Annual Financial Statements 2020

34 ANNUAL FINANCIAL STATEMENTS KEY MANAGEMENT ASSUMPTIONS CONTINUED STANDARD BANK NAMIBIA LIMITED Annual financial statements 2020 35 Sensitivity analysis of CIB forward-looking impact on the total ECL provision on all financial instruments Management assessed and considered the sensitivity of the provision against the forward-looking economic conditions at a client level. The reviews and ratings of each client are performed at least annually. This process entails credit analysts completing a credit scorecard and incorporating FLI. The weighting is reflected in both the determination of significant increase in credit risk as well as the measurement of the resulting provision for the individual client. Therefore, the impact of forward-looking economic conditions is embedded into the total provision for each CIB client and cannot be stressed or separated out of the overall CIB provision. Thus, a sensitivity analysis of the total CIB provision of N$38 million, including off balance sheet ECL, as at 31 December 2020 was performed. This analysis entailed recalculating the total provision, using a 100% weighting of each scenario. The impact of each scenario is N$54 million Forward-looking impact on IFRS 9 provision Scenarios Base Bearish Bullish Refer to note 6 loans and advances, for the carrying amounts of the loans and advances and the credit risk section of the risk and capital management report in annexure C for the company's assessment of the risk arising out of the failure of counterparties to meet their financial or contractual obligations when due. The income statement impact of N$49 million for 2020 was assessed by applying the same sensitivity analysis principles mentioned above. The impact for each scenario is N$72 million (decrease of N$13 million) for the Base scenario, N$214 million (increase of N$129 million) for the Bear scenario and N$1 million (decrease of N$84 million) for the Bull scenario. Post-model adjustments Covid-19 has had a profound impact globally and there remains much uncertainty as to the future economic path and recovery. As mentioned in the sections above in determining the forward- looking impact, from an IFRS 9 perspective, the company has forecasted three possible future macroeconomic scenarios, being the Base, Bear and Bull scenarios and attributed weightings to these three scenarios. The outcome of the Covid-19 pandemic is unpredictable and this makes determining these scenarios and the assumptions underlying them complex. Given this uncertainty, the forward-looking scenario ratios have been changed from base case (60%), bullish (20%) and bearish (20%) to base case (55%), bullish (15%) and bearish (30%). The current period ECL charge has increased from N$239 million to N$254 million which is a 6% increase. Adjusting for the large provision raised in 2019, our provision increased by N$83 million (48.9%) reflective of the impact of Covid-19 on credit impairments compared with the prior period. Gross loans and advances decreased from N$26.2 billion at 31 December 2019 to N25.1 billion as at 31 December 2020 and the related ECL allowance increased from N$599 million to N$801 million. (41% increase in the total provision) for the Base scenario, N$57 million (48% increase in total provision) for the Bear scenario and N$52 million (35% increase in total provision) for the Bull scenario. The income statement impact of N$8 million for 2020 was assessed by applying the same sensitivity analysis principles mentioned above. The impact for each scenarios is N$24 million (increase of N$16 million) for the Base scenario, N$27 million (increase of N$19 million) for the Bear scenario and N$22 million (increase of N$14 million) for the Bull scenario. Sensitivity analysis of PBB forward-looking impact on ECL provision The following table shows a comparison of the forward-looking impact on the provision as at 31 December 2020, based on the probability weightings of the above three scenarios resulting from recalculating each of the scenarios using a 100% weighting of the above factors. 2020 % change 2019 % change of total PBB ECL provision advances of total PBB ECL provision N$'000 on loans and advances on loans and N$'000 84 979 35 360 72 302 214 284 (15) 152 32 596 1 022 (99) 114 840 15 512 (8) 225 (56) Derivatives held-for-hedging Interest rate benchmarks and reference interest rate reform The Financial Stability Board has initiated a fundamental review and reform of the major interest rate benchmarks used globally by financial market participants. This review seeks to replace existing IBORS with alternative risk-free rates (ARRS) to improve market efficiency and mitigate systemic risk across financial markets. This reform is at various stages globally. Accordingly, there is uncertainty surrounding the timing and manner in which the transition would occur and how this would affect various financial instruments held by the company. The company's derivative instruments are governed by International Swaps and Derivatives Association (ISDA) 2006 definitions. ISDA is currently reviewing its definitions in light of IBOR reform and the company expects it to issue standardised amendments to all impacted derivative contracts at a future date. No derivative instruments have been modified as at the reporting date. Consequently, significant judgement is applied in determining whether certain interest rate risk hedge relationships will continue to qualify for hedge accounting. As at 31 December 2020, the company has applied the amendments to IAS 39 and the existing hedge relationships referencing IBORS continue to qualify for hedge accounting. The company will continue to apply the amendments to IAS 39 until the uncertainty arising form the interest rate benchmark reforms in respect of the timing and amount of the underlying cash flows that the company is exposed to, ends. The company has assumed that this uncertainty will not end until the company's contracts referencing IBOR's are amended to specify the implementation date of the alternative benchmark and cash flows. Management is monitoring market and accounting developments in this regard. The company has established a committee and within treasury and capital management to manage the transition to alternative rates. The objectives of the committee working group would include evaluating the extent to which loans advanced and liabilities reference IBOR cash flows, whether such contracts need to be amended as a result of IBOR reform and how to manage communication about IBOR reform with counterparties. The committee and working group are working closely with business teams across the group to establish pricing for new lending products indexed to the ARR in impacted jurisdictions. Fair value Financial instruments In terms of IFRS, the company is either required to, or elects to, measure a number of its financial assets and financial liabilities at fair value, being the price that would, respectively, be received to sell an asset or paid to transfer a liability in an orderly transaction in the principal (or most advantageous) market between market participants at the measurement date. Regardless of the measurement basis, the fair value is required to be disclosed, with some exceptions, for all financial assets and financial liabilities. Fair value is a market-based measurement and uses the assumptions that market participants would use when pricing an asset or liability under current market conditions. When determining fair value it is presumed that the entity is a going concern and is not an amount that represents a forced transaction, involuntary liquidation or a distressed sale. Information obtained from the valuation of financial instruments is used to assess the performance of the company and, in particular, provides assurance that the risk and return measures that the company has taken are accurate and complete. Valuation process The company's valuation control framework governs internal control standards, methodologies and procedures over its valuation processes, which include: Prices quoted in an active market: The existence of quoted prices in an active market represents the best evidence of fair value. Where such prices exist, they are used in determining the fair value of financial assets and financial liabilities. Valuation techniques: Where quoted market prices are unavailable, the company establishes fair value using valuation techniques that incorporate observable inputs, either directly, such as quoted prices, or indirectly, such as those derived from quoted prices, for such assets and liabilities. Parameter inputs are obtained directly from the market, consensus pricing services or recent transactions in active markets, whenever possible. Where such inputs are not available, the company makes use of theoretical inputs in establishing fair value (unobservable inputs). Such inputs are based on other relevant input sources of information and incorporate assumptions that include prices for similar transactions, historic data, economic fundamentals, and research information, with appropriate adjustments to reflect the terms of the actual instrument being valued and current market conditions. Changes in these assumptions would affect the reported fair values of these financial instruments. Valuation techniques used for financial instruments include the use of financial models that are populated using market parameters that are corroborated by reference to independent market data, where possible, or alternative sources, such as, third-party quotes, recent transaction prices or suitable proxies. The fair value of certain financial instruments is determined using industry standard models such as, discounted cash flow analysis and standard option pricing models. These models are generally used to estimate future cash flows and discount these back to the valuation date. For complex or unique instruments, more sophisticated modelling techniques may be required, which require assumptions or more complex parameters such as correlations, prepayment spreads, default rates and loss severity. Valuation adjustments: Valuation adjustments are an integral part of the valuation process. Adjustments include, but are not limited to: credit spreads on illiquid issuers, implied volatilities on thinly traded instruments, correlation between risk factors, prepayment rates and other illiquid risk drivers. In making appropriate valuation adjustments, the company applies methodologies that consider factors such as bid-offer spreads, liquidity, counterparty and own credit risk. Exposure to such illiquid risk drivers is typically managed by: ⚫ using bid-offer spreads that are reflective of the relatively low liquidity of the underlying risk driver ⚫raising day one profit or loss provisions in accordance with IFRS • quantifying and reporting the sensitivity to each risk driver prepayment rates limiting exposure to such risk drivers and analysing exposure on a regular basis. Validation and control: All financial instruments carried at fair value, regardless of classification, and for which there are no quoted market prices for that instrument, are fair valued using models that conform to international best practice and established financial theory. These models are validated independently by the company's model validation unit and formally reviewed and approved by the market risk methodologies committee. This control applies to both off-the- shelf models, as well as those developed internally by the company. Further, all inputs into the valuation models are subject to independent price validation procedures carried out by the company's market risk unit. Such price validation is performed on at least a monthly basis, but daily where possible given the availability of the underlying price inputs. Independent valuation comparisons are also performed and any significant variances noted are appropriately investigated. Less liquid risk drivers, which are typically used to mark level 3 assets and liabilities to model, are carefully validated and tabled at the monthly price validation forum to ensure that these are reasonable and used consistently. Sensitivities arising from exposures to such drivers are similarly scrutinised, together with movements in level 3 fair values. They are also disclosed on a monthly basis at the market risk and asset and liability committees. Refer to note 19 for assets and liabilities at fair value disclosures.