Bank prepares the Corporate Plan and Budget on a rolling basis covering a period of 5 years which includes the computation of Capital Adequacy ratios (CARs).

The Bank carefully analyses the CARs against increases in risk-weighted assets underlying the budgeted expansion of business volumes. The Bank has set up an internal guideline on minimum CARs and ensures that appropriate measures are employed to improve the CARs are also built into the budget.

Budgeting process of the Bank encapsulates all future capital requirements of the Bank and this process invariably captures estimated capital expenditure and the business growth in determining the optimum level of capital to be maintained. The Bank has prepared a capital augmentation plan covering the capital sourced from both internally and externally. The Bank has a well established monitoring process to ensure the level of achievement against the pre-determine target and corrective action is taken for any deviations.

Besides, the Bank has a dynamic ICAAP process with rigorous stress testing embodied in addition to taking into consideration the qualitative aspects such as reputational and strategic risks. This process also proactively identifies the gaps in CARs in advance, allowing the Bank to take calculated decisions to optimise utilisation of capital.

The Bank has addressed all material risk exposures when formulating strategic plan and has a well-diversified assets portfolio which is neither overly exposed to any counterparty nor to any sector. Ways and means of improving the CARs are being monitored on an ongoing basis. Further, in extreme situations, the Bank will deliberate on strategically curtailing risk weighted assets expansion.

The Bank always strives to achieve a reasonable growth in profit which is above the industry average and is ever mindful to pay a consistent stream of dividends to the shareholders. Part of the profit generated is retained for future business expansion. Given the size of the Bank, capital generated through retained profits over the years could be considered as one of the primary sources of internal capital to the Bank. Besides the dividend policy of the Bank designed in such a manner to pay part of the dividend in the form of issuing shares, a vital internal capital for the Bank.

A comprehensive analysis of “Managing Financial Capital” given on pages 24 and 25.

Credit risk under standardised approach (Contd.)

Operational risk under basic indicator approach – Group

Operational risk under the alternative standardised approach – Bank

Operational risk under basic indicator approach – Bank

The Bank has moved to Alternative Standardised Approach (ASA) with effect from June 2018 after obtaining approval from the Central Bank of Sri Lanka.

Explanations of Differences between Accounting and Regulatory Exposure Amounts

Under SLFRS 9: “Financial Instruments: Recognition & Measurement”, the Bank assess the impairment of loans and advances individually or collectively based on the principles of “expected credit loss” (Refer Note 19 on page 208 for details) model which is expected to capture future trends in the economy. However, the regulatory provision made on loans and advances under the Direction No. 03 of 2008 on “Classification of loans and advances, Income Recognition and Provisioning” (and subsequent amendments thereof) issued by the CBSL are “time/delinquency base”. Further, under SLFRS 9, other debt financial assets not held at FVTPL, together with loan commitments and other off balance sheet exposures such as financial guarantee and letter of credits, are subjected to impairment provision, whereas no such regulatory provision is required for those financial assets as per CBSL direction. As a result, SLFRS 9 recognises higher provisions compared to CBSL guidelines.

Financial investments and financial liabilities (other than FVTPL) are carried at "cost" for regulatory reporting purposes while they are classified as "Financial assets measured at fair value through other comprehensive income" carried at fair value or Financial assets/liabilities at amortised cost under the SLFRS 9. The "Fair value" is defined as the best estimate of the price that would be received to sell an asset or be paid to transfer a liability in an orderly transaction between market participants at the measurement date. A variety of valuation techniques combined with the range of plausible market parameters as at a given point in time may still generate unexpected uncertainty beyond fair value. An “amortised cost” of a financial asset or financial liability is the amount at which the financial asset or liability is measured at initial recognition, minus principal repayments, plus or minus the cumulative amortisation using the EIR method of any difference between the initial amount recognised and the maturity amount, minus any reduction for impairment. Hence, the amortised cost of financial investments and financial liabilities under SLFRS 9 is different to the carrying value for regulatory reporting which is the "cost".

As per SLFRS 9, a “Day 1 difference” is recognised, when the transaction price differs from the fair value of other observable current market transactions in the same instrument. Eg: Employee below market loans. Refer Note 7.1.2.1 on page 182 for details. However, the carrying value of such transactions for regulatory reporting purposes is equal to cost/ transaction price.

“Effective risk management is at the core of the Bank’s value creation model as we accept risk in the normal course of business. Significant resources are devoted to this critical function to ensure that it is well articulated, communicated and understood by all employees of the Bank as it is a shared responsibility. It is a dynamic and disciplined function increasing in sophistication and subject to stringent oversight by regulators and other stakeholders. The overarching objectives are to ensure that risks accepted are in line with the Bank’s risk appetite and strategic priorities and that there is an appropriate trade-off between risk and reward enabling delivery of value to key stakeholders.“The risk governance structure,responsibilities attributed throughout the bank, risk management framework, objectives, strategies, policy framework, risk appetite and tolerance limits for key risk types, and the overall risk management approach of the Bank are discussed in the section on "Risk Management" on pages 115 to 139.

“The quantitative disclosures relating to key risk areas such as credit, market, liquidity, operational, and interest rate risk in the banking book are presented and discussed in the Risk Management Report on pages 319 to 353 and in the Financial Risk Management Report on pages 115 to 139.”