DENPASAR, 13 TH MARCH 2008

1. READINESS TO IMPLEMENT BASEL II DENPASAR, 13TH MARCH 2008 Karsanto PT Bank Negara Indonesia (Persero) Tbk

2. Contents • OVERVIEW BNI RISK MANAGEMENT • BNI RISK MANAGEMENT FRAMEWORK • SIMULATION UNDER BASEL II • CONCLUSION

3. I. OVERVIEW BNI RISK MANAGEMENT

4. 1. BNI vs BI Basel II Roadmap Approaches to calculating Capital P I L L A R 1 P I L L A R 2 PILLAR 3 BNI Readiness BI Requirement Other Risk Transparancy BNI Readiness BI Requirement BNI Readiness Market Risk Standardized 2008 Q1 2009 2009 Internal Model 2007 Q2 2008 2009 Credit Risk 2 0 08 Standardized 2008 Q1 2009 2009 2 0 0 9 IRBA 2010 Q4 2010 2011 Operational Risk Basic Indicator 2007 Q1 2009 2009 Standardized 2009 Q4 2010 2011 AMA 2010 Q2 2011 2011

5. 2. Development of BNI Risk Management • The development of BNI risk management system based on Bank Indonesia’s guidance for the Implementation of Risk Management for Commercial Banks and other related documents from the Basel Committee on Banking Supervision, particularly with the Basel II Accord. • BNI continuously develop and improve upon BNI risk management framework to implement an integrated and comprehensive risk management and internal control system. • BNI risk management framework is implemented in the form of policies, procedures, and established limits and designations and other risk management tools. To ensure that policies remain current, periodic evaluations are made and parameters changes to reflect the changing business and risk environments.

6. 2. Development of BNI Risk Management • The basic concept in developing BNI risk management framework is how to make balancing among business unit goals and risk management (incl. corporate governance) in other side. • The modern BNI risk management framework developed start from 2000, and be assist by Boston Consulting Group (BCG). The first step in 2000 developed risk management organization and constructed Internal Rating System (to make prudential credit risk management). Page 6

7. 3. BNI Risk Management Advisor/ Consultant

8. 4. The Supporting to implement BNI Risk Management • To support and to assure that the risk management is properly in place (and proper), BNI has : • Set up risk management directorship (organization) • Set up risk management division • Set up Risk & Capital Committee (consist of RMC, CPC, ALCO). • Four Eyes principles in credit decision • Quality Assurance in every unit (BQA, RQA, DQA) • Risk management socialization (periodic) • Issued Risk Management Booklet/ handbook • Set up BCP in all units

9. 5. BNI Risk Management Organization • Organization • BNI established a multi-layered risk management governance structure. One of the key components of this structure is the separation of credit risk management and compliance functions from business operational functions. • Quality assurance officers located in or responsible for branches, small business credit centers, middle business credit centers and all divisions. • Risk management division, compliance divisions, and internal audit are independent from strategic business units.

10. 5. BNI Risk Management Organization • Risk and Capital Committee • The Risk and Capital Committee advises the Board of Directors on all risk management-related issues. • The Risk and Capital Committee consists of and operates through its three sub-committees: the Risk Management sub-Committee, the Asset and Liability sub-Committee and the Credit Policy sub-Committee, each of which existed prior to the establishment of the Risk and Capital Committee. • The major responsibilities of the Risk and Capital Committee include: • risk management policies, procedures and management systems; • risk limits • credit risk premium for each segments and economic sector, and to set up the maximum pricing of loan interest rates and the loan loss allowances for each segment; • Review some parameters from BNI risk management tools (credit risk ratings, industry rating, etc). • setting asset and liability management goals and formulating policies and strategies for achieving these goals; • e.t.c

11. II. BNI RISK MANAGEMENT FRAMEWORK

12. Credit Risk Credit Risk Framework • Internal Rating System Review • Development of Data base Rating • Probability of Default • Recovery Rate • Expected Loss -2009 • Credit Risk Model & Measurement (unexpected loss) - 2009 • Credit Risk Limit-2010 • Economic Capital & RAROC-2010 3 2 • Data base ( identification, data needed, risk weighted group) • Working Group Basel II - BI • Capital Charge - Standardized Approach - 2008 1 • Implementing Internal Rating System in each loan segment • Loan Exposure Limit (LEL) in each Segment & Sub Sectors • Portfolio Monitoring, Analysis, & NPL Projection • Credit Risk SOP Review Basel II Frame Work Strengthen of credit risk infrastructure Standardized Approach 2006 - 2008 Internal Rating Based Approach 2006-2010

13. Credit Risk Standardized Approach (SA) • Done, however the majority of the debtors are unrated (more than 95% debtors) • Calculation of regulatory capital using SA started from QIS 3 Basel II Credit Risk Foundation Internal Ratings Based Approach (FIRBA) • Not yet assessed, because some parameters (EAD & LGD) are not available. Advanced Internal Ratings Based Approach (AIRBA) • Internal Rating System was developed in 2000, implemented in 2001. • Database of ratings are available since 2003. • PD available, not yet validated. • EAD & LGD are in progress. * EAD : exposure at default, LGD : Loss given default

14. Credit Risk • Basel II Progress • Currently, BNI calculates its Capital Adequacy Ratio using Basel I approach (according to Bank Indonesia regulation), but in Quantitative Impact Study, BNI uses Standardized Approach. • Since 2001, the infrastructure for the more advance credit risk management (using Internal Rating Based approach) has been created. Today, the internal rating system has been implemented in all credit segments in BNI. • BNI credit risk management begins with an assessment of the risk of loss resulting from borrower or counterparty default. BNI determine creditworthiness by using a credit risk system. • Using the credit risk system to measure the credit quality of an individual loan transaction. The credit risk system is also used for regulatory reporting, determining the frequency of review of loans and determining the amount of loan loss allowances.

15. Credit Risk • The credit risk system is composed of the following: • An internal rating system, which contains (1) an industry risk rating incorporating macro economic factors, industry structure, industry characteristic, industry prospect, loan factors and industrial financial performance (2) a customer risk rating and a customer credit rating, each of which incorporate quantitative and qualitative factors, such as industry rating, business condition, quality of management, financial assessment and collateral adequacy; • BNI Internal Rating System is used for (to): • Analyzing loan applications • Making loan decisions • Pricing • Exposure monitoring • A loan exposure limit as the maximum loan exposure at the end of year in economic sectors in each business unit and bank-wide that would be achieved in loan expansion activity. • Measuring credit risk at a bank-wide level and by business unit, industry grouping and customer account. BNI is currently developing a system that is able to generate default probability data using a rating migration & recovery rate data of defaulting borrowers.

16. Credit Risk Credit Risk Management • BNI offer loans to Indonesian borrowers as well as non-Indonesian borrowers, through domestic network, overseas branches and New York agency, and make loans in Rupiah as well as in U.S. dollars and other currencies. • BNI credit risk management processes include: • credit policies and procedures; • credit analysis and approval; • credit review and monitoring; and • credit restructuring and recovery of non-performing loans. • BNI also manage credit risk, in part, through diversification of credit portfolio. BNI offer a variety of lending and trade finance products for customers, such as corporate loans, project finance, commercial real estate, letters of credit, bank guarantees, correspondent banking, small business loans, credit cards, mortgage loans, vehicle financing and Syaria financing products.

17. 2. Market Risk Market Risk Framework 3 • VaR application for overseas branches • Market Risk Integration (Domestic & Overseas) • Improvement of internal methodology in line with the newest PBI 2 • Capital Charge – Market Risk Standardized Approach (CAR reporting to BI) • Methodology improvement in line with the newest PBI 1 • Organization: Overseas branches Market Risk management (2006) • Policy & Procedure Improvement Basel II Frame Work Strengthen of market risk infrastructure Standardized Approach 2006 - continued Internal Model Approach 2006-2010

18. 2. Market Risk Standardized Approach • Already done, • CAR report to BI Basel II MR Internal Model Approach • Already done (domestic & overseas branches). • VaR model is used for day to day market risk management & monitoring system. • Need for supervisor’s validation.

19. 2. Market Risk • Basel II Progress • BI requires that bank use standardized methodology to calculate the amount of capital required to cover market risks. BI has announced that, effective in January 2005, it will incorporate market risk considerations into the calculation of the capital adequacy ratio (CAR). • To calculate capital adequacy ratio (CAR), in line with BI regulation, Standardized Approach is used in periodic reporting. • BNI have already implemented two methodologies of Basel II (Standardized Approach & Internal Model). • BNI also prepares to implement the advance methodology (Internal Model Approach), and today still waiting to be validated by Bank Indonesia. • Internal Model (VaR) is used to manage and monitor day to day market risks, include those of overseas branches.

20. 2. Market Risk Market Risk Management • BNI use VaR to measure the market risk of positions and the maximum losses expected, based on a number of assumptions for changes in market conditions. • The Risk and Capital Committee sets VaR market risk limits on a yearly basis for both trading and banking activities, and reviews these limits every six months. • Trading activity limits include limits on nominal net open position, cut loss limits and VaR for money market, foreign exchange, securities and related products. Banking limits include VaR limits and asset and liability gap limits. These limits are monitored on a daily, weekly and monthly basis. • Risk Management Division monitors and manages the VaR performance and prepares a report of all trading and banking activities in each of business units on a daily basis

21. 3. Operational Risk Operational Risk Framework • Redefinition of Risk Issue & Risk Control • New Cart Of Account in core banking system • Loss Event Data Base • Key Risk Indicator • Development of PERISKOP (Perangkat Risiko Operasional ) – tools to conduct AMA • Capital Measurement & Statistic Solution • Capital Charge – under AMA Approach • Economic Capital & RAROC 4 3 • Working Group Basel II • Business Lines Mapping – convert to Basel II criteria • Capital Charge – Standardized Approach 2 1 • Definition of Gross Income • Capital Charge – Basic Indicator • Risk Issue Identification • Operational Risk Self Assessment • Operational Risk SOP Review • Enhancing Internal Control (Governance) Basel II Frame Work Standardised Approach 2006-2009 Advanced Measu-rement Approach 2006-2010 Strengthen of Infrastructure Basic Indicator Approach 2006 - 2007

22. 3. Operational Risk Basic Indicator Approach (BIA) • Done • Regulatory capital with BNI’s gross income using BIA (started from QIS 3). Basel II OR Standardized Approach • Mapping 8 business lines under Basel II • gross income for each business unit Self Assessment, Loss Event, Key Risk Indicator, Statistic Solutions Advanced Measurement Approach • Self Assessments (ORSA) have been implemented +/- 2 years, Loss Event Management launched – end 2007, and KRI Management still developed. • Statistics Analysis Solution

23. 3. Operational Risk • Basel II Progress • In line with BI, BNI has prepared operational risk capital calculation using Basic Indicator Approach of Basel II. • BNI also prepares to implement the advance operational risk methodology ( using Advance Measurement Approach), by: Identifying risk issues, both from business unit and functional unit. Implementing self assessment tool, Operational Risk Self Assessment (ORSA), to assess operational risk potentials in every units ( branches, regions, loan centers, and head office) Modifying BNI Chart of accounts to capture Operational Risk loss based on 7 risk loss types of Basel II. Mapping BNI’s business lines into 8 Business Lines of Basel II using unit’s gross income approach. Developing an integrated operational risk tool, called PERISKOP ( consist of self assessment, loss event data, Key risk indicator, operational risk action plan, and reporting).

24. 3. Operational Risk Operational Risk management • BNI have strengthened risk management framework and internal control processes to better manage operational risks. In particular, in order to ensure checks and balances, BNI have instituted changes in the lines of reporting for risk management and compliance functions (include Quality Assurance). • Risk Management Division is responsible for managing and monitoring operational risks on a bank-wide basis. Further, internal audit function validates BNI system of internal controls through regular, risk-based and ongoing audit procedures and reports on the effectiveness of BNI internal controls to the Board of Directors and the audit committee. • During 2007, BNI has revisited its Business Continuity Plan (BCP) and made significant improvement in its capability to operate in an emergency situation. BCP is more important, considering the increasing frequency of natural disasters occurring in Indonesian area.

25. III. CAR SIMULATION UNDER BASEL II

26. 1. BASEL II IMPLEMENTATION • Established organization (Risk Management Division) which subsequently produced roadmap, framework, tools, data base, and systems for the implementation of Basel II in BNI. • Established Risk & Capital Committee (consists of 3 Sub Committees: Risk Management Committee, Credit Policy Committee, and Asset & Liability Committee) • Established Basel II Implementation Team and Basel II Monitoring Team which are directly supervised by Board of Directors. • Became a member of Basel II Working Group in Bank Indonesia since 2004. • Joined Quantitative Impact Study (QIS) since in 2003 ( QIS 2). ➲

27. BASEL I vs BASEL II Capital Adequacy Ratio (CAR) 19,5% 18,7% 18,0% 17,61% 16,4% 15,9% 15,6% 15,5% 14,93% 14,3% 12,7% 12,9% 10,1% 10,2% 9,9% 9,61% 8,4% 8,0% 30 Sept 07 1. BASEL II IMPLEMENTATION Basel I vs Basel II Under BI letter - QIS The methodology is used to calculate CAR: Credit Risk : Standardized Approach Market Risk : Standardized Approach Operational Risk : Basic Indicator Approach With national discretion Without national discretion

28. 2. Issues in Basel II Implementation Page 28

29. IV. CONCLUSSION

30. CONCLUSSION • BNI have developed some initiations since 2000 to anticipate the implementation of Basel II in Indonesia. Some of those initiations are as follows: • Set up Risk Management Organization (incl. Risk Management Committee). • Established risk management architectures. • Socialized risk management to all units in BNI. • BNI uses a parallel run technique to implement Basel II. The simplest one is just by simply comply to BI regulation while the more advance one, incorporates day to day risk management and an integrated risk management of Basel II. • Using the simplest approach, the implementation of Basel II would decrease BNI’s CAR for about 2% to 3%. • Some issues to implement Basel II in Indonesia are when bank using standardized approach in credit risk management only few Indonesian companies have external credit ratings, so the result no differences between Basel I and Basel II. Also in operational risk management as of today there is no external loss database available in Indonesia. ➲