Market risk management encompasses all activities in connection with Bank Austria Creditanstalt’s treasury operations and management of the balance sheet structure in Vienna and at Bank Austria Creditanstalt’s subsidiaries. Risk positions are aggregated at least daily, analysed by the independent risk management unit and compared with the risk limits set by the Managing Board and the committees (including MARALCO) set up by the Managing Board. At Bank Austria Creditanstalt, market risk management includes ongoing reporting on the risk position, limit utilisation, and daily presentation of results of the treasury operations.

The Managing Board of Bank Austria Creditanstalt sets risk limits for market risk activities of the entire Bank Austria Creditanstalt Group at least once a year. MARALCO, which as a rule meets on a monthly basis, and the MARALCO subcommittee, which holds a meeting every week, make limit decisions at the operational level and analyse the risk and earnings positions of Bank Austria Creditanstalt’s business units. The decisions and results of these committees are reported directly to the bank’s full Managing Board. Strategic Risk Management, an independent unit separated from the business units up to Managing Board level, is in charge of preparing analyses and monitoring compliance with limits. The principles and organisational framework have been laid down in the market risk management manual and in the bank’s MARALCO policy.

Bank Austria Creditanstalt uses uniform risk management procedures throughout the Group. These procedures provide aggregate data and make available the major risk parameters for the various trading operations at least once a day. Besides Value at Risk (VaR; for internal risk measurement on the basis of a one-day holding period and a confidence interval of 2.33 standard deviations), other factors of equal importance are stress-oriented volume and position limits. Additonal elements of the limit system are stop-loss limits and options-related limits applied to trading and positioning in non-linear products. Bank Austria Creditanstalt’s risk model (“NoRISK”) was developed by the bank itself and has been used for several years. The model is applied and further refined by the Strategic Risk Management unit. Refinement work includes regularly reviewing the model as part of backtesting procedures, integrating new products, implementing requirements specified by the Managing Board and by MARALCO, and adjusting the system to general market developments. In this context a product introduction process has been established in which the risk management unit plays a decisive role in approving a new product.

Regular and specific stress scenario calculations complement the information provided to MARALCO and the Managing Board. Such stress scenarios are based on assumptions of extreme movements in individual market risk parameters. The bank analyses the effect of these fluctuations and a liquidity disruption in specific products and risk factors on the bank’s results and net asset position. These assumptions of extreme movements are dependent on currency, region and liquidity and are set by Strategic Risk Management on a discretionary basis. The results of these stress tests are taken into account in establishing limits.

In addition to the risk model results, income data from market risk activities are also determined and communicated on a daily basis. These data are presented over time and compared with current budget figures. Reporting covers the components reflected in IFRS /IAS-based net income and the marking to market of all investment positions regardless of their recognition in the IFRS/IAS-based financial statements (“total return”). Since the beginning of 2004, the results have been available to Bank Austria Creditanstalt’s trading and risk management units via the access-protected Intranet application “ERCONIS”, broken down by portfolio, income statement item and currency.

In 2003, “MARCONIS”, an application fully integrated in market risk management, was developed to enable Bank Austria Creditanstalt to completely and systematically review the market conformity of its trading transactions. The testing of the function of “MARCONIS” was successfully completed at the end of 2003 and the system has been used in Vienna since the beginning of 2004.

Since 1998 Bank Austria Creditanstalt has used its “NoRISK” risk model, which was approved by the supervisory authorities. In contrast to the internal risk management process, the computation of capital requirements takes into account the statutory parameters (2.33 standard deviations, 10-day holding period) and additionally the multiplier determined as part of the model review is applied. The regulatory model applied throughout the Group currently comprises the risk categories interest rate risk, exchange rate risk and equity position risk. For regulatory purposes, the model covers the specific equity position risk, and the standard method is used for determining the capital requirements for the specific interest rate position risk. In 2004, Bank Austria Creditanstalt plans to extend the model to cover specific risk on interest rate instruments as well as adding a simulation calculation to the current variance/covariance approach.

The results of the internal model based on VaR (1 day, 2.33 standard deviations) for 2003 roughly matched the previous year’s results despite strong fluctuations. The VaR for the Bank Austria Creditanstalt Group ranged between € 10 m and € 40 m, the average was € 21.5 m (2002: € 22.5 m, 2001: € 20.6 m). Interest rate risk accounted for most of this total, with more than half of the amount for interest rate risk relating to Bank Austria Creditanstalt’s medium-term to long-term positions resulting from asset/liability management. CEE units account for less than 20%. The increase in VaR towards the middle of the year was mainly attributable to our positioning and to interest rate increases in the euro and the US dollar. Strong interest rate movements in Poland and especially Hungary in October and November 2003 led to a comparatively lower increase in risk because of more moderate positions.

VaR of the Bank Austria Creditanstalt Group by risk category (in € m)

In addition to VaR, risk positions of the Bank Austria Creditanstalt Group are limited through volume limits, which are set for each pair of currencies, each equity instrument and each country or issuer, and monitored on an ongoing basis. Interest rate positions, which are the predominant factor in the Bank Austria Creditanstalt Group’s risk profile, are managed through the presentation and limitation of “basis point values”, in addition to VaR. For all currencies and maturity bands, the valuation result for a change of one basis point (0.01%) is indicated. As at 31 December 2003, the entire interest rate position of the Bank Austria Creditanstalt Group (trading and investment) for major currencies was composed as follows:

Basis point values of the Bank Austria Creditanstalt Group (31 December 2003, in €)

In 2003, the Bank Austria Creditanstalt Group’s positions focused on the euro, the US dollar and the Swiss franc. Positions in Central and East European currencies, though reflecting the Group’s activities in this region, are at a relatively lower level.

In addition to trading in interest-rate, foreign-currency and equity products, the International Markets segment also comprises trading and investment in emerging markets bonds (“EMI”) and, since the end of 2003, trading in high-yield corporate bonds below investment grade. At the end of 2003, Latin America accounted for 46% of the emerging markets portfolio, CEE countries represented 17% of the total volume, Asia 15% and Russia 12%. At present the average rating of the high-yield portfolio is B.

Bank Austria Creditanstalt has invested in hedge funds through its subsidiary Bank Austria Cayman Islands since 1999. In addition to equity investments and debt finance, these investments focus on convertible arbitrage and, to a considerably smaller extent, on distressed securities. Returns on these investments over the past few years have ranged between 7% p.a. and 10% p.a. During the entire period, only three months showed a negative monthly performance, with a maximum of –0.8%. The investment guidelines define major risk parameters. Compliance with the investment guidelines and daily reviews of valuation results are ensured by the risk management unit at Bank Austria Cayman Islands within central risk management guidelines laid down in Vienna.

Bank Austria Creditanstalt’s risk model is subjected to daily backtesting in accordance with regulatory requirements. The model results are compared with changes in value on the basis of actually observed market fluctuations. As the number of backtesting excesses (negative change in value larger than model result) has been within the “green zone” ever since the model was introduced, the multiplier need not be adjusted. In 2003 there was no backtesting excess.

At Bank Austria Creditanstalt, market risk management covers the activities in Vienna and the positions at the bank’s subsidiaries, especially in Central and Eastern Europe. These subsidiaries have local risk management units with a reporting line to Strategic Risk Management. The “NoRISK” risk model has been implemented at major units. Calculations for smaller units are performed centrally, and the risk calculation results are made available to these units. Uniform processes and limit systems ensure uniform risk management procedures adjusted to local conditions.

Splitting net interest income into a terms-related contribution allocated to the business divisions and a contribution from maturity transformation reflecting the results of interest rate risk creates the basic conditions for uniform centralised management of all market risks, including in particular customer and proprietary positions for which interest rates have not been locked in. Bank Austria Creditanstalt’s profit centres are released from any market risk through a matched funds transfer pricing system applied throughout the Group. If there are no interest rate lock-in arrangements, or if the bank can assume – on the basis of past experience – that the actual interest-rate and capital lock-in will differ significantly from contractual arrangements, the assumptions in respect of investment period and interest rate sensitivity are modelled accordingly and taken into account in the overall position on the basis of these assumptions.

In the Austrian customer business, uniform risk analyses and limitations are of special significance for the development of net interest income, and are highly complex. Therefore they are complemented by a regular analysis of the effect of interest rate changes on net interest income in subsequent quarters and years. In this context, simulations of the development of net interest income are based on assumptions regarding new business, demand behaviour (interest rate elasticity) of customers, and general developments affecting margins in major market segments, as well as on the assumption of steady volumes and margins. The latter method identifies isolated effects of interest rate changes on net interest income. But as this scenario does not assume any future changes in the structure of customer positions and in margins, this scenario is not to be seen as a measure of future net interest income. As at 31 December 2003, on the basis of an interest rate shock of 200 basis points (2 percentage points), the maximum impact on net interest income in the first year would be – € 42 m.

The main requirements under the future New Basel Capital Accord (“Basel II”) in respect of the “interest rate risk in the banking book” relate to organisational arrangements, the ongoing presentation of and compliance with a 200 basis point shock, and scenario calculations regarding the development of net interest income. With the market risk management procedures described above, Bank Austria Creditanstalt is well prepared, in terms of both methodology and substance, to meet the requirements arising from the proposed new capital adequacy framework, and the bank regularly conducts test calculations in this connection.