The goal of the Group's Risk Management program is to maintain stability and asset quality. The Group achieves this by a disciplined and constant assessment and monitoring of clients and by using the Group's proven and established risk management tools and tests, as described in the IAS Notes to the financial accounts, page 130. Use of these tools improves asset quality, structural liquidity and performance ratios while also providing an early warning signal in order to minimise the Group's exposure to risk.

The Group and the Bank, conform with all the control requirements specified by the Bank of Slovenia; in addition the subsidiaries must also comply with the Bank's standards of internal credit risk control, as defined in the contracts which they have already executed or are in the process of execution. The Bank plays a central role applying risk control processes throughout the organisation and works closely with its subsidiaries to prepare credit and market risks policies, set strategies and place limits within the decision making process.

Group Credit Risk Management

The Group reviews credit risk from three aspects:

• specific components of risk for each counterparty,
• portfolio risk, and
• country risk.

Credit risk management includes constantly analysing the loan portfolio and providing credit analyses by considering any adverse issues (both before and after commencement of the contract).

The credit portfolio includes loans (to corporate, retail and public sector customers); exposure to other banks and financial institutions; corporate bonds and other credit risk Bank products including guaranties, derivative instruments, etc. The portfolio's quality is analysed by classifying clients into five credit grades (A to E), A being the highest and E the lowest quality credit risk. Migration matrices for the past 28 quarters (1994 to 2001) as well as those based on migrations within the years from 1995 to 2001 show that the quality of the Bank's asset base is strong and stable.

The above table also reflects the extent of migration exposure. The computation of average ratings is based on assigning a numerical code to each credit rating grade (A=5, B=4, C=3, D=2, E=1). The average rating indicates the credit quality of the Bank's customers.

The following conclusions can be drawn:

• The major migrations are between grades A and B.
• There is no significant migration between the groups of performing (A,B) and non-performing (C, D, E) credit exposures.
• The last two rows in Table 13 show that the credit quality of new clients is higher than that of those clients which, for various reasons (mainly due to paying off the loan or write-off) have been withdrawn from the portfolio.

The following table contains the credit rating migration data for 2001 only and shows that it does not differ significantly from the average.

The above cumulative migration matrix confirms the stability of rating migration patterns and thus the stability of the Bank's internal credit rating system. The overall credit quality of the Bank's loan portfolio continues to rise, despite differences in credit quality between various classes of client and variations over time. The comparison between different forms of migration matrices (size of clients, industries etc.) also reflects a healthy diversification across the loan portfolio.

All the Bank's subsidiaries in Slovenia apply the same criteria regarding credit grading, limits, quality of collateral, minimum level of provisions and data structure. The cover ratio (provisions (BCDE)/CDE total assets portfolio) is higher than 85 per cent in the Bank and all its Slovenian banking subsidiaries. This is well above the minimum required by the Bank of Slovenia. The Bank's foreign subsidiaries adhere to all local banking requirements.

Country risk is managed by applying maximum risk levels appropriate for each country. Assessment of individual risk levels is achieved through reviewing that country's major macroeconomic data, its political situation and also the rating attributed to it by respected international rating agencies.

The quality of the Group's portfolio is high, with exposure to clients credit rated A and B reaching 94.6 per cent of the total asset portfolio. The coverage of endangered, impaired or non-performing loans and other credit risk exposures towards clients rated as C, D and E credit rate with specific provisions stood at 86 per cent at 2001 year end.

Group market risks management

Basic market risks that the Group is facing include foreign exchange, interest rate, securities portfolio and liquidity risks. These risks are analysed and managed on three levels. First, business departments are responsible for managing market risks within their areas of authority determined by each Bank's Board of Directors. Second, at the Bank level, risks are analysed and managed according to the Bank's internal policies and the Bank of Slovenia standards. Third, market risks exposure of each bank and of the Group as a whole, is controlled by the Risk Management Centre of the Bank.

Foreign exchange risks

Foreign exchange risks result from the Group's FX activities in the existing macro-economic environment (savings in foreign currencies, export financing, intervening in capital flows, borrowing abroad and financing corporate activity in domestic currency).
FX risk management calls for a daily revaluation of the Group's FX portfolio on the basis of the historical trend in market prices and their correlation over the past years (Value at Risk methodology). The resulting distribution of profits and losses is used to determine the possible losses in the value of the FX portfolio as a result of market changes.

Interest rate risks

The measurement of interest rate risk exposure means quantifying the potential loss (in terms of cash flow, P&L and equity market value) of a position resulting from an adverse interest rate change. The Bank and its subsidiaries in Slovenia use gap methodology and duration to assess risk, while its foreign subsidiaries use their own models, applying local scenarios for interest rate movements.

Structural liquidity

The Group's liquidity situation should not be viewed solely from the liability side as a set of activities for meeting the required cash outflows. Therefore, at the Group level, we are planning to implement the same methodology of measuring and determining structural liquidity as the Bank. This includes using different ratios such as liquid securities/total assets, asset quality structure, long-term loans/total loans, loan disbursements/loan repayments, net liquid assets (difference between liquid assets and volatile liabilities).