The First MicroFinance Bank Financial Statements · The First MicroFinance Bank (the Bank) was...

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Building a better working world

The First MicroFinance Bank

Financial Statements

For the year ended 31 December 2013

Ernst & Young Ford Rhodes Sidat Nyder Chartered Accountants House 1011, Street 2 Shirpoor Road, Kabul Afghanistan

Tel: +93 752 055 025 [email protected] ey.com/pk

EY Building a better working world

Ernst & Young Ford Rhodes Sidat Nyder Tel: +93 752 055 025 Chartered Accountants eyfrsh.kab©gmail.com House 1011, Street 2 ey.com/pk Shirpoor Road, Kabul Afghanistan

Independent auditors' report to the Board of Supervisors

We have audited the accompanying financial statements of The First Microfinance Bank Afghanistan ("the Bank"), which comprise the statement of financial position as at 31 December 2013 and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and a summary of significant accounting policies and other explanatory information.

Management's responsibility for the financial statements

Management is responsible for the preparation and fair presentation of these financial statements in accordance with International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB), the Banking Law of Afghanistan and regulations issued by the Central bank of Afghanistan and in compliance with disclosure guidelines for financial reporting by microfinance institutions which are voluntary norms recommended by a group of sponsors, including the donors who make up the Consultative Group to Assist the Poor (CGAP) and the members of the Small Enterprise Education and Promotion network (SEEP), and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.

Auditors' responsibility

Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditors' judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate for the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

A member firm of Ernst 8 Young Global Limited

EY Building a better working world

Opinion

In our opinion, the financial statements give a true and fair view of the financial position of the Bank as of 31 December 2013, and of its financial performance and cash flows for the year then ended in accordance with International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB), the Banking Law of Afghanistan and regulations issued by the Central bank of Afghanistan and in compliance with disclosure guidelines for financial reporting by microfinance institutions which are voluntary norms recommended by a group of sponsors, including the donors who make up the Consultative Group to Assist the Poor (CGAP) and the members of the Small Enterprise Education and Promotion network (SEEP).

Ernst & Young'f-orc v hodes Sidat Hyder Chartered Accountants Date: 7 May 2014 Place: Kabul, Afghanistan Engagement partner: Muhammad Basheer Juma

A member firm of Ernst & Young Global Limited

A member firm of Ernst & Young Global Limited

THE FIRST MICROFINANCE BANK NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS

FOR THE YEAR ENDED DECEMBER 31, 2013

1. STATUS AND NATURE OF BUSINESS

The First MicroFinance Bank (the Bank) was registered with Afghan Investment Support Agency (AISA) in December 2003 and on March 18, 2004 received formal banking license to operate nationwide from the Da Afghanistan Bank (DAB), the Central Bank of Afghanistan.

The Bank is a limited liability company and is incorporated and domiciled in Afghanistan. The ultimate parent of the Bank is Aga Khan Agency for Microfinance (AKAM). The registered office of the Bank is situated at plot no. 148, Fourth street, Ansari square in front of Holland Embasy, Sharre Naw, Kabul, Afghanistan.

Since commencement of operations on May 1, 2004, the Bank has been operating as the leading financial services provider in Afghanistan contributing to poverty alleviation and economic development, through the provision of sustainable financial services primarily targeted at the micro and small businesses and households.

The bank had 38 branches (2012: 35 branches) in operation including 16 (2012: 16) urban branches and 22 (2012: 19) rural/peri urban branches in operation as at December 31, 2013 and employed 1,028 (2012: 978) staff and consultants.

2. BASIS OF PRESENTATION OF FINANCIAL STATEMENTS

These financial statements have been presented in accordance with International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB) and Banking Law of Afghanistan and regulations issued by the Central Bank of Afghanistan.

These financial statements also comply with the Disclosure Guidelines for Financial Reporting by Microfinance Institutions which are voluntary norms recommended by a group of sponsors, including the donors who make up the Consultative Group to Assist the Poor (CGAP) and the members of Small Enterprise Education and Promotion Network (SEEP).

The preparation of financial statements in conformity with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date and the reported amounts of revenues and expenses during the reporting period. Management believes that the underlying assumptions are appropriate and that the financial statements therefore present the financial position and results fairly. The areas involving a higher degree of judgment or complexity, or areas where assumptions and estimates are significant to the financial statements, are disclosed in note 3.17. The financial statements are presented in AFN and all values are rounded off to the nearest thousand.

Financial statements are prepared on an accrual basis. Transactions are recognized when they occur, not when cash is received or paid.

(a) Standards, amendments and interpretations to existing standards that are not yet effective and have not been early adopted by the Bank.

IFRS 9 'Financial Instruments' (issued in November 2009) (effective from January 1, 2015)

-

IFRS 9 'Financial Instruments' (issued in October 2010) (effective from January 1, 2015)

IFRS 10 'Consolidated Financial Statements' (effective from January 1, 2013)

-

IFRS 11 'Joint Arrangements' (effective from January 1, 2013)

-

IFRS 12 'Disclosure Of Interest in Other Entities' (effective from January 1, 2013)

-

IFRS 13 'Fair Value Measurements' (effective from January 1, 2013)

-

IAS 27 (Revised) 'Investments in Associates and Joint Ventures' (effective from January 1, 2013)

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THE FIRST MICROFINANCE BANK

Amendments to IAS 32 'Offsetting Financial Assets and Financial Liabilities' (effective from 1 January 2014)

Amendments to IFRS 7 and IFRS 9 'Mandatory effective date and transition disclosures' (effective 1 January 2015)

(b) Standards, amendments and interpretations to existing standards that became effective and are relevant for the Bank's operations

IAS 24 'Related Party Disclosure (Revised)'

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The principal accounting policies applied in the preparation of these financial statements are set out below. These policies have been consistently applied to all the years presented, unless otherwise stated.

3.1 Basis of measurement

These financial statements have been prepared under the historical cost convention except for any modifications required by International Financial Reporting Standards (IFRS) referred to in the accounting policies given below.

3.2 Cash and cash equivalents

For the purposes of the cash flow statement, cash and cash equivalents comprise balances with less than six months' maturity from the date of acquisition, including cash in hand, balances with the DAB and other banks and short term placements with other banks.

3.3 Financial assets

Financial assets of the Bank are classified into following categories:

(a) Financial assets at fair value through profit or loss

Financial assets at fair value through profit or loss are financial assets held for trading. A financial asset is classified in this category if acquired principally for the purpose of selling in the short-term. Derivatives (if any) are also categorised as held for trading unless they are designated as hedges. Assets in this category are classified as current assets.

(b) Loans and receivables

Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. The Bank's loans and receivables comprise loans to customers and cash equivalents.

(c) Held-to-maturity financial asset

Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Bank's management has the positive intention and ability to hold till maturity. If the Bank were to sell other than an insignificant amount of held-to-maturity assets, the entire category would be reclassified as available for sale. Short term placements are classified under this category.

(d) Available-for-sale financial asset

Available-for-sale assets are those intended to be held for an indefinite period of time, which may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices.

Regular-way purchases and sales of financial assets at fair value through profit or loss, available for sale, and held-to-maturity are recognized on trade-date — the date on which the Bank commits to purchase or sell the asset.

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Financial assets are initially recognized at fair value plus transaction costs for all financial assets not carried at fair value through profit or loss. Financial assets carried at fair value through profit and loss are initially recognized at fair value, and transaction costs are expensed in the statement of comprehensive income. Financial assets are derecognized when the rights to receive cash flows from the financial assets have expired or where the Bank has transferred substantially all risks and rewards of ownership.

Available-for-sale financial assets and financial assets at fair value through profit or loss are subsequently carried at fair value. Gains and losses arising from changes in the fair value of available-for-sale financial assets are recognized directly in equity, until the financial asset is derecognized or impaired. At this time, the cumulative gain or loss previously recognized in equity is recognized in the statement of comprehensive income. Gains and losses arising from changes in the fair value of the 'financial assets at fair value through profit or loss' category are included in the statement of comprehensive income in the period in which they arise.

Loans and receivables and held-to-maturity investments are carried at amortized cost using the effective interest rate method.

Interest calculated using the effective interest method and foreign currency gains and losses on monetary assets classified as available for sale are recognized in the income statement.

The Bank establishes fair value using valuation techniques. These include the use of recent arm's length transactions and discounted cash flow analysis.

3.4 Loans and advances

These are stated net of provision on loans and advances considered standard and provision for non-performing loans and advances, if any. The outstanding amounts of advances are classified in accordance with the banking regulations of Afghanistan and funding covenants as follows:

a) Standard: These are loans and advances, which are paying in a current manner and are supported by sound net worth and paying capability of the borrower. In terms of policy of the Bank, a general risk based provision is maintained in the books of account @ 5.52% (2012: 4.94 %) of value of such loans and advances.

b) Watch-list: These are loans and advances which are adequately protected, but are potentially weak. All loans and advances which are past due by 31 to 60 days for principal or interest payments are classified as watch-list. Such advances constitute an unwarranted credit risk, but not to the point of requiring a classification to Substandard. A provision is maintained in the books of account @ 6% (2012 : 5%) of value of such loans and advances, however as per Classification and Loss Reserve Regulations (CLRR) issued by DAB the rate of provision against such loans is prescribed @ 5 %.

c) Substandard: These are loans and advances which are inadequately protected by current sound net worth and paying capacity of the borrower or by the collateral, if any, supporting it. Further, all loans and advances which are past due by 61 to 90 days for principal or interest payments are also classified as substandard. A provision is maintained in the books of account @ 25% of value of such loans and advances as per CLRR issued by DAB.

d) Doubtful: These are loans and advances which can be classified as Substandard and have added characteristic that these weaknesses make collection or liquidation in full, on the basis of current circumstances and values, highly questionable and improbable. Further, all loans and advances which are past due by 91 to 180 days for principal or interest payments are also classified as Doubtful. A provision is maintained in the books of account @ 50% of value of such loans and advances as per CLRR issued by DAB.

e) Loss: These are loans and advances which are not collectible and or such little value that their continuance as a bankable asset is not warranted. Further, all loans and advances which are past due over 180 days for principal or interest payments are also classified as Loss. Loans and advances classified as loss are immediately charged off against the provision as per CLRR issued by DAB.

f) Rescheduled: Rescheduled loans and advances are fully provided as per funding covenant requirements.

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3.5 Provisions

Provisions are recongnised when the Bank has a present legal and constructive obligation as a result of past event; it is probable that an outflow of resources will be required to settle the obligation, and the amount could be readily estimated. Provisions are not recongnised for future operating losses.

Where there are a number of similar obligations, the likelihood that an outflow will be required in settlement is determined by class of obligations as a whole. A provision is recongnised even if the likelihood of an outflow with respect to any one item included in the same class of obligations may be small.

All provisions are reviewed at each reporting date and adjusted to reflect the current best estimate.

3.6 Operating fixed assets

(a) Tangible assets

Tangible fixed assets are stated at cost less accumulated depreciation and impairment, if any. Depreciation is charged to income applying the straight-line method to allocate cost over their estimated useful life at the following annual rates.

Leasehold improvements 20% Furniture and fittings 20% Vehicles 20% Office equipment 25% Computer equipment 33%

Depreciation is charged from the date an asset is put into use until the date of its disposal. Major renewals and improvements are capitalized. Gain or loss on disposals is dealt with through the statement of comprehensive income.

The assets' residual values, useful lives and method of depreciation are reviewed, and adjusted if appropriate, at each reporting date. An asset's carrying amount is written down immediately to its recoverable amount if the asset's carrying amount is greater than its estimated recoverable amount. The recoverable amount is the higher of the asset's fair value less costs to sell and its value in use.

Subsequent costs are included in the asset's carrying amount or recognized as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the Bank and the cost of the item can be measured reliably. The carrying amount of the replaced part is derecognized. All other repairs and maintenance are recognised in the statement of comprehensive income during the financial period in which they are incurred.

Gains and losses on the sale of property, plant and equipment are recognized in the period in which disposal is made.

(b) Intangible assets

Intangible assets are capitalized and to the extent that the future economic benefits can be derived by the Bank. Intangible assets are subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Intangible assets are stated at cost less accumulated amortization. Amortization is charged to income applying the straight-line method.

Computer software

Acquired computer software licences are capitalised on the basis of the costs incurred to acquire and bring to use the specific software. These costs are amortised over their estimated useful life of 5 years.

3.7 Impairment of non-financial assets

Assets that have an indefinite useful life are not subject to amortization and are tested annually for

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impairment. Assets that are subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognized for the amount by which the asset's carrying amount exceeds its recoverable amount. An impairment loss or reversal of impairment loss is recongnised in the statement of comprehensive income. The recoverable amount is the higher of an asset's fair value less costs to sell and its value in use. For the purposes of assessing impairment, assets are grouped at the lowest level for which there are separately identifiable cash flows (cash-generating units). Non-financial assets that suffered impairment are reviewed for possible reversal of the impairment at each reporting date. Reversals of impairment loss is restricted to the extent of lower of recoverable amount and carrying value less depreciation had no impairment been booked.

3.8 Financial liabilities

Financial liabilities are recognised when the Bank becomes party to the contractual provision of the instruments and the Bank loses control of the contractual right that comprises the financial liability when the obligation specified in the contract is discharged, cancelled or expired. The Bank classifies its financial liabilities in two categories: at fair value through profit or loss and financial liabilities measured at amortized cost. The classification depends on the purpose for which the financial liabilities were incurred. Management determines the classification of its financial liabilities at initial recognition.

(a) Financial liabilities at fair value through profit or loss

Financial liabilities at fair value through profit or loss are financial liabilities held for trading. A financial liability is classified in this category if incurred principally for the purpose of trading or payment in the short-term. Derivatives (if any) are also categorised as held for trading unless they are designated as hedges.

(b) Financial liabilities measured at amortized cost

These are non-derivative financial liabilities with fixed or determinable payments that are not quoted in an active market. These are recognised initially at fair value, net of transaction costs incurred and are subsequently stated at amortised cost; any difference between the proceeds (net of transaction costs) and the redemption value is recognised in the statement of comprehensive income using effective rate method.

3.9 Taxation

Current

The current income tax charge is calculated on the basis of the tax laws enacted or substantively enacted at the reporting date. Management periodically evaluates positions taken in tax returns with respect to situations in which applicable tax regulation is subject to interpretation and establishes provisions, where appropriate, on the basis of amounts expected to be paid to the tax authorities.

Deferred

Deferred tax is accounted for using the balance sheet liability method in respect of all temporary differences arising from differences between the carrying amounts of assets and liabilities in the financial statements and the corresponding tax basis used in the computation of taxable profit.

Deferred tax liabilities are recognised for all taxable temporary differences and deferred tax assets are recognised to the extent that it is probable that taxable profits will be available against which the deductible temporary differences, unused tax losses and tax credits can be utilised.

Deferred tax is calculated at the rates that are expected to apply to the period when the differences reverse, based on tax rates that have been enacted or substantially enacted at the reporting date.

3.10 Borrowings

Borrowings are recognized initially at fair value net of transaction costs incurred. Borrowings are subsequently stated at amortized cost; any difference between proceeds net of transaction costs and the redemption value is recognized in the statement of comprehensive income over the period of the borrowings using the effective interest method.

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3.11 Grants

Grants are recognized at their fair value where there is reasonable assurance that the grant will be received and the Bank will comply with all the required conditions.

(a) Revenue grants

Grants relating to costs are recognized as income over the period necessary to match these grants with the related costs that they are intended to compensate. Fixed obligation grants are recognized when the right to receive the grant has been established on achievement of certain milestones as stated in the grant agreement.

(b) Deferred grants

Grants for fixed assets are recorded as deferred grants in the statement of financial position and recognized as non-operating income on a systematic basis over the useful life of assets acquired from the grant.

3.12 Interest income and expense

Interest income and expenses for all interest-bearing financial instruments, except for those classified as held for trading or designated at fair value through profit or loss, are recognized within 'interest income' and 'interest expense' in the statement of comprehensive income using the effective interest method.

The effective interest method is a method of calculating the amortized cost of a financial asset or a financial liability and of allocating the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, the Bank estimates cash flows considering all contractual terms of the financial instrument but does not consider future credit losses.

Due but not yet recieved service charges are accrued on overdue advances for periods up to 30 days. After 30 days, overdue advances are classified as non-performing and further accrual of unpaid service charges/income ceases. Accrued service charges on non-performing advances are reversed and credited to suspense account.

3.13 Fee and commission income and expense

Fees and commissions are recognized on an accrual basis when the service has been provided or received. Commission and fees arising from negotiating, or participating in the negotiation of, a transaction for a third party are recognized on the completion of the underlying transaction.

3.14 Foreign exchange rate

(a) Functional and presentation currency

Items included in the financial statements of the Bank are measured using the currency of the primary economic environment in which the entity operates (the functional currency), which is the Afghani (AFN).

(b) Transactions and balances

Foreign currency transactions are translated into functional currency using the exchange rate prevailing at the date of the transaction. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year-end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the statement of comprehensive income.

1 USD

1 EURO The exchange rate of following currencies against AFN:

as at December 31, 2013

56.01

76.73 as at December 31, 2012

52.08

68.54

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3.15 Operating leases

Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Payments made under operating leases are charged to statement of comprehensive income on a straight-line basis over the period of the lease.

3.16 Offsetting

Financial assets and liabilities are offset and the net amount is reported in the statement of financial position, if the Bank has a legally enforceable right to setoff the recognised amounts and the Bank intends to settle either on a net basis or realize the asset and settle the liability simultaneously.

3.17 Critical accounting estimates and judgments

The preparation of financial statements in conformity with approved accounting standards requires use of certain critical accounting estimates, judgments and assumptions. These are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Followings are the critical accounting estimates, judgments and assumptions used in preparing these financial statements.

(a) Provision for income taxes

The Bank recognises tax liabilities for pending tax assessments using estimates based on expert opinion obtained from tax/legal advisors. Differences, if any, between the income tax provision and the tax liability finally determined is recorded when such liability is so determined.

(b) Operating fixed assets

The Bank reviews useful lives, residual values and methods of depreciation of operating fixed assets (note 3.6) on regular basis. Any change in estimates may affect the carrying amounts of the respective items of property, plant and equipment with a corresponding effect on the depreciation charge.

(c) Provision for loan losses

The Bank reviews loans to customer balances monthly for impairment and records the provision for possible loan losses as per the Bank's policy, funding covenants and instructions from DAB as disclosed in note 3.4.

(d) Held-to-maturity investments

Held-to-maturity financial assets are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Bank's management has the positive intention and ability to hold till maturity. If the Bank intends to sell other than an insignificant amount of held-to-maturity financial assets, the whole category would be tainted and reclassified as available for sale.

Held to maturity investments are recognised at fair value which existed on the trade date, the date on which the Bank commits to purchase plus transaction costs.

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4. CASH AND BALANCES WITH CENTRAL BANK

Cash in hand

Note Dec 31, 2013 AFN '000

Dec 31, 2012 AFN '000

Local currency 223,819 184,263 Foreign currency 72,550 57,015 Cash in transit 59,224

296,369 300,502

Balance with Da Afghanistan Bank ( Central Bank ) Local currency 4.1- 4.2 1,265,025 901.609 Foreign currency 343,386 469,282

1,608,411 1,370,891 1,904,780 1,671,393

4.1 This includes an amount of AFN 400,421 thousands (2012: AFN 340,620 thousands) held with Da Afghanistan Bank to meet the reserve requirements calculated as 8% of demand and time liabilities this comes on interest rate of 2.82 % (2012: 0.95 %).

4.2 This also includes an over-night deposit of AFN 454,608 thousands (2012: AFN 286,848 thousands) both at the rate of % 2.82 (2012: 0.95%).

5. BALANCES WITH OTHER BANKS

This represents balances with commercial banks in local and foreign currency current accounts held in Afghanistan, United States of America, Germany and Switzerland. These balances include AFN 289,946 thousands (2012: AFN 348,057 thousands) held with related parties.

SHORT TERM PLACEMENTS WITH OTHER BANKS Note Dec 31, 2013 Dec 31, 2012 AFN '000 AFN '000

Da Afghanistan Bank ( Central Bank) 6.1 680,816 Other banks 6.2 1,943,875 1,079,850

2,624,691 1,079,850

6.1 This represents capital notes issued by the Central Bank for 28 and 182 days and carries interest in the range of 0.04 % to 4.96 %(2012: 0.1 % to 3 )̀/0).

6.2 All these placements are with the related parties and carries interest rate ranging from 0.04% to 4.96% (2012: 0.10% to 3%).

7. LOANS AND ADVANCES TO CUSTOMERS — NET

Note Dec 31, 2013 Dec 31, 2012 Number of

Loans AFN '000 Number of

Loans AFN '000

Microfinance loans 60,647 3,621,544 59,100 3,633,320 Loans to small and medium size enterprises 935 735,809 669 610,014

7.1 61,582 4,357,353 59,769 4,243,334

Specific and general provision 7.2

Microfinance loans 228,384 183,281 Loans to small and medium enterprises 72,031 41,759

300,415 225,040

Loans and advances to customers - net 4,056,938 4,018,294

6.

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7.1 Microfinance loans carry service charges at effective rates ranging from 9% to 37% (2012: 9% to 36%) per annum, whereas interest on short and medium term loans to small and medium size enterprises and microfinance housing loan is charged at the effective rates of 20% to 33% (2012: 23% to 33%). All loans are secured by various kinds of properties and personal guarantees. AFN 71,079 thousands of microfinance loans (2012: AFN 97,684 thousands) and AFN 172,229 thousands (2012: AFN 163,147 thousands) of loans to small and medium enterprises are denominated in foreign currency. Furthermore, this includes loan portfolio of AFN 1,066 million (2012: AFN 1,076 million) outstanding from rural and peri-urban areas of Afghanistan.

7.2 Specific and general provision of outstanding loans and advances at the year end is made in accordance with the accounting policy outlined in note 3.4. Loans and advances have been classified as shown below:

Number of Amount customers outstanding

AFN '000

Provision required

Provision held

AFN' 000 0/0 AFN '000

Standard 60,155 4,221,303 5.52 233,050 233,050 Overdue

Watch-List 319 23,697 6.00 1,422 1,422 Substandard 224 18,780 25.00 4,695 4,695 Doubtful 844 64,649 50.00 32,324 32,324 Loss 100.00

Rescheduled 40 28,924 100.00 28,924 28,924 1,427 136,050 67,365 67,365

61,582 4,357,353 300,415 300,415

The general risk based provision on standard loans was increased from 4.94 % to 5.52% during the period and accordingly increased the provisioning rate on Watch list from 5% to 6% during the year. The impact of this change has been an increase in the general provision by some AFN 24.5 million in the period and AFN 0.236 million on specific provisioning.

7.3 Portfolio Quality Report

The Bank's main measure of loan delinquency is an aged portfolio-at-risk ratio. Loans are separated into classes depending upon the number of days they are overdue. For each such class of loan, the outstanding principal balance of such loan is divided by the outstanding principal balance of the gross loan portfolio before deducting provision for loan losses.

Loans are considered overdue if any payment has fallen due and remained unpaid for more than 30 days. Loan payments are applied first to to any penalty interest applicable, then to the interest due and then any remaining balance is applied to principal. The number of days of delay is based on the due date of the earliest loan installment that has not been fully paid. The Bank does not convert interest on late payment/ penalty into principal.

As at December 31, 2013 there were overdue loans of AFN 107,127 thousands (2012: AFN 11,870 thousands).

The Bank allows loan rescheduling only under limited and rare circumstances. Loan rescheduling is not allowed as a means of delaying an imminent bad debt situation; a loan can be rescheduled solely if a genuine and acceptable reason can be demonstrated and the rescheduling terms must clearly show that the borrower is subsequently able to meet the loan repayments. During the year, loans disbursed to 40 (2012: 30) borrowers were rescheduled.

In 2013, loans were disbursed relating to 13 loan products with tenures ranging from 6 month to 15 years, in accordance with the needs of the borrowers. Loan repayments are scheduled monthly. The management estimates that average term of its loan portfolio is about 69 weeks [1.3 years] (2012: 65 weeks [1.25 years] ) based on disbursements made during the year.

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Measures related to the classification of late payments are referred to in note 3.4.


7.4 Current Recovery Ratio

Current recovery ratios are calculated and reported on a quarterly basis. The numerator of this ratio is total cash payments of principal received during the reporting period. The denominator is the total loans falling due during the period along with the payments in arrears at the start of the period. Penalty interest is not included in the numerator or the denominator of the ratio. Loan delinquency is measured using the Non Performing Loans (NPL) ratio.

Period Current recovery ratio in %

Dec 31, 2013 Current recovery ratio in

Dec 31, 2012

1st Quarter 98.20 98.17 2nd Quarter 97.40 98.68 3rd Quarter 94.30 98.04 4th Quarter 91.50 98.56

January - December 95.35 98.36

The loans are repayable in 69 weeks (1.3 year) on average computed on the basis of a sample of tenure of loans disbursed during the year.

Under these circumstances, a current recovery ratio of 95.35 percent for 69 week loans is approximately equivalent to an Annual Loss Rate (ALR) of 7.15 percent, considering the year end Portfolio at Risk (PAR) of 2.5% and high early repayments.

The calculation of Annual Loss Rate is based on the following formula.

ALR = [(1 - CR) / T] x 2 ALR = [(1 - 95.35) / 1.25] x 2

= 7.15%

Where:

ALR = Annual Loss Rate CR = Collection rate T = Loan term

7.5 Particulars of the provision Dec 31, 2013 Dec 31, 2012

AFN '000 AFN '000 Specific General Total Specific General Total

Opening 16,639 208,401 225,040 4,626 90,379 95,005

Charge / (reversal) for the year 55,055 78,189 133,244 12,157 118,022 130,179 Written off against provision* (4,328) (53,541) (57,869) (144) (144)

50,727 24,648 75,375 12,013 118,022 130,035

Closing 67,366 233,050 300,415 16,639 208,401 225,040

* Loans have been written off according to the CLRR issued by DAB but does not limit the Bank's right to follow up for these loans for outstanding principal.

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8. ADVANCES, PREPAYMENTS AND OTHER RECEIVABLES

Note Dec 31, 2013 AFN '000

Dec 31, 2012 AFN '000

Advances for procurement 1,001 351 Advances to staff 2,349 1,504 Other advances 751 4,852 Prepayments 30,151 22,748 Grant income receivable from MISFA 8,981 2,776 Grant income receivable from Kfw 5,753 Office supplies and stationery in inventory 3,616 2,898 Interest receivable 52,309 42,072 Other receivables 8.1 7,748 6,933 Less: Provision against identified financial frauds 8.2 (7,748) (6,933)

Penalties receivable from customers 135 Receivable from Roshan against M Paisa 1,863 6,483

106,774 83,819

8.1 This represents frauds identified during previous years and cash shortages identified during the year.

8.2 This represents provision against receivables related to identified frauds. These are now receivable from former staff members of the Bank and related customer's representatives involved in fraudulent activities.

Dec 31, 2013 AFN '000

Dec 31, 2012 AFN '000

Opening balance 6,933 6,793 Provision for the year 815 140 Written off during the year

Closing balance 7,748 6,933

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9. OPERATING FIXED ASSETS AND INTANGIBLE ASSETS

COS T ACCUMULATED DEPRECIATION WRITTEN DEPRE- DOWN VALUE CIATION

RATES As at Additions/ As at As at Charge for As at As at

January 1, (deletions) December 31, January 1, the year / December 31, December 31, Per Description Note 2013 2013 2013 (deletions) 2013 2013 annum

Operating fixed assets AFN '000

Leasehold improvements 36,056 6,602 40,336 29,641 3,425 31,763 8,573 20 (2,322) (1,303)

Furniture and fittings 22,684 6,625 28,296 19,585 2,206 21,141 7,155 20 (1,013) (650)

Vehicles 9,650 15,053 9,650 6,285 3,212 7,992 1,658 20 (15,053) (1,505)

Office equipment 44,460 8,807 45,748 33,637 5,335 32,376 13,372 25 9.1 (7,519) (6,596)

Computer equipment 40,948 11,568 46,764 37,006 3,818 36,088 10,676 33 (5,752) (4,736)

153,798 48,655 170,794 126,154 17,996 129,360 41,434 (31,659) (14,790)

Intangible assets

Computer software 20,309 90 20,399 17,299 1,263 18,562 1,837 20

2013 174,107 48,745 191,193 143,453 19,259 147,922 43,271 (31,659) (14,790)

9.1 Deletions during the year include items written off/disposal having cost of AFN 31.659 million (2012: 10.846 million), net book value of AFN 17.086 million (2012: 16.038 million).

Description

C 0 S T ACCUMULATED DEPRECIATION WRITTEN

DOWN VALUE

DEPRE- CIATION RATES

As at January 1,

Note 2012

Additions/ (deletions)

As at December 31,

2012

As at January 1,

2012

Charge for the year /

(deletions)

As at December 31,

2012

As at December 31,

2012 Per

annum

Operating fixed assets AFN '000 0/0

Leasehold improvements 34,777 1,279 36,056 25,735 3,906 29,641 6,415 20

Furniture and fittings 21,710 974 22,684 16,982 2,603 19,585 3,099 20

Vehicles 9,650 9,650 5,113 1,172 6,285 3,365 20

Office equipment 38,963 6,557 44,460 29,289 5,395 33,637 10,823 25 (1,060) (1,047)

Computer equipment 37,960 2,988 40,948 34,229 2,777 37,006 3,942 33

143,060 11,798 153,798 111,348 15,853 126,154 27,644 (1,060) (1,047)

Intangible assets

Computer software 20,201 108 20,309 16,067 1,232 17,299 3,010 20

2012 163,261 11,906 174,107 127,415 17,085 143,453 30,654 (1,060) (1,047)

Page: 16


10.

10.1

Note DEPOSITS

Deposits from customers Demand liabilities

Call and Current deposits

Dec 31, 2013 Dec 31, 2012 Number of AFN '000 Number of AFN '000 Accounts Accounts

Local currency 1,596 776,690 1,279 646,163 Foreign currency 1,034 1,961,151 825 1,913,128

Saving deposits 10.3 Local currency 51,732 585,752 46,762 465,074 Foreign currency 17,632 799,425 15,088 1,543,200

71,994 4,123,018 63,954 4,567,565 Time liabilities

Term deposits 10.4 Local currency 1 847,000 1 550,000 Foreign currency 3 1,160 3 1,150

4 848,160 4 551,150 71,998 4,971,178 63,958 5,118,715

Particulars of ownership Individual depositors 70,754 1,260,388 62,925 965,216 Institutional depositors/

Corporations/firms 1,244 3,710,790 1,033 4,153,499 71,998 4,971,178 63,958 5,118,715

10.2 Deposits from banks Term Deposits 10.4 1 300,000 1 300,000

10.5 71,999 5,271,178 63,959 5,418,715

10.3 The rate of interest on saving deposits ranges from 0% to 0.5% (2012: 0.5% to 3%)

10.4 The rate of interest on term deposits ranges from 0.6% to 3.86% (2012: 0.6% to 3.85%).

10.5 Deposits include AFN 1.4 billion (2012: AFN 1.1 billion) due to related parties.

gr

Page: 17


ACCRUED AND OTHER LIABILITIES

Note Dec 31, 2013 AFN '000

Dec 31, 2012 AFN '000

Performance bonus - employees 16,217 18,195 Withholding tax payable 10,528 12,212 Accrued expenses 53,820 24,118 Customer draw down accounts 11.1 181,043 165,229 Unspent balance of grants 9,497 Payable to AKAM 11.2 1,979 3,299 Other liabilities 18,607 2,326

282,194 234,876

11.1 These include amounts lying in the drawn down accounts of customers on account of un-utilized loan disbursements and amount of loan installments received in advance from customers.

11.2 This represents net amount payable to AKAM in respect microfinance loans recovered by the Bank under an agreement signed with AKAM as well as an amount due against staff insurance and FMSys outstanding invoices.

LONG-TERM LOANS

Note Dec 31, 2013 AFN '000

Dec 31, 2012 AFN '000

Ministry of Finance, Afghanistan 12.1 408,929 431,152 Microfinance Investment Support Facility for Afghanistan 12.2 1,950,000 1,450,000 Agence Francaise de Developpement 12.3 27,240 45,400 Nederlandse Financierings-Maatschappij Voor

Ontwikkelingslanden N.V. 12.4 146,314 228,319 Interest payable on long term loans 29,363 21,214

2,561,846 2,176,085

Maturity within one year 151,787 143,602 Maturity after one year 2,410,059 2,032,483

2,561,846 2,176,085

12.1 A 15-year credit line of AFN 222 million was extended by the Ministry of Finance - Afghanistan on behalf of KfW under the financing and project agreement signed in November 2005. The facility was disbursed in 3 tranches carrying financial charges at the rate of 7.678% per annum, 7.482% per annum and 6.356% per annum. These rates were revised during 2010 to 2.558% per annum, 2.518% per annum and 2.426% per annum respectively. Loan is repayable through 20 bi-annual installments, starting from November 17, 2010. A 15-year credit line of Euro 4 million in local currency was extended by the Ministry of Finance - Afghanistan on behalf of KfW under the financing and project agreement signed in March 2009. The facility was availed on May 21, 2011 at an annual interest rate of 5% per annum payable in arrears. This loan is repayable through 20 bi-annual installments, starting from June 30, 2016. During the year an amount of AFN 22, 222 thousands was repaid (2012: AFN 22, 223 thousands).

12.2 On October 2, 2010 Microfinance Investment Support Facility for Afghanistan (MISFA) and the Bank signed an agreement, under which MISFA consolidated all the loans provided to FMFB to an aggregate amount of AFN 950 million for a period of ten years. This loan agreement carries financial charges at the rate of 5% per annum with effect from July 1, 2010. Loan is repayable through 20 quarterly installments, starting from September 1, 2015. On 17 June 2012 MISFA and the Bank signed a further loan agreement for an amount of AFN 500 million carrying financial charges of 6% per annum. This loan is repayable through 20 quarterly installments, starting from June 30, 2017, and was fully drawn in 2012. The total loan facilities from MISFA of AFN 1.45 billion are supported by promissory notes issued by the Bank to MISFA. As security for these promissory notes the Bank has assigned all rights and interests in the whole or such portion of the Bank's loan portfolio as MISFA may select in its sole discretion up to the amount of the loans outstanding under the loan agreements.

Page: 18

11.

12.


12.3 A credit facility agreement in Afghanis for an amount equivalent to Euro 1 million, was extended by Agence Frangaise de Developpement (AFD) in July 2007. This facility carries interest rate of 3.5 % + Libor (2012: 3.5 % + Libor) per annum. Loan is repayable through 8 bi-annual installments, starting from September 30, 2011. During the year an amount of AFN 18, 160 thousands was repaid (2012: AFN 18, 160 thousands).

12.4 A 10-year sub-ordinated credit facility in Afghanis for AFN 150 million and 7-year credit facility for AFN 302 million was extended by Nederlandse Financierings-Maatschappij Voor Ontwikkelingslanden N.V. (FMO) under agreements signed with the Bank in February 2007. These fully drawn facilities carry financial charges of 3.5% and 1.5% per annum respectively plus the weighted average rate for the 5 latest 28 days Capital notes as auctioned by Da Afghanistan Bank. Loans are repayable through 14 bi-annual installments, starting from April 15, 2011 and 10 bi-annual installments, starting from April 15, 2010 respectively. During the year an amount of AFN 82,006 thousands was repaid (2012: AFN 82,005 thousands).

13. DEFERRED TAX LIABILITY

This represents deferred tax liability related to taxable temporary difference arising on accelerated tax depreciation.

Dec 31, 2013 AFN '000

Dec 31, 2012 AFN '000

Opening Balance 4,416 3,409 Deferred tax arising on the accelerated tax depreciation 5,193 Reversal of temporary difference (3,229) (4,186) Closing Balance 1,187 4,416

14. DEFERRED GRANT

This represents the cost of fixed assets purchased by the Bank in respect of Khana grant.

Dec 31, 2013 AFN '000

Dec 31, 2012 AFN '000

Opening Balance 2,432 3,225 Addition 249 164 Amortization for the year (519) (957)

2,162 2,432

SHARE CAPITAL

Authorized 15,717,600 $ 8,880,000

88,800 ordinary shares of US $ 177 each (2012: 88,800 of US $ 100)

Issued, subscribed and paid-up 88,288 ordinary shares of US $ 177 each (2012; 88,288 of US $ 100) fully paid in cash as follows: 15,626,976 $ 8,288,000

AFN '000 AFN '000

Aga Khan Agency for Microfinance (AKAM) 34,784 ordinary shares of US $ 177 each (2012: 34,784 of US $ 100) 310,646 171,156

Kreditanstalt fur Wiederaufbau (KfW) 28,200 ordinary shares of US $ 177 each (2012:28,200 of US $ 100) 254,811 141,725

International Finance Corporation (IFC) 14,800 ordinary shares of US $ 177 each (2012: 14,800 of US $ 100) 133,974 74,624

Aga Khan Foundation USA (AKF USA) 10,504 ordinary shares of US $ 177 each (2012: 10,504 of US $ 100) 96,577 54,454

796,008 441,959

15.

Page: 19


15.1 CAPITALISATION RESERVE

Pursuant to letter no.918/703 dated May 17, 2010 issued by Da Afghanistan Bank (DAB), all commercial banks in Afghanistan were required to increase their paid-up capital to AFN 1 billion (equivalent to US $ 20 million) by 30 June, 2012. During year 2012, the Bank issued 28,800 shares having par value of US $ 100 per share at a premium of US $ 138 per share (US $ 6.9 million converted to AFN 355.3 million at the rate of AFN 51.84 per US $) for cash and these shares were fully subscribed by the shareholders by December 31, 2012. This injection of capital brought the paid-up capital to AFN 648 million including share premium of AFN 206 million. DAB agreed with the Bank that the balance of this paid up capital requirement can be met by way of capitalisation of retained earnings. Consequently, an amount of AFN 354 million was set aside from retained earnings to a capitalisation reserve as at December 31, 2012. The formal completion of this capitalisation of earnings took place by Feb 15, 2013 increasing the par value of shares form US$ 100 to US$ 177.

16. SHARE PREMIUM Dec 31, 2013 Dec 31, 2012

AFN '000 AFN '000

In 2012, 28,800 new ordinary shares of US$ 100 each were issued at a premium of US$ 138 per share.

206,038 206,038

17. CONTINGENCIES AND COMMITMENTS

Commitments For disbursements Loans pending disbursement under signed contracts Bank guarantees issued

156,859

1,140,150 127,804

1,140,150 284,663

INTEREST AND SIMILAR INCOME

Interest income on:

Dec 31, 2013 AFN '000

Dec 31, 2012 AFN '000

Microfinance loans 881,212 792,144 Loans to small and medium size enterprises

159,359 126,074

Short term placements with other banks 36,669 22,129 Late payment of installments 41,693 29,458

1,118,933 969,805

INTEREST EXPENSE

Interest expense on: Borrowings from other banks/financial institutions 125,070 91,837 Deposits from customers 49,313 47,500

174,383 139,337

FEE AND COMMISSION INCOME

Loan processing fee 57,334 58,028 Bank charges related to foreign remittances and other services 23,183 20,857

80,517 78,885

18.

19.

20.

Page: 20


ADMINISTRATIVE EXPENSES

Note Dec 31, 2013 AFN '000

Dec 31, 2012 AFN '000

Staff salaries and benefits 483,131 414,086 Consultancy fee 3,569 5,618 Office services fee 282 293 Office rent 30,121 24,651 Communication 20,617 18,454 Depreciation / amortization 18,740 16,127 System maintenance 12,865 3,956 Generator fuel and maintenance 16,999 19,219 Insurance 7,909 4,164 Legal, professional and statutory fee 5,246 5,048 Audit fee 2,546 2,032 Office security 98,810 74,156 Office stationery and supplies 9,413 10,035 Other operating expenses 5,027 2,893 Repairs and maintenance 4,568 2,528 Travel and transportation 44,174 40,542 Director's traveling 188 559 Trainings 2,583 3,047 Utilities 6,584 5,919 Marketing and promotional expenses 1,483 2,139 Grant expenditure written off 6,817

781,672 655,466

21.1 Included in above are reimbursable expenses of AFN 2,602,424 (2012: AFN 3,495,021), incurred for providing services of follow-up and recovery of loan portfolio related to AKAM.

Note Dec 31, 2013 AFN '000

Dec 31, 2012 AFN '000

GRANTS

Grants Recognised as Income Grants from: United States Agency for International Development

(KHANA) 22.2 3,973 4,180 Microfinance Investment Facility for Afghanistan (MISFA) 22.3 27,069 18,670 Ministry of Finance -KFW 5,753

36,795 22,850

Amortisation of deferred grants 14 519 957 37,314 23,807

22.2 This represents grant received from USAID under a cooperation agreement signed between USAID and the Bank in 2009 under which USAID would cooperate with the Bank in development of its housing microfinance product by contributing 50% in advisory service package estimated to be US $ 500,000 (AFN 26,584,775).

22.3 This represents grant received from MISFA under an agreement signed on 16th August 2011 to increase access to finance for the rural poor in Afghanistan, specifically to strengthen the Bank's capacity to research, develop and deliver appropriate rural and agricultural financial products and services.

21.

22

22.1

Page: 21


22.4 Income from grants

Staff salaries and benefits Travel and transportation Consultancy fee Training fee Printing and Stationary Depreciation

Dec 31, 2013 AFN '000

4,156

Dec 31, 2012 AFN '000

3,316 1,281

17,294 692 267 957

23,807

31,058 1,047

534 519

37,314

22.5 The Bank has not received any in-kind donations during the year.

Dec 31, 2013 Dec 31, 2012 AFN '000 AFN '000

23. TAXATION Current Deferred Prior

35,317 (3,229)

36,078 1,007 3,054

40,139

32,088

23.1 Applicable tax rate is 20% (2012: 20%).

24. EARNINGS PER SHARE

Dec 31, 2013 Dec 31, 2012

Profit after taxation (AFN in thousands)

163,629

165,763 Weighted average number of ordinary shares (numbers)

88,288

88,288 Basic earning per share (AFN in thousands)

1.853

1.878

25. RELATED PARTY TRANSACTIONS

Following is the list of related parties of the Bank:

Shareholders Aga Khan Agency for Microfinance (AKAM) Kreditanstalt fur Wiederaufbau (KfW) International Finance Corporation (IFC) Aga Khan Foundation-USA (AKF-USA)

Associated companies Institutions of various agencies of the Aga Khan Development Network, KfW and IFC.

Key Management Personnel Key management personnel relates to the Bank's Management Board comprised of CEO, CFO, CIO and CRO.

The related-party transactions during the year and outstanding balances at the year-end are as follows:

Note Dec 31, 2013 Dec 31, 2012 AFN '000 AFN '000

(a) Balances with related parties

Key Management Personnel Deposits as at December 31

Shareholders and Associated Companies Deposits as at December 31 Grant income receivable (Payable to)/ Receivable from AKAM Bank balances with related parties Short term placements with related parties

6,017 13,915

1,483,570 1,788,237

11.2 (1,979) (3,299)

289,946 348,057

1,943,875 1,079,850

Page: 22


(b) Transactions with related parties

Key Management Personnel

Note Dec 31, 2013 AFN '000

Dec 31, 2012 AFN '000

Salary and Benefits- Management Board 56,206 34,804

Shareholders and Associated Companies Interest expense on deposits 11 7 Interest income on placements 11,584 2,022 Fee and commission income 7,161 11,643 Fee and commission expense 245 210 Share subscription- AKAM 51,623 Share subscription- KfW 114,894 Share subscription- IFC 59,224 Share subscription- AKF-USA 129,601 Costs incurred for AKAM loan recovery reimbursed 2,522 3,495

26. CASH AND CASH EQUIVALENTS

Cash in hand and balances with DAB 4 1,904,780 1,671,393 Balances with other banks 5 758,702 2,171,754 Short term placements with other banks 6 2,624,691 1,079,850

5,288,173 4,922,997

'Iv

Page: 23


27. ANALYSIS OF STATEMENT OF FINANCIAL POSITION

Note

Financial Assets

Interest bearing

Upto one Over one Over six Over one Over five month month upto months upto year upto years Total Total

six months one year five years Dec 31, 2013 Dec 31, 2012 AFN ' 000

Balances with DAB 4.1 400,421 680,816 1,081,237 627,468 Loans and advances to customers 7 472,679 1,836,748 1,299,522 685,964 62,440 4,357,353 4,243,334 Provision against loans and

advances to customers 7 (32,588) (126,633) (89,595) (47,293) (4,306) (300,415) (225,040) Short term investment - held to

maturity 6.1 1,943,875 1,943 875 1,079,850

Non-interest bearing Cash in hand and transit 4 296,369 296,369 300,502 Balance with DAB 4 1,207,990 1,207,990 743,423 Balances with other banks 5 758,702 758,702 2,171,754 Advances and other receivables 8 9,580 52,309 14,734 76,623 52,971

Total financial assets 5,057,028 2,443,240 1,224,661 638,671 58,134 9,421,734 8,994,262

Prepayments other receivables 8 30,151 30,151 30,848

Operating fixed assets 9 41,434 41, 434 27,644

Intangible assets 9 1,837 1,837 3,010

Total Assets 5,130,450 2,443,240 1,224,661 638,671 58,134 9,495,156 9,055,764

Financial Liabilities

Interest bearing Deposits 10 1,385,178 597,336 550,823 2,533,337 2,859,425 Long term loan 12 27,095 63,462 61,230 1,181,589 1,228,470 2,561,846 2,176,085

Non-Interest bearing Deposits 10 2,737,841 2,737,841 2,559,290 Income Tax Payable 29,596 29,596 35,876 Accrued and other liabilities 11 240,343 23,963 11,024 6,864 282,194 234,876

Total financial liabilities 4,390,457 714,357 623,077 1,188,453 1,228,470 8,144,814 7,865,552

Deferred Income Tax 13 2,162 2,162 2,432 Deferred grants 14 1,187 1,187 4,416

Net assets 736,644 1,728,883 601,584 (549,782) (1,170,336) 1,346,993 1,183,364

Page: 24


28. FINANCIAL RISK MANAGEMENT

The Bank's activities expose it to a variety of financial risks and those activities involve the analysis, evaluation, acceptance and management of some degree of risk or combination of risks. Taking risk is core to the financial business, and the operational risks are an inevitable consequence of being in business. The Bank's aim is therefore to achieve an appropriate balance between risk and return and minimize potential adverse effects on the Bank's financial performance.

The Bank's risk management policies are designed to identify and analyse these risks, to set appropriate risk limits and controls, and to monitor the risks and adherence to limits by means of reliable and up-to-date information systems. The Bank regularly reviews its risk management policies and systems to reflect changes in markets, products and emerging best practices.

Risk management is carried out by the Asset Liability Committee (ALCO) under policies approved by the Board of Supervisors. ALCO identifies, evaluates and hedges financial risks in close co-operation with the Bank's operating units. The Board provides written principles for overall risk management, as well as written policies covering specific areas, such as liquidity risk, foreign exchange risk, interest rate risk and credit risk. In addition, Internal Audit is responsible for the independent review of risk management and the control environment. The most important types of risks are credit risk, liquidity risk, market risk and other operational risk. Market risk includes currency risk, interest rate risk and other price risk.

28.1 Credit risk

The Bank takes on exposure to credit risk, which is the risk that a counterparty will cause a financial loss for the Bank by failing to discharge an obligation. Credit risk is the most important risk for the Bank's business; management therefore carefully manages its exposure to credit risk. Credit exposures arise principally in lending activities that lead to loans and advances into the Bank's asset portfolio. The credit risk management and control are managed through the credit policies of the Bank which are updated regularly. The Bank is also exposed to other credit risks arising from short term placements and balances with other banks which are controlled through board approved counterparty limits.

28.1.1 Credit risk measurement

In measuring credit risk of loan and advances to customers and to banks at a counterparty level, the Bank reflects three components (i) the 'probability of default' by the client or counterparty on its contractual obligations; (ii) current exposures to the counterparty and its likely future development, from which the Bank derives the 'exposure at default'; and (iii) the likely recovery ratio on the defaulted obligations (the 'loss given default').

28.1.2 Risk limit control and mitigation policy

The Bank manages, limits and controls concentrations of credit risk wherever they are identified — in particular, to individual counterparties and groups.

The Bank structures the levels of credit risk it undertakes by placing limits on the amount of risk accepted in relation to one borrower or counterparty. Such risks are monitored on a revolving basis and subject to an annual or more frequent review, when considered necessary.

Exposure to credit risk is also managed through analysis of the ability of borrowers and potential borrowers to meet interest and capital repayment obligations at the time of loan appraisal for initial and subsequent loans.

28.1.3 Impairment and provisioning policies

Management assess the existence of impairment, based on the following criteria set out by the Bank:

i) Delinquency in contractual payments of principal or interest; ii) Cash flow difficulties experienced by the borrower; iii) Breach of loan covenants or conditions; iv) Deterioration in the value of collateral.

Page: 25


28.1.4 Maximum exposure to credit risk before collateral held or other credit enhancements and provisions

Credit risk exposures relating to on-balance sheet assets are as follows:

Maximum exposure

Dec 31, 2013 AFN '000

Dec 31, 2012 AFN '000

Balances with other banks 758,702 2,171,754 Short term placements with other banks 1,943,875 1,079,850 Loans and advances to customers

Microfinance customers 3,621,544 3,633,320 Small and medium enterprises 735,809 610,014

4,357,353 4,243,334 Advances and other receivables 76,623 52,971

7,136,553 7,547,909

The above table represents a worst case scenario of credit risk exposure to the Bank at December 31, 2013 and 2012, without taking account of any collateral held or other credit enhancements attached. For on balance sheet assets, the exposures set out above are based on net carrying amounts as reported in the statement of financial position.

28.1.5 Loans and advances are summarised as follows:

Dec 31, 2013 Dec 31, 2012 Loans to small Loans to small

Microfinance and medium Microfinance and medium loans enterprises loans enterprises

AFN '000 AFN '000 AFN '000 AFN '000

Neither past due nor impaired 3,531,132 719,094 3,614,833 595,103 Past due but not impaired 90,412 16,715 18,487 14,911 Gross 3,621,544 735,809 3,633,320 610,014 Less: allowance for impairment 228,384 72,031 183,281 41,759 Net 3,393,160 663,778 3,450,039 568,255

28.1.6 Concentration of risks of financial assets with credit risk exposure

(a) Geographic sectors

The following table breaks down the Bank's main credit risk exposure relating to on balance sheet assets at their carrying amounts, as categorized by the geographic sectors of the Bank's counterparties.

Afghanistan AFN '000

Europe AFN '000

America AFN '000

Total AFN '000

Balances with other banks 29,313 439,443 289,946 758,702 Short term placements with other banks 1,468,925 474,950 1,943,875 Microfinance loans 3,621,544 - - 3,621,544 Loans for small and medium enterprises 735,809 735,809 Advances and other receivables 76,314 309 76,623 As at December 31, 2013 5,931,905 439,443 765,205 7,136,553

As at December 31, 2012 6,368,426 2,202,317 348,057 8,918,800

Page: 26


(b) Industry sectors

The following table breaks down the Bank's main credit risk exposure relating to on balance sheet assets at their carrying amounts, as categorized by the industry sectors of the Bank's counterparties.

Financial Others Individuals Total AFN '000 AFN '000 AFN '000 AFN '000

Balances with other banks Short term placements with other banks

758,702 1,943,875

758,702 1,943,875

Microfinance loans - - 3,621,544 3,621,544 Loans for small and medium enterprises - 735,809 735,809 Advances and other receivables 798 75,825 76,623 As at December 31, 2013 2,703,375 4,433,178 7,136,553

As at December 31, 2012 2,011,853 4,295,722 6,307,574

28.2 Market risk

The Bank takes on exposure to market risks, which is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. Market risks arise from open positions in interest rate and currency, all of which are exposed to general and specific market movements and changes in the level of volatility of market rates or prices such as interest rates, credit spreads and foreign exchange rates. The Bank's exposure to market risk is only on non-trading portfolios.

The market risks arising activities are concentrated and mitigated by the Bank's ALCO.

Page: 27


28.3 Foreign exchange risk

The Bank takes on exposure to the effects of fluctuations in the prevailing foreign currency exchange rates on its financial position and cash flows. The table below summarises the Bank's exposure to foreign currency exchange rate risk at December 31, 2013 Included in the table are the Bank's financial instruments at carrying amounts, categorised by currency presented in AFN.

If the functional currency, at the year end date, fluctuates by 5% against the USD and EUR with all other variables held constant, the impact on profit after taxation for the year would have been AFN 14,325 thousands and AFN 405 thousands (2012: AFN 12,154 thousands and AFN 482 thousands) respectively higher/lower, mainly as a result of exchange gains/losses on translation of foreign exchange denominated receivables and payables. As of the year end, excluding off balance sheet items, the Bank had a total on-balance sheet positive net open foreign currency position of AFN 286,507 thousands (2012: AFN 315,900 thousands negative).

Total Foreign USD EUR Currency AFN '000 TOTAL Converted to AFN ' 000 AFN '000

On-balance sheet items

As at December 31, 2013

Assets Cash and balances with central

banks Balances with other Banks Short-term placements with other

banks Loans and advances to customers Advances and other receivables Total financial assets

341,604 74,297 415,901 2,169,695 2,585,596 308,948 424,684 733,632 25,070 758,702

1,260,225 383,650 1,643,875 300,000 1,943,875 286,357 - 286,357 3,770,581 4,056,938

9,356 143 9,499 67,125 76,623 2,206,490

882,774

3,089,264

6,332,471

9,421,734

1,887,056 874,679 2,761,736 2,509,442 5,271,178 41,021 41,021 241,173 282,194

- - - 2,561,846 2,561,846 1,928,077 874,679 2,802,757 5,312,461 8,115,218

278,413 8,095 286,507 1,020,010 1,306,516

840,150 840,150 300,000 1,140,150

1,747,451 2,053,025 3,800,475 5,423,084 9,223,559 1,443,896 2,040,971 3,484,866 4,380,687 7,865,553

303,555

12,054

315,609 1,042,397

1,358,006

Liabilities Customers' deposits Accrued and other liabilities Long term loan Total financial liabilities

Net on-balance sheet financial position

Off-balance sheet items

Loans pending disbursement under signed contracts

Bank guarantees issued

As at December 31, 2012 Total financial assets Total financial liabilities Net on-balance sheet financial

position

Page: 28


28.4 Interest rate risk

Cash flow interest rate risk is the risk that the future cash flows of a financial instrument will fluctuate because of changes in market interest rates. Fair value interest rate risk is the risk that the value of a financial instrument will fluctuate because of changes in market interest rates. The Bank takes on exposure to the effects of fluctuations in the prevailing levels of market interest rates on both its fair value and cash flow risks. Interest margins may increase as a result of such changes but may reduce losses in the event that unexpected movements arise.

If interest rates on variable rate assets and liabilities, at the year end date, fluctuates by 1% higher/lower with all other variables held constant, profit after taxation for the year would have been AFN 7,842 thousands approx. ( 2012: AFN 19,682 thousands approx.) lower/higher.

The table below summarises the Bank's exposure to interest rate risks. It includes the Bank's financial instruments at carrying amounts, categorised by the earlier of contractual repricing or maturity dates:

Interest Bearing Non-

Contractual Up to1 1-6 6 months to 1-5 Over 5 interest exposure month months 1 year years years bearing Total

AFN '000 As at December 31, 2013

Assets

Cash and balances with central banks Variable 1,561,394 343,386 1,904,780

Balances with other Banks 758,702 758,702

Short-term placements with other banks Fixed 2,624,691 2,624,691

Loans and advances to customers Fixed 472,679 1,836,748 1,299,522 685,964 62,440 4,357,353

Provision against loans and advances to customers (32,588) (126,633) (89,595) (47,293) (4,306) (300,415)

Advances and other receivables 9,580 52,309 14,734 30,151 106,774

Total financial assets 4,635,756 2,105,810 1,224,661 638,671 58,134 788,853 9,451,885

Liabilities

Customers' deposits Variable 1,385,178 597,336 550,823 2,737,841 5,271,178

Accrued and other liabilities 240,343 23,963 11,024 6,864 282,194

Long term loan Variable 11,111 11,111 168,236 218,470 408,928

Long term loan Fixed 27,095 52,351 50,119 1,013,353 1,010,000 2,152,918

Total financial liabilities 1,652,616 684,761 623,077 1,188,453 1,228,470 2,737,841 8,115,218

Net financial exposure 2,983,140 1,421,049 601,584 (549,782) (1,170,336) (1,948,988) 1,336,667

Total interest repricing gap Variable 176,216 (265,061) (561,934) (168,236) (218,470) (1,037,485)

Total interest gap Fixed 3,070,275 1,784,397 1,249,403 (327,389) (947,560) 4,829,126

3,246,491 1,519,336 687,469 (495,625) (1,166,030) 3,791,641

As at December 31, 2012

Total financial assets 2,116,515 1,799,402 1,307,448 695,646 31,639 8,994,262

Total financial liabilities 2,008,274 61,585 911,954 865,342 1,167,141 7,601,648

Net financial exposure 108,241 1,737,817 395,494 (169,694) (1,135,502) 936,356

Page: 29


28.5 Liquidity risk

Liquidity risk is the risk that the Bank is unable to meet its payment obligations associated with its financial liabilities when they fall due and to replace funds when they are withdrawn. The consequence may be the failure to meet obligations to repay depositors and fulfil commitments to lend. Accordingly, The Bank needs to reduce the exposure to the risk that depositors demand for repayment may outstrip its ability to transform assets into cash, be able to meet its obligations as they fall due, conduct its business in a prudent manner not only in a financial sense but also to protect the Bank's reputation and that of its shareholders and to maintain adequate liquidity at all times. It is essential that the Bank has ample funding capacity, strong liquidity management, market perception, earnings and asset quality to maintain a mix of sources of liquidity.

Liquidity risk management process

The Bank's liquidity management process, as carried out within the Bank and monitored by the ALCO includes:

i) Day-to-day funding, managed by monitoring future cash flows by currency and business segment to ensure that requirements can be met, expressed through a maturity mismatch approach within different time bands on a maturity ladder. The Board approves the agreed level of mismatch within the different time bands.

ii) Maintaining a portfolio of highly marketable assets and/or standby credit lines that can easily be liquidated/drawn as protection against any unforeseen interruption to cash flow.

iii) Monitoring balance sheet liquidity ratios against internal and regulatory requirements.

iv) Managing the concentration and profile of deposit and debt maturities.

Monitoring and reporting take the form of cash flow measurement and projections by currency and business segment for the next day, week and month respectively, using the maturity mismatch approach outlined above, as these are key periods for liquidity management. The starting point for these projections is an analysis of the contractual maturity of the financial liabilities and the expected collection date of the financial assets. The Bank also monitors unmatched medium-term assets, the level and type of un-drawn lending commitments. Sources of liquidity are regularly reviewed by the ALCO to maintain a wide diversification by currency, provider, product and term.

28.6 Non-derivative cash flows

The table below presents the cash flows payable by the Bank under non-derivative financial liabilities by remaining contractual maturities at the balance sheet date. The amounts disclosed in the table are the contractual undiscounted cash flows.

As at December 31, 2013 Note

Up to 1 month

1-6 months

6 months 1-5 to 1 year years

AFN ' 000

Over 5 years Total

Total financial liabilities (contractual maturity dates)

27 4,390,457 714,357 623,077 1,188,453 1,228,470 8,144,814

Total financial assets (expected maturity dates)

27 5,057,028 2,443,240 1,224,661 638,671 58,134 9,421,734

As at December 31, 2012 Total financial liabilities (contractual maturity dates)

4,818,042 100,749 914,279 865,342 1,167,141 7,865,553

Total financial assets (expected maturity dates)

5,359,978 1,707,021 1,236,383 657,835 33,044 8,994,262

Assets available to meet all liabilities and to cover outstanding loan commitments include cash and balance with central bank, balances with other banks, short term placements with other banks and loans and advances to customers.

Carrying amounts of the financial instruments are taken as approximation of fair value.

Page: 30


28.7 Capital management

The Bank's objectives when managing capital, which is a broader concept than the 'equity' on the face of the statement of financial position, are:

i) to comply with the capital requirements set by DAB (refer note 15.1 for the steps taken by the Bank to raise the paid-up capital to AFN 1 billion.

ii) to safeguard the Bank's ability to continue as a going concern so that it can continue to be self-sustainable; and

iii) to maintain a strong capital base to support the loan portfolio outreach.

Capital adequacy and the use of regulatory capital are monitored regularly by the Bank's management. DAB requires each bank to maintain its Tier 1 Capital ratio and Regulatory Capital ratio to be at least 6 )̀/0 and 12 % respectively. The Bank's policy is to maintain these ratios well above the required level.

The table below summarises the composition of the regulatory capital and ratio of the Bank:

Regulatory Capital Worksheet

Tier 1 (Core) Capital:

Dec 31, 2013 AFN ' 000

Dec 31, 2012 AFN ' 000

Total equity capital 1,346,993 1,183,364 Minus: Profit for the year 163,629 165,763 Intangible assets 1,837 3,010

1,181,527 1,014,591

Tier 2 (Supplementary) Capital:

General loss reserves on credits as per DAB's capital regulation 56,230 55,589

Subordinated debt 85,697 107,121 Profit for the year 163,629 165,763

305,556 328,473

Regulatory Capital = Tier 1 + Tier 2 1,487,083 1,343,064

Risk-Weight Categories

0% Risk Weight:

Cash in Afghani and Fully-convertible Foreign Currencies 296,369 241,277 Direct Claims on DAB 2,289,227 1,370,892

2,585,596 1,612,169

0% Risk-Weight Total (Above Total x 0%)

Page: 31

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