Overview

The Bank is exposed daily to a number of market risks. Market risk relates to the risk that movements in market risk factors, including foreign exchange rates, commodity prices, interest rates, credit spreads and equity prices, will have an adverse effect on the profitability and/or net worth of the Bank, eg an adverse interest rate movement. Liquidity risks relate to the risk of insufficient liquid assets to meet the Bank's obligation as they fall due or meet the obligations at excessive costs.

Market Risk Structure and Framework

The Bank ensures that all the market risk exposures are consistent with its business strategy and within its risk tolerance. The goals of the Bank are principally to:

1. Define the Bank's market risk appetite;
2. Ensure that the Bank's overall market risk exposure is maintained at levels consistent with the available capital; and
3. Ensure that management and individuals responsible for market risk management possess sound expertise and knowledge to accomplish the risk management function.

Regular market risk reports are presented to the Board Audit and Risk Management Committee (BARAC) and the Assets & Liabilities Management Committee (ALCO).

The Assets & Liabilities Management Committee, made up of Executive Directors and other relevant Divisional Heads, is responsible for the following:

1. Review of policies relating to market risk management and assets & liabilities management;
2. Recommend market risk policies to the Board;
3. Provide management oversight for the implementation of policies relating to liquidity, interest rate, foreign currency and equity risks;
4. Review market and liquidity risk strategy and recommend same for Board approval;
5. Monitor liquidity, asset and liability mismatch, pricing and interest rates;
6. Develop policies, procedures, tools and systems for identifying, measuring, controlling and reporting market and liquidity risks;
7. Evaluate market risk inherent in new products;
8. Ensure compliance with statutory and regulatory requirements relating to market risks;
9. Review and recommend for approval market and liquidity risks related limits i.e. position, concentration, currency, dealing gap, total portfolio and counterparty limits;
10. Approve appointment of dealers; and
11. Balance sheet management.

BARAC and full Board are responsible for the following:

1. Approve market and liquidity risk management framework, policies, strategies, guidelines and philosophy;
2. Provide Board oversight for the implementation of market and liquidity risk management policies;
3. Approve market and liquidity risks related limits for the Bank and subsidiaries.

Implementation of the Bank's market and liquidity risk management policies, procedures and systems is delegated to the Head, Market and Liquidity Risk Management Department who reports to the ED/Chief Risk Officer.

FirstBank is committed to managing market risks emanating from the following activities:

• Money Market Activities
• Capital Market Activities
• Financial Intermediation Activities

The Bank maintains a well-articulated market risk policy, which drives the level of market and liquidity risk exposures during trading activities and determines business size and maturities that are subject to re-pricing when the interest rate changes. The Bank is moving from traditional methods of market risk management (risk mitigation) to risk optimisation by linking the Bank's business strategy to its day-today risk exposures.

Due to the size of the Bank's holdings in rate-sensitive assets and liabilities and its volume of foreign exchange trade, a major area of market risk exposures in the Bank relates to interest rate and foreign exchange risks. Some of the Bank's subsidiaries engage in limited proprietary trading in quoted equities but there is control oversight on such exposures. In addition, each subsidiary has a risk management framework and policy that is consistent with the Enterprise Risk Management manual.

Market Risk Policy and Strategy

FirstBank has put in place a clearly defined Market Risk Management Framework that provides the Board of Directors and Management with guidance on market risk management processes. The Bank has also prescribed tolerable market and liquidity related losses, vis a vis quantum of available capital and level of other risk exposures.

The Bank's Market Risk strategy and policy is anchored on the following:

1. Product diversification which involves trading in a wide range and class of products such as debt, equity, derivative, foreign exchange instruments, corporate securities and government securities;
2. Risk-taking within well-defined limits with the sole purpose of creating and enhancing shareholder value and competitive advantage;
3. Effective utilisation of risk capital;
4. Continuous re-evaluation of risk appetite and communication of same through market risk limits;
5. Independent market and liquidity risk management function that reports directly to Management;
6. Robust market and liquidity risk management infrastructure reinforced by strong automated system for controlling, monitoring and reporting market risk, including transactions between the Bank and its subsidiaries;
7. Deployment of a variety of tools to monitor and restrict market risk exposures such as position limits, sensitivity analysis, ratio analysis and management action triggers;
8. Adoption of Value-at-Risk (VaR) as one of the risk measurement tools:
   • The Bank, during the year, improved on its use of the VaR model to estimate the potential losses that could occur on risk positions as a result of movements in market rates and prices over a specified time at a given level of confidence. The VaR model is based on historical simulation with potential market movements calculated by reference to published data from preapproved sources for two years. It is calculated to a 99% confidence level and for a 10-day holding period.
   • The use of the VaR model is still in its nascent stage as limits are still substantially based on contract/volume basis – rather than factor sensitivity limits which are set on the basis of maximum loss allowable based on volatility in the various markets.
9. Use of stress testing:
   • In recognition of the volatile market environment and the frequency of regulations that have had significant effect on market rates and prices, the Bank augments other risk measures with stress testing to evaluate the potential impact of possible extreme movements in financial variables on portfolio values.
10. Usage of variety of tools to measure non-tradable interest rate risk such as:
    • Interest rate gap analysis (which allows the Bank to maintain a positive or negative gap depending upon the forecast of interest rate position). The size of the gap is then adjusted to either hedge net interest income against changing interest rates or to speculatively increase net interest income;
    • Forecasting and simulating interest rate margins;
    • Market Value Sensitivity;
    • Calculating Earnings-At-Risk (EAR) using various interest rate forecasts;
    • Re-pricing risk in various portfolios and yield curve analysis;
    • Using the Assets and Liabilities Management process to determine balance sheet interest rate sensitivity and implement market risk management practices to hedge the potential effect of interest rate changes.
11. Setting Internal Open Position Limit (OPL) lower than the CBN prescribed limit (currently 5% of Shareholders' funds). The Bank has put in place approval process for exceeding the internal OPL limit. However, any trading above the CBN regulated OPL limit must be approved by the Central Bank;
12. Enforcement of market risk operating limits and other risk management guidelines that will ensure consistent compliance with OPL limit.

Liquidity and Funding

Policies and Procedures

The objective of the Bank's liquidity risk management is to ensure that all anticipated funding commitments can be met when due and that access to funding sources is co-ordinated and cost effective. The principal mechanism for implementing the Bank's liquidity policy is to maintain liquid assets to deposit ratio above the regulatory defined ratio of 25%. The Bank's definition of liquid assets is more stringent than as defined by the Central Bank. While the apex bank admits federal government of Nigeria bonds as liquid assets, the Bank has stressed its liquid assets only to the portion of securities available for immediate sale and for which a deep and liquid market exists.

The liquidity ratio is interpreted in conjunction with cash flow projection and liability concentration ratios to measure the Bank's exposure to liquidity risk. The cash flow technique used is the maturity ladder which assesses all the Bank's cash inflows against its outflows to identify the potential for net shortfalls or net funding requirements. In order to ensure compliance with liquidity levels, the Bank has pre-set liquidity gap limits. The liquidity and funding management process also includes the preparation of multi-currency balance sheets and assessing cash flows by major currencies and projecting cash flows under stress scenarios. The Bank's use of concentration ratios prevents it from relying on limited number of depositors or funding sources.

Primary Sources of Funding

The Bank's funding base consists of well-diversified corporate and retail deposits as well as inter-bank and other borrowings. Traditionally, the Bank has sought to attract lower-cost demand and savings deposits in order to keep its funding cost as low as possible and has attempted to minimise its reliance on higher cost time deposits as a significant source of funding. The Bank places considerable importance on the demand and savings deposit which form 73% of its funding base. Although these accounts are contractually repayable on demand, in reality, they are stable and have formed a core component of the Bank's liabilities. Also due to market perception of the Bank as one of the strongest banks in Nigeria, it enjoys a relatively lower cost time deposit base by attracting the retail segment whose principal consideration is the safety of their funds.

Loans-to-Deposit Ratio

The Bank emphasises the importance of core current and savings deposit accounts as a source of funds to finance lending to customers and discourage reliance on short-term wholesale funding (inter-bank borrowing and public sector fund). This is achieved by placing limits on the various Business Development Units of the Bank, which restrict their ability to increase loans and advances to customers without corresponding growth in current and savings deposit accounts. The pre-set loans to deposit ratio set and monitored by ALCO is 80%.

Diversification Policy on Asset Base and Contingent Liquidity Risk

The Bank maintains a large portfolio of tradable liquid assets in the form of Nigerian Treasury Bills and federal government of Nigeria bonds which are low in risk and can be converted in a short period of time or used to enhance the Bank's borrowing. The Bank also maintains a large portfolio of low risk assets which can be securitised and traded as off-balance sheet items. In addition, the Bank has put in place contingency funding arrangements with similar-sized Nigerian banks and maintains a standing credit facility with Central Bank of Nigeria, which can be assessed at short notice.

Market Turmoil and Liquidity Risk Position

The global financial crisis and margin lending related exposures by the banking industry continue to have adverse effects on the liquidity and funding risk profile of the banking industry. At systemic levels, these may be summarised as follows:

• Cancellation of offshore credit lines to Nigerian banks;
• Inter-bank funding cost increased as banks became reluctant to lend to each other;
• Many asset classes primarily considered to be liquid became illiquid;
• The difficulty of many banks to raise wholesale deposits at reasonable cost; although this has been mitigated by CBN Expanded Discount Window.

In specific terms, the Bank's exposure in margin lending is relatively insignificant to the size of its loan portfolio and, therefore, its liquidity position is unaffected. Also, the strain arising from the liquidity trapped in margin lending exposures is concentrated in the inter-bank market where FirstBank has been a dominant net placer of funds. The retail market from which the Bank derives its current and savings deposits is relatively unaffected. The desire by most customers for flight to safety and the Bank's market perception as a stronger Bank have impacted positively on the level of deposits.

Market and Liquidity Risk Reporting

Various Market and Liquidity Risk Management reports are issued on a daily, fortnightly, monthly and quarterly basis as shown below:

• Daily Liquidity & Market Risk Report: All ALCO members
• Fortnightly ALM & Market Risk Report: ALCO meeting
• Monthly ALM & Market Risk Report: ED, Risk & Mgt Control
• Quarterly ALM & Market Risk Report: Board of Directors

Market and Liquidity Risk Exposures

The major sources of market risk in the Bank's books have been identified and are being well managed. Interest rate risk in the USD175 million subordinated debt was fully hedged with the aid of an interest rate swap with a top rated investment bank. The exchange rate risk associated with the EUR borrowing disbursed in dollars is being managed through an accumulator contract that will close the open position over the life of the borrowing without a loss to the Bank.

Foreign currency liabilities generally fund assets in the same currency and, where tenors differ, re-pricing and liquidity risks are generally adjudged fair.

Generally, market risk management in the Bank is still in its nascent stage but as new products enter the market, there is greater emphasis on strengthening systems and people.

The Bank's liquidity position on the naira side is very robust. In the period under review, growth in our deposit liabilities exceeded growth in risk assets. The Bank's focus this year will remain on liability generation which will be a necessary pre-condition for significant asset growth.

Capital Adequacy and Management

FirstBank's capital management approach is driven by its strategy and organisational requirements, taking into account the regulatory and commercial environment in which it operates.

The Bank achieved Capital Adequacy Ratio of 29.7% at the end of the year; a marked reduction over the 48.2% recorded for the year ended March 2008. This is attributable to 55.3% increase in net Loans and Advances during the year. The   Bank, as a policy, works to maintain adequate capital cover for its trading activities. While the regulatory requirement is 10%, FirstBank has a minimum internal target of 16%. Current position is closely monitored and reported fortnightly to the Assets & Liabilities Management Committee.

Capital Adequacy

	31.03.09	31.03.08
Capital Adequacy Ratio	29.74%	48.23%
Capital Composition:	N’mn	N’mn
Tier I
Paid up Capital	12,432	9,945
Reserves	333,407	324,687
Tier II
Long Term Debt Stock	25,266	20,379
Reserves	5,215	5,215
Capital Utilisation:	376,320	360,226
Qualifying Risk Weighted Assets	1,192,475	700,099