MARKET RISK MANAGEMENT Market Risk - Trading Book

Annual Report 2013 PT Bank Mandiri Persero Tbk.

2. MARKET RISK MANAGEMENT Market Risk - Trading Book

Trading book market risk refers to potential losses due to the way in which changes in interest and exchange rates afect the trading portfolio including derivative instruments. In managing market risk on the trading book, the Bank applies the principle of independent segregation of duties by separating the functions and responsibilities for trading transactions in the Treasury Group, which consists of a front oice unit trading transactions, middle oice unit risk management processes, preparing policies and procedures and the back oice unit transaction settlement process. The Bank conducts a valuation process on a daily basis based on independent sources for all instruments classiications in the trading book portfolio. The market price sources used are: i the price quoted by Reuters, Bloomberg or similar sources; Ii the price quoted on the stock exchange exchange price or secondary market; Iii the price quoted on dealer screens screen prices; or iv the most conservative quotation given by at least two reputable brokers and or market makers, one of whom is independent. Indonesian inancial market dynamics have unique characteristics, with market prices often not being available for some instruments. In treating instruments that do not have market prices, the Bank employs the the mark-to-model approach based on appropriate methodology. To ensure the accuracy and efectiveness of the mark the model approach, reviews are regularly conducted. In order to ensure that the Bank has suicient capital to anticipate trading book market risk, the measurement of market risk for capital adequacy calculation purposes is conducted using two methods: the standardized model and the internal model. The standardized model is used by the Bank in calculating its Minimum Capital Adequacy Requirement CAR consolidated with its subsidiaries for reporting to Bank Indonesia on a monthly and quarterly basis. Meanwhile the internal model is applied for the purpose of preparing daily reports to management using the Value at Risk VaR methodology. risk management Annual Report 2013 PT Bank Mandiri Persero Tbk. Table 7.1 Disclosure of Market Risk Using Standardized Method in million rupiah NO Risk Type 31 December 2013 Bank Consolidation Capital Charge RWA Capital Charge RWA 1 2 3 4 5 6 1 Interest rate risks a. Speciic Risks 5.323 66.535 6.798 84.975 b. General risks 32.149 401.858 33.725 421.560 2 Exchange rate risks 120.292 1.503.648 114.890 1.436.126 3 Equity risks - - 3.806 47.581 4 Commodity risks - - - - 5 Option risks - - - - TOTAL 157.763 1.972.041 159.219 1.990.242 NO Risk Type 31 December 2012 Bank Consolidation Capital Charge RWA Capital Charge RWA 1 2 3 4 5 6 1 Interest rate risks a. Speciic Risks 3.123 39.035 12.081 151.010 b. General risks 42.620 532.746 48.701 608.757 2 Exchange rate risks 37.789 472.368 36.192 452.397 3 Equity risks - - 2.566 32.074 4 Commodity risks - - - - 5 Option risks - - - - TOTAL 83.532 1.044.148 99.539 1.244.238 risk management Annual Report 2013 PT Bank Mandiri Persero Tbk. The VaR employs two methods: i the Variance Covariance Method, which calculates the market risk related to plain vanilla products. This method uses the exponential weighted moving average EWMA concept to calculate volatility by assigning a heavier weight for the latest data, based on a decay factor of 0.94; ii the historical simulation method, which is used to calculate market risk in the case of derivatives transactions. Valuation at Risk realization during 2013 is as shown in the following table: Table 7.2.a Disclosure of Market Risk using Internal Model Value at Risk VaR – Bank Unconsolidated and Consolidated in million rupiah NO Risk Type 31 December 2013 Average VaR Maximum VaR Minimum VaR VaR at End Period 1 2 3 4 5 6 1 Interest rate risks 6.510 14.873 1.761 4.761 2 Exchange rate risks 5.609 22.775 1.647 10.646 3 Option risks - - - - TOTAL 9.565 27.041 2.189 13.135 NO Risk Type 31 December 2012 Average VaR Maximum VaR Minimum VaR VaR at End Period 1 2 3 4 5 6 1 Interest rate risks 54.527 14.999 668 3.660 2 Exchange rate risks 4.876 11.700 1.277 2.254 3 Option risks 79 169 - 169 TOTAL 7.548 16.663 1.747 4.842 risk management Annual Report 2013 PT Bank Mandiri Persero Tbk. Table 7.2.b Disclosure of Market Risk using Internal Model Value at Risk VaR – Bank Consolidated in million rupiah NO Risk Type 31 December 2013 Average VaR Maximum VaR Minimum VaR VaR at End Period 1 2 3 4 5 6 1 Interest rate risks 6.510 14.873 1.761 4.761 2 Exchange rate risks 5.609 22.775 1.647 10.646 3 Equity risks - - - - 4 Commodity risks - - - - 5 Option risks - - - - TOTAL 9.565 27.041 2.189 13.135 NO Risk Type 31 December 2012 Average VaR Maximum VaR Minimum VaR VaR at End Period 1 2 3 4 5 6 1 Interest rate risks 54.527 14.999 668 3.660 2 Exchange rate risks 4.876 11.700 1.277 2.254 3 Equity risks - - - - 4 Commodity risks - - - - 5 Option risks 79 169 - 169 TOTAL 7.548 16.663 1.747 4.842 A comparison between Minimum Capital Adequacy Requirement realization as between the Standardized Model and the Internal Model is shown in the following graph: 109,17 134,83 134,54 140,71 122,48 50,87 85,78 140,00 85,69 110.24 124,66 135,64 127,44 73,52 59,75 48,47 51,32 52,73 51,13 2013 104,10 78,76 136,07 157,76 140,76 Market Risk Capital Charge Rp, Billion Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec risk management Annual Report 2013 PT Bank Mandiri Persero Tbk. In order to ensure that the risks faced are compatible with the Bank’s risk appetite, the Bank conducts risk monitoring of treasury operations by comparing the results of market risk calculations with the prescribed limits. Monitoring is conducted on a daily basis in respect of limit utilization, including individual limits Intraday Net Open Position Limit, Net Overnight Open Position Limit, Loss Limit and Holding Period Limit and portfolio limits VaR Limit and Greek Limit. In addition, the Bank also monitors treasury performance to ensure that business and revenue targets are achieved. To ensure the accuracy and efectiveness of the VaR model, the Bank conducts testing using the backtesting approach. The backtesting process provides an overview of the extent to which divergences have occurred, whether the loss estimates produced by VaR calculation are in line with actual hypothetical losses, and the extent to which divergences can be tolerated. Backtesting is conducted using two methods, namely, the Unconditional Coverage Test Basel Zone and Kupiec Test and Conditional Coverage Test Christofersen Test. Based on the results of backtesting during December 2013, it may be concluded that our VaR calculations using the two methods were “accurate”, with the level of P L deviations on the daily VaR being acceptable and not mutually inluential. Backtesting Value-at-Risk 28-Des-12 27-Jan-13 Proit and Loss VaR upper VaR lower 26-Feb-13 28-Mar-13 27-Apr-13 27-Mei-13 26-Jun-13 26-Jul-13 25-Ags-13 24-Sep-13 24-Okt-13 23-Nov-13 23-Des-13 In extreme market conditions, the Bank conducts stress testing to evaluate the robustness of the models to very signiicant large-scale movements in market factors and to prepare the necessary response strategies. Such stress testing combines stressed scenarios: i based on the Bank Indonesia scenario, with the largest potential loss sufered by the Bank being Rp 298.64 billion where the interest rate increases 400 basis points and the rupiah exchange rate appreciates 20; and Ii based on the Bank’s historical scenario, with the largest potential loss sufered by the Bank being Rp 395.156 billion if interest rates increase by 31-575 basis points and the Rupiah exchange rate appreciates 30. Market Risk - Banking Book Banking book market risk arises due to changes in interest rates and the exchange rate, and the impacts thereof on banking book operations. Banking book market risk is managed by optimizing the Bank’s balance sheet structure so as to obtain maximum returns based on a level of risk that is acceptable to the Bank. Banking book market risk is controlled by setting limits based on both regulatory provisions and internal rules. These limits are monitored on both a weekly and monthly basis by the Market Risk Management Unit. 30.000.000.000 Rp Million 30.000.000.000 20.000.000.000 20.000.000.000 10.000.000.000 10.000.000.000 risk management Annual Report 2013 PT Bank Mandiri Persero Tbk. Banking book interest rate risk arising from movements in market interest rates that run counter to the Bank’s positions or transactions have the potential to afect the Bank’s proitability earnings perspective and the value of the Bank’s economic capital economic value perspective. Banking book interest rate risks include repricing risks repricing mismatch between assets and liabilities components, basis risk the use of the diferent reference rates, yield curve risk changes in the shape and slope of the yield curve, and option risk loan repayment or redemption of deposits before maturity. The Bank employs a repricing gap and conducts sensitivity analyses in order to forecast Net Interest Income NII and Economic Value of Equity EVE. Based on the results of the sensitivity analysis simulation that was conducted on 31 December 2013, the impact of a 100 bps change in the interest rate would result in the Bank’s NII declining by 4.75 from the set target for 12 months ahead, and a fall of 2.06 in the Bank’s Equity. INTEREST SENSITIVITY ANALYSIS Keterangan December 2012 December 2013 NII Sensitivity 100bps, NII 12 mo of NII target 2,74 4,75 EVE Sensitivity 100bps: Equity 2,82 2,06 Earning at Risk Equity 0,26 0,32 Capital at Risk Equity 1,06 1,13 Foreign exchange risks arise from exchange rate movements that are contrary to the Bank’s open position. Such risks originate from foreign exchange transactions with customers and counterparties that give rise to foreign exchange open positions, or foreign exchange structural positions resulting from equity investments. The Bank manages forex rates by monitoring and managing its Net Open Position NOP based on internal and regulatory limits. As of 31 December 2013, the overall NOP absolute stood at 2.06 of capital. Pricing Management The Bank applies pricing policies to fund and credit products as part of its strategy to maximize net interest margin NIM, while at the same time supporting the Bank in expanding revenue market share having regard to competitive conditions. The Bank consistently strives to apply this strategy as the market leader in terms of funds pricing. Nevertheless, taking into account liquidity and funding requirements, the Bank may from time to time adopt aggressive strategies more expansive than principal competitors or defensive strategies equal or less expansive than principal competitors. The Bank applies a risk-based pricing approach, namely, the interest rates applied to customers varies based on their respective credit risk levels. In order to minimize interest rate risk, the loan interest rate is adjusted to take account of the rates charged by funding sources. In addition to considering the cost of funds, loan interest rates are also set by considering overhead costs, credit risk premium and proit margin, while having regard to the Bank’s competitiveness vis-à-vis its major competitors. Loan interest rates can be either loating or ixed. The Bank publicizes its Rupiah Base Lending Rate through announcements posted in every Bank oice and on the Bank’s website. In addition, the Rupiah Base Lending Rate is published in newspapers every quarter, in line with the provisions of Bank Indonesia Circular No.135DPNP dated 8 February 2011. risk management Annual Report 2013 PT Bank Mandiri Persero Tbk.

3. LIQUIDITY RISK MANAGEMENT