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Internal Capital Adequacy Assessment Process (“ICAAP”) for FirstRand Banking and the FirstRand Banking Group SECTION 4: DEMAND FOR CAPITAL

Page 132

The above table presents the calculation of the estimated South African stress liquidity premium and its application to the repricing5 of the Bank’s wholesale funding book. Based on that methodology, and a simplifying assumption which reprices quarterly repricing instruments on a monthly basis, an amount of R0.939bn in extra interest is calculated. The Bank has accordingly set aside R1bn in capital to protect earnings against the potential higher costs that could arise in a stress event.

4.1.7.3 Translation risk

4.1.7.3 a. Risk factor and brief description

Translation risk is the risk associated with banks that deal in foreign currencies or list foreign assets on their balance sheets. The greater the proportion of asset, liability and equity classes denominated in a foreign currency, the greater the translation risk.

This poses a potential threat for banks conducting business in foreign markets. Exchange rates usually change between financial statements, causing potential variances between the reported figures. Banks generally attempt to minimise these transaction risks by purchasing currency swaps or hedging through futures contracts.

4.1.7.3 b. Amount of capital

BASEL II REQUIREMENT - REGULATORY

FRAMEWORK – ECONOMIC

FRBG 0 0FRB 0 0

While some banks do assess capital for translation risk, very often they take the view that the risk is, in fact, hedged from a capital ratio perspective.

By way of an example, consider a bank with R900m in RWAs in its home country, and R100m home currency equivalent in a foreign subsidiary. Assume also that the parent has R90m in shareholders’ funds (“SHF”) in its own currency and the offshore entity has R10m. On a consolidated basis, the capital ratio is 10%.

If the foreign currency depreciates by 10%, then the bank will suffer a reduction in (consolidated) SHF by R1m. However, the RWAs of the offshore unit also fall by R10m, so overall the capital ratio remains unchanged (now R99m divided by R990m).

5 Instruments whose interest rates reset quarterly have been repriced on a monthly basis in order to capture the average level of repricing that occurred.

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Internal Capital Adequacy Assessment Process (“ICAAP”) for FirstRand Banking and the FirstRand Banking Group SECTION 6: RISK MANAGEMENT

Page 191

• Where appropriate criteria is not met, make use of the so-called “red box” as graphically demonstrated below:

Structured debate on alternatives and optimisation possibilities

B - Review of ROEs and value add in Jan 2007 (Use Test) At a FRBG level there is pressure on core equity as asset growth has outstripped profitability. Presented at FRBG EXCO in Jan 2007 was a comparison of marginal ROEs and capital consumption per major brands.

A B C (40% xB)

D (60% xB) E D - E

ROE 2006 ROE 2005

Dividendpayout

(40% ofROE)

Capitalretained in

thebusiness

for growth

Capitalrequired

for growth

Shortfallin coreequity

FNB 36.9% 34.7% 13.9% 20.8% 26.7% (5.9%)

RMB 32.9% 33.2% 13.3% 19.9% 15.0% 4.9%

FRAEM 29.0% 29.2% 11.7% 17.5% 22.0% (4.5%)

WesBank 17.1% 17.3% 6.9% 10.4% 14.9% (4.5%)

OUTsurance 43.9% 46.5% 18.6% 27.9% 16.4% 11.5%

Group support 11.6% 13.4% 5.4% 8.0% 15.0% (6.9%)

Total FRBG 26.8% 27.2% 11.1% 16.6% 19.6% (3.0%)

It was clear from the analysis that value was eroded in some of the brands, but that continued high ROEs in certain business units have been hiding inefficiencies in other areas.

Internal Capital Adequacy Assessment Process (“ICAAP”) for FirstRand Banking and the FirstRand Banking Group SECTION 5: SUPPLY OF CAPITAL

Page 167

Nearly all jurisdictions with active banking markets formally require banking institutions to maintain at least a minimum level of capital. The diagram below shows the Basel II requirement per the Regulations that came into effect on 1 January 2008, and also agrees it back to FirstRand’s capital targets and actual results as at the end of March 2008:

The technical challenge for both banks and supervisors has been to determine how much capital is necessary to serve as a sufficient buffer against banks’ unexpected losses. • If capital levels are too low, banks may be unable to absorb high levels of loss.

Excessively low levels of capital increase the risk of bank failures, which, in turn, may place depositors’ funds at risk.

• If capital levels are too high, banks may not be able to make the most efficient use of their resources, which may constrain their ability to make credit available.

The previous section of this report covers the buffers kept by FRBG. We maintain that a buffer of 2% over core equity and 2.25% over total capital is necessary to prevent FRBG from ever piercing the regulatory minimum. This buffer leaves the required level of capital for FRBG at 12.0%. The bank remains well capitalised, with the bank well above set targets. However, as demonstrated in section 5.3 on stress testing, extreme scenarios may lead to management intervention to ensure regulatory minimums are never pierced.

Transferabil ity of capitalAs shown in the organisational structure included in section 2 of this report, FRBG operates outside the borders of South Africa as follow:

Internal Capital Adequacy Assessment Process (“ICAAP”) for FirstRand Banking and the FirstRand Banking Group SECTION 8: USE OF THE ICAAP WITHIN THE ORGANISATION

Page 222

number that serves a common measure across all types of financial risks and captures the risk of unexpected losses or unexpected reductions in income in a business, a portfolio or a single transaction. At FirstRand, economic capital is disclosed as “the capital that the FirstRand Banking Group must hold, commensurate with its risk profile under severe stress conditions, to give comfort to third party stakeholders (shareholders, counterparties and depositors, ratings agencies and regulators) that it will be able to discharge its obligations to third parties in accordance with an indicated degree of certainty even under stress conditions, and would operate as a going concern entity.

The following graph indicates the economic capital analysis per risk type for 2007:

Many banks use a risk-reward methodology to actively manage their portfolios of investments or activities and for performance evaluation. At FirstRand, Net income after capital charge (“NIACC”) – a derivative from Economic Profit, or EVA – is the performance measure that has been in place since July 2006.

FirstRand follows an active approach to capital allocation and uses RAPM processes to influence business results by adjusting the capital allocated to particular business units and encourages managers to maximise returns on this allocated capital. Once the amount of capital available has been determined, targets are set for expected returns (or “hurdle” rate).

Internal business unit performance measures in a financial institution are vital to monitoring performance and review. These measures are dependent on internal methodologies, such as economic capital allocation, funds transfer pricing and expense allocation via service-level agreements. These internal methodologies need to be economically fair and generally transparent so that business units, whose performances are being measured, view them as fair and objective.

Internal Capital Adequacy Assessment Process (“ICAAP”) for FirstRand Banking and the FirstRand Banking Group SECTION 5: SUPPLY OF CAPITAL

Page 174

The importance of core equity as target is explained in more detail in section 4.3 while we stress the importance of the measure in the NIACC discussion, and expand on the usage of economic capital as primary attribute in the calculation.

5.1.4 Composition of capital for peers and international banks –compared with Basel I I

The next graph shows the composition of capital for the FRB and compares it with the Bank’s peers (Basel I and Basel II environment). Both FRB and FRBG remained capitalised well above the industry average.

Going forward, memo items per the BA 700 will also be compared with peers and will be unpacked as part of the quarterly graph discussions.

We also contrast the quality of FRB’s capital mix at the end of Dec 2007 with that of the 4 major UK banks (latest set of disclosed numbers). Note that the information is before any

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The team

Desireé RobertsonWORKER ANT 2

Colleen DavisWORKER ANT 3

Debra RayWORKER ANT 1

Dylan ArmstrongWORKER ANT 4

Charity MoyoRECEPTIONIST

René RingSALES & MARKETING

Peet van RensburgFINANCE

René Ringrene@workerant.co.za+27 82 895 5347www.workerant.co.za