risk management

The risk management disclosures in this chapter constitute an integral part of the financial statements chapter.

The year 2007 has been an extraordinarily challenging year for risk management. Sophisticated risk management systems, approval of DNB to use internal models for Basel II market and credit risk, improvements in model validation and strong governance structure, could not fully protect the bank from major losses in the structured credits portfolios in the US. Although the Bank did calculate Value at Risk using a long-term history of market data, continuously low volatility in the last couple of years led to relatively low Value at Risk (VAR) figures. VAR figures should be, and are always accompanied by, stress tests to understand the P&L impact of positions in case markets move outside the zone determined by confidence intervals. The regular stress tests performed at NIBC did show the risk and potential large losses that could arise from these portfolios in historical and theoretical stress scenarios. The combination of unprecedented spread widening, now part of the framework of stress tests, with sudden and extreme illiquidity in the market, even for AAA bonds that in previous events were seen as safe heaven assets, surprised the bank.

During 2007, instability in the US credit fixed-income markets led to non-recurring losses in the US Asset Backed Securities investment book. For transparency reasons, the exposure in the investment book is designated at fair value through profit and loss, whether realized or unrealized. During the first half of the year 2007, exposure to the US residential and corporate markets was sold, eliminating profit and loss exposure attributable to these portfolios. In addition, an appropriate set of risk management actions was initiated to further strengthen and improve portfolio monitoring and reporting. The set of risk management actions include improved credit risk assessments of markets and assets that are in a market risk environment (in addition to the rating assessment of rating agencies), as well the establishment of a Capital Markets Committee that focuses on the intersection of market risk and credit risk of capital markets' assets. Continued volatility in the credit markets may nevertheless impact the profit and loss of the bank given other exposure to credit markets and the applicable accounting treatment.

Risk is inherent in almost every business decision and business activity. To that end, NIBC's risk management and control systems can never provide an absolute guarantee that all risks are adequately managed or that the company's objectives will be realized.