Part of the Consolidated Financial Statements as of 31 December 2007, which were audited by KPMG Deutsche Treuhand AG.

As part of our overall framework of risk management, the Loan (Glossary)Exposure Management Group (LEMG) focuses on managing the (Glossary)credit risk of loans and lending-related commitments of the international investment-grade (Glossary)portfolio and the medium-sized German companies’ portfolio within our Corporate and Investment Bank Group Division.

Acting as a central pricing reference, LEMG provides the respective Corporate and Investment Bank Group Division businesses with an observed or derived capital market rate for loan applications; however, the decision of whether or not the business can enter into the loan remains with Credit Risk Management.

LEMG is concentrating on two primary initiatives within the credit risk framework to further enhance risk management discipline, improve returns and use capital more efficiently:

  • to reduce single-name and industry (Glossary)credit risk concentrations within the credit portfolio, and
  • to manage credit exposures actively by utilizing techniques including loan sales, (Glossary)securitization via collateralized loan obligations, default insurance coverage and single-name and (Glossary)portfolio (Glossary)credit default swaps.

The notional amount of LEMG’s risk reduction activities increased by 23% from € 38.3 billion as of December 31, 2006, to € 47.0 billion as of December 31, 2007.

As of year-end 2007, LEMG held (Glossary)credit derivatives with an underlying notional amount of € 31.6 billion. This position totaled € 24.8 billion as of December 31, 2006.

The credit (Glossary)derivatives used for our (Glossary)portfolio management activities are accounted for at (Glossary)fair value.

LEMG also mitigated the credit risk of € 15.3 billion of loans and lending-related commitments as of December 31, 2007, by synthetic collateralized loan obligations supported predominantly by financial guarantees and, to a lesser extent, credit derivatives for which the first loss piece has been sold. This position totaled € 13.4 billion as of December 31, 2006. LEMG further mitigated € 74 million of loans and lending-related commitments as of December 31, 2007 by way of credit-linked notes. This position totaled € 121 million as of December 31, 2006. Credit mitigation by way of credit-linked notes or synthetic collateralized loan obligations supported by financial guarantees addresses the credit risk of the less liquid underlying positions.

Our adoption of (Glossary)IFRS in 2007 enabled LEMG to utilize the fair value (Glossary)option under IAS 39 to report loans and commitments at fair value, provided the criteria for this standard are met. As of December 2006, LEMG had € 33.8 billion of notional loans and commitments designated to be reported at (Glossary)fair value. The notional amount of loans and commitments reported at fair value increased during 2007 to € 44.7 billion as new deals were originated and those that qualified were designated to be reported at fair value. By reporting loans and commitments at fair value, LEMG significantly reduced profit and loss volatility that resulted from the accounting mismatch that existed when all loans and commitments were reported at historical cost while derivative hedges were reported at fair value.