Page 93 - Annual Report 2023

ANNUAL REPORT 2023 24
Notes to the Consolidated Financial Statements for the year ended 31 December 2023
(amounts in USD, unless otherwise stated)

That particular rating of the Bank is assigned proper probability of default rate (PD rate), which is externally calculated – expert data
given by the external credit rating agency. However, PD is just a probability. In order to approximate full credit risk, LGD is needed. By
multiplying the PD rate and LGD rate, credit loss rate is obtained, and this is the approximation of credit risk.

Determining fair values
The determination of fair value for financial assets and liabilities for which there is no observable market price requires the use of
valuation techniques as described in accounting policy 3 (g) (viii). For financial instruments that trade infrequently and have little price
transparency, fair value is less objective, and requires varying degrees of judgment depending on liquidity, concentration, uncertainty of
market factors, pricing assumptions and other risks affecting the specific instrument. See also “Valuation of financial instruments” below.
Critical accounting judgments made in applying the Bank’s accounting policies include:

Valuation of financial instruments
The Bank’s accounting policy on fair value measurements is discussed under note 3 (g) (viii).
The Bank measures fair values using the following hierarchy of methods:

• Level 1: Quoted market price in an active market for an identical instrument.
• Level 2: Valuation techniques based on observable inputs. This category includes instruments valued using: quoted market prices
in active markets for similar instruments; quoted prices for similar instruments in markets that are considered less than active; or
other valuation techniques where all significant inputs are directly or indirectly observable from market data.
• Level 3: Valuation techniques using significant unobservable inputs. This category includes all instruments where the valuation
technique includes inputs not based on observable data and the unobservable inputs could have a significant effect on the
instrument’s valuation. This category includes instruments that are valued based on quoted prices for similar instruments where
significant unobservable adjustments or assumptions are required to reflect differences between the instruments.

Fair values of financial assets and financial liabilities that are traded in active markets are based on quoted market prices or dealer
price quotations. For all other financial instruments the Bank determines fair values using valuation techniques. Valuation techniques
include net present value and discounted cash flow models, comparison to similar instruments for which market observable prices
exist and other valuation models. The objective of valuation techniques is to arrive at a fair value determination that reflects the price of
the financial instrument at the reporting date that would have been determined by market participants acting at arm’s length.

The Bank uses widely recognized valuation models for determining the fair value of common and more simple financial instruments,
like interest rate and currency swaps that use only observable market data and require little management judgment and estimation.
Observable prices and model inputs are usually available in the market for listed debt and equity securities, exchange traded derivatives
and simple over the counter derivatives like interest rate swaps. Availability of observable market prices and model inputs reduces
the need for management judgment and estimation and also reduces the uncertainty associated with determination of fair values.
Availability of observable market prices and inputs varies depending on the products and markets and is prone to changes based on
specific events and general conditions in the financial markets.

For more complex instruments, the Bank uses proprietary valuation models, which usually are developed from recognized valuation
models. Some or all of the significant inputs into these models may not be observable in the market, and are derived from market prices
or rates or are estimated based on assumptions. Valuation models that employ significant unobservable inputs require a higher degree
of management judgment and estimation in determination of fair value. Management judgment and estimation are usually required for
selection of the appropriate valuation model to be used, determination of expected future cash flows on the financial instrument being
valued, determination of probability of counterparty default and prepayments and selection of appropriate discount rates.