Risk Management Executive Summary

The overall focus of Risk and Capital Management in 2012 was on strengthening our capital base and supporting our strategic initiatives whilst maintaining our risk profile in line with our risk strategy.

Overall Risk Assessment

Key risk categories for us include credit risk, market risk, operational risk, business risk (including tax and strategic risk), reputational risk and liquidity risk. We manage the identification, assessment and mitigation of top and emerging risks through a rigorous governance process and robust risk management tools and processes. Our proactive approach to identification and impact assessment aims to ensure that we mitigate the impact of these risks on our financial results, long term strategic goals and reputation.

As part of our regular risk and cross-risk analysis, sensitivities of the key portfolio risks are reviewed through a bottom-up risk assessment and through a top-down macro-economic and political scenario analysis. This two-pronged approach allows us to capture risks that have an impact across our risk inventories and business divisions or those that are relevant only to specific portfolios.

Current portfolio wide risks on which we have been focused in 2012 include: the potential escalation of the European sovereign debt crisis, the impact of a potential US fiscal austerity shock, a potential slowdown in Asian growth and the potential risk of a steep oil price increase resulting from a geopolitical shock. These risks have been a consistent focus throughout recent quarters. The assessment of the potential impacts of these risks has been made through integration into our group-wide stress tests which assess our ability to absorb these events should they occur. The results of these tests showed that we currently have adequate capital and liquidity reserves to absorb the impact of these risks if they were to materialize.

The year 2012 has continued to see increased regulation in the financial services industry. We are also focused on ensuring that we act proactively to identify potential political and regulatory changes and assess the possible impact on our business model or processes. We have a dedicated function which oversees and coordinates the proactive identification, assessment and implementation of requirements due to new regulation including the participation in numerous consultation processes.

As part of our overall capital strategy, assets and portfolios deemed as non strategic or in some cases underperforming have been moved to a newly created Non-Core Operations Unit (NCOU). This division actively oversees, manages and drives an accelerated de-risking program aligned with our externally announced strategic targets. Assets assigned to this unit are managed consistently and in accordance with our risk framework and principles.

Credit Risk Summary

  • Adherence to our core credit principles of proactive and prudent risk management has enabled us to weather a sustained volatile macro-economic credit environment over 2012 and has contributed to the containment of loan losses. This has been achieved by application of our existing risk management philosophy of conservative underwriting standards, active concentration risk management and risk mitigation strategies including collateral, hedging, netting and credit support arrangements.
  • Credit exposure remained diversified by region, industry and counterparty. Regional exposure is evenly spread across our key markets (Germany 27 %, Rest of Western Europe 28 % and North America 30 %) and has been stable year on year. Our largest industry exposure is to Banks and Insurances, which constitutes 33 % of overall gross exposures (i.e., before consideration of collateral) and was € 359 billion, a decline of € 17.3 billion from December 31, 2011, when it represented 34 % of gross exposures. These exposures are predominantly with highly rated counterparties and generally are collateralized. On a counterparty level we remained well diversified with our top ten exposures representing 11 % on a gross basis, all with highly rated investment-grade counterparties and including structured trades with high risk mitigation.
  • The economic capital usage for credit risk totaled € 12.6 billion at year-end 2012. The decrease of € 238 million, or 2 %, compared to € 12.8 billion at year-end 2011, mainly reflected overall exposure reduction.
  • Provision for credit losses decreased in 2012 by € 118 million to € 1.7 billion. This decrease excludes the effect of Postbank releases related to loan loss allowances recorded prior to consolidation of € 157 million and € 402 million in 2012 and 2011 respectively. The impact of such releases is reported as interest income on group level. Adjusted for this accounting effect, our provision for credit losses in 2012 would have been € 1.6 billion reflecting an increase of € 126 million compared to the prior year.
  • Our overall loan book as of December 31, 2012 decreased to € 402 billion versus € 417 billion as of December 31, 2011. Reductions were mainly driven by focused de-risking in the newly established NCOU. Our single largest industry category loan book is Household mortgages equating to € 142 billion as of December 31, 2012, with € 112 billion of these in the stable German market. Our corporate loan book, which accounts for 55 % of the total loan book, is composed 66 % of loans with an investment-grade rating as of December 31, 2012, increased from 64 % as of December 31, 2011 driven by a heavier weighting of reductions to non investment-grade counterparties.

Market Risk Summary

  • Nontrading market risk economic capital usage totaled € 8.5 billion as of December 31, 2012, which is € 1.2 billion, or 17 %, above our economic capital usage at year-end 2011. The increase was largely driven by the extension of nontrading market risk economic capital coverage to include material credit spread risks from the banking book.
  • The economic capital usage for trading market risk was € 4.7 billion at year-end 2012, and decreased by € 34 million, or 1 % compared to prior year end. The materially unchanged economic capital usage for trading market risk reflected offsetting effects of methodology refinements and exposure reductions.
  • The average value-at-risk of our trading units was € 57.1 million in 2012, compared to € 72.7 million per 2011. The decrease was driven primarily by a broad risk reduction across most asset classes, but also partly due to the benefit of lower levels of market data volatility.

Operational Risk Summary

  • The economic capital usage for operational risk increased by € 172 million, or 3.5 %, to € 5 billion as of December 31, 2012. The increase is primarily due to higher industry operational risk loss experience and the integration of BHF-BANK into our Advanced Measurement Approach (AMA) model in the first quarter 2012. Our regulatory capital continues to include the safety margin applied in our AMA model, which was implemented in 2011 to cover unforeseen legal risks from the current financial crisis.
  • Internal operational risk losses increased in 2012 compared to prior year driven by increased litigation provisions relating to events over the past decade.

Liquidity Risk Summary

  • Liquidity reserves as of December 31, 2012 were € 232.2 billion (now including € 25.9 billion from Postbank following integration). Excluding Postbank (which was not included as of December 31, 2011), our liquidity reserves decreased by € 16.4 billion over the year. The primary driver of this was a reduction of € 40 billion in our discretionary wholesale funding during the year, offset by growth in more stable funding sources. Overall our liquidity risk profile remains within our liquidity risk appetite, as confirmed by all year-end stress tests resulting in a net liquidity surplus.
  • Our 2012 issuance activities amounted to € 17.9 billion. This compares to our full year plan of € 15-20 billion.
  • 62 % of our overall funding came from the most stable funding sources, comprising capital markets and equity, retail, and transaction banking liabilities.

Capital Management Summary

  • The Common Equity Tier 1 capital ratio in accordance with Basel 2.5 amounted to 11.4 % based on Common Equity Tier 1 capital of € 38.0 billion and risk-weighted assets of € 334 billion. This compares to a Common Equity Tier 1 capital ratio of 9.5 % at year-end 2011 based on Common Equity Tier 1 capital of € 36.3 billion and risk-weighted assets of € 381.2 billion.
  • Risk-weighted assets decreased in 2012 by € 47.6 billion to € 334 billion at the end of 2012, reflecting de-risking activities as well as model and process improvements.
  • The newly established NCOU division has contributed to significant de-risking. The overall de-risking achieved by the NCOU in 2012 resulted in a reduction in total assets adjusted of € 35 billion (27 %) from € 130 billion as of December 31, 2011 to € 95 billion as of December 31, 2012.
  • The internal capital adequacy ratio, signifying whether the total capital supply is sufficient to cover the capital demand determined by our risk positions, increased to 160 % as of December 31, 2012, compared to 159 % as of December 31, 2011.
  • As at December 31, 2012, our pro forma, fully loaded Basel 3 Common Equity Tier 1 capital ratio was 7.8 %, comprising € 31 billion Common Equity Tier 1 capital and € 401 billion risk-weighted assets.

Balance Sheet Management Summary

  • As of December 31, 2012, our adjusted leverage ratio was 21, unchanged from the level at the end of 2011 and below our target leverage ratio of 25. Our leverage ratio calculated as the ratio of total assets under IFRS to total equity under IFRS was 37 as of December 31, 2012, a slight decrease compared to end of 2011.