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76 Pages·2011·6.17 MB·English

RISK MANAGEMENT REPORT
BANCO DO BRASIL S.A.

3rd quarter of 2011
Risk Management Report
Summary

List of Tables ........................................................................................................................... 3
List of Figures .......................................................................................................................... 5
1. Introduction .......................................................................................................................... 6
2. President’s Message ........................................................................................................... 7
3. Governance ......................................................................................................................... 8
Risk Exposure ...................................................................................................................... 8
Types of Risks ...................................................................................................................... 8
Corporate Risk Governance ............................................................................................... 10
Risk Management Process ................................................................................................ 11
Reports............................................................................................................................... 11
4. Regulation .......................................................................................................................... 12
Basel Accord ...................................................................................................................... 12
Background ........................................................................................................................ 12
Basel I ................................................................................................................................ 12
1996 Market Risk Amendment ........................................................................................... 13
Basel II ............................................................................................................................... 13
Basel III .............................................................................................................................. 17
5. Basel II at Banco do Brasil ................................................................................................. 19
6. Regulations ........................................................................................................................ 21
7. Financial Conglomerate ..................................................................................................... 22
8. Risk Management .............................................................................................................. 23
8.1 Financial Conglomerate ............................................................................................... 23
8.1.1 Credit Risk ............................................................................................................. 23
8.1.2 Market and Liquidity Risks .................................................................................... 43
8.1.3 Operational Risk .................................................................................................... 54
8.2 Non-financial Companies ............................................................................................. 59
9. Capital ................................................................................................................................ 60
9.1 Regulatory Capital ........................................................................................................ 60
9.1.1 Referential Equity (PR) .......................................................................................... 60
9.1.2 Required Referential Equity (PRE) ........................................................................ 68
9.1.3 Basel Index (IB) ..................................................................................................... 71
9.2 Economic Capital ......................................................................................................... 73

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List of Tables

Table 1. Timetable for Basel III Implementation in Brazil ...................................................... 19
Table 2. Credit-risk exposure by Risk Weights ...................................................................... 30
Table 3. Average credit-risk exposure in each quarter .......................................................... 30
Table 4. Credit-risk exposure by geographic region and country .......................................... 31
Table 5. Credit-risk exposure of the financial conglomerate by economic sector .................. 32
Table 6. Credit-risk exposure of the economic-financial consolidated group by sector ......... 33
Table 7. Amount of transactions in arrears ............................................................................ 33
Table 8. Concentration levels of the ten biggest clients in relation to the total from lending
transactions ........................................................................................................................... 34
Table 9. Flow of transactions written-off ................................................................................ 34
Table 10. Stock of allowances for doubtful accounts ............................................................. 34
Table 11. Loss operations assigned, with substantial transfer of risks and benefits ............. 35
Table 12. Value of the exposures derived from acquiring FIDC and CRI .............................. 36
Table 13. Notional value of contracts to be liquidated in clearing house liquidation systems, in
which the house acts as central counterparty ........................................................................ 38
Table 14. Notional value of contracts subject to counterparty credit risks in which clearing
houses do not act as central counterparty ............................................................................. 38
Table 15. Notional value of contracts where clearing houses did not act as central
counterparty, and which do not have guarantees – active position ....................................... 39
Table 16. Notional value of contracts where clearing houses did not act as central
counterparty, and which do have guarantees – long and short positions .............................. 39
Table 17. Positive gross value of contracts subject to counterparty credit risks, not taking into
account the positive values from compensation agreements, as set forth in CMN Resolution
3.263/05 ................................................................................................................................. 40
Table 18. The value of guarantees which cumulatively meet the requirements of paragraph
VI, Article 8, of Bacen Circular 3.477/09 ................................................................................ 41
Table 19. Notional value of credit derivatives ........................................................................ 41
Table 20. Mitigated value of exposure, weighted by respective risk factors .......................... 42
Table 21. Derivative financial instruments in the country and abroad – 3Q10 ...................... 44
Table 22. Derivative financial instruments in the country and abroad – 4Q10 ...................... 44
Table 23. Derivative financial instruments in the country and abroad – 1Q11 ...................... 45
Table 24. Derivative financial instruments in the country and abroad – 2Q11 ...................... 45
Table 25. Derivative financial instruments in the country and abroad – 3Q11 ...................... 46
Table 26. Total value of the Negotiable Portfolio by relevant market risk factor – 3Q10 ....... 49
Table 27. Total value of the Negotiable Portfolio by relevant market risk factor – 4Q10 ....... 49
Table 28. Total value of the Negotiable Portfolio by relevant market risk factor – 1Q11 ....... 49
Table 29. Total value of the Negotiable Portfolio by relevant market risk factor – 2Q11 ....... 50
Table 30. Total value of the Negotiable Portfolio by relevant market risk factor – 3Q11 ....... 50
Table 31. Phases of the operational risk management process ............................................ 55
Table 32. Monitoring of operating losses ............................................................................... 58
Table 33. Referential Equity .................................................................................................. 61
Table 34. Capital and Retained Earnings .............................................................................. 62
Table 35. Equity valuation adjustments ................................................................................. 63
Table 36. Non Controlling Participation ................................................................................. 63
Table 37. Perpetual Bonds .................................................................................................... 64
Table 38. Subordinated Debt ................................................................................................. 65
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Table 39. Subordinated Debt Eligible as Capital ................................................................... 65
Table 40. Perpetual Bonds .................................................................................................... 66
Table 41. Financial Instruments excluded from the PR ......................................................... 66
Table 42. PR historical series – Financial Conglomerate ...................................................... 67
Table 43. PR historical series – Consolidated Economic and Financial ................................ 67
Table 44. Required Referential Equity for the Financial Conglomerate ................................. 69
Table 45. Required Referential Equity for the Consolidated Economic – Financial .............. 70
Table 46. The Basel ratio and capital margin - Financial Conglomerate. .............................. 72
Table 47. The Basel ratio and capital margin - Consolidated Economic and Financial ......... 72
Table 48. Economic Capital ................................................................................................... 73
Table 49. Distribution of economic capital in the credit portfolio. ........................................... 74
Table 50. Economic capital for market risk, by risk factors .................................................... 74
Table 51. Economic capital for operational risk, by loss event category ............................... 75

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List of Figures

Figure 1. Governance Structure ............................................................................................ 10
Figure 2. Management Structure and Process ...................................................................... 11
Figure 3. Basel II Pillars ......................................................................................................... 14
Figure 4. Capital allocation .................................................................................................... 14
Figure 5. Pillar III Structure .................................................................................................... 16
Figure 6. Credit-risk management ......................................................................................... 23
Figure 7. Credit-risk management structure .......................................................................... 26
Figure 8. Operational risk management structure ................................................................. 54

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1. Introduction

BB considers risk and capital management as its fundamental vectors for decision-
making, providing greater stability, better capital allocation, and optimization of the
risk-return ratio.

The objective of this section is to inform shareholders and interested parties of the
management practices and policies that comprise risk management at BB.

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2. President’s Message

Participation by the country’s representative in the Basel Committee on Banking
Supervision in Switzerland is a source of pride for Brazilians, reaffirming the new
level of stability achieved by Brazil’s financial system.

As is well-known, banking system sustainability is indissolubly linked with risk-
management policies and mechanisms. The methods of identifying, measuring,
assessing, monitoring, and controlling risk safeguard financial institutions in adverse
situations and provide support for positive, recurring earnings over time.

The expectation of smaller bank spreads reinforces that conviction. Just as important
as increasing the volume of business is the consistency of a company’s risk
governance and the efficiency of its management processes. Institutions that are able
to transcend mere compliance with regulatory requirements and take risk into
account in a quick and accurate way when making decisions are the ones that will
rise to the challenge.

Brazil’s participation in the Basel Committee on Banking Supervision will encourage
broader, timelier adoption of international prudential standards. These new frontiers
of the regulatory environment will require Brazilian financial institutions to become
more agile and adaptable.

In these aspects the bank is mature and conscious of its commitment to its clients,
shareholders, investors, and society. Banco do Brasil continually seeks to keep pace
with best management practices, including its risk-management architecture, which
has a multidimensional scope to address credit, liquidity, market, and operational
risks. The specifics are described in this space.

Aldemir Bendine

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3. Governance

Risk Exposure

Changes to the global financial environment, such as market integration through
globalization, the emergence of new transactions and products, increasing
technological sophistication, and new regulations, have made financial activities and
processes - and their risks - ever more complex.

Additionally, the lessons learned from financial disasters, such as those of the
Metallgesellschatt Group and Barings, have helped show the essential need for risk
management in the banking industry.

These factors have influenced regulatory agencies and financial institutions to invest
in risk management, seeking to strengthen the financial health of banks and to
prevent detrimental effects on the financial system.

In concert with this outlook, BB has invested in the continual improvement of its risk-
management process and practices, in accordance with international market
benchmarks and the New Basel Accord, known as Basel II, and by the fine-tuning
provided by Basel III.

Types of Risks

The main risks to which BB is exposed in its business are:

a) Situational Risk: arises from the possibility of losses caused by changes to
political, cultural, social, economic, or financial conditions in Brazil and other
countries. It includes the following risks:
i. Strategic Risk – risk of losses from adopting unsuccessful strategies, taking
into account the dynamics of business and competition, political changes in
the country and abroad, and changes in the domestic and global economy;
ii. Country Risk – understood as the possibility of losses associated with non-
fulfillment of financial obligations according to negotiated terms by a borrower
or counterparty located outside of the country, resulting from actions taken by
the government of the country where the borrower or counterparty is located;
and transfer risk, understood as the possibility of difficulties occurring during
currency conversion of funds received; and
iii. Systemic Risk – Possibility of losses due to the financial difficulties of one or
more institutions that cause substantial damage to others, or a disruption of
normal operations of the national financial system.

b) Credit Risk: defined as the possibility of losses associated with non-fulfillment
by a buyer or a counterparty of their respective financial obligations according to
negotiated terms, the devaluation of a loan agreement due to a drop in the
borrower’s risk rating, a decline in gains or earnings, advantages offered during
renegotiation, and recovery costs. Among other things, credit risk is defined as
including:
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i. counterparty credit risk, understood as the possibility of a given counterparty
not fulfilling its obligations related to settlement of transactions that involve
trading financial assets, including those related to the settlement of financial
derivatives;
ii. country risk – understood as the possibility of losses associated with non-
fulfillment of financial obligations according to negotiated terms by a borrower
or counterparty located outside of the country, resulting from actions taken by
the government of the country where the borrower or counterparty is located;
and transfer risk, understood as the possibility of difficulties occurring during
currency conversion of funds received;
iii. the possibility of having to make disbursements to honor guarantees, bonds,
co-obligations, credit commitments, or other transactions of a similar nature;
and
iv. the possibility of losses associated with a loan broker or intervening party not
fulfilling their financial obligations according to negotiated terms.

c) Image Risk: possibility of losses from the institution having its name sullied on
the market or with authorities, as a result of negative publicity, whether true or
not.
d) Market Risk: the possibility of losses from fluctuations of the market value of
positions held by a financial institution. It includes the risks of transactions
subject to fluctuations of exchange rates, interest rates, share prices, and
commodity prices.
e) Legal Risk: this can be defined as the possibility of losses due to fines,
penalties or indemnities arising from actions by regulators, and losses due to
unfavorable rulings in lawsuits and administrative actions.
f) Liquidity Risk: is the occurrence of imbalances between tradable assets and
liabilities payable - "mismatches" between payments and receipts - which can
affect the institution’s payment ability, taking into account the various currencies
and settlement terms of its rights and obligations; and
g) Operational Risk: possibility of losses due to failures, deficiencies, or improper
internal processes, people and systems or external events. This definition
includes the legal risk associated with improper or deficient contracts signed by
the institution, as well as sanctions resulting from noncompliance with legal
provisions and compensation for damages to third parties resulting from
activities engaged in by the institution.

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