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RISK REPORT

RISK MONITORING

Effective risk management is a prerequisite for the long-term development and the strategic safeguarding of the success of
DZ PRIVATBANK S.A. To direct and monitor the risks arising from banking business, the Bank has set up monitoring systems that are constantly upgraded. Risk monitoring extends continuously to the DZ PRIVATBANK Group, which comprises DZ PRIVATBANK S. A.,
DZ PRIVATBANK (Schweiz) AG, DZ PRIVATBANK Singapore Ltd., IPConcept (Luxemburg) S. A. and IPConcept (Schweiz) AG.

The Bank’s risk management covers all actions taken by the divisions responsible for implementing a chosen risk strategy. Such actions mainly comprise conscious decisions to take on or limit risk. The Risk Control Department is responsible, in particular, for ensuring that risks undertaken are transparent in all risk categories. This entails making a daily risk report to members of the Board of Management and various departments, focusing on the following points:

  • Market price risk on a value-at-risk basis (VaR) (group level and various sub-portfolios)
  • Credit-VaR (group level and various sub-portfolios)
  • Daily portfolio performance
  • Operating risk and business risk
  • Overview of the liquidity position

In addition, various risk reports are submitted to the Supervisory Board, the Board of Management and specific departments based on monthly and quarterly reports. These include stress test presentations and sensitivity matrices.

BASIC PRINCIPLES OF INTEGRATED RISK AND INVESTMENT CONTROL

It was agreed that an economically integrated risk and investment management system (IRKS) be implemented in order to comply with supervision rules on best practice management approaches in financial institutions. This has created a solid basis for uniform and strategic planning that takes account of risk strategy.

The purpose of the IRKS is to create transparency regarding the:

  • basic risk structure,
  • the appropriateness of the ratio between the identified risk and available funds to hedge unexpected losses (ability to bear risk), and
  • risk-adjusted profitability (RAP).

The IRKS focuses on combining the following four elements into a single framework concept:

  • Risk measurement: an adequate definition of the Bank’s risk position is a core element of the IRKS. This requires risk to be classified into types, for all material risks and minimum requirements, in terms of quantifying these risks.
  • Ability to bear risk: an analysis of the risk-bearing capacity contrasts the upper loss limit and the risks measured centrally by DZ Bank AG against the reduced risk cover amount around the capital buffer needs.
  • Risk-adjusted profitability: the figures for Economic Value Added (EVA) and Return on Risk-Adjusted Capital (RORAC) create transparency regarding the Bank’s added value based on the assumed risks.
  • Risk and investment management: the IRKS is applied in practice through continuous involvement in the planning process, standardised monitoring for KPIs and regular reporting with clear responsibilities and escalation levels.

 

RISK MEASUREMENT

Value-at-Risk (VaR) and performance changes included in stress tests are used for measuring financial risk. The VaR indicates the loss which will not be exceeded within a predefined period according to a defined probability (confidence level). Stress tests indicate the analysis of performance changes under suitably defined crisis scenarios. The result of the Value-at-Risk measurement and suitable stress tests is known as the risk capital requirement. All types of risks are measured at individual institution level and at subgroup level.

 

DEFINITION OF RISK TYPES

RISK MANAGEMENT IN IRKS

In the IRKS, material risks are divided into six types of risk:

  • Market price risk
  • Credit risk
  • Operational risk
  • Business risk
  • Investment risk
  • Liquidity risk


MARKET PRICE RISK

The Bank incurs market price risks in order to take advantage of business opportunities. A market price risk is defined as a potential loss that can arise through changes in interest rates, spreads, ratings (migration risk), exchange rates, share prices or volatilities. Spread and migration risks are measured and limited centrally by DZ Bank both for the Group and the individual management units. All remaining market price risks are restricted by a local limit and measured and monitored within DZ PRIVATBANK on the basis of a Value-at-Risk approach.

The historical simulation approach is based on a confidence level of 99% and an assumed holding period of one trading day over an observation period of 300 days. The limit was applied based on a confidence level of 99.9% and a holding period of one year.

Back testing is carried out daily in order to check the reliability of the Value-at-Risk approach. This involves comparing the daily profits and losses with the Value-at-Risk figures calculated on the basis of risk modelling. Basis point value and stress test procedures, in which various market movements are simulated, widen the monitoring of market price risk.

MARKET PRICE RISK DEVELOPMENT - DZ PRIVATBANK S.A.

EUR million, figures from 01/01/2016 to 31/12/2016, 99% confidence level, ten-day holding period.

 

CREDIT RISK

Credit risk indicates the risk of unexpected losses caused by counterparty insolvency. The risk capital requirement for the credit risk is quantified by means of a portfolio model (Creditmetrics). This procedure determines the loss distribution on the basis of simulation calculations which can then be used to estimate the unexpected loss and thus the risk capital requirement.

 

– CONCENTRATION OF CREDIT RISKS

The credit department of DZ PRIVATBANK S.A. is responsible throughout the group for the German cooperative banks' lending business in foreign currencies. It covers the direct refinancing of cooperative banks and the guaranteed lending business of their customers. Other business activities include collateralised loans, money market operations and securities transactions.

In a letter dated 20 July 1994, the Luxembourg regulatory authority (CSSF) approved a request made by DZ PRIVATBANK S.A. to apply an overall weighting of zero to the risks against companies of the DZ BANK Group with regard to limiting major risks.

 

OPERATIONAL RISK

According to the banking supervision definition, the Bank defines operational risk as the risk of an unexpected loss, arising from human actions, process or project management weaknesses, technical failure or through external influences. The definition takes into account legal risk, but does not cover strategic and reputation risks. Operational risks involve their own form of risk and correspondingly require extensive management, controlling and monitoring. The goal is to identify, limit and avoid such risks.

 

– EARLY WARNING SYSTEM/RISK INDICATORS

Early warning systems are employed for the systematic detection and recognition of as many of the risks as possible involved in banking. Risk indicators, measured using fixed thresholds, are warning signals that indicate possible operational risks. They can therefore serve as an early warning system for the Bank, to indicate unwelcome trends or developments in banking operations.

 

– LOSS DATABASE

Data on losses is especially useful for identifying operational risks. The systematic collating and analysis of such data enables weak points to be identified so that measures can be undertaken for their improvement. To comply with the need for completeness, quality and security of auditing, the Bank uses VöB-ORC software to acquire data on losses. The loss database contains data from 2003 onwards.

 

– SELF-ASSESSMENT

The self-assessment of DZ PRIVATBANK S. A. serves as a risk potential analysis. It is conducted as part of the risk self-assessment of the DZ Bank Group. The basic scenarios are determined centrally by DZ Bank. The specific scenario descriptions and characteristics are based on this (evaluation of amount and frequency of losses). Here, a distinction is made between Group-wide, limited (across DZ PRIVATBANK) and individual scenarios.

To counter possible risks in staffing, the Bank sets great store by selecting, training, deploying, promoting and developing its employees. The Bank's structural and procedural organisation is characterised by the strict separation of tasks, the observance of the principle of dual control, strict access control, deputising and competence regulations. All corporate handbooks and work instructions are continually updated.

A standardised procedure ensures that operational and all other risks are adequately checked when new products or product variants
are introduced. The identification and processing of legal risks are the task of the Bank's Legal Compliance and Money Laundering Department. The monitoring duties resulting from legal compliance requirements are also handled by this department. With its Business Recovery and Disaster Centres, the Bank's operations can be continued locally at another site in Luxembourg.

The risk capital requirement for the operational risk is determined at a central level by DZ BANK AG each quarter. The economic model is affected both by the historical data on losses and the risk potential estimates from the risk self-assessment.

 

BUSINESS RISK

Business risk indicates the risk of losses through unexpected changes in the current and future business volumes or margins (e.g. due to a change in competition).

In accordance with the risk management and controlling concepts of other risks, the Bank measures its business risk as Value-at-Risk (VaR) based on a variance/co-variance approach. The capital required to secure business risks is determined by the volatility of both of thrisk drivers - income and expenses - and their correlation.

 

INVESTMENT RISK

Investment risks are calculated for investments that are not directly included in the risk management strategy of DZ PRIVATBANK S.A. Since all units of DZ PRIVATBANK are involved in risk management, this approach to the reporting date is irrelevant.

 

LIQUIDITY RISK

DZ PRIVATBANK S.A. interprets liquidity risk as the risk of there being insufficient funds available to meet payment obligations. Liquidity risk is thus considered as insolvency risk. Refinancing risk is the risk of loss that may arise for DZ PRIVATBANK from a deterioration in the liquidity spread (as part of the own-issue spreads). With rising liquidity spreads, future liquidity requirements can only be met subject to additional costs.

The main sources of liquidity risks are identified on the basis of the Bank’s business strategy and business activities.

The Bank uses an internal liquidity model for measuring and controlling liquidity risks. This ensures transparency for expected and unexpected liquidity flows (forward cash exposure) and for the liquidity reserves used to offset liquidity shortages (counterbalancing capacity) on a daily basis. Both a normal scenario and several stress scenarios are considered. The objective is a positive cash surplus in all relevant scenarios in the corresponding prognosis period. There will be no separate deposit with risk capital. A liquidity contingency plan is in place to allow the bank to respond to a crisis situation quickly and in a coordinated manner.

Luxembourg, 17 February 2017

The Board of Management

 

Dr. Stefan Schwab

Ralf Bringmann

Richard Manger

Dr. Frank Müller

 

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