest rates between 2.55 and 12.5% 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. 136/10 and 127/11) and Guidelines on the Amended Manner of Forming, Recording and Reporting of Reserves for Credit Losses no. 01-D-1/11, the Banking Agency of the Republic of Srpska arranged for the banks to implement methodology for measuring impairment of loans and other financial assets in accordance with IАS/IFRS (whose application has been obligatory from January 1, 2010). Accordingly, the Bank was obligated to reclassify the balance sheet items of general and special reserves from the liabilities and equity to appropriate balance sheet asset items. The Decision on Minimum Standards for Credit Risk Management and Classification of Banks’ Assets (Official Gazette of RS, no. 49/13 and 01/14) became effective as of June 30, 2013.




17. LOANS AND ADVANCES TO CUSTOMERS (Continued) In thousands of BAM

December 31,

2013 December 31,

2012In BAM: Short-term loans - up to a year Short-term loans to retail customers 2,044 2,106 Short-term loans to corporate customers 31,238 28,911 Short-term loans to public sector 4,950 650 Long -term loans – over a year Short-term loans to retail customers 34,577 34,939 Short-term loans to corporate customers 42,951 40,770 Short-term loans to public sector 57,986 60,019 - In foreign currencies: - Long-term loans to corporate customers 3,520 5,867 Long-term deposits - 267 Less: Allowance for impairment of loans to customers (1,589) (1,865)

TOTAL LOANS AND ADVANCES

175,677 171,664

In thousands of BAM

MATURED LOANS December 31,

2013 December 31,

2012 Matured loans in BAM 18,585 17,442 Less: Allowance for impairment of loans in BAM (6,742) (5,329)

Matured loans in foreign currencies 104 104 Less: Allowance for impairment of loans in foreign currencies (104) (104)

TOTAL MATURED LOANS

11,843

12,113 18. SECURITIES

In thousands of BAM

December 31,

2013 December 31,

2012

Investments in securities in local currency 2,442 - Investments in securities in foreign currencies 14,084 -

16,526 -

Investments in securities 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 and war reparations), which are traded in the Banja Luka Stock Exchange. Investments in securities in foreign currencies refer to investments in bonds issued by the Government of the Republic of Serbia. Bonds are classified as financial assets available for sale.




19. EQUIPMENT AND INTANGIBLE ASSETS

In thousands of BAM

Equipment and

Other Assets Assets under Construction

Leasehold Improvements

Total Equipment

Investment Property

Intangible Assets

(Licenses and Programs)

Intangible Assets under Construction

Cost - Balance, January 1, 2012 4,506 135 635 5,276 - 1,891 - Additions 262 253 19 534 2,199 - 217 Transfers - (312) - (312) - 141 (109) Disposals (78) - - (78) - - - Balance, December 31, 2012 4,690 76 654 5,420 2,199 2,032 108 Balance, January 1, 2013 4,690 76 654 5,420 2,199 2,032 108 Additions 249 270 15 534 - - 423 Transfers - (264) - (264) - 464 (464) Disposals (59) - - (59) - - - Balance, December 31, 2013 4,880 82 669 5,631 2,199 2,496 67 Accumulated Depreciation and

Amortization Balance, January 1, 2012 2,806 - 424 3,230 - 1,267 - Charge for the year 559 - 34 593 11 358 - Disposals (57) - - (57) - - - Balance, December 31, 2012 3,308 - 458 3,766 11 1,625 - Balance, January 1, 2013 3,308 - 458 3,766 11 1,625 - Charge for the year 489 - 31 520 42 373 - Disposals (52) - - (52) - - - Balance, December 31, 2013 3,745 - 489 4,234 53 1,998 - Net Book Value December 31, 2012 1,382 76 196 1,655 2,188 407 108 December 31, 2013 1,135 82 180 1,397 2,146 498 67




20. DUE TO OTHER BANKS

In thousands of BAM

December 31,

2013 December 31,

2012

Short-term banks’ deposits in BAM - 5,000 Transaction banks’ foreign currency accounts 51 51 Short-term banks’ deposits in foreign currencies - 4,890

51 9,941

21. CUSTOMER DEPOSITS In thousands of BAM

December 31,

2013 December 31,

2012In BAM: Retail customer transaction accounts 13,490 10,984 Transaction accounts of corporate customers 51,789 40,434 Transaction accounts of public companies and state agencies

and institutions 16,374 16,674 Retail customer short-term deposits 3,949 3,380 Short-term deposits of corporate customers 2,592 5,779 Short-term deposits of public companies and state agencies

and institutions 1,100 1,350 Retail customer long-term deposits 6,880 8,936 Long-term deposits of corporate customers 20,426 14,805 Long-term deposits of public companies and state agencies

and institutions 13,601 11,624

130,201 113,966 In foreign currencies: Retail customer transaction accounts 4,791 4,164 Transaction accounts of corporate customers 2,673 1,884 Transaction accounts of public companies and state agencies

and institutions 880 658 Retail customer short-term deposits 16,344 15,801 Short-term deposits of corporate customers 16 79 Short-term deposits of public companies and state agencies

and institutions - 100 Retail customer long-term deposits 10,157 4,212 Long-term deposits of corporate customers 1,786 6,586 Long-term deposits of public companies and state agencies

and institutions 4,143 3,684 40,790 37,168 TOTAL CUTOMER DEPOSITS 170,991 151,134




21. CUSTOMER DEPOSITS (Continued)

Short-term deposits of public companies and state agencies and institutions in BAM were placed at interest rates ranging from 0.1% to 3.25 % annually. Long-term deposits of the public sector accrued interest at the annual rates from 4.3% to 5%. Demand deposits of corporate clients in BAM accrued interest at the rates ranging from 0.1% to 3.1% annually, whereas demand deposits of corporate clients in foreign currencies were placed at interest rates between 0.1% and 2.5 % annually.

Short-term retail BAM deposits were placed at interest rates ranging between 0.4% and 3.2% and long-term ones at rates ranging from 0.25% to 5.3%. Earmark deposits accrue interest at the rates ranging from 0% to 6% annually.

22. BORROWINGS

In thousands of BAM

December 31,

2013 December 31,

2012

Local currency borrowings 13,960 10,596 Foreign currency borrowings 9,779 -

23,739 10,596

Interest rates applied to borrowings obtained in BAM ranged from 1.2% to 3.4% annually. Local currency borrowings relate to the loan facility the Bank uses based on the investment made by the Investment and Development Bank of the Republic of Srpska. Interest rates applied to borrowings in foreign currencies ranged from 4.395% to 4.424% annually. Foreign currency borrowings relate to the loans approved to the bank by Komercijalna Banka AD Beograd and European Fund for Southeast Europe.

23. OTHER LIABILITIES

In thousands of BAM

December 31,

2013 December 31,

2012

Interest payable in BAM, not matured 1,312 1,365 Interest payable in foreign currencies, not matured 833 493 Matured interest and fees payable in BAM 45 27 Advances received 374 307 Accounts payable in BAM 381 331 Accounts payable in foreign currencies 64 14 Taxes and contributions payable 16 156 Other liabilities payable in BAM 42 38 Other liabilities payable in foreign currencies - -

3,067 2,731




24. PROVISIONS FOR POTENTIAL LOSSES

In thousands of BAM

December 31 ,

2013 December 31,

2012 Provisions for potential losses 435 501

435 501 25. EQUITY

The total share capital of the Bank as of December 31, 2013 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 AD, Beograd holding an equity interest of 99.998%.

In thousands of BAM

December 31,

2013 December 31,

2012

Share capital 60,000 60,000 Reserves from profit - - Revaluation reserve 76 - Special reserves for estimated losses 4,231 3,181 Profit for the year 256 1,050

64,563 64,231

As of December 31, 2013 revaluation reserves were formed based on the subsequent measurement of financial assets available for sale at their fair value and the gains on valuation of these assets were recognized under revaluation reserves within equity.

26. COMMITMENTS AND CONTINGENT LIABLITIES

In thousands of BAM

December 31,

2013 December 31,

2012 Guarantees and other sureties issued in BAM 4,286 21,821 Guarantees and other sureties issued in foreign currencies 1,643 4,916 Irrevocable undrawn loan commitments in BAM 8,303 3,685 Irrevocable undrawn loan commitments in foreign currencies - - Other off-balance sheet items 242,600 272,017 Other off-balance sheet item exposures of the Bank - 623

256,832 303,062




27. LITIGATION

As of December 31, 2013, contingent liabilities arising from legal suits filed against the Bank totaled BAM 250 thousand and RSD 15,571 thousand for one legal suit (the total number of cases: 11). Out of the 11 legal suits, two are without monetary claims presented. The Bank’s management and its legal representatives anticipate no significant adverse outcomes that could have materially significant effects on the Bank’s financial statements. Accordingly, the Bank formed provisions for potential losses thereof in the amount of BAM 5 thousand. As of December 31, 2013, Komercijalna banka a.d., Banja Luka was involved in 308 lawsuits as a plaintiff, against third parties for collection of loan repayment receivables in the amount of BAM 13,621 thousand.

28. RELATED PARTY TRANSACTIONS

In thousands of BAM

December 31,2013

December 31,2012

BALANCE SHEET Ass ets Special-purpose interest-free account held with foreign banks for

international settlement - Komercijalna banka a.d., Beograd 93 77 Regular foreign currency account –

Komercijalna banka a.d., Beograd - 62 Regular foreign currency interest-free account –

Komercijalna banka a.d., Beograd 65 - 158 139 Liabilities Foreign currency transaction accounts of foreign banks -

Komercijalna banka a.d., Beograd 51 51 Long-term loan obtained in foreign currency from the related party

Komercijalna banka a.d., Beograd 3,912 - Deferred interest payable for loans obtained in foreign currency

from the related party Komercijalna banka a.d., Beograd 45 - 4,008 51 Off-balance sheet items Other off-balance sheet items – foreign loans with

Komercijalna banka a.d., Beograd 5,867 15,647




28. RELATED PARTY TRANSACTIONS (Continued)


2013 2012 INCOME STATEMENT Interest income from deposits

7

10

Fees for foreign exchange operations 23 Foreign exchange gains 41 123 71 133 EXPENSES Interest expenses arising from borrowings 45 27 Payment transfer fees 6 6 Brokerage and similar fees and commissions 1 1 Fees for foreign exchange operations - - Foreign exchange losses 81 112

133

146

The Bank had no transactions with the related entities Komercijalna banka a.d., Budva and KomBank Invest a.d., Beograd in the reporting periods under review. The gross and net remunerations to the Board of Directors* of the Bank, Supervisory Board and Audit Committee members in 2013 were as follows: * We underline that 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). In thousands of BAM

Year Ended December 31, 2013 2012 Gross remunerations – Executive Board* 371 380 Net remunerations – Executive Board* 224 230 Gross remunerations – Supervisory Board and

Audit Committee 186

132 Net remunerations – Supervisory Board and Audit Committee 112 115

29. COMPLIANCE WITH LEGAL REQUIREMENTS

The Bank is obligated to adjust the scope and structure of its operations to legally prescribed business and adequacy indicators, i.e. to reconcile the scope and structure of its risk-weighted assets with the accounting standards and regulations of the Republic of Srpska as established by the Banking Agency of the Republic of Srpska.

As of December 31, 2013, the Bank was in full compliance with the accounting standards and regulations of the Republic of Srpska defined by the Banking Agency of the Republic of Srpska.




30. RISK MANAGMENT

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 it is or may be exposed to. Risk assumption is in the core of the banking business and is critical to continuous profitable operations of the Bank. 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. Risk Management System

The risk management system is governed by the Bank’s internal enactments.

In order to ensure more successful risk management, as of December 31, 2011, the Bank adopted a set of bylaws governing risk management: risk management strategy, policies, procedures and the methodologies for managing certain types of risks. Risk Management Strategy adopted as of December 31, 2011 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.

Procedures and methodologies 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. Competencies

The Bank’s competent bodies and organizational units executing and participating in risk management system are responsible for implementation of the risk management strategy.

The Supevisory Board is authorized and responsible for establishing a uniform risk management system and for monitoring such system, adopting policies and procedures 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.




30. RISK MANAGEMENT (Continued)

Competencies (Continued)

The Executive Board is authorized and responsible for implementation of risk management strategy and 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. 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. Types of Risk

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





30.1. 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. The credit risk depends on the debtor credit worthiness, regularity in liability settlement toward the Bank as well as the collateral quality.

Credit risk includes the following: 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; Risk of reduced value of receivables – is a risk of possible emergence of negative effects on the Bank’s financial results and capital due to reduced value of repurchased receivables for cash on non-cash liabilities of the previous creditor to the debtor; Settlement/delivery risk – is a risk of possible emergence of negative effects on the Bank’s financial results and capital due to counterparty default on free delivery transactions as of contractually defined settlement/delivery date; Counterparty risk – is a risk of possible emergence of negative effects on the Bank’s financial results and capital due to counterparty failure to settle its liabilities prior to the ultimate settlement of the transaction cash flows, i.e. settlement of cash payment; Credit foreign exchange risk – represents probability that the Bank will incur a loss due to default of the debtor in liability settlement within contractually defined terms, which is caused by adverse impact of the RSD exchange rate changes on the debtor’s financial situation; the Bank is not exposed to this type of risk; Environmental risk – is a risk of possible emergence of negative effects on the Bank’s financial results, capital and reputation due to events having or likely to have adverse material effects on the environment, health or safety or the community as a whole.

The Bank monitors the following credit-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, commodities, etc.; 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. Country risk encompasses the following risks:

• Political and economic risk, entailing likelihood of loss incurrence due to the Bank's inability to collect due receivables because of the restrictions stipulated by the enactments of the government or other authorities of the debtor's country of origin as well as because of the general circumstances therein;

• Transfer risk, entailing likelihood of loss incurrence due to the Bank's inability to collect due receivables denominated in other than official currency of the debtor's country of origin because restrictions imposed on liability settlement to foreign creditors in certain currency stipulated by the enactments of the government or other authorities of the debtor's country of origin. .




30. RISK MANAGEMENT (Continued) 30.1. CREDIT RISK (Continued)

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

per off-balance sheet as required by IAS 39 and IAS 37 and calculating provisions pursuant to the regulations of the National Bank of Serbia;

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

The rating system is not merely an instrument for forming individual decisions and assessing risk levels of individual investments; it is also a basis for portfolio analysis, support in loan approval and loan impairment procedure as well as in estimating provisions against losses per off-balance sheet items for the purpose of loan and investment ranking by risk level and stating realistic value of receivables. The internal rating system is subject to regular review and improvement.





In addition to the internal rating system, in credit risk analysis the Bank also uses principles prescribed by the 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. In accordance with the Supervisory Board's Decision on Loan and Guarantee Conclusion for the approval of which the opinion of the Risk Management Department is required, as well as with credit risk management procedures, an independent attitude of the Risk Management Department is developed. In order to maintain the credit risk at the acceptable level, the bank has defined the risk alleviating procedure, which includes the following:

• Definition of exposure limits; • Definition and implementation of risk mitigation measures; and • Decision making system.

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.

Measures undertaken as protection from the credit risk can be short-term and long-term. The basic techniques for alleviating credit risk are risk reduction, diversification, transfer and avoiding, which minimize losses.

The credit risk monitoring procedure defines rules in respect of responsibilities for, regularity of and reporting on the execution of the adopted measures for credit risk mitigation.

Monitoring 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. In addition, the Bank continuously monitors and checks the adequacy of the process of loan rating and classification into the risk categories according to the extent of their recoverability.

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 hedge 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. If the undertaken measures for regulating collection, i.e. enforced collection and court proceedings fail to provide expected results, i.e. when receivables cannot be collected in full, the Bank initiates write-off of the remaining receivables. Apart from credit risk exposure, the Bank also has off-balance sheet exposures (various types of payment and performance guarantees, 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.

30.1.1. Total Credit Risk Exposure

The largest credit risk for the Bank arises from actual loan arrangements; however, the Bank is exposed to the credit risk based on off-balance sheet items, which is caused by commitments and contingent liabilities.

The total exposure to credit risk is presented here in the gross amount before the effects of risk alleviation and asset impairment. As compared to the previous period, the report includes certain adjustments in line with the new regulations and corrections of the previous year data in order to provide comparability, which relate to the assets subject to classification, i.e. other assets.





30.1. CREDIT RISK (Continued) 30.1.1. Total Credit Risk Exposure (Continued) Breakdown of assets (gross) In thousands of BAM

Assets subject to

classification Other assets Total 2013 2012 2013 2012 2013 2012 Assets 177,799 169,537 72,676 74,678 250,475 244,215 Revocable loans and deposits - - 39,718 39,799 39,718 39,799 Interest, fee and commission

receivables and changes in the fair value of derivatives and other receivables 2,808

2,598 5

-

2,813

2,598 Loans and advances to

customers 173,720 165,971 22,131 25,000 195,851 190,971 Other investments 124 129 - 124 129 Other assets 1,147 839 10,822 9,879 11,969 10,718

Other assets

14,722

214

13,613

8,547

28,335

8,761

Cash and cash equivalents

187

214

11,142

8,547

11,329

8,761 Securities 14,535 - 2,471 - 17,006 - Equity investments - - - - - - Off -balance sheet items 12,539 12,905 1,693 17,517 14,232 30,422 Payment guarantees 3,255 8,383 1,608 17,425 4,863 25,808 Performance bonds 1,061 914 5 15 1,066 929 Acceptances - - - - - Irrevocable letters of credit - - - - - Irrevocable commitments 8,223 3,608 80 77 8,303 3,685 Other - - - - - -

30.1.2 Downgrade Risk

The quality of the Bank’s assets is measured by the level of exposure to individual risk categories according to internal rating system criteria. The internal rating system focuses on quantitative and qualitative parameters for assigning customer ratings. The rating scale consists of 5 risk categories that are subdivided into 17 subcategories. The rating scale is used as a uniform method for assigning ratings which ensures that customers with the same rating have the same credit characteristics and the same probability of default, in part or in full, over the period of one year. The basic parameters of credit risk used in determining a risk subcategory are calculated and monitored on a monthly basis.

A low level of risk implies doing business with customers with a high credit rating (risk rating categories 1 and 2), increased level of risk implies doing business with customers with operating difficulties that could have a negative impact on the settlement of liabilities (risk rating category 3), and a high level of risk characterizes customers with negative operating results and poor credit rating history (risk rating categories 4 and 5).





30.1. CREDIT RISK (Continued) 30.1.2 Downgrade Risk (Continued)

The Bank guards against downgrade risk through continuous monitoring of customers’ business operations and by identifying changes that could arise through: deterioration of a borrower’s financial standing, delays in repayment and changes in the business environment, as well as by securing appropriate collaterals.

Overview of exposure per risk categories based on t he Bank’s internal rating system criteria

In thousands of BAM 2013 2012 Gross Net Gross Net Rating category 1 47,132 46,814 43,569 43,231 Rating category 2 71,971 71,675 54,746 54,461 Rating category 3 30,291 30,063 48,381 48,073 Rating category 4 7,415 7,221 4,268 3,965 Rating category 5 20,990 13,223 18,573 11,487

Total

177,799 168,996 169,537 161,217 30.1.3. Risk of Change in the Value of Assets

Allowance for impairment of investments 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 investments 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.

Key elements in assessing impairment of investments are as follows: overdue payments on principal or interest, cash flow difficulties on the part of the borrower, the borrower’s credit rating deterioration or changes in the initial terms of contract, etc. Allowance for impairment is based on estimated future cash flows from the borrower’s business or collateral foreclosure if it is assessed that a loan can be realistically settled from such assets.

Overview of impairment per risk categories: In thousands of BAM

Impairment allowance of balance

sheet assets Provisions for losses on off-balance sheet items

2013 2012 2013 2012 Rating category 1 318 337 22 4 Rating category 2 296 285 22 88 Rating category 3 228 308 48 49 Rating category 4 194 303 10 - Rating category 5 7,767 7,086 - -

Total

8,803

8,319

102

141




30. RISK MANAGEMENT (Continued) 30.1. CREDIT RISK (Continued) 30.1.3. Risk of Change in the Value of Assets (Conti nued)

Assessment of Allowance for Impairment of Receivable s

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 investment and considers 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 investments that are not individually significant and for individually significant loans and advances, when there is no objective evidence of individual impairment. 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 in default status per type of borrower or product. The obtained migration percentages are adjusted for collected receivables.

Allowance for impairment is based on estimated future cash flows from the borrower’s business or collateral foreclosure if it is assessed that a loan can be realistically settled from such assets.

Impairment of loans decreases the value of loans and is 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.





Overview of Individual and Group-Level Impairment A llowance of Balance Sheet Assets

In thousands of BAM Loans and Advances 2013 2012 I. Individual impairment allowance Rating category 1 - 241 Rating category 2 67,560 50,725 Rating category 3 28,006 41,753 Rating category 4 6,731 3,382 Rating category 5 15,213 14,684 Loans and receivables, gross 117,510 110,785 Impairment allowance 2,369 3,658 Carrying amount 115,141 107,127 II. Group-level impairment allowance Rating category 1 43,913 40,103 Rating category 2 4,299 3,602 Rating category 3 2,284 1,528 Rating category 4 685 802 Rating category 5 5,777 3,944 Loans and receivables, gross 56,958 49,979 Impairment allowance 6,434 4,661 Carrying amount 50,524 45,318

III. Receivables matured but not provided for Rating category 1 65 96 Rating category 2 - 26 Rating category 3 - 7 Rating category 4 - 15 Rating category 5 - - Loans and receivables, gross 65 144 Receivables matured but not provided for include: 0-30 days past-due 65 109 31-60 days past-due - 13 61-90 days past-due - 12 91-180 days past-due - 11 Over 180 days past-due - - Carrying amount 65 145

IV. Receivables not matured and not provided for Rating category 1 3,155 3,073 Rating category 2 111 394 Rating category 3 - 5,092 Rating category 4 - 68 Rating category 5 Carrying amount 3,266 8,627

Total carrying amount, gross 177,799 169,536 Total impairment allowance 9,554 8,319 Total carrying amount, net 168,245 161,217 Total unclassified assets 72,676 74,678 TOTAL 250,475 244,214 Rescheduled / restructured loans 8,669 8,846





Individually Impaired Loans and Advances

In thousands of BAM Loans and Advances 2013 2012 Gross Net Gross Net Rating category 1 - - 241 233 Rating category 2 67,560 67,391 50,725 50,502 Rating category 3 28,006 27,870 41,753 41,534 Rating category 4 6,731 6,653 3,382 3,316 Rating category 5 15,213 12,476 14,684 11,542

Total

117,510 114,390 110,785 107,127 30.1.4. Concentration Risk

The Bank controls concentration risk by establishing a system of limits to the exposures with the same or similar risk factors in accordance with the BARS Decision on Credit Risk Concentration, per industry sectors/activities, product types, geographical regions and collaterals debtor country of origin.

Breakdown of Loans and Advances per Geographical Region:

In thousands of BAM 2013 2012 Gross Net Gross Net Bosnia and Herzegovina 174,023 164,475 163,402 155,093 Republic of Srpska 157,144 149,898 146,013 139,323 Federation of BH 6,909 4,927 7,205 5,870 Brčko District 9,970 9,650 10,184 9,900 European Union 256 256 267 267 Other 3,520 3,514 5,868 5,857 Total 177,799 168,245 169,537 161,217




30. RISK MANAGEMENT (Continued) 30.1. CREDIT RISK (Continued) 30.1.4. Concentration Risk (Continued)

Breakdown of Loans and Advances per Industry: In thousands of BAM

2013 2012 Gross Net Gross Net Financial and insurance sector 456 455 363 363 Public companies and enterprises 99,727 95,151 94,27 90,530 Agriculture 1,725 1,703 1,893 1,866 Processing industry 25,925 25,044 35,773 34,620 Power industry 8,939 8,933 - - Construction industry 3,505 3,200 2,777 2,648 Wholesale and retail 44,949 42,112 42,035 39,993 Service industries 12,845 12,352 9,765 9,402 Real estate and related activities 1,839 1,807 2,029 2,001 Entrepreneurs 1,351 1,178 792 704 Public sector 22,072 22,050 12,588 12,567 Retail customers 40,168 35,515 40,780 36,468 Non-residents - foreign entities - - - - Other customers 14,025 13,896 20,742 20,585 Total

177,799

168,245

169,537

161,217

Depending on general economic trends in certain industry sectors, the Bank diversifies its investments in industrial sectors that are resistant to the impact of negative economic trends.

Breakdown of Loans and Advances per Customer Type:

In thousands of BAM 2013 2012 Gross Net Gross Net Corporate sector 115,251 113,241 105,626 103,758 Large entities 33,453 33,343 33,610 33,405 Medium-sized entities 14,623 14,498 16,368 16,266 Small-sized entities 24,429 22,809 18,287 16,868 Other 42,746 42,591 37,361 37,219 Banks 81 81 96 96 Retail sector 62,467 54,923 63,815 57,363 Private individuals 40,168 35,515 40,766 36,454 Agricultural producers - - - - Micro businesses 20,948 18,230 22,257 20,205 Entrepreneurs 1,351 1,178 792 704 Total 177,799 168,245 169,537 161,217




30. RISK MANAGEMENT (Continued) 30.1. CREDIT RISK (Continued) 30.1.5. Off-Balance Sheet Items

In addition to credit exposure, the Bank also has off-balance sheet exposures (guarantees, letters of credit...) based on which the Bank has contingent liabilities to make payments on behalf of third parties. The Bank uses control processes and procedures for off-balance sheet exposures identical to those used for credit risk.

Provisions for Losses per Off-Balance Sheet Items

In thousands of BAM

2013 2012 Gross Net Gross Net

Provisions – off-balance sheet items Rating category 1 7,895 7,874 2,563 2,559Rating category 2 5,468 5,445 9,317 9,229Rating category 3 847 799 990 941Rating category 4 21 11 34 33Rating category 5 1 1 2 2 Gross investments (1-5) 14,232 14, 130 12,906 12,764

30.1.6. Credit Risk Hedges (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, as well as the guarantees of the Brčko District Government (for loan facilities approved to agricultural producers);

• 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. Assets acquired to securitize/in lieu of receivable collection are not used for the Bank's regular operating purposes.




30. RISK MANAGEMENT (Continued) 30.1. CREDIT RISK (Continued) 30.1.6. Credit Risk Hedges (Collateral) (Continued)

Fair Value of Collaterals

In thousands of BAM Loans and Advances 2013 2012 I Individual allowance for impairment Mortgages 87,409 98,621 Deposits 524 255 Guarantees 200 10,000 Pledged assets 44,320 43,797 Other - 2 Total 132,453 152,675 II Portfolio-level allowance for impairment Mortgages 60,997 59,486 Deposits 3,038 6,203 Guarantees 1,513 12,328 Pledged assets 22,919 21,438 Other 30 37 Total 88,497 99,492 III Loans and advances matured but not provided for Mortgages 326 4,565 Deposits - 203 Pledged assets 23 1,805 Total 349 6,573 IV Loans and advances not matured and not provided for Mortgages 1,835 2,481 Deposits 7 836 Guarantees 71 - Pledged assets 2,464 1,467 Other - 83 Total 4,377 4,867 Total fair value 225,676 263,607




30. RISK MANAGEMENT (Continued) 30.1. CREDIT RISK (Continued) 30.1.6. Credit Risk Hedges (Collateral) (Continued)

As of December 31, 2013, the Bank had at its disposal the following properties acquired to securitize/in lieu of debt collection:

Collaterals Acquired to Securitize/in Lieu of Colle ction of Loan Repayment

In thousands of BAM 2013 2012 Residential buildings 74 - Business premises - - Land and forests - - Equipment - - Total 74 - Accumulated depreciation Fair value 74 -

30.2. LIQUIDITY RISK

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 (debt to equity ratio) and sufficient liquidity reserves which do not compromise realization of the projected return on equity. 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. Liquidity risk may be manifest as:

• risk related to sources of funds (withdrawal of the existing sources of funding and inability to obtain new ones) and

• market liquidity risk (difficulty in converting assets into liquid asset sue to market disruptions). 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 has 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; • Creates a solid basis through dispersion of private individual roles and through loans facilities; • Manages market resources; • Defines Contingency Plan for emergency situation that may undermine the liquidity of

Komercijalna banka a.d., Banja Luka; and • Undertakes other measures.

The liquidity management process comprises identification, measurement, minimizing, monitoring, control and liquidity risk reporting.




30. RISK MANAGEMENT (Continued) 30.2. LIQUIDITY RISK (Continued)

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. Risk identification entails analyses of assets, liabilities and off-balance sheet items, i.e. continuous analyses of both internal and external liquidity risk factors. 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 (liquidity risk indicator); and • Stress test (sensitivity analysis and scenario analysis).

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 prescribed by the Bank’s internal enactments.

The Bank’s operations are reconciled daily with legally prescribed liquidity ratio as follows: minimum 0.8 for one working day; minimum 0.9 for no longer than three consecutive working days and minimum 1 as the average liquidity ratio for all working days in a month. In order to reduce its liquidity risk exposure, the Bank also monitors the rigid/cash liquidity ratio, which represents priority 1 liquid receivables relative to the sum of the appropriate percentage of liabilities without contractually defined maturities and the total liabilities with defined maturities due for payment within a month (rigid/cash liquidity ratio does not include priority 2 liquid receivables, i.e. those maturing in the forthcoming month).

Internal limits of liquidity ration and rigid liquidity ratio are as follows:

Internally prescribed liquidity ratios Liquidity Rat io Rigid/Cash

Liquidity Ratio For one working day 0. 8 0. 5 For three consecutive working days 0. 9 0. 6 Average ratio for all working days in a month 1. 0 0. 7

Liquidity ratio 2013 2012 As at December 31 2.87 2.56 Average for the period 2.78 2.07 Maximum for the period 3.91 4.13 Minimum for the period 2.02 1.11

Rigid liquidity ratio 2013 2012 As at December 31 2.16 1.95 Average for the period 2.30 1.80 Maximum for the period 3.02 3.95 Minimum for the period 1.55 0.98




30. RISK MANAGEMENT (Continued) 30.2. LIQUIDITY RISK (Continued)

During 2013, the Bank’s liquidity and rigid liquidity ratios were above the prescribed limits.

The Bank sets internal limits, based on the internal reporting on liquidity GAP for all balance sheet components.

Compliance with internally defined limits of liquid ity as of the last day was as follows: Liquidity indicators Limits 2013 2012 GAP up to 1 month/Total assets Max (10%) 16. 45 % 15. 24% Cumulative GAP up to 3 months / Total assets Max (20%) 18. 07 % 17. 35%

In addition, the Bank limits and coordinates its operations with the limits defined for maturity per major foreign currencies. Maturity structure of monetary assets and monetary liabilities as of December 31, 2013 in thousands of BAM:

Up to 1

month From 1 - 3

months From 3 -12

months From 1 - 5

years Over 5 years Total


11,329

-

-

-

-

11,329 Revocable deposits and loans 39,718 - - - - 39,718 Interest, fee and commission receivables

1,781

-

-

-

-

1,781

Loans and advances to customers 31,004 19,811 34,526 71,492 30,943 187,776

Other investments 35 144 420 15,030 1,377 17,006 Other assets 20 - - - - 20 Cash and cash equivalents 723 - - - - 723 Total 84,610 19,955 34,946 86,522 32,320 259,104 Transaction deposits

89,708

-

-

-

-

89,708

Other deposits 5,806 17,330 22,866 34,726 583 81,311 Borrowings 126 231 1,154 10,695 5,690 17,896 Interest, fee and commission

payables 45

-

-

-

-

45

Other liabilities 1,386 46 642 5,496 6 7,576 Total 97,071 17,607 24,662 50,917 6,279 196,536 Liquidity gap As of December 31, 2013 (12,461)

2,348

10,284

35,605

26,041

61,817

As of December 31, 2012 (9,278) (722) (5,287) 47,549 28,706 60,967

The report on the maturity structure of monetary assets and liabilities includes monetary balance sheet items distributed according to maturities outstanding, i.e. the conservative assumption was used that all transaction and demand deposits will be withdrawn within one month.

Adequate diversification of the deposit portfolio per number and type of depositors as well as historical experience provide a solid basis for existence of a stable and long-term deposit base, i.e. no significant outflow of funds is expected thereof.

The stability of operations from liquidity aspect is further supported by the fact that the Bank has sufficient liquidity reserves which can be used in extreme liquidity crisis conditions, which is confirmed by the results of stress testing and updating of the Emergency Liquidity Management Plan of Komercijalna banka a.d., Banja Luka.




30. RISK MANAGEMENT (Continued) 30.3. MARKET RISK

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 banking book interest rate risk, currency risk for all 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 has the most significant role therein as well as other competent boards/committees, whose decisions can impact the Bank's exposure to this risk.

30.3.1. 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. 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 and matching adequate sources to investments per interest rate type and maturity. 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; • Economic value of equity; and • Stress test.

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

Internal limits are determined based on the internal report on the interest rate GAP, which includes all the balance sheet items.





30.3. MARKET RISK (Continued)

30.3.1. Interest Rate Risk (Continued)

Compliance with internally defined interest rate ri sk limits at the last day was as follows:

Indicators Limit 2013 2012 Relative GAP 22.06 % 26. 01 %Mismatch ratio 1.30 1. 38Annual cumulative GAP ± 30% 30.70 % 30. 82 %

The Bank has defined internal limits for interest rate risk exposure in order to restrict the negative effects thereof to the Bank's financial result and equity. The effects on the financial result are limited to the period of up to one (1) year by setting maturity limits, i.e. interest rate repricing. The effects on equity are limited by setting the maximum economic value of equity.

Compliance with internally defined limits of econom ic value of equity:

Limit 2013 2012 Economic value of equity Max 20% 4.5% 5.13%

The exposure to interest rate risk can be reviewed through the Report on Interest Rate GAP in monetary assets and liabilities as follows:

The Report on Interest Rate GAP in monetary assets a nd liabilities as of December 31, 2013 in thousands of BAM

Item Up to 1 Month

From 1 to 3

Months

From 3 to 12

Months

From 1 to 5

Years

Over 5 Years

Total Interest-Bearing

Non-Interest Bearing

Total


6,456

-

-

-

-

6,456

4,873

11,329 Revocable loans and deposits

39,718

-

-

-

-

39,718

-

39,718

Interest and fee receivables

-

-

-

-

-

-

1,781

1,781

Loans and advances to customers

61,001

37,801

33,008

40,790

15,176

187,776

-

187,776

Securities 34 16 92 15,021 1,363 16,526 480 17,006 Other investments - - - - - - 20 20 Other assets - - - - - - 723 723 Total 107,209 37,817 33,100 55,811 16,539 250,476 7,877 258,353

Transaction deposits

89,708

-

-

-

-

89,708

89,708 Other deposits 5,638 17,268 22,639 33,075 430 79,050 2,261 81,311 Borrowings 102 15,814 1,956 - - 17,872 24 17,896 Interest, fee and commission payables and changes in the fair value of derivatives -

-

-

-

-

-

45

45

Other liabilities - - 5,867 - - - 1,709 7,576 Total 95,448 33,082 30,462 33,075 430 192,497 4,039 196,536 Interest rate GAP, net

December 31, 2013 11,761 4,735 2,638 22,736 16,109 57,979 3,838 61,817 December 31, 2012 16,922 2,634 (3,929) 27,892 18,684 62,203 (1,235 ) 60,967




30. RISK MANAGEMENT (Continued) 30.3. MARKET RISK (Continued) 30.3.1. Interest Rate Risk (Continued)

Interest rate risk GAP report of monetary sub-balance includes monetary balance items distributed according to the shorter of period of interest rate repricing and maturity outstanding. In accordance with the aforesaid, the conservative assumption is used that all transactions and demand deposits will be withdrawn within one month.

Appropriate compliance of positions per interest rate type and interest rate repricing period constitutes a solid prerequisite for existence with required financial results achieved and maintenance of economic value of equity. Nevertheless, the bank has defined the Business Plan whereby it intends to perform further matching of items in the forthcoming period in order to achieve better results and at the same time decrease the adverse effects of the changes in interest rates on the economic value of equity.

30.3.2. 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 (except for EUR, where the exchange rate of BAM to EUR is fixed and not subject to change). All items in the banking book and the trading book that are denominated in a foreign currency, as well as currency clause-indexed items in BAM 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 currency gaps 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, by items that are recorded in the banking book and the trading book.

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

• GAP analysis; • Currency risk ratio; and • Stress test.

Relieving foreign currency risk entails maintenance of risk at an acceptable level for the Bank’s risk profile.

Control and monitoring of the currency risk consists of observation and supervision of compliance with internally and externally defined limits as well as monitoring of defined and implemented measures. Continuous monitoring and control of foreign currency risk during the day ensures timely undertaking measures for the purpose of maintaining the currency risk within defined limits. Foreign currency risk control means control at all management levels as well as independent control system implemented by the organizational units responsible for internal audit and compliance monitoring. Reporting on currency risk includes internal and external reporting systems; it is performed on a daily basis and according to set schedules and in accordance with the defined system. The Bank reconciles its business operations with the prescribed foreign currency risk ratio, which represents the ratio between the total net foreign currency balance and the position of gold relative to the Bank’s regulatory capital.





30.3. MARKET RISK (Continued) 30.3.2. Currency Risk (Continued)

An overview of the total currency risk balance and legally defined currency risk ratio as at December 31: 2013 2012 Net currency risk balance 7.462% 11.313Currency risk ratio 13% 19%Legally-defined limit 30% 30% Currency risk exposure can be viewed based on the Summary of monetary assets and liabilities per currency.

Summary of Monetary Assets and Monetary Liabilities per Currencies as of December 31, 2013 in thousands of BAM:

EUR

USD

CHF Other

currencies

FX Total Currency

Clause BAM

Items

Total


5,922

848

1,256

379

8,405

-

2,924

11,329 Revocable deposits and loans - - - - - - 39,718 39,718 Interest, fee and commission receivables - - - - - - 1,781 1,781

Loans and advances to customers

3,514 256 - - 3,770 130,623 53,383 187,776

Other investments 14,535 - - - 14,535 - 2,471 17,006 Other assets - - - - - - 20 20 Cash and cash equivalents 99 14 - - 113 - 610 723 Total 24,070 1,118 1,256 379 26,823 130,623 100,907 258,353

Transaction deposits

6,777

819

625

173

8,394

49,506

31,808

89,708 Other deposits 31,630 346 422 30 32,428 42,711 6,172 81,311 Borrowings 3,918 2 - - 9,787 13,960 16 17,896 Interest, fee and commission payables and changes in the fair value of derivatives

-

-

-

-

-

-

45

45 Other liabilities 6,658 103 1 814 1,709 - - 7,576 Total 48,983 1,270 1,048 1,017 52,318 106,177 38,041 196,536 Net currency gap

December 31, 2013 (24,913) (152) 208 (638) (25,495) 24,446 62,866 61,817 December 31, 2012 (30,827) 86 125 203 (30,413) 41,726 49,655 60,967

30.4. 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 is defined as an event that occurred as the result of inappropriate or unsuccessful internal processes, employee and system actions or system and other external events, internal and external abuses, hiring and security practices at the workplace, customer receivables, product distribution, fines and penalties for infractions, damage incurred to property, disruptions in operations and system errors and process management. The Bank monitors operational risk events according to the following business lines: corporate financing, trade and sales, retail brokerage services, corporate banking, retail banking, payment transfers, agency services and asset management.




30. RISK MANAGEMENT (Continued) 30.4. OPERATIONAL RISK (Continued)

The process of operational risk management represents an integral part of the Bank’s activities performed at all levels, which enables operational risk identification, measurement, mitigation, monitoring and control and reporting before risk occurrence, on an ongoing basis, in accordance with the requirements and deadlines prescribed by effective regulations and the Parent Bank. The process in place relies on the reliable methods for measuring operational risk exposure, database of operational risk losses and updated system of control and reporting. The Bank monitors operational risk events daily and manages operational risks. For the purpose of efficient operational risk monitoring, the Bank appoints employees who are in charge of operational risk with the objective of monitoring operational risk in its every organizational part, where such employees are responsible for accuracy and timeliness of information about all operational risk events that occur in their organizational unit, as well as for keeping records about all such events in the operational risk database. The organizational part of the Bank which is responsible for risk management monitors and reports operational risks to the Bank’s Supervisory Board, 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. Self-assessment consists of assessment of risk exposure by organizational units based on the roadmap for identifying operating risks, through measurement of potential ranges and frequencies of events that can result in losses, identification of levels of control that business areas must maintain over these risks and measures of improvement. The Bank cannot eliminate all operational risks, but by introducing a rigorous framework of control, monitoring and response to potential risks it is capable of managing these risks. The basic protective measure against operational risk is control that includes effective duty segregation, application of and adherence to “four eyes principle,” consistent implementation of internal procedures, employee training and special supervision by the Internal Audit. 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. By reliable reporting on the realization of operational risk mitigation measures, the bank has established a system for monitoring activities in order to reduce operational risks and respond in such a manner as to prevent operating risk events.

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

30.5. THE BANK’S INVESTMENT RISK

The Bank’s investment risk relates to the risk of investing in other entities and capital expenditures. The Bank is not exposed to risk of investing into other legal entities, while capital expenditures are performed in accordance with the Supervisory Board’s Decision on the Amount and Conditions of Approval of Investment Risk Related Transactions, investment risk management policy and procedure. The Plan for Capital Expenditures is prepared by all Bank’s organizational units based on the financial framework - the annual Business Plan. The Plan for Capital Expenditures includes procurement of fixed assets (equipment) determined by the Plan of Investment into the Bank’s Business Network and purchases of assets intended for replacement of depreciated assets. The Procurement Commission is in charge of the execution of the Procurement Plan. All purchases of fixed assets are conducted based on the Guidelines for Procurement of Komercijalna banka a.d., Banja Luka.





30.5. THE BANK’S INVESTMENT RISK (Continued)

The Bank measures, i.e. assesses risk of investment into fixed assets through quantitative and/or qualitative estimates of the identified capital expenditure investment risk. The Bank measures, i.e. assesses the current and future exposure to risk of investment into fixed assets based on comprehensive information and procurement, disposal and retirement plan. The Bank measures, i.e. assesses the investment risk based on the effective regulations and IAS/IFRS. Through risk alleviation procedure, the Bank determines measures for mitigation of risk of investing in fixed assets. These measures include:

� Exposure limit definition; � Definition and implementation of investment risk mitigation measures; � Decision-making system.

30.6. EXPOSURE RISK

Large exposures of the Bank to a single entity or a group related entities, including Bank’s related parties, are exposures amounting to over 15% of the Bank’s capital. In its operations, the Bank takes care of the compliance with statutory exposure limits: � The Bank’s exposure to a single entity or group of related entities cannot exceed 40% of the Bank’s

equity; � The Bank’s exposure to a private individual that is related to the Bank cannot exceed 1% of the

Bank’s equity, while total exposure to the Bank’s related parties – private individuals cannot exceed 10% of the Bank’s equity;

� The aggregate amount (sum) of the Bank’s large exposures cannot exceed 300% of the Bank’s equity.

� The aggregate amount (sum) of the Bank’s exposures per contingent off-balance liabilities, except for performance bonds, cannot exceed 200% of the Bank’s equity.

The Bank calculates exposure to a single entity or a group of related entities in accordance with the BARS requirements but also by using an internal approach for the purpose of reporting to the Parent Bank. In accordance with the BARS Decision on Credit Risk Concentration, the total credit risk exposure (the “TCRE”) of the Bank to a single entity or a group of related entities represents the sum of already incurred (balance sheet assets) and all contingent (off-balance sheet items) credit risk exposures to an entity or a group of related entities and comprises the aggregate carrying balance of: � All receivables from a single entity or a group of related entities for principal of loans extended or

other advances, matured and not matured; � All matured interest accrued and fees from a single entity or a group of related entities; � All securities (debt securities and equity securities) issued by a single entity or a group of related

entities; � All types of irrevocable commitments for payment or execution the Bank assumed on behalf of

and/or for the account of a single entity or a group of related entities in favor of third parties; and � Other elements determined by BARS.




30. RISK MANAGEMENT (Continued) 30.6. EXPOSURE RISK (Continued)

The total credit risk exposure of the Bank does not relate to the following:

� Demand deposits and time deposits placed for periods of up to 30 days on accounts of banks mostly recently ranked as having at least BBB rating by Standard & Poor’s, Fitch - IBCА or Thompson Bank Watch as having at least Baa3 rating per Mood’s ranking, less the portion intended for securitizing the assumed commitments;

� Cash funds held on the reserves account with the central Bank of Bosnia and Herzegovina; � Receivables from Governments of the Zone A countries and receivables securitized by their

unconditional guarantees payable at first call; � Receivables based on direct and indirect debt of and securities issued by the Republic of Srpska

Government, Federation of Bosnia and Herzegovina Government and Council of Ministers of Bosnia and Herzegovina and receivables securitized by their unconditional guarantees payable at first call, whereby the aggregate exposure on this basis cannot exceed 300% of the core capital;

� Receivables from the Central Bank of Bosnia and Herzegovina and central banks of the Zone A countries and receivables securitized by their unconditional guarantees payable at first call;

� Investments or portion of investments and contingent liabilities of the Bank collateralized by monetary deposits placed with the same bank if it is contractually defined that the monetary deposits as collateral shall be attached to the relevant credit-guarantee transaction until full collection of receivables or cessation of the contingent liability.

The Bank is obligated to treat as total credit exposure to a single entity the following: 1. The sum of individual credit exposures to the entity’s related parties; and 2. The sum of credit risk exposures to the entities referred to in Article 100 of the Law on Banks of the

Republic of Srpska, whereby: - the entities owning at least 5% of the total number of Bank’s shares (common or preferred) shall

be considered the Bank’s related parties; and - the entities referred to in Article 1 of the Law on Banks of the Republic of Srpska shall be

considered related parties of the Bank, while the entities owning at least 5% of the total number of Bank’s shares shall be considered related parties of the Bank’s shareholders.

30.7. COUNTRY RISK

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

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

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

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

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.




30. RISK MANAGEMENT (Continued) 30.7. COUNTRY RISK

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.

30.8. 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 provisions 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 proportion of the Bank’s net capital and sum of assets weighted by credit risk. The total Bank’s asset risk is the sum of products of appropriate risk weights and asset items, i.e. credit equivalents of off-balance sheet items exposed to risk. The capital adequacy ratio represents the proportion of the Bank’s capital and sum of assets weighted by credit risk, foreign currency gap and exposure to operational risk. Risk-weighted balance sheet and off-balance sheet items are determined pursuant to risk weights prescribed for all types of assets. 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. The MACROR formed 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. The Banking Agency of the Republic of Srpska has extended the implementation of the Decision on the Minimum Standards for Market Risk Management until December 31, 2014, which is the reason that WMR (weighted market risk) affecting the capital adequacy is not yet calculated.

Capital adequacy ratio In thousands of BAM Core capital

2013

2012

59,435 59,485 Supplementary capital 3,282 3,532 Deductible items (10,274) (8,683)

Capital 52,443 54,334 Credit risk-weighted assets 189,192 161,673 Operational risk exposure 16,505 15,939 Currency risk exposure - -

Capital adequacy ratio 25.5% 30.6 %

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%.




30. RISK MANAGEMENT (Continued) 30.8. CAPITAL MANAGEMENT (Continued)

The Bank manages capital on a continuous basis in order to:

• Ensure the business continuity in the unlimited period of foreseeable future; • Preserve optimal equity structure; • Minimize capital costs; • Hedge risks; • Ensure growth, by widening the range of its services i.e. the Bank’s development of new

software and methodology solutions; • Preserve the customers’ trust in the Bank’s financial potential.

30.9. TAXATION RISKS

The Republic of Srpska and Bosnia and Herzegovina currently have several tax laws in effect, as imposed by various governmental agencies. The applicable taxes include: a turnover tax, corporate tax, and payroll (social) taxes, among others. Following their introduction, the regulations governing these taxes were not enforced for substantial periods of time; in contrast to similar legislation in more developed market economies. Moreover, the regulations defining the implementation of these laws are often unclear or non-existent. Hence, few precedents with regard to tax issues have been established in the Republic of Srpska. Often, contrary opinions pertaining to legal interpretations exist both among, and within, governmental ministries and organizations, thus creating uncertainties and areas of legal contention. Tax declarations, together with other legal compliance matters (e.g., customs and currency control matters) are subject to the review and investigation by a number of authorities that are legally enabled to impose extremely severe fines, penalties and interest charges.

The interpretation of tax legislation by tax authorities as applied to the transactions and activity of the Bank may not coincide with that of the management. As a result, transactions may be challenged by tax authorities and the Bank may be assessed additional taxes, penalties and interest. The aforedescribed situation creates tax risks in the Republic of Srpska that are substantially more significant than those typically existing in countries with more developed tax systems. Banks in Bosnia and Herzegovina are of an opinion that legislation ought to define a uniform manner of determining taxable base for calculation of taxes, contributions and income taxes in the Federation of Bosnia and Herzegovina, Republic of Srpska and Brčko District.

30.10. MACROECONOMIC ENVIRONMENT AND BANK’S OPERATIONS IN 201 3

Slow economy recovery in the Eurozone and the countries of the region during 2013 as well as prolonged ongoing uncertainty had adverse effect on the economic activity in Bosnia and Herzegovina, which is in a difficult situation. The difficult economic situation in Bosnia and Herzegovina further deteriorated due to decline in direct foreign investment, which is directly related to the unstable political situation and unwise investment policy. Investment climate in Bosnia and Herzegovina is rather bad with the key factors mostly referring to the political instability, restrictive labor market policy, long and complicated permit issuance procedures, inadequate infrastructure quality and complex foreign trade policy. Poor image of Bosnia and Herzegovina is reflected in the fact that it moved up only one place in the global competitiveness scale, now ranked as 87th among the total of 148 countries included in the scale, as per the latest global competitiveness report of the World Economic Forum (WEF). According to the WEF analysis, Bosnia and Herzegovina is the least competitive country in the region. The current credit rating of Bosnia and Herzegovina is still satisfactory. According to the most recent data available (September 27, 2013) Standard & Poor’s credit rating for Bosnia and Herzegovina stands at “B with a stable outlook.” Standard & Poor’s analysts hold that the Stand-By Arrangement with IMF from September 2012 has provided stability to Bosnia and Herzegovina and that the budget deficit will be at the level of 1%, while the public debt ought to reach the maximum 39% of GDP this year, whereafter it should decline to 36% of GDP up to 2016.





30.10. MACROECONOMIC ENVIRONMENT AND BANK’S OPERATIONS IN 2013 ( Continued)

In 2013 commercial banks in Bosnia and Herzegovina undertook more active lending to domestic sectors; however, at the same time borrowers repaid substantial portion of the matured liabilities so that the total balance of loans did not alter significantly year-on-year. In addition, there were no major changes in the total balance of deposits as compared to the previous two years. Deposits made by the public sector fell to the historically lowest level in June 2013 although two tranches of the Stand-By Arrangement with IMF were drawn in the amount of BAM 75.6 million each. In 2013 commercial banks further decreased their liabilities based on loans and deposits toward non-residents. Data on weighted average interest rates applied in 2013 suggest that there were no significant changes in interest rate movements so they did not have a significant impact on the banking activities.

Total banking sector loans in Bosnia and Herzegovina did not record substantial movements as compared to the previous year. Commercial banks continued more active lending to the domestic sectors. The new contracted loans in 2013 totaled BAM 1.48 billion, implying that there were larger repayments of the matured liabilities as well as that a portion of the new loans was used for rescheduling the existing liabilities.

As per sector structure, there were no major changes year-on–year and the largest portion of loans pertains to the loans approved to non-financial sector private and public companies. The growth rates of the total loans approved to non-financial sector companies were still very low. As per maturity, growth rates are higher for short-term loans than for long-term ones, which suggests lack of major investment projects, i.e. the need for current working assets.

In the structure of total loans extended to the private and public companies, about 28% refers to revolving loans and other overdrafts, which implies that a significant portion of funds borrowed is used for financing current liabilities and liquidity issues. Second most important sector the banks’ loan portfolios are exposed to is the retail banking sector, where customers use over 75% of all borrowed funds for current spending. The aforesaid clearly shows that the largest portion of funds borrowed is used for financing current liabilities and personal spend. Commercial banks contracted new retail loans totaling over BAM 600 million; however, despite the significant amount of loans, there were no major changes in the total balance of such loans, which means that a large portion of the newly approved loans is used for refinancing or renewing old debts.

The share of total deposits of commercial banks in the liabilities of those banks equals about 60%. Deposits of the public sector exhibited a downward trend until May 2013, when the third tranche of the Stand-By Arrangement with IMF was drawn in the amount of BAM 75.6 million, and a month later, the fourth trance as well in the same amount. However, these founds did not substantially influence the total balance of deposits made by the public sector so that the total share thereof was at the historically lowest level of 8.45% at the end of Q2 of 2013. To the contrary of the aforedescribed, deposits of the non-governmental sector showed a growing trend although slowed down in Q2 2013 quarter-on quarter. The largest impact on the total deposit growth was made by the recent retail deposit increase, with the retail deposits accounting for the largest share in the total non-governmental sector deposits (64.2%). Data on the weighted average interest rates applied in 2013 suggest that there were no significant changes in interest rate movements. Commercial banks that are most active lenders have rather stable interest rate policies so that there were no major fluctuations in weighted average interest rates in the last two quarters of 2013.

Macro-economic trends call for integrated overall risk management. Accordingly, in its asset management the Bank focuses on comprehensive loan analyses from the credit risk viewpoint and protection of a portion of the loan portfolio by investing in the securities with the least risk, such as those issued by the Republic of Srpska and the Republic of Serbia, due to insufficient quality demand. In 2013 the Bank’s operations were directed toward increasing market share and maintaining the acceptable credit risk level through increased lending activities towards Budget beneficiaries, institutions and funds financed from the Republic Budget, whereby the Bank continued its prudent lending policy and strict monitoring of the existing loan arrangements, rescheduling matured receivables and active participation in debt collection.

The Bank's management undertakes the necessary activities and will continue to undertake them in the forthcoming period in order to provide sustainable growth and business continuity, strengthening market position, in order to maintain the quality of loan portfolio, minimize the risk exposures and maintain adequate level of capital in accordance with the complex business conditions.




31. EXCHANGE RATES

The official exchange rates for major currencies as of December 31, 2013 and 2012 used in the translation of balance sheet components denominated in foreign currencies into BAM were as follows:

In BAM

December 31,

2013 December 31,

2012

USD 1.419016 1.483600 CHF 1.595424 1.619065 EUR 1.955830 1.955830

Documents

KOMERCIJALNA BANKA A.D., BANJA LUKA Financial ......KOMERCIJALNA BANKA A.D., BANJA LUKA Translation of the Independent Auditors’ Report Issued in the Serbian language 3 BALANCE SHEET