Risk
Management
MANAGING RISK
Financial risk management is at the heart of the banking industry. NIBCapital’s diversifying spectrum of activities and the implicitly growing complexity of our product range result in exposures to different levels of risk. NIBCapital systematically manages credit, market, liquidity and operational risk and has organized its risk management functions accordingly. Since risk management is about assessing, measuring and controlling risk and acting accordingly and proactively, NIBCapital has sophisticated and integrated risk management systems to measure and manage financial risk on an enterprise-wide basis.

This Risk Management chapter is an integral part of the Annual Accounts.

The risk management framework that NIBCapital has developed over the last few years facilitates the generation of integrated risk profiles and stress scenarios. It also supports the new IFRS rules and provides sufficient data to meet the new Basel II requirements. This framework underpins internal decision making, optimising Risk Adjusted Return On Capital (RAROC) and impairment calculations. It also supports and maintains the Aa3/AA-/A+ rating of NIB Capital Bank N.V.

RISK MANAGEMENT ORGANIZATION
The risk management activities are predominantly organized out of the Corporate Risk Management function. Various risk management BUs and committees deal with the main risk categories. Formal authority and ultimate decision making is the responsibility of the Risk Management Committee and its subcommittees. This ensures that approval of credit or market risk exposure is independent of the business originators. The risk management BUs carry out the daily risk control and monitoring activities, and also prepare and implement new review and control policies on all risk portfolios. The primary responsibility of these BUs is to identify, measure, evaluate and report on all credit risks (including counterparty risks), liquidity and market risk to which NIBCapital is exposed.

It goes without saying that risk management is a core competence of a professional financial institution. All our staff are therefore constantly responsible for ‘Intelligent’ risk management.We consider the proactive involvement of our risk management BUs in our commercial activities and product development absolutely vital, also to ensure compliance with NIBCapital’s Corporate Values and Business Principles.

CREDIT RISK
The New Capital Accord, ‘Basel II’, requires sophisticated systems and historical data gathering in the processes of risk management.We took the initiative to set up a data pool with other comparable wholesale banks, to improve the data gathering for every participating bank. This will make it possible for every participating bank to qualify even more effectively for the so-called advanced approach. Based on our long experience in corporate lending, and in conjunction with Standard & Poor’s and KPMG, and partly in anticipation of Basel II, in 2000 we developed a sophisticated credit rating methodology for all our relevant types of counterparty products. The rating system has been validated by S&P for the fifth consecutive year with consistent strong mapping results. Several of our clients have already shown strong interest in our approach and have consulted us regarding rating methodology and modelling issues. Occasionally we provide a ‘shadow rating’ for our clients in anticipation of a formal rating.

Of the total loan portfolio, 95% is rated. The following graph gives a breakdown of our loan portfolio per rating category (and corresponding S&P rating).The rating categories are a reflection of the probabilities of default of our counterparties, but do not incorporate the underlying collateral positions of the respective loans granted to these counterparties. Compared to last year it shows a relatively stable rated portfolio that improved slightly in the second half of 2004.
The outcome of the rating system (Probability of Default per counterparty, and Expected Loss per facility) is used as the input for extensive credit portfolio analysis, taking into account the Global One Obligor Exposure and industry concentration and diversification effects. Throughout the credit process – acquisition, validation, portfolio management – the concepts of Risk Adjusted Return On Capital (RAROC), based among other things on the credit rating and loss data, and Economic Value Added (EVA), are implemented as the leading principles for optimising the use of the bank’s economic capital.

After a few consecutive years of relatively high provisioning, 2004 saw the provisioning return to a net release. Looking at the IFRS impairment rules, for which we developed a new integrated cash flow model for our rating system, we believe the present provisioning level is adequate and compliant with IFRS standards.
The entire NIBCapital balance sheet has a strong credit profile due to a diversified portfolio of externally rated assets, combined with our mortgage, bank loan and equity & intermediate capital portfolios.

A substantial part of the credit risk is found in the corporate loan portfolio. The corporate loan portfolio was composed as follows at year-end 2004, divided by exposure and provisions per sector.

MARKET RISK
Market risk is defined as the risk of a change in the value of an asset in response to changes in, for instance, market prices, interest rates, foreign exchange rates, credit spreads and equity prices. At NIBCapital all market risks are concentrated in the SBU Financial Markets with the exception of capital invested in the Corporate Center. In order to manage market risks we have put in place a consistent set of risk limits, and implemented an advanced risk management system (Algorithmics) to calculate and to project the relevant risk figures. Virtually all transactions are analysed within the Algorithmic system on a daily basis, giving us an instant overview of all the bank’s market risks. All relevant risk parameters, such as credit VaR (Value at Risk), interest rate VaR and Greeks (i.e. Delta, Gamma, Vega, Theta) are available on a daily basis and can be drilled down from SBU level to transaction level. Economic capital for all activities is calculated weekly on the basis of these risk numbers.

The Asset & Liability Committee (ALCO) resets the allocation of the banks’ total economic capital to the different activities each quarter, based on actual usage, as well as the realised and expected return on economic capital.
VaR is calculated as a result of one-day changes in market prices assuming a 99% confidence level and using one year of historical data. VaR limits have been set for all NIBCapital’s financial market activities. A wide set of scenarios, including stress testing and vulnerability identification, both based on historical events and on possible future scenarios, complement the risk reports.
For the trading books, all risk positions are measured on a daily basis. Any significant excess is reported to senior management together with the required background information. Senior management also receives P&L reports of the trading books on a daily basis. The ALCO receives periodical reports on all excesses.

TRADING RISK MANAGEMENT

CLIENT TRADING RISK MANAGEMENT
The positions in the Client Trading books originate from market making activities for clients. Positions are taken in interest rate and credit spread markets based on customer demand and expected developments in the relevant markets. Products used in the trading activities include swaps, futures, FRAs, options, bonds and credit derivatives. Client Trading trades only in mature and liquid markets. Risks are measured using duration measures, Value at Risk and ‘Greeks’. Stress testing is used to calculate the possible P&L effect in severe market conditions and to determine the sensitivity to event risk. Client Trading has a daily Value at Risk limit of in total € 1 million. Total VaR is broken down into seven categories. These are interest rate risk, government and five credit classes. Credit spread risk is also measured per rating class and time bucket.

The table below summarises the key risk statistics for 2004.

The chart shows that the average VaR is well below the set limits. In 2004, no P&L numbers outside the 99% VaR figures were realised.

WAREHOUSING FOR SECURITISATIONS
Other trading portfolios involve credit related investment portfolios and the warehouses for future securitisations. Asset classes included in the warehouses are corporate credits, structured credits such as Asset Backed and Mortgage Backed Securities, Collateralised Debt Obligations and Leveraged Loans. In the warehouses, assets are managed during the ramp-up period of new securitisations.Warehouse positions have a holding period varying from several days to one year. Interest rate risks in these books are fully hedged, leaving credit risk as the predominant risk in these portfolios. The same risk measures used for Client Trading are used for the risk management of the trading positions. The risk reporting based on duration, VaR and stress test is complemented by a detailed counterparty framework to limit specific risk in the portfolios and ensure adequate risk diversification.

NON TRADING RISK MANAGEMENT

INTEREST RATE RISK MANAGEMENT
Structural interest rate risk arises in all activities where assets and liabilities have different repricing dates. Interest rate risk is measured for the whole bank on a daily basis. NIBCapital´s policy is to concentrate interest risk in the trading and mismatch book and to minimise the sensitivity of net interest income to changes in interest rates for all other activities. Interest rate risk is measured in basis point value and in VaR.

CURRENCY RISK
NIBCapital does not maintain open currency positions other than translation exposures arising from future income in foreign currencies.

LIQUIDITY RISK MANAGEMENT
Maintaining a healthy funding profile is one of the most important risk management measures. The funding profile is analysed by mapping all assets and liabilities in time buckets, corresponding to their maturities. Given the fact that trading assets are more liquid than their contractual maturity indicates, NIBCapital treats them partly as liquids (with time buckets of six months or less) and partly as long term (with time buckets up to 10 years). NIBCapital´s policy is to maintain an excess of assets over liabilities, ensuring a comfortable liquidity position and protect asset spreads. The mapping below shows the actual position as of 31 December 2004:

Via the use of liquid investment and trading portfolios, we will ensure that we can meet our financial obligations, even in the – extremely unlikely – event of being temporarily unable to raise new funding. In this stress scenario it is assumed that we immediately sell all liquid bonds at a discount of 20%. The graph above shows that NIBCapital has an excellent liquidity position and that we will be able to meet our financial obligations even if we were unable to raise new funding over the next 12 months.

OPERATIONAL RISK
On a European level, the Basel Committee on Banking Supervision (BCBS) has reviewed its capital adequacy rules, laid down in the Basel Accord of 1988.The new Accord, which will come into effect in 2007, has added the new element of "Other Risks" to the rules on Credit Risk and Market Risk. The main component of "Other Risks" is Operational Risk, but it also includes such elements as Reputational Risk, Strategic Risk and Integrity Risk.
Our operational risk management function is built into our business processes, and monitored on a regular basis by the Internal Audit and Compliance BUs, which also closely monitor NIBCapital’s Reputational and Integrity Risk.

ECONOMIC CAPITAL
The capital of the bank is allocated by the ALCO on a quarterly basis to the NIBCapital SBUs and BUs, taking into account business expectations and the desired risk profile. Economic capital is based on a one-year risk horizon and the implied default probability for AA- rated banks. The capital usage per SBU in 2004 is summarised in the following table.

The table shows that the capital usage per SBU and the overall capital usage were fairly stable in 2004.

Total economic capital is also broken down into several risk classes to support the management of NIBCapital’s risk profile. In December 2004, economic capital usage per risk class was as follows:

The table shows that credit risk is the predominant risk class of NIBCapital, using 68% of total capital.

Description of risk categories:

CORPORATE RISK CONTROL

INTRODUCTION
The corporate and accounting scandals in the US and, more recently, in Europe have highlighted the importance of independent, sound and effective risk control. Perhaps more importantly, they have also underlined the value of corporate integrity and ethical standards.
In the US, this led to the 2002 Sarbanes-Oxley act, a set of corporate governance rules designed to restore investor confidence in the integrity of the business community. The recently launched Dutch Corporate Governance Code also includes elements of risk management and risk control.

NIBCapital strives to continuously improve the quality of its performance in its core businesses. This also applies to our risk management and risk control functions, both internally and on behalf of our clients. The new financial rules and regulations give the financial sector, including NIBCapital, a clearly defined set of standards against which to benchmark internal risk controls.
NIBCapital also brings this expertise to its strategic partnerships. Our risk control and compliance standards apply to all our partnerships.We assess the organisation, risk control and compliance standards of our potential partners and advise on any improvements we believe are necessary.We have procedures in place to assess the risk of any new products and services introduced by NIBCapital or our strategic partners.

Of course, risk management and risk control cannot be conducted by one BU alone. It is not just about rules and regulations, either internal or external. It is about the integrity of the entire organisation. Every BU and every person within NIBCapital has a responsibility to manage and control risk. It is a partnership between our commercial and operational people on one side and the risk management, audit and compliance BUs on the other. This teamwork enables us to combine operational and risk-related expertise to create an internal control system which is more than the sum of its parts. And, again, it illustrates the need for our risk management functions to play an integral and proactive role in our commercial activities.

The Managing Board is responsible for risk management and for all risk control systems that are implemented in NIBCapital, as well as its group entities, among which NIB Capital Bank N.V. These systems aim to control the risks of non-realisation of the company objectives. Yet, they can never give an absolute guarantee regarding the management of risks.

RISK MANAGEMENT POLICY
To execute the responsibility as described above, NIBCapital has developed a risk management framework. This framework ensues from our risk management policy and is an integral part of the internal control system. The design is customized for the specific situation at NIBCapital and is focused on the control of the identified risks related to the execution of the different business activities. The Managing Board is supported in its operational control of the identified risks by the (Strategic) Business Unit managers, who in turn submitted separate In Control Reports. Through membership of the different risk management committees, members of the Managing Board have immediate control to adapt the risk management policy and risk management framework, if necessary. The various risk management committees are an inseparable part of NIBCapital’s internal control system.

Accordingly, the Managing Board has executed the following activities:

ATTENTION POINTS OF THE MANAGING BOARD
In 2004 the following events required the specific attention of the Managing Board. The measures and the route to improvement are also indicated:

TARGETS FOR 2005

CONCLUSIONS
The Managing Board believes that within the current risk management system certain events in 2004 were identified in a timely manner and, where necessary, it was possible to start an improvement process. This is a direct result of the way the risk management framework is integrated in the NIBCapital organisation. In reference to the attention points identified above, appropriate measures were taken, some of which run into 2005.

The attention points of 2004 and the targets for 2005 with respect to the internal risk management and risk control systems, as well as the risk management reports, have been discussed with the Audit Committee and the Supervisory Board.