DEVELOPMENT BANK OF MONGOLIA

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DEVELOPMENT BANK OF MONGOLIA

ANNUAL REPORT 2012

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CONTENTS
03 04 06 08 10 11 11 11 11 12 12 14 16 17 18 20 21 22 24 26 27 29 31 32 33 33 33 33 34 36 37 38 40
Mission and Vision Message from the Chairman of the Board of Directors Message from the Chief Executive Officer Economic Overview of Mongolia Economic Outlook State Budget Foreign Trade Inflation Money Supply Exchange Rate Banking System Corporate Development Corporate Governance Organization Structure Board of Directors Management Team Our Staff Highlights Business Operation Medium and Long-Term Business Operation Funding Operation Credit and Financing Operation Business Cooperation Risk Management Credit Risk Market Risk Liquidity Risk Operational Risk Corporate Social Responsibility Corporate Social Responsibility Corporate Social Responsibility Review Financial Overview Independent Auditor’s Report

DEVELOPMENT BANK OF MONGOLIA

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Mission
Development Bank of Mongolia is a leading Mongolian financial institution that provides solutions to ensure sustainable economic growth, achieve economic diversification, support the production of value-added goods and integrate nationwide development policies.

Vision
To develop a prosperous and sound Mongolian economy that is competitive on an international level.

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The primary aim of Development Bank of Mongolia is to promote the competitiveness of the Mongolian nation through investment in longterm development projects so that all Mongolian citizens can benefit from the country’s entry into the global marketplace.

MessaGe FROM THE CHAIRMAN OF THE BOARD OF DIRECTORS

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MESSAGE FROM THE CHAIRMAN OF THE BOARD OF DIRECTORS

We must strive to be innovative and keep pace with the changes that are re-shaping Mongolia. We must maintain long-term profitability and implement prudent policies so that the Bank can sustain long-term operations. The success of our Bank lies in the prudent and efficient financing of large-scale investment programs. We are collaborating with the Government of Mongolia, international investors and, most importantly, the people of Mongolia to find the best financing solution for investment projects in our country.

Even though 2012 was a difficult year globally we were able to overcome the difficulties without considerable hardship in the political and economic spheres. With support from the Government of Mongolia, the Development Bank of Mongolia raised capital through successful issuance of our debut bond on the international capital markets. This capital was put to good use, financing major infrastructure and mining projects. The successful issuance was testament to the confidence of investors in Mongolia and to the excellent management of the Bank. The economy grew at 12.3 percent in 2012, considerably lower than the record 17.5 percent of previous year. Despite this moderate slowdown, sectors such as transportation, communication and construction were able to maintain consistent growth, in part due to effficient financing. Our aim is to become a national institution that provides medium to long-term financing solutions for large-scale investment programs in Mongolia, implemented in line with the growth cycles of the local economy.

In 2013 the Bank plans to set yet another strong benchmark by becoming a strong national institution that provides financing solutions to the Government’s medium to long-term investment programs. This will be achieved through meticulously advancing our funding options and assuring that all operations of the Bank are sustainable in the long-term. The responsibility to provide financing solutions for the infrastructure, energy, mining and manufacturing sectors has been placed firmly on the shoulders of our Bank. Our financing options must be in line with the Government’s medium and long-term investment policies. The Bank will be a pillar that supports Mongolia’s sustainable growth. The Bank and its members will continue to strengthen business operations through vigorous collaboration with our investors. My sincere appreciation and thanks go out to all the organizations and individuals that support our operations. In closing, I wish you all great success.

B.Shinebaatar Chairman of the Board of Directors

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The Development Bank of Mongolia was established one year ago to provide financial solutions for large scale strategic projects that ensure sustainable economic growth.

MessaGe FROM THE Chief eXecUtiVe officer

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MESSAGE FROM THE CHIEF EXECUTIVE OFFICER

The Development Bank of Mongolia has employed best practices and solidified its status in the financial sector. It is a privilege and honor for the Bank to be part of Mongolia’s growth story.

Two significant events took place in 2012. The first was the 6th parliamentary election held in June and the second was the commencement of exports from the Oyu Tolgoi gold, copper and silver project. These events set a strong positive outlook for Mongolia’s social and economic sectors and opens vast opportunities for the country’s future. Given the global economic headwinds in 2012, the Bank received numerous offers from international financial groups to strengthen the Bank’s presence in the international markets. We raised USD 580 million on March 21st, 2012 through the successful issuance of our bond with maturity of 5 years on the international capital markets. As a quasi-sovereign guaranteed by the Government of Mongolia, this historic transaction set a strong stepping stone for later issuances from Mongolia. With this funding the Bank financed projects that will enhance key sectors such as mining, energy, infrastructure, industrial, construction and small medium enterprises.

To ensure a brighter future for the Mongolian people in 2013 we will strive to accelerate economic growth by operating effectively, strengthening our position in the industry, expanding business cooperation, increasing the transparency and independence of the Bank’s operations, focusing on social responsibility and achieving new heights in the banking sector with help of our skilled employees. At the end of the reporting period, the Bank financed 46 projects totaling MNT 489.7 billion or USD 351.8 million under the “Mid Term New Development Program” of the Government. On behalf of our management team, I would like to wish our partners, investors and staff great success in their future endeavors.

Kim Jang Jin Chief Executive Officer

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ECONOMIC REVIEW OF MONGOLIA

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DEVELOPMENT BANK OF MONGOLIA

ANNUAL REPORT 2012

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Economic Outlook
GDP growth

16 17.5% 14 12 10 8.9% 8 6 4 2 -1.3% 6.4%

(MNT billion)

20%

15% 12.4% 10%

5%

Mongolia’s GDP grew by 12.4 percent in 2012, lower than the growth rate of 17.5 percent during 2011. Key component of export or coal exports decreased during the reporting period. The overall economic growth was lower than forecasted but other sectors such as agriculture, construction, transportation and telecommunications performed well. The increase in mining and construction sector in addition to purchase and import of equipments and petroleum based products drove foreign trade deficit to 20 percent of GDP during 2011 and 2012, higher than levels of 7.6 percent during 2010.

0%

-5% 2008 2009 GDP
GDP structure

2010

2011 GDP growth

2012

100% 80% 60% 40% 20% 0% 2008 2009 2010 2011 2012 Source: National Statistic Committee
Although GDP growth remains at two-digits, contributions to GDP growth of sectors of the economy have changed significantly in 2012. For instance, the mining sector revenue made the largest contribution or accounted for 20.0 percent of GDP. Its contribution to GDP decreased by 3.9 percent from 2011. Revenue from wholesale and retail trade and repair of motor vehicles was the second largest contributor and accounted for 17.7 percent of GDP. Contribution of the agriculture sector increased by 2.1 percent and accounted for 14.2 percent of GDP. Another significant change was the revenue from the education sector, contribution of which increased by 0.6 percent and reached 4.6 percent of GDP. Contribution of the processing industry sector, which is one of the largest contributors to the Mongolian economy, decreased in 2012. The Government was able to successfully close its USD 1.5 billion debut sovereign bond issuance on November 2012. Pricing was tightest among debut issuers and order book was over-subscribed by a factor of 10. Successful completion is a testament to the positive business environment in Mongolia. GDP per capita reached MNT 4.9 million or USD 3,300. GDP is expected to grow by 18.1 percent during 2013 and in 2013 GDP per capita is expected to reach USD 5,300. This puts Mongolia among countries with above-average living standards. Given the moderate slowdown of the economy and decline in foreign direct investment, the vast natural resources of the country during 2013 and future years will provide growth opportunities.

Net taxes on products Services Industry, construction Agriculture

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State Budget
Government budget revenue and debt reached MNT 4,975.8 billion and MNT 6,017.8 billion, representing an increase of 13.0 percent and 26.1 percent, respectively. Budget deficit reached MNT 1,042.0 billion or 7.4 percent of GDP. Preliminary government budget revenue is expected to increase by 42.4 percent to MNT 7.1 trillion or 40.2 percent of GDP. Non-tax revenue and Value added tax (VAT) are expected to increase to MNT 617.0 billion and MNT 1,942.7 billion, respectively. VAT representing a 50.0 percent increase from previous year. Government expenditure is expected to increase by 62.9 percent to MNT 7,444.6 billion. 81.4 percent of investment from state budget will focus on construction.

Inflation
Inflation reached 14.0 percent, higher than Central Bank of Mongolia’ target rate, as a result of rapid economic growth. Food items contributed 5.1 points or one-third of inflation was attributable to food items in the consumer basket. Monitory policy to curb inflation was dealt with by the Central Bank of Mongolia through increasing policy rate to 13.25 percent and increasing reserve requirements. Memorandum of Understanding was signed on October of 2012 between Government of Mongolia and Central Bank of Mongolia to establish “Price Stabilization of Consumer Goods” program. The program consists of: 1) Staple Food Price Stability Pogrom; 2) Fuel Price Stability Program; 3) Consumer Goods Price Stability Program; 4) Construction and Housing Sector Price Stability Program. The State’s guidelines, which was ratified by the Parliament of Mongolia, on monetary policies during 2013 states that the Central Bank will target inflation at 8.0 percent.

Foreign Trade
Mongolia has 142 trade partners and trade turnover reached USD 11.0 billion, 2.6 percent lower than previous year. Exports decreased by 9.0 percent while imports increased by 2.1 percent. Trade deficit reached USD 2.4 billion or 23.5 percent of GDP. Largest trade partners were China and Russia accounting for 53.0 percent and 17.0 percent of trade. Commodities such as coking coal, copper concentrate, iron ore concentrate, molybdenum, fluorspar and gold continue to account for more than 80.0 percent of total exports. Import of fuel related products reached USD 1.3 billion or 21.0 percent more than previous year. Equipments and machinery imports reached USD 2.9 billion. Foreign direct investment decreased to USD 3.8 billion or by 20.0 percent compared to previous year. Capital raised through the Hong Kong Stock Exchange accounted for 51.0 percent of investments. Other countries such as China, United States of America, Great Britain and Canada accounted for 9.0 percent, 7.0 percent, 5.0 percent and 3.0 percent of investments into Mongolia.

Money Supply
During the 2012, Mongolia’s money supply reached MNT 7.6 trillion, increasing by 19.0 percent. This increase was relatively low compared to previous years. In 2012, the Central Bank raised its policy rate to 13.25 percent and the reserve requirement ratio to 12.0 percent in order to reduce the impact of the money supply on inflation, which in turn affected the money supply growth rate. Tugrug current accounts did not increase significantly while Tugrug savings accounts increased by 19.8 percent. Foreign currency current and savings accounts increased by 10.0 percent and foreign currency savings accounts increased by 46.7 percent. Consequently, the current account balance in the money supply decreased and savings balance in the money supply increased.

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Exchange Rate
The exchange rate of USD to Tugrug as of December 2012 stood at MNT 1,396.1, representing a 21.9 Tugrug depreciation compared to last year. Prior to the first quarter of 2012 the Tugrug appreciated in value before subsequently declining after May of 2012. Exchange rate volatility was fairly low throughout the year.
1450.0 1400.0 1350.0 1300.0 1250.0 1200.0 1150.0 1100.0
1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 2011 2012 1228.5 1323.4 1246.9 1291.9 1259.9 1235.7 1395.1 1374.2 1364.2 1340.7 1328.0 1256.4 1313.1 1396.1

During the financial crisis of 2008 to 2009, two banks switched to the conservatorship of the Central Bank. Non-performing loans reached 4.2 percent during the reporting period, lower than 5.8 percent during 2011. The decrease in non-performing loans was primarily due to the overall loan portfolio expansion of commercial banks.

Total Loans

( MNT billion)

8,000 6,000 4,000 2,000 2010-I II III IV 2011-I II III IV 2012-I II III IV

20% 15% 10% 5% 0%
Total loans Non-performing loans Percentage of non-performing loans

Source: Central Bank of Mongolia

Banking System
Commercial Banks At the end of 2012, 14 commercial banks were operating in Mongolia. Banking assets increased by MNT 2.6 trillion to MNT 11.9 trillion or 86.0 percent of GDP. Deposits of commercial banks increased by MNT 1.1 trillion or 30.0 percent to reach MNT 4,855.9 billion. Deposit base consists of 70.9 percent denominated in local currency and the rest in foreign currencies.

Source: Central Bank of Mongolia

At the end of 2011, loans issued to the mining sector comprised 12.0 percent of total loan portfolio but in 2012 decreased to 11.5 percent. Real estate sector loans decreased from 14.1 percent to 13.9 percent and loans for construction sector increased from 11.8 percent to 12.9 percent from 2011 to 2012. The total amount of loan issued to these three sectors grew from 37.9 percent in 2011 to 38.5 percent in 2012.

Banking assets to GDP
14.0 12.0

( MNT trillion) 85% 74% 86%
90% 80%

Loan concentration (Business sectors)
100%

67%
10.0 8.0 6.0 4.0 2.0 0.0

11.9 9.4

70% 60% 50%

80%

56%

60%

6.3 3.7 4.4

40% 30% 20% 10% 0% 20% 40%

2008 Asset / GDP (percent)

2009

2010

2011

2012

0% 2008
Trade

Banking Assets

2009
Real State

2010
Construction

2011
Industry

2012
Mining

Source: Central Bank of Mongolia

Source: Central Bank of Mongolia

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The 2007 global financial crisis affected the Mongolian economy to some degree. The Law on Insurance for Bank Deposits was adopted on November 25th, 2008 in order to establish a mandatory scheme for protection of bank deposits. At that time, the Government took it as the optimal tool to prevent additional turmoil in the market caused by withdrawal of bank deposits. It was decided that the insurance for bank deposits shall be implemented for four years and in November 25th, 2012 the law expired.
Non-Banking Financial Institutions A total of 212 Non-Banking Financial Institutions (NBFI) operate in Mongolia, only 17 of which are foreign invested. 8 new NBFIs opened their offices in 2012. According to Mongolia’s law on the operation of financial Institutions, NBFIs can provide credits, foreign exchange services, investment, advisory services, factoring and other services. Assets of NBFIs reached MNT 252.0 billion or 2.1 percent of the total banking system. The loan portfolio of NBFIs increased by MNT 38.7 billion or 32.6 percent during 2012. Performing loans increased by 32.1 percent, while past due loans increased 1.8 times and non-performing loans increased by 5.6 percent. The minimum and maximum average lending rates were 2.1 percent and 3.8 percent, respectively. The average monthly lending of NBFIs was 2.9 percent, 2.2 times higher than rates of commercial banks. Total NBFI assets were comprised of MNT 80.7 billion (32.0 percent) in liabilities and MNT 171.3 (67.9 percent) in shareholders’ equity. This represents an increase of liabilities and shareholders’ equity of 20.1 percent and 24.0 percent, respectively. During the reporting period, NBFIs’ revenue increased by 52.1 percent to MNT 70.5 billion. NBFIs’ cost of goods sold increased by 48.4 percent to MNT 51.9 billion. Finally, profit after tax was MNT 18.6 billion. NBFIs’ revenue is generated through 39.3 percent from interest income and 20.1 percent from non-interest income. 47.0 percent of non-interest income is generated from foreign exchange trade and an additional 30.1 percent comes from exchange rate arbitrage. The remaining 17.1 percent comes from other financial services. Compared to last year, total expenditure increased by 48.4 percent. Interest expenses, non-interest expenses, contingency expenses, non-operating expenses and tax expenses, increased by 28.4 percent, 54.4 percent, 9.8 percent, 59.6 percent and 64.8 percent, respectively.

Capital Markets A total of 133.8 million shares with value of MNT 145.1 billion were traded on the Mongolian Stock Exchange in 2012. This represents a decline in value of MNT 205.1 billion from the previous year. The regulation formed under the Decree on Government Security Issuances and Secondary Market Trading from the Central Bank of Mongolia and the Ministry of Finance regulates the government’s bond issuances on the Central Bank’s platform. As a result, the total turnover of government bonds on the MSE declined sharply. The total market capitalization of the MSE declined by 17.0 percent, while the Top 20 Index declined by 3,973.6 points or 18.3 percent. However, despite declines, 29 companies distributed dividends of MNT 79.1 billion to their shareholders. Dividend per share and profitability of companies listed on the MSE showed improvement since last year. According to data provided from the Securities Clearing House and Central Depository the value of securities traded by Golomt Bank, Khan Bank, Xac Bank and Trade Development Bank reached MNT 2.6 billion during the six months following the installation of the Millennium IT system. At the end of the reporting period, the number of listed companies on the MSE reached 328. 83.8 percent of the companies were privately owned and the rest stated owned. New regulations and policies were approved by Financial Regulatory Commission. These regulations were updated to meet already published laws and the Company Law. Insurance Total assets of insurance companies rose 1.3 times compared to the previous year and reached MNT 107.6 billion. Companies with foreign ownership hold 35.3 percent of market share. The working capital of insurance companies rose 1.3 times as a result of Financial Regulatory Commission’s Resolution to increase minimum requirements for paid in capital. At the end of 2012, two companies held 10.0 percent or more of total assets of insurance companies. Eight companies held up 1.0 percent to 5.0 percent and seven companies held up 5.0 percent to 10.0 percent of total assets. 77.2 percent of total collection of these companies was from insurance policies on fixed assets, construction and transportation. Insurance of the indemnity amount during the previous years increased and reached MNT 16.9 billion. Mongol Daatgal LLC issued 41.9 percent of the total indemnities during the reporting period. The reserve fund for insurance rose to MNT 48.2 billion. This is 2.2 times higher than five years ago.

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Corporate Governance

The Bank is committed to conducting its operations in compliance with international corporate governance and financial standards by fulfilling principles of transparency and integrity in its operations. The Bank aims to integrate the interests of the Board of Directors, to make prudent decisions by building effective management, to support the equality of rights, and conduct open financial operations.

The Board of Directors consists of nine members. Three independent members are from the Central Bank of Mongolia, the National Chamber of Commerce and Industry, and the Mongolian Bankers Association. The other six members are appointed from the Government of Mongolia. In 2012 with accordance Resolution No.45 of the Board of Directors of the Development Bank of Mongolia, three committees on Nomination, Audit, and Remuneration were set up under the Board of Directors. Committees are operating within international corporate governance standards. Korean Development Bank was selected as a partner through an open international tender based on Government Resolution No.195 of July 20th, 2010 and State Property Committee Resolution No.346 of September 2nd, 2010. The Executive Management is carried out by a joint team from the Development Bank of Mongolia and the Korean Development Bank. The Executive Management leads and organizes daily activities of the Bank in accordance with the Bank’s principles and rules, as specified in the agreement concluded with the Board of Directors. To support daily activities and to improve its efficiency, department and division direc-

The highest level of authority of the Bank is the shareholders’ meeting and the sole shareholder is the Government of Mongolia. The management of the Bank adopts principles of integrity and transparency in its operations.

tors report regularly to the Chief Executive Officer and the First Deputy Chief Executive Officer. The committees’ structure shall be defined by Executive Management. The Executive Management Committee, the Credit Committee, and the Asset and Liability Management Committee monitor the Bank’s business operations within corporate governance regulations.

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Organization Structure
To meet the needs of newly expanding business activity, the developing economy, and market demands the Bank continued with the improvements of its organizational structure. In 2012, the Bank made structural changes to cope with expanding activities.

Shareholders Meeting

Nomination Committee Remuneration Committee Audit Committee Internal Audit Chief Executive Officer Executive Management Committee Asset and Liability Committee Credit Committee Board of Directors Secretary to the Board of Directors

Advisor

First Deputy Chief Executive Officer

Asset and Liability Management Department

Credit Department

Risk Management Department

Monitoring and Administration Department

Accounting and Reporting Division

Public-Private Partnership Division

Public Finance and Due Diligence Division

Correspondent Banking Division

Treasury Management Division

Strategy and Planning Division

Corporate Finance Division

Credit Risk Provision Unit

Human Resources and Development Unit

Financial Risk Division

Co-Finance Division

Administration Unit

Funding Division

Expert’s Counsel

Research Unit

Public Relations Unit

In 2011, Bank had four departments – Asset and Liability Department, Credit Department, Risk Management Department and Monitoring and Administration Department – 11 divisions and two units. In 2012, by Resolution No.54 of the Board of Directors, a new organizational structure of the Bank was approved. At the end of 2012, the Bank started operations with four departments, 13 divisions and five units with total staff of 46 highly professional individuals.

Legal Division

IT Division

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Board of Directors
The Board of Directors determine the strategy of the Bank, and approve its risk management policy, annual budget, and business plans. They monitor the performance indicators of the Bank and provide strategic guidance.

Shinebaatar Begzsuren State Secretary, Ministry of Economic Development

Boldbaatar Danzannorov Head of Economic Cooperation, Loan and Assistance Policy Department, Ministry of Economic Development

Lkhagvasuren Byadran Head, Supervision Department, Central Bank of Mongolia

Batzaya Baasandorj State Secretary, Ministry of Road and Transportation

Bayanmunkh Myagmarsuren Head, Heavy Industry Policy Implementation and Coordination Department, Ministry of Industry and Agriculture

Otgochuluu Culuuntseren Head of Strategic Policy and Planning Department, Ministry of Mining

Naidalaa Badrakh Chief Executive Officer and General Secretary, Mongolian Bankers Association

Nergui Chuluunbat Head, Consolidated Policy, Planning and Coordination Department, Mongolian National Chamber of Commerce and Industry

Battur Davaakhuu State Secretary, Ministry of Finance

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Nomination Committee The Nomination Committee is focused on nominating, selecting, and determining requirements for candidates for the Board of Directors, for committee membership, and for Executive Management. The nomination committee is responsible for evaluating the activities of members of the Board of Directors and Executive Management, as well as providing advice to the Board of Directors.

Committee Head

Shinebaatar Begzsuren State Secretary, Ministry of Economic Development

Member

Bayanmunkh Myagmarsuren Head, Heavy Industry Policy Implementation and Coordination Department, Ministry of Industry and Agriculture

Member

Naidalaa Badrakh Chief Executive Officer and General Secretary, Mongolian Bankers Association

Audit Committee The Audit Committee shall review the reliability of accounting statements of the Bank and its compliance with international standards. It also monitors and evaluates internal audit and risk management activities and the integrity of financial and economic data. They present their reports to the Board of Directors.

Committee Head

Lkhagvasuren Byadran Head, Supervision Department Central Bank of Mongolia

Member

Otgochuluu Culuuntseren Head of Strategic Policy and Planning Department, Ministry of Mining

Member

Battur Davaakhuu State Secretary, Ministry of Finance

Remuneration Committee The Remuneration Committee was established to develop and approve salary and reward system policies for the members of Board of Directors and Executive Management. They ensure that remuneration arrangements support the strategic aims of the business and other governing authorities.

Committee Head

Boldbaatar Danzannorov Head of Economic Cooperation, Loan and Assistance Policy Department, Ministry of Economic Development

Member

Batzaya Baasandorj State Secretary, Ministry of Road and Transportation

Member

Nergui Chuluunbat Head, Consolidated Policy, Planning and Coordination Department, Mongolian National Chamber of Commerce and Industry

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Management Team
The Executive Management leads and organizes daily activities in accordance with Bank’s principles and rules, as specified within the agreement concluded with the Board of Directors. The Executive Management of the Bank exercises the following powers in addition to the ones specified in the Company Law: they can approve internal rules, regulations and instructions; establish criteria for a prudential ratio on the activities of the Bank; determine the policy on selecting, training, and re-training its personnel; decisions related with loans and financial accounting activities.

Кim Jang Jin Chief Executive Officer

Sandagdorj Sukhbaatar First Deputy Chief Executive Officer

Dashzevge Gantumur Deputy Chief Executive Officer, Administration and Monitoring Department

Batbaatar Otgonbat Deputy Chief Executive Officer, Asset and Liability Department

Choi Jong Kook Deputy Chief Executive Officer, Credit Department

Park Yong Bae Deputy Chief Executive Officer, Risk Management Department

Furthermore, the Executive Management shall implement business plans, define asset and liability management policy, take actions to enforce financial disciplines, and establish a supervision system for loan operations. The Executive Management team consists of experienced Mongolian and foreign specialists. The Executive Management team includes the Chief Executive Officer, the First Deputy Chief Executive Officer and four Deputy Chief Executive Officers.

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Our Staff

The key to our success lies in our professional, experienced staff who have the aspiration to contribute to development of Mongolia and who are creative and determined team players.

The mission of all Bank’s staff is to establish reliable and professional financial activities that are consistent with international standards.

Since the establishment of the Bank, we have strived the top professionals in the industry in order to develop human resources in line with the scope and development of the Bank’s operations. We always strive to find the best management. The Bank started its activities on May 12th, 2011 with nine employees and by December 31st, 2012 the number of employees had grown to 46. The average age of Bank’s staff members is 33. 60.0 percent of our staff members have obtained diplomas abroad and 40.0 percent have obtained diplomas domestically. 60.0 percent of the employees hold Bachelors Degree, 37.0 percent Masters Degrees and 2.9 percent hold a Ph.D. During the reporting period, 41 employees attended training programs organized by investment banks, financial institutions and law firms such as Deutsche Bank, Barclay’s, Korea Development Bank, Korea Development Institution, International Financial Corporation of the World Bank Group and law firm Allen & Overy. In accordance with the Bank’s 2013 business plan, we are planning to expand our employees to 76 so that we can improve our operations and keep pace with our growing activities. We will increase the number of credit officers and raise the number of staff in other departments and divisions as necessary. A sophisticated training program has been developed to expand the human resources development in line with that of other development banks.

In order to improve the skills of managerial personnel and to ensure these skills are passed down to future management, we are planning to implement a “Best Leader” program, which will involve mentoring of mid-level managers. This program will establish a management culture that fits our unique business activities. The curriculum will coves development bank management methods, team work and individual leadership skills, as well as problem solving and mentoring skills.

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Highlights

November 30th, 2011
Euro Medium Term Note program is established. For the first time, the Development Bank of Mongolia establishes a USD 600.0 million Euro Medium Term Note program backed by sovereign guarantee.

July 20th, 2010
Mongolian Government Resolution is issued to establish the Development Bank of Mongolia.

May 12th, 2011
State owned Development Bank is established for the first time in Mongolia. With the purpose of accelerating economic growth in Mongolia by financing projects and programs in strategically important sectors of Mongolia.

February 10th, 2011
Law on Development Bank of Mongolia is approved.

December 9th, 2011 March 25th, 2011
Development Bank of Mongolia has received its State Registration license and its permission to start operations. Debut bond issuance within Euro Medium Term Note program. Development Bank of Mongolia issues an initial USD 20.0 million privately placed bond with 1 year maturity as part of the USD 600.0 million Euro Medium Term Note program.

August 30th, 2011
A Management Contract is established between Development Bank of Mongolia and Korea Develoment Bank. The State Property Committee announced an open international tender to select an experienced management team for the Development Bank of Mongolia. Korea Development Bank was selected.

March 21st, 2012
Development Bank of Mongolia issued USD 580.0 million bonds at 5.75 percent coupon. After holding a roadshow in Hong Kong, Singapore and London, the Development Bank of Mongolia issues USD 580.0 million 5 year bond on the international market at 5.75 percent coupon.

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August 6th, 2012 June 15th, 2012
Development Bank of Mongolia provides financing for low interest housing mortgage program. Development Bank of Mongolia provides MNT 50.0 billion financing to the State Bank for the Program to provide civilians with 6 percent interest mortgage loans in accordance with the Mongolian Government Resolution No.55 of 2012. Development Bank of Mongolia provides financing for road projects. In accordance with Government Resolution No.47, 110, 106, 336, 124 and 105, Development Bank of Mongolia disbursed MNT 202.5 billion financing for road projects. A total of 1,280 km road construction work has been carried out with this financing.

October 19th, 2012
Development Bank of Mongolia provides financing for Khutul cement plant expansion. Development Bank of Mongolia disbursed USD 61.3 million to Basement LLC for the purpose of increasing the capacity of Khutul cement and limestone plant to 1 million tons per annum.

October 5th, 2012
Development Bank of Mongolia provides financing for Erdenes Tavan Tolgoi LLC. USD 100.0 million in financing was disbursed in accordance with the Government Resolution No.148 of 2012. The implementation of this project will lead to the development of mining, energy and other strategically important sectors.

December 31st, 2012
Development Bank of Mongolia received Bloomberg Award. Development Bank of Mongolia received Bloomberg’s “Best Debut Bond” Award at the closing reception ceremony of The Mongolian Economic Forum 2013 for the issuance of it first quasi-sovereign bond on the international markets

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BUSINESS OPERATION

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Medium and Long-Term Business Operation

The Bank was established to create economic stability and accelerate economic growth by providing long-term sources of funding for processing industries and the production of value-added, import subtitution products in the infrastructure and mining sectors.

The Bank shall finance large scale projects and programs in strategically important sectors approved by the Parliament and Government. Financing will be provided in the following areas to help support sustainable development of the economy, promote ecological balance and support production of value-added export products and import replacement goods, including: Energy production and energy transfer infrastructure Manufacturing (to introduce eco-friendly advanced tech niques and technologies, upstream and/or downstream pro duction of raw materials and minerals) Infrastructure (road and railway networks, utilities) Mining We shall strive to provide financial advisory services for strategically important projects in accordance with the Law on Development Bank of Mongolia, the decisions of the Parliament and the decrees of the Government. We shall focus on the following activities: Support priority sectors through medium and long-term loans, co-financing, syndicated loans and other financial solutions, focusing on development projects and programs for energy production, infrastructure, processing industries and engineering facilities, Promote foreign capital inflow and foster domestic capital formation, Allocate required funds for proper economic diversification which in turn will increase the export of domestically produced goods, create new areas for export, and improve national competitiveness, Support sustainable social development and regional development, reduce urban rural disparities by generating jobs and applying good governance principles.

BUSINESS OPERATION

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Funding Operation

The Bank established its Euro Medium Term Note program in November 2011. Within the program the Bank successfully issued USD 20.0 million of 1 year bond with 6.0 percent coupon in December 2011 and an additional USD 580 million of 5 year bond with 5.75 percent coupon, the lowest rate for a debut Asian sovereign bond in its rating class, on March 2013.

Other Asian issuances in the same ratings class such as Sri Lanka (8.75 percent), Vietnam (6.75 percent) and the Philippines (8.75 percent), have a substantially higher coupon. This shows that investors have high expectation and confidence in the Bank and Mongolia. The final order book for the Bank’s was over USD 6.25 billion. The issuance was 11 times oversubscribed and more than 300 separate accounts participated. The transaction was highlighted by international news agencies and investment banks as one of the most successful transactions in recent years. In 2013, the Bank is planning to diversify its funding sources by issuing bonds in foreign currencies (Yen “Samurai” bonds and Yuan “Dim Sum” bonds), receiving bilateral and syndicated loans from international investment and commercial banks, co-financing and cooperating with other countries’ development and export-import banks.

The Mongolian Law on 2013 budget has included MNT 50.0 billion to increase the Bank’s equity as a support given from the Government as well as to increase capital adequacy.
Issuer Program establishment date
The Development Bank of Mongolia USD 600 million Euro Medium Term Note Program

Development Bank of Mongolia November 30th, 2011 Moody’s: B1 (Stable) / S&P: BB- (Positive) / Fitch: B+ (Stable) Unconditionally and irrevocably guaranteed by the Government of Mongolia USD 600.0 million 5 years Singapore Stock Exchange 6 months after first proceed and semi-annually

Credit rating Guarantor Issuance size Tenor Listing venue Interest payment

Use of proceeds
Underwritters

To finance new railway projects, design and construction of roads and infrastructure projects related to housing.

Issuance type

Private and public placement

Drawdowns

2011-12-09, 1 year, 20 million USD, 6.0% (private) 2012-03-21, 5 years, 580 million USD, 5.75% (public)

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Credit Rating

In December 2011, Standard & Poor’s and Moody’s credit rating agencies assigned BB- (positive) and B1 (stable) ratings respectively to Bank’s USD 600.0 million Euro Medium Term Note program which are same as the sovereign`s rating, on the back of irrevocable and unconditional guarantee provided by Ministry of Finance on behalf of the Government of Mongolia.

March 6th, 2012 - Standard & Poor’s Ratings Services assigned its ‘BB-’ foreign currency issue rating to the proposed issue of U.S. dollar notes by Development Bank of Mongolia.

March 6th, 2012 - Moody’s Investors Service has assigned a definitive long-term rating of B1 applicable to the initial draw down under the Euro Medium Term Note Program of the Development Bank of Mongolia LLC.

BUSINESS OPERATION

029

1.0% 2.0%

1.0%

Credit and Financing Operation
Starting in 2012, the Bank has been providing financing for projects and programs to be implemented in key economic sectors approved by the Government from the funds raised on the international market. The Bank’s lending activities are in four main areas, which include: 1) socially beneficial projects 2) corporate financing projects 3) trade financing and co-financing projects and 4) public-private partnership projects.

10.0%

17.0%

41.0%

28.0%

At the end of 2012, Bank’s loan portfolio was MNT 489.7 billion or USD 351.8 million, which was comprised of 46 projects operating within the framework of the “New Development” program. As of December 31st, 2012, the Bank disbursed loans in the following sectors:
Repaid by State budget
Number of Projects Disbursed Amount MNT billion

Projects Road Mining Construction materials Housing program finance SME Fund Air transportation Power plant Infrastructure Total

Number of Projects 39 1 1 1 1 1 1 1 46

Disbursed Disbursed Percentage of Amount MNT Amount USD Portfolio billion million 202.5 139.2 85.3 50 2.1 7.4 2.8 0.4 489.7 145.5 100 61.3 35.9 1.478 5.3 2 0.3 351.8 41.0% 28.0% 17.0% 10.0% 2.0% 1.0% 1.0% 0.0% 100.0%

Repaid by Project cash flow
Disbursed Amount USD million Number of Projects Disbursed Amount MNT billion Disbursed Amount USD million

Projects

Projects

Road Infrastructure Housing program finance

39 1 39

202.5 0.4 202.5

145.5 0.3 145.5

Mining

39

202.5

145.5

Air transportation

1

0.4

0.3

SME Fund

1

2.1

1.5 Construction materials 1 85.3 61.3

Power plant Total

1 43

2.8 257.8

2.0 185.2 Total 3 231.9 166.6

52.6 percent of the loan portfolio or MNT 257.8 billion or USD 185.2 million in financing was provided for projects to be repaid from the State budget. The remaining 47.4 percent or MNT 231.9 billion or USD 166.6 million in financing was provided to projects to be repaid from project cash flows.

DEVELOPMENT BANK OF MONGOLIA

ANNUAL REPORT 2012

030

Summary of Project Financing for the Reporting Year within the Framework of the “New Development” program:
Road financing The Government resolved that MNT 2.4 trillion will be issued to 104 projects in order to improve the nation-wide auto road network, connect rural roads to the network, reduce migration from rural to urban areas and increase the circulation of goods among economic sectors. At the end of 2012, the Bank had disbursed MNT 202.5 billion or USD 145.5 million for 39 road design, consulting, construction and monitoring projects in Ulaanbaatar and rural areas. As a result, 1,280 km of road construction has been carried out. Utilities financing The Government Resolution No.149 of 2011 resolved to provide MNT 425.7 billion for 64 projects (20 heat distribution utilities projects with cost of MNT 161.1 billion, 14 electricity, power source and transmission utilities projects with cost of MNT 58.6 billion, 25 clean water and sewage utilities projects with cost of MNT 151.9 billion and five inter-sum projects with total cost of MNT 54.1 billion). According to this decision MNT 450.0 million financing was disbursed to a water treatment facility with a 4,200m3 capacity in Khovd Province. Housing program In order to implement Government Resolution No.138 on “Course of Action to Provide Housing for Civilians” of 2011 and Government Resolution No.55 on “Issuing Securities and Government Guarantee” of 2012 the Bank disbursed MNT 50 billion or USD 35.9 million to the State Bank to issue mortgage loan to civilians with 6 percent interest rate. Promoting small and medium-sized enterprises The Government Resolution No.138 and 208 of 2012 resolved to provide concessionary loans to generate jobs through increasing SME capacity in regional centers, provinces and rural areas. According to this decision the Bank has started disbursing MNT 50.0 billion to commercial banks. Power plant The Government Resolution No.99 and 119 of 2012 authorized the Bank to issue USD 70.0 million financing for the project to install 100MW turbine to increase the capacity of Power Plant IV. Accordingly, initial disbursement of MNT 2.8 billion or USD 1.9 million was made in 2012.

Electric power consumption from the Central Energy System is expected to increase by 35-50 MW annually and heating consumption is expected to increase by 80 Gcal per hour. Thus, expansion of Power Plant IV plays an important role in accommodating the increasing demand for energy. Upon completion of this project, Power Plant IV capacity shall increase to 680 MW where annual production of energy shall increase by 500 million KW per hour and production of heating shall increase by 400,000 Gcal per hour. Supporting Strategically Important Sectors: Erdenes Tavantolgoi project The Government Resolution No.148 and 161 of 2012 resolved to issue USD 200.0 million to Erdenes Tavan Tolgoi JSC to support strategically important projects in the mining sector. MNT 139.2 billion or USD 100.0 million has been disbursed as the initial funding for the project. Completion of this project shall increase the capacity of the mining sector and reduce product cost. Air transportation Due to increasing demand for air travel, MIAT LLC has been working on renewing its aircraft fleet in order to reduce its operational costs and improve its services. The purchase of aircraft was included in the Public Investment Program for 2013 to 2017 approved by Government Resolution No.223 of 2012. “State Policy to be Implemented in the Civil Aviation Sector Until 2020” was approved by the Parliament Resolution No.18 dated February 7th, 2013. In April 2011, MIAT LLC established a purchase agreement with Boeing company. The Bank has provided financing of MNT 7.4 billion or USD 5.3 million for the pre-delivery payment of the aircraft. The purchase of this aircraft shall increase the operational efficiently of MIAT LLC and further promote development of the air transportation sector in Mongolia. Construction material plant 60.0 percent of products imported through Zamiin-Uud port are construction materials, 90.0 percent of which are cement. Therefore, in order to reduce imported cement and to support domestic production, Line II of the Khutul Cement and Lime LLC is being replaced by dry technology line and the capacity is being increased to 1 million tons per annum. An open cut mining and auto transportation complex are also being built in order to promote development of the construction material sector. Completion of this project will stabilize the construction material prices, which in turn will create the conditions to reduce housing prices. A continuous supply of cement will facilitate the implementation development projects. The Bank disbursed MNT 85.3 billion or USD 61.3 million for implementation of this project.

BUSINESS OPERATION

031

Business Cooperation
Since its founding, the Bank has actively built partnerships and signed cooperation agreements with various international financial institutions. Cooperation Agreements Signed in 2011: August 24th, 2011 Memorandum of Understanding with the Export-Im port Bank of China of People’s Republic of China to sup-

port the diplomatic cooperation of the two countries and finance various projects. October 10th, 2012: Memorandum of Understanding with GAUFF Engineer ing, Germany to organize training and seminars in Memorandum of Understanding with association of Ex- Im Banks of North-East Asian countries, Greater Tumen

“Technical Issues of Road Projects” and “Infrastructure Financing”. December 06th, 2011 Memorandum of Understanding with Kuwait Investment Authority to invest in minerals, mining,

Initiative (GTI), to support regional cooperation in economic development and technical assistance. In 2013, the Bank is planning to further increase its contacts and cooperation with international organizations in the Asia Pacific region. Training Seminars Organized Under Cooperation Initiatives: Memorandum of Understanding with Kuwait Fund for Arab Economic Development to conduct feasibility The Bank and Japan International Cooperation Agency (JICA) organized a “Project Finance” training seminar in Ulaanbaatar on July 5th to 6th of 2011. During this training, relevant experts presented on issues related to project financing, project evaluation, feasibility studies as well as case studies on projects financed by Development Bank of Ja Memorandum of Understanding with Sumitomo-Mit- sui Banking Corporation (SMBC) to contribute to ecopan. Representatives from the Bank, the National Development and Innovation Committee, the Ministry of Finance, the State Property Commission, the Ministry of Road, Transportation, Construction and Urban Development, the Ministry of Mining and Energy and government agencies on roads and railways participated March 21st, 2012 Cooperation Agreement with China Development Bank to finance rural and urban road construction, resithe training. The Bank organized trainings on “Technical Issues of Road Projects” and “Infrastructure Financing” with GAUFF Engineering in Germany from September 20th to 23rd of 2011. The training included sessions by German experts (i) on financing of road projects, its quality, safety and usage along with case studies and (ii) on financing of May 01 , 2012
st

banking and financial services sectors as well as railway and strategic projects.

studies and provide concessionary loans to projects with high impact potential for the Mongolian economy. Cooperation Agreements Signed in 2012: March 12th, 2012

nomic development by financing infrastructure, mining and development projects.

dential housing construction and other projects agreed between the banks.

infrastructure projects, associated risks and its management and public-private partnerships.

Memorandum of Understanding with the Export-Im port Bank of the United States (US Ex-Im) to finance The Bank and Shearman & Sterling LLP, a global law firm, organized a seminar titled “Project Financing and International Capital Markets in Relation to Development of Mongolia’s Mining Sector” on February 8th, 2012, which was attended by over 100 participants from various public and private entities.

large scale projects by utilizing the country’s latest technologies and long-term low-cost funding. US Ex-Im will be able to provide funding to mining, infrastructure, railway, roads, energy, housing and industrial projects.

DeVeLoPment banK of monGoLia

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032

RISK MANAGEMENT

033

Risk management The Executive Management Committee, Credit Committee and Risk Management Department cooperates closely with the Board of Directors to carry out operations in line with prudential risk management ratios in order to monitor ever changing social, economic and business environments.
The Executive Management Committee and Risk Management Committees will supervise the bank’s credit risk management, influence of international and domestic factors as well as funds for provision of possible loss on loans and its relevant policies and procedures. In 2012, the Risk Management Department carried out its operations by providing professional advice and instructions as well as by cooperating with the Bank’s other departments and clients in areas of operating efficiently in uncertain economic and financial situations, managing financial discipline and mitigating associated risks. The Bank has prepared internal policies, procedures and instructions in line with internationally accepted standards to ensure continued stable operations. Also, routine risk management procedures such as risk analysis and reports were introduced to the core risk management structure. Credit Risk According to the Credit Policy approved by the Board of Directors, the Credit Committee has the authority to approve loans and guarantees with a total amount of up to MNT 5.0 billion. Any requests with higher amounts need to approved by the Board of Directors, before which the Risk Management Department will issue an independent risk analysis report on case by case basis. The Law of the Development Bank of Mongolia states that the bank’s loan assets, guarantees and securities must not be greater than 50 times the value of its equity. The Bank complied with this regulation in 2012. 51.0 percent of loan portfolio consists of projects repaid from the State budget. Projects that are paid through State budget are deemed to have low credit risk. At the end of 2012, the Bank’s loan operations had no non-performing loan outstanding, which demonstrates a favorable social and economic environment for clients and the Bank’s efficient and prudent execution of risk management strategy. In 2013, the Bank is planning to introduce an internationally accepted system to manage evaluation counterpart risk, approval of loans, prevention and management of risks as well as allocation of funds. The Bank will reflect Mongolia’s social and economic environment to the system as well.

Market Risk The foreign exchange rate and interest rate risks of the Bank are managed through close monitoring of mismatch in borrowing and lending positions. The majority of the Bank’s funding resources are proceeds from the Bank’s U.S Dollar bond and when the Bank issues loans in MNT, the potential loss from foreign exchange rate fluctuations is covered by a specific agreement with the Ministry of Finance of Mongolia. Going forward, the Bank is planning to utilize value-at-risk (Var) method, which is commonly used worldwide. Liquidity Risk Development banks give liquidity risk higher priority than commercials due to their lack of access to deposits or central bank supports. The Asset and Liability Management Committee manages liquidity risk of the bank and at any given time, the committee places funds with same amount as equity at minimum in liquid assets. Going forward, the Bank is planning to place funds in liquid assets that will be utilized to meet financial obligations such as operational expenses, financial expenses and disbursement of approved projects as well as managing liquidity risk by closely monitoring cash flows for the next 12 months. Operational Risk The Risk Management Department has worked tirelessly to identify, standardize and manage the bank’s operational risk and introduced relevant policies and procedures. In 2012, the Bank has focused on the following matter within initiative of managing operational risks, which include: Anti-corruption operations; Business operation consistency and stability management; Anti-fraud crimes risk management; Anti-money laundering and fighting of terrorism financing; Information risk management; Compliance operations management. The Risk Management Department has produced and introduced relevant policies, procedures and instruction in terms of above mentioned operational risk and conducted internal trainings for employees.

DeVeLoPment banK of monGoLia

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034

CORPORATE SOCIAL RESPONSIBILITY

035

DEVELOPMENT BANK OF MONGOLIA

ANNUAL REPORT 2012

036

Corporate Social Responsibility

One of the most concerning issues the world is facing today is safeguarding the natural environment. This goal is given high priority by Mongolia, whose economy based on the extraction of rich mineral resources. Mongolia is on the brink of rapid economic acceleration and in order to realize its full potential, the country has to develop complete solutions to infrastructure bottlenecks and employ innovative technologies that are environmentally friendly to promote national development. As operations expand, the Bank has an increasing level of responsibility to its clients, shareholder, employees and country. The Bank’s role is to finance large revenue generating and socially ben-

To promote the competitiveness of the Mongolian nation through investment in long-term development projects so that all Mongolian citizens can benefit from the country’s entry into the global marketplace.

eficial projects that will contribute to Mongolia’s economic growth. As a result of its operations, the Bank has contributed to economic and social developments on the national and regional level. Going further, the bank will cooperate with various entities from the public and private sectors to contribute to the economic development of a humane and ecologically friendly society.

CORPORATE SOCIAL RESPONSIBILITY

037

Corporate Social Responsibility Review

The Bank has financed national projects and programs aimed at Mongolia’s development while taking consideration of environmental issues and organizing publicly oriented events.

The Bank employees have planted trees under “Let’s Plant Trees” initiative at “Shavi” Complex school in Bayanzurkh District under “plant and transfer” agreement, where teachers and students will look after the trees.

To promote Mongolian culture, the Bank auctioned painter Ch.Khurelbaatar and sculpturist N.Sukhburen’s creations. The proceeds were later donated to good-cause activities for the youth. Financing Environmentally Friendly Developments to Foster Mongolia’s Economic Development: The Bank has allocated funds to projects in relation to their contribution to national development and usage of innovative green technology as well as generation of employment opportunities for national companies. The Bank did not put profits first and took associated risks for a holistic contribution to the national interest. The Bank has participated in the “Open Government” event organized by the Government along with all of the ministries to showcase economic and social contributions of strategic projects that are being financed by the Bank. Support for Humanitarian Activities: Employees have volunteered to participate in social events on a good will basis.

The employees have donated a day’s salary to rural herders to support their preparation ahead of the winter under “Herders’ Day” campaign.

DEVELOPMENT DeVeLoPment BANK banK OF MONGOLIA of monGoLia

ANNUAL REPORT 2012

038

038

FINANCIAL REVIEW

039

Financial Overview

The Development Bank of Mongolia started operations in 2011 with total assets of MNT 76.9 billion and increased 11.5 times in 2012 to MNT 888.6 billion. In terms of total asset breakdown, 24.0 percent was cash, current accounts at Central Bank of Mongolia and commercial banks, 19.0 percent was deposits at commercial banks, 55.0 percent was loans provided to companies and 2.0 percent was other assets. Balance Sheet
1,000 888.6 800 600 489.7 400 200 0 Total Asset Loan Equity (MNT billion)

The Bank’s revenue generating assets increased from 12.0 percent in 2011 to 74.0 percent in 2012, which was a 62.0 percent increase, equal to MNT 647.7 billion. Bank has successfully started to finance projects of strategic importance in various sectors.
The Bank established its USD 600.0 million Euro Medium Term Note program and issued USD 20.0 million bond with 6 percent coupon in 2011, which was followed by successful public offering of 5 year USD 580.0 million bond with 5.75 percent coupon in 2012. The bank is planning to diversify its funding resources in 2013 by upsizing its current program or by establishing a new bond program and issuing bonds through public placement and/or public offering in international capital markets. The Bank’s assets have increased by a factor of nearly 30 since 2011 (36.0 percent of total assets) to MNT 820.7 billion in 2012 (92.0 percent of total assets). The Law on the Development Bank of Mongolia states that the Bank’s equity can consist of budget allocations and other resources. Operations started with equity equal MNT 16.7 billion and subsequently increased equity by MNT 33.0 billion in 2011 and MNT 23.6 billion in 2012, for a total of MNT 73.3 billion in equity at the end of 2012. The Bank had capital adequacy ratio of 8.2 percent. The Bank generated interest revenues of MNT 36.8 billion and paid interest expenses of MNT 37.7 billion in 2012. The net interest expense of MNT 0.9 billion was caused by a placement mismatch between funds raised and funds disbursed. The net before tax loss of MNT 8.3 billion incurred during the tax year was attributable to losses resulting from foreign currency exchange rate fluctuations on funds raised (MNT 5.7 billion or 69.0 percent of net loss) and other factors.

76.9 0

49.7

72.7

Profit and Loss Statement
2 0 -2 -4 -6 -8 -10 Net interest income -8.3 -0.67 -0.9 0.12 2011 2012

(MNT billion)

Profit and loss before taxes

DEVELOPMENT DeVeLoPment BANK banK OF MONGOLIA of monGoLia

ANNUAL REPORT 2012

040

040

INDEPENDENT AUDITOR’s REPORT

041

Deliotte Onch Audit LLC 4th floor, suite 409, Khukh Tenger Tower Peace Avenue 17, Sukhbaatar district, 1st khoroo Ulaanbaatar 14240, Mongolia Tel: +976-11-325852, +976-70120450 Fax: +976-11-329611, www.deloitte.com

INDEPENDENT AUDITOR’S REPORT To the Board of Members of Development Bank of Mongolia We have audited the accompanying financial statements of Development Bank of Mongolia (‘the Bank’),which comprise the statement of financial position as at 31 December 2012, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the period 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, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether or due to fraud or error. Auditor’s 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 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 auditor’s 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 in 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. Opinion In our opinion, the financial statements present fairly, in all material respects, the financial position of Development Bank of Mongolia as at 31 December 2012, and it’s financial performance and cash flows for the period then ended in accordance with International Financial Reporting Standards.

Deloitte Onch Audit LLC Ulaanbaatar, Mongolia May 7, 2013

DEVELOPMENT BANK OF MONGOLIA

ANNUAL REPORT 2012

042

DEVELOPMENT BANK OF MONGOLIA
15160 Ulaanbaatar, Chingeltei district UN Street 5/1, Government Building II Fax: 976-70130602, Tel: 701305013 http://www.dbm.mn , info@dbm.mn Date Ref 2013.05.07 2/253

STATEMENT BY EXCUTIVES

I, Kim Jang Jin is the Executive Director of Development Bank of Mongolia LLC (“the Company”)and Tuyachimeg Sevjid is the Chief Accountant, being the officers primarily responsible for the financial reporting of the Company , do hereby state that, in our opinion, the accompanying financial statements set out on pages 43 to 83 are drawn up in accordance with applicable International Financial Reporting Standards so as to give a true and fair view of the financial position of the Company as at December 31st, 2012 and of the results and the cash flows of the Company for the year then ended.

KIM JANG JIN EXECUTIVE DIRECTOR

TUYACHIMEG SEVJID HEAD OF ACCOUNTING DIVISION

INDEPENDENT AUDITOR’s REPORT

043

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
December 31   ASSETS Cash and balances at central banks Investments Loans and advances Accrued interest receivable Other current assets Property, Plant and Equipment, net Intangible assets, net Deferred tax asset 6 7 8 9 10 11 12 22 215,990,270 167,052,000 489,704,568 9,121,272 2,285,515 234,558 726,688 3,465,282 888,580,153 LIABILITIES AND EQUITY Liabilities Accounts and Other Liabilities Current account from customers Accrued interest payable Long-term debt   Equity Share capital Retained earnings 17 73,300,000 (5,469,669) 67,830,331 888,580,153 49,700,000 (602,190) 49,097,810 76,860,194 15 14 13 3,425,135 6,960 12,896,260 804,421,467 820,749,822 1,139,593 102,400 26,520,391 27,762,384 66,709,512 9,000,000 108,233 3,667 182,563 811,286 44,933 76,860,194 Notes 2012 2011

The accompanying notes form an integral part of these financial statements.

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DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)

  Interest income and similar income Interest expense and similar expense Net Interest (Expense)/Income Non-Interest Income Operating Income Operating Expenses Profit (Loss) Before Tax Income tax benefit Profit (Loss) for the Year Other comprehensive income Total comprehensive loss for the year  

Notes 18 19

2012 36,787,338 (37,652,609) (865,271)

For the period from 12 May 2011 to 31 December 2011 253,433 (120,503) 132,930 132,930 780,053 (647,123) 44,933 (602,190) (602,190)

20

48,057 (817,214)

21

7,470,614 (8,287,828)

22

3,420,349 (4,867,479) (4,867,479)

The accompanying notes form an integral part of these financial statements

  Notes Balance, May 12, 2011 Contribution from Government Profit (Loss) for the period Balance, December 31, 2011 Profit (Loss) for the year Additional contribution from Government Balance, December 31, 2012 1     1 Share Capital 49,700,000 49,700,000 23,600,000 73,300,000 Retained Earnings (602,190) (602,190) (4,867,479) -  (5,469,669) Total 49,700,000 (602,190) 49,097,810 (4,867,479) 23,600,000 67,830,331

The accompanying notes form an integral part of these financial statements

INDEPENDENT AUDITOR’s REPORT

045

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
    Cash Flows from Operating Activities Profit (loss) for the period Adjustments for: Income tax expense Interest income Interest expense Loss (gain) from foreign exchange rate differences Depreciation and amortization (3,420,349) (36,787,338) 37,652,609 34,913,681 149,868 27,640,992 Change in loans and advances Change in other current assets Other cash payments   Interest paid Interest received Net cash from (used) in operating activities Cash Flows from Investing Activities Purchase of fixed assets Purchase of intangible assets Net investment in time deposit Interest received Net cash from (used in) investing activities Cash Flows from Financing Activities Proceeds from borrowings Payment of borrowings Proceeds of capital from the government Net cash from (used in) financing activities Effects of exchange rate changes on cash Net Increase (Decrease) in Cash and Cash Equivalents Cash and Cash Equivalents, Beginning Cash and Cash Equivalents, End   769,717,076 (28,019,600) 23,600,000 765,297,476 20,232 149,280,758 66,709,512 215,990,270 25,497,955 49,700,000 75,197,955 509,036 66,709,512 66,709,512   (117,265) (158,410,070) 3,275,584 (155,251,751) (212,579) (840,732) (9,000,000) (10,053,311) (488,377,343) (2,281,848) 2,292,555 (488,366,636) (24,846,075) 24,786,520 (460,785,199) (44,933) (253,433) 120,503 515,463 59,462 (205,128) (3,667) 1,138,619 1,134,952 (19,192) 145,200 1,055,832 (4,867,479) (602,190)

2012

2011

   

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046

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
1. CORPORATE INFORMATION

The Development Bank of Mongolia (‘the Bank’) is a Government-owned, policy-implemented statutory financial institution established on 25 March, 2011 pursuant to Resolution No. 195 dated 20 July, 2010 by the Government of Mongolia. The Bank conducts its business under the direct supervision of the Board of Directors by the Government, and is regulated, principally, by the Development Bank Law. The Bank commenced operations in May 2011. The Government of Mongolia is the Bank’s sole shareholder. In May and December 2011, the Government contributed MNT 16.7 billion and MNT 33.0 billion, respectively, in cash to the Bank’s capital. During 2012, the Government contributed a further MNT 23.6 billion and as at 31 December, 2012, the Bank’s share capital was 73.3 billion. In accordance with Article 21.1 of the Development Bank Law, Parliament determines the source and amount of equity financing the Government can provide to the Bank and determines the limits of loan guarantees to be provided by the Government. The executive management of the Bank is carried out by a joint team from the Bank and the Korean Development Bank. The Korean Development Bank was selected through an open international tender. The executive management of the Bank is carried out by a joint team from the Bank and the Korean Development Bank, which was selected through an open international tender, under the pursuant to Resolution No. 195 dated 20 July, 2010 by the Government of Mongolia. The Bank’s principal place of business is at Government Building 2, 5/1 United Nations Street, Ulaanbaatar 15160. The Bank had 46 employees during the year ended 31 December 2012 (2011: 38). These financial statements were approved for issue by the Board of Directors of the Bank on May 7, 2013. 2. FINANCIAL REPORTING FRAMEWORK AND BASIS OF PREPARATION AND PRESENTATION

Statement of Compliance The financial statements of the Bank have been prepared in accordance with International Financial Reporting Standards (IFRS), which includes all applicable IFRS, International Accounting Standards (IAS), and interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC) and Standing Interpretations Committee (SIC). Basis of Preparation and Presentation The financial statements have been prepared on the historical cost basis except for certain financial instruments carried at amortized cost. Functional Currency These financial statements are presented in Mongolian tugrugs (‘MNT’) the currency of the primary economic environment in which the Bank operates. 1. APPLICATION OF NEW AND REVISED INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRSs)

3.1 New and revised IFRSs affecting amounts reported in the current year (and/or prior years) For the year ended 31 December 2012, there were no new or revised IFRSs that affected either the reported financial performance and financial position or the presentation and disclosure. 3.2 New and revised IFRSs applied with no material effect on the financial statements The following new and revised IFRSs have been applied in the current year. The application of these new and revised IFRSs has not had any material impact on the amounts reported for the current and prior years but may affect the accounting for future transactions or arrangements.

INDEPENDENT AUDITOR’s REPORT

047

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
Amendments IFRS 1 - Severe Hyperinflation1

The amendments regarding severe hyperinflation provide guidance for entities emerging from severe hyperinflation either to resume presenting IFRS financial statements or to present IFRS financial statements for the first time.

IFRS 1 - Removal of Fixed Dates for First-time Adopters1

The amendments regarding the removal of fixed dates provide relief to first-time adopters of IFRSs from reconstructing transactions that occurred before their date of transition to IFRSs.

IFRS 7 - Disclosures – Transfers of Financial Assets1

The amendments to IFRS 7 increase the disclosure requirements for transactions involving transfers of financial assets. These amendments are intended to provide greater transparency around risk exposures of transactions where a financial asset is transferred but the transferor retains some level of continuing exposure in the asset.

IAS 12 - Deferred Tax -Recovery of Underlying Assets2

The amendment provides a presumption that recovery of the carrying amount of an asset measured using the fair value model in IAS 40 Investment Property will, normally, be through sale.

1 2

Effective for annual periods beginning on or after 1 July 2011. Effective for annual periods beginning on or after 1 January 2012.

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DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)

3. APPLICATION OF NEW AND REVISED INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRSs) (CONT’D) 3.3 New and revised IFRSs in issue but not yet effective The Company has not applied the following new and revised IFRSs that have been issued but are not yet effective. IFRS 9 - Financial Instruments2 IFRS 9 issued in November 2009 introduces new requirements for the classification and measurement of financial assets. IFRS 9 amended in October 2010 includes the requirements for the classification and measurement of financial liabilities and for derecognition. Key requirements of IFRS 9 are described as follows: • • IFRS 9 requires all recognised financial assets that are within the scope of IAS 39 Financial Instruments: Recognition and Measurement to be subsequently measured at amortised cost or fair value. The most significant effect of IFRS 9 regarding the classification and measurement of financial liabilities relates to the accounting for changes in the fair value of a financial liability (designated as at fair value through profit or loss) attributable to changes in the credit risk of that liability. Changes in fair value attributable to a financial liability’s credit risk are not subsequently reclassified to profit or loss. Previously, under IAS 39, the entire amount of the change in the fair value of the financial liability designated as at fair value through profit or loss was presented in profit or loss.

IFRS 10 - Consolidated Financial Statements1

IFRS 10 replaces the parts of IAS 27 Consolidated and Separate Financial Statements that deal with consolidated financial statements. SIC-12 Consolidation – Special Purpose Entities has been withdrawn upon the issuance of IFRS 10. Under IFRS 10, there is only one basis for consolidation that is control. In addition, IFRS 10 includes a new definition of control that contains three elements: (a) power over an investee, (b) exposure, or rights, to variable returns from its involvement with the investee, and (c) the ability to use its power over the investee to affect the amount of the investor’s returns. Extensive guidance has been added in IFRS 10 to deal with complex scenarios.

IFRS 11- Joint Arrangements1

IFRS 11 replaces IAS 31 Interests in Joint Ventures. IFRS 11 deals with how a joint arrangement of which two or more parties have joint control should be classified. SIC-13 Jointly Controlled Entities – Non-monetary Contributions by Venturers has been withdrawn upon the issuance of IFRS 11. Under IFRS 11, joint arrangements are classified as joint operations or joint ventures, depending on the rights and obligations of the parties to the arrangements. In contrast, under IAS 31, there are three types of joint arrangements: jointly controlled entities, jointly controlled assets and jointly controlled operations.

INDEPENDENT AUDITOR’s REPORT

049

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
3. APPLICATION OF NEW AND REVISED INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRSs) (CONT’D) 3.3 New and revised IFRSs in issue but not yet effective (Cont’d) IFRS 11- Joint Arrangements1 (Cont’d) In addition, joint ventures under IFRS 11 are required to be accounted for using the equity method of accounting, whereas jointly controlled entities under IAS 31 can be accounted for using the equity method of accounting or proportionate accounting.

IFRS 12 - Disclosure of Interests in Other Entities1

IFRS 12 is a disclosure standard and is applicable to entities that have interests in subsidiaries, joint arrangements, associates and/or unconsolidated structured entities. In general, the disclosure requirements in IFRS 12 are more extensive than those in the current standards. IFRS 13 establishes a single source of guidance for fair value measurements and disclosures about fair value measurements. The Standard defines fair value, establishes a framework for measuring fair value, and requires disclosures about fair value measurements. In general, the disclosure requirements in IFRS 13 are more extensive than those required in the current standards. Revised in 2011, the amendments to IAS 19 change the accounting for defined benefit plans and termination benefits. The most significant change relates to the accounting for changes in defined benefit obligations and plan assets. The amendments require the recognition of changes in defined benefit obligations and in fair value of plan assets when they occur, and hence eliminate the ‘corridor approach’ permitted under the previous version of IAS 19 and accelerate the recognition of past service costs. The amendments require all actuarial gains and losses to be recognised immediately through other comprehensive income in order for the net pension asset or liability recognised in the statement of financial position to reflect the full value of the plan deficit or surplus. Revised in 2011, the amended version of IAS 27 which now only deals with the requirements for separate financial statements, which have been carried over largely unchanged from IAS 27 Consolidated and Separate Financial Statements. Revised in 2011, this Standard supersedes IAS 28 Investments in Associates and prescribes the accounting for investments in associates and sets out the requirements for the application of the equity method when accounting for investments in associates and joint ventures. The Standard defines ‘significant influence’ and provides guidance on how the equity method of accounting is to be applied (including exemptions from applying the equity method in some cases). It also prescribes how investments in associates and joint ventures should be tested for impairment.

IFRS 13 - Fair Value Measurement1

IAS 19 - Employee Benefits1 (as revised in 2011)

IAS 27 - Separate Financial Statements1 (as revised in 2011) IAS 28 - Investments in Associates and Joint Ventures1 (as revised in 2011)

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DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
3. APPLICATION OF NEW AND REVISED INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRSs) (CONT’D) 3.3 New and revised IFRSs in issue but not yet effective (Cont’d) IFRS 1- Government Loan1 The amendments to provide relief to first-time adopters of IFRSs by amending IFRS 1 to allow prospective application of IAS 39 or IFRS 9 and paragraph 10A of IAS 20 Accounting for Government Grants and Disclosure of Government Assistance to government loans outstanding at the date of transition to IFRSs.

IFRS 7- Disclosures –Offsetting Financial Assets and Financial Liabilities1

The amendments to IFRS 7 require entities to disclose information about rights of offset and related arrangements (such as collateral posting requirements) for financial instruments under an enforceable master netting agreement or similar arrangement

IAS 1- Presentation of Items of Other Comprehensive Income4

The amendments to IAS 1 retain the option to present profit or loss and other comprehensive income in either a single statement or in two separate but consecutive statements. However, the amendments to IAS 1 require additional disclosures to be made in the other comprehensive income section such that items of other comprehensive income are grouped into two categories: (a) items that will not be reclassified subsequently to profit or loss; and (b) items that will be reclassified subsequently to profit or loss when specific conditions are met. Income tax on items of other comprehensive income is required to be allocated on the same basis.

IAS 32- Offsetting Financial Assets The amendments to IAS 32 clarify existing application issues relating to the offsetting and Financial Liabilities1 requirements. Specifically, the amendments clarify the meaning of ‘currently has a legally enforceable right of set-off’ and ‘simultaneous realization and settlement’.

IFRS 10, IFRS 12 and IAS 27Investment Entity3

Amends IFRS 10 Consolidated Financial Statements, IFRS 12 Disclosure of Interests in Other Entities and IAS 27 Separate Financial Statements to: • provide ‘investment entities’ (as defined) an exemption from the consolidation of particular subsidiaries and instead require that an investment entity measure the investment in each eligible subsidiary at fair value through profit or loss in accordance with IFRS 10 Financial Instruments or IAS 39 Financial Instruments: Recognition and Measurement • require additional disclosure about why the entity is considered an investment entity, details of the entity’s unconsolidated subsidiaries, and the nature of relationship and certain transactions between the investment entity and its subsidiaries • require an investment entity to account for its investment in a relevant subsidiary in the same way in its consolidated and separate financial statements (or to only provide separate financial statements if all subsidiaries are unconsolidated).

INDEPENDENT AUDITOR’s REPORT

051

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
3. APPLICATION OF NEW AND REVISED INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRSs) (CONT’D) 3.3 New and revised IFRSs in issue but not yet effective (Cont’d) Annual Improvements to: IFRS 1 - First-time Adoption of International Financial Reporting Standards1 Repeated application of IFRS 1 The amendments clarify that an entity may apply IFRS 1 if its most recent previous annual financial statements did not contain an explicit and unreserved statement of compliance with IFRSs, even if the entity applied IFRS 1 in the past. An entity that does not elect to apply IFRS 1 must apply IFRSs retrospectively as if there was no interruption. The entity should disclose: • the reason why it stopped applying IFRSs; • the reason why it is resuming the application of IFRSs; and • the reason why it has elected not to apply IFRS 1, if applicable. Borrowing costs The amendments clarify that borrowing costs capitalized under previous GAAP before the date of transition to IFRSs may be carried forward without adjustment to the amount previously capitalized at the transition date. As for borrowing costs incurred on or after the date of transition to IFRSs that relate to qualifying assets under construction at the date of transition, the amendments clarify that they should be accounted for in accordance with IAS 23 Borrowing Costs. The amendments also state that a first-time adopter can choose to apply IAS 23 at a date earlier than the transition date.

IAS 1- Presentation of Financial Statements1

The amendments to IAS 1 clarify that an entity is required to present a statement of financial position as at the beginning of the preceding period (third statement of financial position) only when the retrospective application of an accounting policy, restatement or reclassification has a material effect on the information in the third statement of financial position and that the related notes are not required to accompany the third statement of financial position. The amendments also clarify that additional comparative information is not necessary for periods beyond the minimum comparative financial statements requirements of IAS 1. However, if additional comparative information is provided, the information should be presented in accordance with IFRSs, including related note disclosure of comparative information for any additional statements included beyond the minimum comparative financial statement requirements. Presenting additional comparative information voluntarily would not trigger a requirement to provide a complete set of financial statements.

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DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
3. APPLICATION OF NEW AND REVISED INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRSs) (CONT’D) 3.3 New and revised IFRSs in issue but not yet effective (cont’d) Annual Improvements to (Cont’d): IAS 16 - Property, Plant and Equipment1 The amendments clarify that spare parts, stand-by equipment and servicing equipment should be classified as property, plant and equipment when they meet the definition of property, plant and equipment in IAS 16 and as inventory otherwise.

IAS 32- Financial Instruments: Presentation1

The amendments clarify that income tax on distributions to holders of an equity instrument and on transaction costs of an equity transaction should be accounted for in accordance with IAS 12.

IAS 34 - Interim Financial Reporting1 (2009-2011 Cycle)

The amendments clarify that the total assets and total liabilities for a particular reportable segment would be separately disclosed in interim financial reporting only when the amounts are regularly provided to the chief operating decision maker and there has been a material change from the amounts disclosed in the last annual financial statements for that reportable segment.

New Interpretation IFRIC 20 - Stripping Costs in the Production Phase of a Surface Mine1 IFRIC 20 identifies two benefits accruing to an entity from its waste removal (‘stripping’) activity: usable ore that can be used to produce inventory and improved access to further quantities of material that will be mined in future periods. The interpretation only deals with waste removal costs that are incurred in surface mining activity during the production phase of the mine and requires that costs of stripping activity to be accounted for in accordance with the principles of IAS 2 Inventories to the extent that the benefit from the stripping activity is realized in the form of inventory production; while the costs of stripping activity that provides a benefit in the form of improved access to ore is recognized as a non-current ‘stripping activity asset’ where certain criteria are met.

Effective for annual periods beginning on or after 1 January 2013. Effective for annual periods beginning on or after 1 January 2015 3 Effective for annual periods beginning on or after 1 January 2014. 4 Effective for annual periods beginning on or after 1 July 2012.
1 2

INDEPENDENT AUDITOR’s REPORT

053

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
2. SIGNIFICANT ACCOUNTING POLICIES

Financial Assets Initial recognition of financial assets Financial assets are recognized in the Bank’s financial statements when the Bank becomes a party to the contractual provisions of the instrument. Financial assets are recognized initially at fair value. Transaction costs are included in the initial measurement of the Bank’s financial assets, except for investments classified at fair value through profit or loss. Investments are recognized and derecognized on settlement date accounting when the purchase or sale of an investment is under a contract whose terms require delivery of the investment within the timeframe established by the market concerned. Classification of financial assets Financial assets are classified into the following specified categories: financial assets ‘at fair value through profit or loss’, ‘heldto-maturity’ investments, ‘available-for-sale’ financial assets and ‘loans and receivables’. The classification depends on the nature and purpose of the financial assets and is determined at the time of initial recognition. Financial assets at fair value through profit or loss The Bank classifies financial assets as at fair value through profit or loss when the financial asset is held for trading or designated upon initial recognition. A financial asset is classified as held for trading if: • • it is a part of an identified portfolio of financial instruments that the Bank manages together and has a recent actual pattern of short-term profit-taking; or it is a derivative that is not designated and effective as a hedging instrument.

A financial asset other than a financial asset held for trading may be designated as at fair value through profit or loss upon initial recognition if: • such designation eliminates or significantly reduces a measurement or recognition inconsistency that would otherwise arise; or • the financial asset forms part of a group of financial assets or financial liabilities or both, which is managed and its performance is evaluated on a fair value basis, in accordance with the Bank’s documented risk management or investment strategy, and information about the grouping is provided internally on that basis; or • it forms part of a contract containing one or more embedded derivatives, and it is permitted that the entire combined contract to be designated as at fair value through profit or loss. Originated loans and advances Loans and advances are presented net of allowances for uncollectability. Allowances are made against the carrying amount of loans and advances that are identified as being potentially impaired, based on regular reviews of outstanding balances, to reduce these loans and advances to their recoverable amount in accordance with regulations on asset classification and establishment and disbursement of loan loss provision of the Bank. 4. SIGNIFICANT ACCOUNTING POLICIES (CONT’D) Originated loans and advances (Cont’d) Increases in the allowance account are recognized in the statement of comprehensive income. When a loan is known to be uncollectible, all the necessary legal procedures have been completed and the final loss has been determined, the loan is written off directly. In accordance with the Bank’s Provisioning Guidelines, the Bank is required to determine the quality of loans and advances based on their qualitative factor and time characteristics in classifying them and create provisions. Such model classifies the Bank’s loans and makes allowances for loan losses at the rates of 0%, 5%, 25%, 50% and 100%, based on credit classification

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DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
categories of performing, in arrears, substandard, doubtful and loss, respectively. Under IFRS, impairment or uncollectibility of financial assets measured at amortized cost basis shall be measured at the difference between carrying amount and the net present value of future cash flows discounted at the financial asset’s original effective interest rate. Qualitative characteristics taken into consideration for credit classification include completeness of loan file, financial indicators of the borrower, value of the collateral and previous rescheduling of the loan, etc. When a subsequent event causes the amount of impairment loss to decrease, the decrease in impairment loss is reversed through profit or loss Held-to-maturity investments Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturity dates that the Bank has the positive intent and ability to hold to maturity. Held-to-maturity investments are measured at amortized cost using the effective interest method less any impairment, with revenue recognized on an effective yield basis. Available-for-sale financial assets Available-for-sale financial assets are non-derivative financial assets that are designated as available-for-sale or are not classified as loans and receivables, held-to-maturity investments or financial assets at fair value through profit or loss. At 31 December 2012, the Bank had no available-for-sale assets. Effective interest method The effective interest method is a method of calculating the amortized cost of a debt instrument and of allocating interest income over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash receipts through the expected life of the debt instrument or, when appropriate, a shorter period, to the net carrying amount on initial recognition. Income is recognized on effective interest basis for debt instruments other than those assets classified as at fair value through profit or loss. Impairment of Financial Assets Financial assets, other than those at fair value through profit or loss, are assessed for indicators of impairment at the end of each reporting period. Financial assets are considered to be impaired when there is objective evidence that, as a result of one or more events that occurred after the initial recognition of the financial asset, the estimated future cash flows of the investment have been affected. 4. SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Objective evidence of impairment For all financial assets carried at amortized cost, objective evidence of impairment could include: • • • • • • significant financial difficulty of the issuer or counter party; or breach of contract, such as default or delinquency in interest or principal payments; or it becoming probable that the borrower will enter bankruptcy or financial re-organization; or the disappearance of an active market for that financial asset because of financial difficulties; or the lender, for economic or legal reasons relating to the borrower’s financial difficulty, granting to the borrower a concession that the lender would not otherwise consider; or observable data indicating that there is a measurable decrease in the estimated future cash flows from a group of financial assets since the initial recognition of those assets, although the decrease cannot yet be identified with the individual financial assets in the group.

Loans and advances are presented net of allowances for uncollectability. Allowances are made against the carrying amount of loans and advances that are identified as being potentially impaired, based on regular reviews of outstanding balances, to reduce these loans and advances to their recoverable amount in accordance to Regulations on Asset Classification and provisioning approved by the Executive director of Development Bank of Mongolia. Increases in the allowance account are recognized in the statement of comprehensive income. When a loan is known to be uncollectible, all the necessary legal procedures have been completed and the final loss has been determined, the loan is written off directly.

INDEPENDENT AUDITOR’s REPORT

055

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
4. SIGNIFICANT ACCOUNTING POLICIES (CONT’D) Financial assets carried at amortized cost If there is objective evidence that an impairment loss on loans and receivables or held-to-maturity investments carried at amortized cost has been incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows, excluding future credit losses that have not been incurred, discounted at the financial asset’s original effective interest rate, i.e., the effective interest rate computed at initial recognition. If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognized, the previously recognized impairment loss shall be reversed. The reversal shall not result in a carrying amount of the financial asset that exceeds what the amortized cost would have been had the impairment not been recognized at the date the impairment is reversed. The amount of the reversal shall be recognized in profit or loss. Available-for-sale financial assets If, in a subsequent period, the fair value of a debt instrument classified as available-for-sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognized in profit or loss, the impairment loss shall be reversed, with the amount of the reversal recognized in profit or loss. In respect of available-for-sale equity securities, impairment losses previously recognized in profit or loss are not reversed through profit or loss. Any increase in fair value subsequent to an impairment loss is recognized in other comprehensive income. Offsetting financial instruments Financial assets and liabilities are offset and the net amount reported in the statements of financial position when there is a legally enforceable right to offset the recognized amounts and there is an intention to settle on a net basis or realize the asset and settle the liability simultaneously. Derecognition of financial assets The Bank derecognizes a financial asset only when the contractual rights to the cash flows from the asset expire; or when the Bank transfers the financial asset and substantially all the risks and rewards of ownership of the asset to another entity. The difference between the carrying amount of the financial asset derecognized and the consideration received or receivable is recognized in profit or loss. If the Bank neither transfers nor retains substantially all the risks and rewards of ownership and continues to control the transferred asset, the Bank recognizes its retained interest in the asset and an associated liability for amounts it may have to pay. If the Bank retains substantially all the risks and rewards of ownership of a transferred financial asset, the Bank continues to recognize the financial asset and also recognizes a collateralized borrowing for the proceeds received. On derecognition of a financial asset other than in its entirety (e.g. when the Bank retains an option to repurchase part of a transferred asset), the Bank allocates the previous carrying amount of the financial asset between the part it continues to recognize under continuing involvement, and the part it no longer recognizes on the basis of the relative fair values of those parts on the date of the transfer. The difference between the carrying amount allocated to the part that is no longer recognized and the sum of the consideration received for the part no longer recognized and any cumulative gain or loss allocated to it that had been recognized in other comprehensive income is recognized in profit or loss. A cumulative gain or loss that had been recognized in other comprehensive income is allocated between the part that continues to be recognized and the part that is no longer recognized on the basis of the relative fair values of those parts. 4. SIGNIFICANT ACCOUNTING POLICIES (CONT’D) Cash and cash equivalents Cash and cash equivalents include cash on hand, unrestricted balances on correspondent and time deposit accounts with original maturities of less than 90 days, which are subject to insignificant risk of changes in their fair value, and are used by the Bank in the management of short-term commitments.

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DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
Prepayments Prepayments represent expenses not yet incurred but already paid in cash. Prepayments are initially recorded as assets and measured at the amount of cash paid. Subsequently, these are charged to profit or loss as they are consumed in operations or expire with the passage of time. Property, Plant and Equipment Property, plant and equipment are initially measured at cost. At the end of each reporting period, property, plant and equipment are measured at cost less any subsequent accumulated depreciation, amortization and impairment losses. Cost includes expenditure that is directly attributable to the acquisition of the asset. Cost also may include transfers from other comprehensive income of any gain or loss on qualifying cash flow hedges of foreign currency purchases of property, plant and equipment. Purchased software that is integral to the functionality of the related equipment is capitalized as part of that equipment. When an item of property, plant and equipment is acquired in an exchange for non-monetary asset/s, or a combination of monetary and non-monetary assets, the cost of that item is measured at fair value unless: • the exchange transaction lacks commercial substance; or • the fair value of neither the asset received nor the asset given up is reliably measurable. Subsequent expenditures relating to an item of property, plant and equipment that have already been recognized are added to the carrying amount of the asset when it is probable that future economic benefits, in excess of the originally assessed standard of performance of the existing asset, will flow to the Bank. All other subsequent expenditures are recognized as expenses in the period in which those are incurred. Depreciation is computed on the straight-line method, based on the estimated useful lives of the assets as follows:

IT Equipment Furniture and fixture Vehicles

3 years 10 years 10 years

Assets held under finance leases are depreciated over their expected useful lives on the same basis as owned assets; otherwise the assets are depreciated over the shorter of the assets useful lives or the lease term. Derecognition of property, plant and equipment An item of property, plant and equipment is derecognized upon disposal or when no future economic benefits are expected to arise from the continued use of the asset.   Gain or loss arising on the disposal or retirement of an asset is determined as the difference between the sales proceeds and the carrying amount of the asset and is recognized in profit or loss. 4. SIGNIFICANT ACCOUNTING POLICIES (CONT’D) Intangible Assets Acquired intangible assets Intangible assets that are acquired by the Bank with finite useful lives are initially measured at cost. At the end of each reporting period items of intangible assets acquired are measured at cost less accumulated amortization and accumulated impairment losses. Cost includes purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates and any directly attributable cost of preparing the intangible asset for its intended use. Subsequent expenditure is capitalized only when it increases the future economic benefits embodied in the specific asset

INDEPENDENT AUDITOR’s REPORT

057

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
to which it relates. All other expenditure, including expenditure on internally generated goodwill and brands, is recognized in profit or loss as incurred. Amortization for intangible asset with finite useful life is calculated over the cost of the asset, or other amount substituted for cost, less its residual value. Amortization is recognized in profit or loss on a straight-line basis over the estimated useful lives of intangible assets from the date that they are available for use, since this most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset. The estimated useful lives are as follows: • Software 10 years

Intangible assets with indefinite life are not amortized. However, these assets are reviewed annually to ensure the carrying value does not exceed the recoverable amount regardless of whether an indicator of impairment is present. Derecognition of intangible assets An intangible asset is derecognized on disposal, or when no future economic benefits are expected from use or disposal. Gains or losses arising from derecognition of an intangible asset are measured as the difference between the net disposal proceeds and the carrying amount of the asset and are recognized in profit or loss when the asset is derecognized. Impairment of Tangible and Intangible Assets At the end of each reporting period, the Bank assesses whether there is any indication that any of its tangible and intangible assets may have suffered an impairment loss. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss, if any. When it is not possible to estimate the recoverable amount of an individual asset, the Bank estimates the recoverable amount of the cash-generating unit to which the asset belongs. A reasonable and consistent basis of allocation can be identified, assets are also allocated to individual cash-generating units, or otherwise they are allocated to the smallest group of cash-generating units for which a reasonable and consistent allocation basis can be identified. Intangible assets with indefinite useful lives and intangible assets not yet available for use are tested for impairment annually and whenever there is an indication that the asset may be impaired. Recoverable amount is the higher of fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset for which the estimates of future cash flows have not been adjusted. 4. SIGNIFICANT ACCOUNTING POLICIES (CONT’D) Impairment of Tangible and Intangible Assets (Cont’d) If the recoverable amount of an asset or cash-generating unit is estimated to be less than its carrying amount, the carrying amount of the asset or cash-generating unit is reduced to its recoverable amount. An impairment loss is recognized as an expense. Impairment losses recognized in respect of CGUs are allocated first to reduce the carrying amount of any goodwill allocated to the units, and then to reduce the carrying amounts of the other assets in the unit (group of units) on a pro rata basis. Impairment losses recognized in prior periods are assessed at the end of each reporting period for any indications that the loss has decreased or no longer exists. An impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortization, if no impairment loss had been recognized. A reversal of an impairment loss is recognized as income.

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DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
Financial Liabilities and Equity Instruments Classification as debt or equity Debt and equity instruments are classified as either financial liabilities or as equity in accordance with the substance of the contractual arrangements. Financial liabilities Financial liabilities are recognized in the Bank’s financial statements when the Bank becomes a party to the contractual provisions of the instrument. Financial liabilities are initially recognized at fair value. Transaction costs are included in the initial measurement of the Bank’s financial liabilities, except for debt instruments classified at fair value through profit or loss. Financial liabilities are classified as either financial liabilities at fair value through profit or loss or other financial liabilities. Other financial liabilities Since the Bank does not have financial liabilities classified at fair value through profit or loss, all financial liabilities are subsequently measured at amortized cost using the effective interest method, with interest expense recognized on an effective yield basis. The effective interest method is a method of calculating the amortized cost of a financial liability and of allocating interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments through the expected life of the financial liability or, when appropriate, a shorter period, to the net carrying amount on initial recognition. Derecognition of financial liabilities Financial liabilities are derecognized by the Bank when the obligation under the liability is discharged, cancelled or expired. The difference between the carrying amount of the financial liability derecognized and the consideration paid and payable is recognized in profit or loss. Equity instruments An equity instrument is any contract that evidences a residual interest in the assets of the Bank after deducting all of its liabilities. Equity instruments issued by the Bank are recognized at the proceeds received, net of direct issue costs. Ordinary shares As at 31 December 2012, the Government of Mongolia had paid in capital contributions to the Bank, but no share certificates had been issued. 4. SIGNIFICANT ACCOUNTING POLICIES (CONT’D) Derivative Financial Instruments and Hedge Accounting The Bank has embedded derivatives in its loan contracts to manage its overall exposure to foreign exchange rate movements. The embedded derivative has been deemed not to be closely related to the underlying contract and accordingly is accounted for separately at fair value through profit or loss. Derivatives are classified at fair value through profit or loss unless such are designated and effective hedging instruments. Derivatives are initially recognized at fair value at the date a derivative contract is entered into and are subsequently remeasured to their fair value at the end of each reporting period. All derivatives are carried as assets if the fair value is positive, otherwise derivatives are carried as liabilities. The resulting gain or loss is recognized in profit or loss immediately unless the derivative is designated and effective as a hedging instrument, in which event the timing of the recognition in profit or loss depends on the nature of the hedge relationship. Derivatives embedded in other financial instruments or other host contracts are treated as separate derivatives when their risks and characteristics are not closely related to those of host contracts and the host contracts are not carried at fair value with unrealized gains or losses reported in profit or loss. The Bank has no hedging policy. Provisions, Contingent Liabilities and Contingent Assets

INDEPENDENT AUDITOR’s REPORT

059

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
Provisions Provisions are recognized when the Bank has a present obligation, either legal or constructive, as a result of a past event, it is probable that the Bank will be required to settle the obligation through an outflow of resources embodying economic benefits, and the amount of the obligation can be estimated reliably. The amount of the provision recognized is the best estimate of the consideration required to settle the present obligation at the end of each reporting period, taking into account the risks and uncertainties surrounding the obligation. A provision is measured using the cash flows estimated to settle the present obligation; its carrying amount is the present value of those cash flows. When some or all of the economic benefits required to settle a provision are expected to be recovered from a third party, the receivable is recognized as an asset if it is virtually certain that reimbursement will be received and the amount of the receivable can be measured reliably. Provisions are reviewed at the end of each reporting period and adjusted to reflect the current best estimate. If it is no longer probable that a transfer of economic benefits will be required to settle the obligation, the provision is reversed. Contingent Liabilities and Assets Contingent liabilities and assets are not recognized because their existence will be confirmed only by the occurrence or nonoccurrence of one or more uncertain future events not wholly within the control of the entity. Contingent liabilities are disclosed, unless the possibility of an outflow of resources embodying economic benefits is remote. Contingent assets are disclosed only an inflow of economic benefits is probable. 4. SIGNIFICANT ACCOUNTING POLICIES (CONT’D) Credit related commitments From time to time, the Bank enters into credit related commitments, including letters of credit and financial guarantees. Financial guarantees represent irrevocable assurances to make payments in the event that a customer cannot meet its obligations to third parties and carry the same credit risk as loans. Financial guarantees and commitments to provide a loan are initially recognized at their fair value, which is normally evidenced by the amount of fees received. This amount is amortized on a straight line basis over the life of the commitment, except for commitments to originate loans if it is probable that the Bank will enter into a specific lending arrangement and does not expect to sell the resulting loan shortly after origination; such loan commitment fees are deferred and included in the carrying value of the loan on initial recognition. At the end of each reporting period, the commitments are measured at the higher of (i) the remaining unamortized balance of the amount at initial recognition and (ii) the best estimate of expenditure required to settle the commitment at the end of each reporting period. In cases where the fees are charged periodically in respect of an outstanding commitment, they are recognized as revenue on a time proportion basis over the respective commitment period. Employee Benefits Short-term benefits The Bank recognizes a liability net of amounts already paid and an expense for services rendered by employees during the accounting period. A liability is also recognized for the amount expected to be paid under short-term cash bonus or profit sharing plans if the Bank has a present legal or constructive obligation to pay this amount as a result of past service provided by the employee, and the obligation can be estimated reliably. Short-term employee benefit obligations are measured on an undiscounted basis and are expensed as the related service is provided. Post-employment benefits The Bank does not have any pension arrangements separate from the state pension system of Mongolia, which requires

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DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
current contributions by the employer calculated as a percentage of current gross salary payments; such expense is charged to the statement of comprehensive incomes in the period the related salaries and wages are payable. In addition, the Bank has no post-retirement benefits or other significant compensated benefits requiring accrual. Revenue Recognition Interest Interest income from a financial asset is recognized when it is probable that the economic benefits will flow to the Bank and the amount of income can be measured reliably. Interest income is accrued on a time proportion basis, by reference to the principal outstanding and at the effective interest rate applicable, which is the rate that exactly discounts estimated future cash receipts through the expected life of the financial asset to that asset’s net carrying amount. Fee and commission income Fees and commissions are generally recognised on an accrual basis when the related service has been provided. Loan commitment fees for loans that are likely to be drawn down are deferred (together with related direct costs) and recognised as an adjustment to the effective interest rate on the loan. 4. SIGNIFICANT ACCOUNTING POLICIES (CONT’D) Expense Recognition Expenses are recognized in profit or loss when decrease in future economic benefit related to a decrease in an asset or an increase in a liability has arisen that can be measured reliably.  Expenses are recognized in profit or loss: on the basis of a direct association between the costs incurred and the earning of specific items of income; on the basis of systematic and rational allocation procedures when economic benefits are expected to arise over several accounting periods and the association with income can only be broadly or indirectly determined; or immediately when an expenditure produces no future economic benefits or when, and to the extent that, future economic benefits do not qualify, or cease to qualify, for recognition in the statements of financial position as an asset. Foreign Currency Foreign currency transactions Transactions in currencies other than the MNT are recorded at the rates of exchange prevailing on the dates of the transactions. At the end of each reporting period, monetary assets and liabilities that are denominated in foreign currencies are retranslated at the rates prevailing at the end of the reporting period. Non-monetary assets and liabilities carried at fair value that are denominated in foreign currencies are translated at the rates prevailing at the date the fair value was determined. Gains and losses arising on retranslation are included in profit or loss for the year. Non-monetary assets and liabilities that are measured in terms of historical cost in a foreign currency are not retranslated. Related Party Transactions A related party transaction is a transfer of resources, services or obligations between the Bank and a related party, regardless of whether a price is charged. A person or a close member of that person’s family is related to the Bank if that person: • • • has control or joint control over the Bank or has significant influence over the Bank or is a member of the key management personnel of the reporting entity or of a parent of the Bank

An entity is related to the Bank if any of the following conditions apply: • the entity and the Bank are members of the same group which means that each parent, subsidiary and fellow subsidiary is related to the others; • one entity is an associate or joint venture of the other entity or an associate or joint venture of a member of a group of which the other entity is a member; • both entities are joint ventures of the same third party;

INDEPENDENT AUDITOR’s REPORT

061

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
• • • • one entity is a joint venture of a third entity and the other entity is an associate of the third entity; the entity is a post-employment benefit plan for the benefit of employees of either the Bank or an entity related to the Bank; the entity is controlled or jointly controlled by a person who is a related party as identified above; and a person that has control or joint control over the reporting entity has significant influence over the entity or is a member of the key management personnel of the entity or of a parent of the entity.

4.SIGNIFICANT ACCOUNTING POLICIES (CONT’D) Taxation Income tax expense represents the sum of the current tax expense and deferred tax. Current tax The tax currently expensed is based on the taxable profit for the year. Taxable profit differs from net profit as reported in the statements of comprehensive income because it excludes items of income or expense that are taxable or deductible in other years and it further excludes items that are never taxable or deductible. The Bank’s liability for current tax is calculated using tax rates for the current period. Deferred tax Deferred tax is recognized on temporary differences between the carrying amounts of assets and liabilities in the financial statements and the corresponding tax base used in the computation of taxable profit. Deferred tax liabilities are generally recognized for all taxable temporary differences, while deferred tax assets are generally recognized for all deductible temporary differences to the extent that it is probable that taxable profits will be available against which those deductible temporary differences can be utilized. The carrying amount of deferred tax assets is reviewed at the end of each reporting period and reduced to the extent that it is no longer probable that sufficient taxable profits will be available to allow all or part of the asset to be recovered. Deferred tax liabilities and assets are measured at the tax rates that are expected to apply in the period in which the liability is settled or the asset realized, based on tax rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting period. The measurement of deferred tax liabilities and assets reflects the tax consequences that would follow from the manner in which the Bank expects, at the end of the reporting period, to recover or settle the carrying amount of its assets and liabilities. Deferred tax assets and liabilities are offset when there is a legally enforceable right to set off current tax assets against current tax liabilities and they relate to income taxes levied by the same taxation authority and the Bank intends to settle its current tax assets and liabilities on a net basis. Current and deferred tax for the year Current and deferred tax are recognized as an expense or income in profit or loss, except when they relate to items that are recognized outside profit or loss (whether in other comprehensive income or directly in equity), in which case the tax are also recognized outside profit or loss. 3. CRITICAL ACCOUNTING JUDGMENTS AND KEY SOURCES OF ESTIMATION UNCERTAINTY

In the application of the Bank’s accounting policies, management is required to make judgments, estimates and assumptions about the carrying amounts of assets and liabilities that are not readily apparent from other sources. The estimates and associated assumptions are based on the historical experience and other factors that are considered to be relevant. Actual results may differ from these estimates. The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period or in the period of the revision and future periods if the revision affects both current and future periods.

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062

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
5. CRITICAL ACCOUNTING JUDGMENTS AND KEY SOURCES OF ESTIMATION UNCERTAINTY (CONT’D)

Key Sources of Estimation Uncertainty The following are the key assumptions concerning the future and other key sources of estimation uncertainty at the end of each reporting period that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year. Determining the fair value of financial instruments The Bank carries some of its financial assets and liabilities at fair value, which requires extensive use of accounting estimates and judgment. While significant components of fair value measurement were determined using verifiable objective evidence, i.e., foreign exchange rates, interest rates, volatility rates, the amount of changes in fair value would differ if the Bank utilized different valuation methodology. Any changes in fair value of these financial assets and liabilities would affect profit or loss and equity. 4. CASH AND BALANCES AT CENTRAL BANKS

Cash and balances at central banks as of December 31, 2012 and 2011 consist of the following:   Cash on hand Placements with banks and financial institutions Deposits with local banks Balances with Bank of Mongolia 2012 6,132 31,358,100 152,953,718 31,672,320 215,990,270 2011 1,352 16 66,708,144 66,709,512

Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. The Bank classifies an investment as cash equivalent if that investment has a maturity of three months or less from the date of acquisition The average interest on the short term investment is 4.5%-11.25% depending on maturity and currency during 2012. (in 2011: nil) 7. INVESTMENTS

Investment securities as of December 31, 2012 and 2011 consist of the following:   Golomt Bank Ulaanbaatar City Bank Khaan Bank Khas Bank 2012 139,210,000 27,842,000 167,052,000 2011 4,000,000 3,000,000 2,000,000 9,000,000

The Bank allocated its deposits at the local banks amounting to USD 120,000,000 with different maturities (over three months) and interest rate 3.8%-5.5%. All deposits expired within the first quarter of 2013 in accordance with the contracts.

INDEPENDENT AUDITOR’s REPORT

063

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
8. LOANS AND ADVANCES

Loans and advances as of December 31, 2012 and 2011 consist of the following:   Loans and advances to State organizations Loans to Corporate customers Gross loans and advances Allowance for loan losses Net loans and advances 2012 205,001,077 284,703,491 489,704,568 489,704,568 2011 -

Loans and advances to state organization are guaranteed by the Ministry of Finance. None of the principal of the loan was due as at 31 December 2012. The Ministry of Finance has also guaranteed loans to corporate customers in the amount of MNT 141,980.5 million. None of the principal of the loans is due as at 31 December 2012. The Bank has a policy to estimate allowances for loan losses. However, given the guarantees issued by the Ministry of Finance and the fact that no principal repayments are currently due, management has deemed that no allowance for loan losses is required as at 31 December 2012. 8. LOANS AND ADVANCES (CONT’D) At 31 December 2012, MNT 74,297 million of loans and advances are expected to be recovered more than 12 months after the year end (2011: Nil). Total amount of loans are provided to 6 customers including Ministry of Finance, MIAT, Erdenes Tavan Tolgoi, Basement LLC, 4th Power Station and State Bank of Mongolia. Government project loan for Road projects implemented by the Ministry of Roads Transport Construction and Urban Development and State Governor Administration amounted to MNT 202,943,077 thousand (2011: Nil) and represents 41% (2011: Nil) of State Organization. The analysis by credit quality of loans outstanding at 31 December 2012 is as follows: Corporate Neither past due nor impaired - Excellent - Good - Loans renegotiated Total neither past due nor impaired Past due but not impaired - less than 30 days overdue - 30 to 90 days overdue Total past due but not impaired Less: Impairment provisions Total loans and advances 284,703,491 284,703,491 284,703,491 State Organizations 205,001,077 205,001,077 205,001,077 489,704,568 Total 489,704,568 489,704,568 -

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064

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
8. LOANS AND ADVANCES (CONT’D) Information about collateral at 31 December 2012 is as follows: Corporate MNT ‘000 Loans collateralized by: - - - - Government guarantees Cash deposit Machinery and Equipment Other 191,980,582 92,722,908 284,703,491 205,001,077 202,671,313 2,329,764 394,651,895 2,329,764 92,722,908 489,704,568 State Organization MNT ‘000 MNT ‘000 Total

Unsecured Loans Total Loans and Advances to Customers (before impairment) The financial effect of collateral at 31 December 2012: Over collateralized assets Carrying value of loans and advances MNT ‘000 Corporate State organizations* 284,703,491 205,001,077 489,704,568

Under collateralized assets Carrying value of loans and advances MNT ‘000 Fair value of collateral MNT ‘000 -

Fair value of collateral MNT ‘000 329,468,601 207,330,841 536,799,442

* Collateral of loans for the State Organizations is related to the Bank retaining 5% of the amount paid to contractors in contracts utilizing loans for the State Organizations. This 5% collateral relates only to project financing and will be paid to the contractor at the end of the loan term. 9. ACCRUED INTEREST RECEIVABLE

Accrued interest receivable as of December 31, 2012 and 2011 consist of the following: 2012 2,054,031 4,716,815 2,350,426 9,121,272 2011 108,233 108,233

  Accrued interest on State Organization loans Accrued interest on Corporate loans Accrued interest on Deposits

INDEPENDENT AUDITOR’s REPORT

065

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
10. OTHER CURRENT ASSETS

Other current assets as of December 31, 2012 and 2011 consist of the following:   Receivable from Ministry of Finance* Prepayments Supply materials Others 2012 2,168,468 114,283 2,513 251 2,285,515 2011 3,197 470 3,667

* The receivable from the Ministry of Finance is due to the Project Financing Agreements between the Ministry of Finance and Government Project implementation bodies (Ministry of Roads Transport Construction and Urban Development and State Governor Administration, Ministry of Foods and Agricultural of Mongolia) and the Bank. The Project Financing Agreements require MNT loans to be translated into US$ at the date of disbursement and settlement. Any resulting foreign exchange loss will be reimbursed by the Ministry of Finance. As of December 2012, MNT 2.2 billion loss was estimated, however there were no loan repayments made, or due, during the year. 11. PROPERTY, PLANT AND EQUIPMENT

Movements in the carrying amounts of the Bank’s property, plant and equipment are as follows:
Furniture and fixtures at cost

Equipment at cost

Vehicles at cost

Total

  Cost Balance, May 12, 2011 Additions Disposals Balance, December 31, 2011 Additions Disposals Balance, December 31, 2012 Accumulated Depreciation Balance, May 12, 2011 Depreciation Disposals Balance, December 31, 2011 Depreciation Disposals Balance, December 31, 2012 Net Book Value 31 December 2011 31 December 2012

140,609 140,609 7,239 147,848 25,607 25,607 47,070 72,677 115,002 75,171

71,970 71,970 71,970 4,409 4,409 7,197 11,606 67,561 60,364

110,026 110,026 11,003 11,003 99,023

212,579 212,579 117,265 329,844 30,016 30,016 65,270 95,286 182,563 234,558

There was no disposal of property, plant and equipment during the years 2012 and 2011. Management believes that there is no indication that an impairment loss has occurred.

DeVeLoPment banK of monGoLia

AnnUaL rePort 2012

066

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
12. INTANGIBLE ASSETS

Intangible assets relate to banking software system. The carrying amounts of the Bank’s intangible asset is as follows:   Cost Balance, May 12, 2011 Additions Disposals Balance, December 31, 2011 Additions Disposals Balance, December 31, 2012 Accumulated Amortization Balance, May 12, 2011 Amortization Disposals Balance, December 31, 2011 Amortization Disposals Balance, December 31, 2012 Carrying Amount 31 December 2012 31 December 2011 The Bank and amortizes the system over 10 years for financial reporting purpose and 3 years for tax purposes. There was no disposal of intangible assets during the years 2012 and 2011. Management believes that there is no indication of an impairment loss. 13. ACCOUNTS AND OTHER LIABILITIES The Bank’s account and other liabilities at 31 December comprise: 2012 Deposits from borrowers Accrued payroll Advances from Ministry of Finance Unearned income Others 2,329,763 95,477 344,012 589,683 66,200 3,425,135 2011 1,139,593 1,139,593 811,286 726,688 Amount

840,732 840,732 840,732

29,446 29,446 84,598 114,044

The Bank earns loan fees on disbursed loans to Corporate customers. The loan fee is 0.3% of the total loan. The Bank defers this income and recognizes it as income over the period of loan.

INDEPENDENT AUDITOR’s REPORT

067

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
14. LONG TERM DEBT

This account is composed of: 2012 Notes Unamortized bond issuance cost 807,418,000 (2,996,533) 804,421,467 2011 27,927,400 (1,407,009) 26,520,391

The Bank has established a US$ 600 million Euro Medium Term Notes Programme that allows it to issue notes denominated in any currency agreed between the Bank and the dealer. The Ministry of Finance irrevocably and unconditionally guarantees the due and principal payment of all amounts due in respect of the notes. On December 9, 2011, an initial series of notes was issued amounting to USD 20,000,000 with a fixed interest rate of 6.0% and 1 year maturity. The Bank fully repaid these notes in December 2012. The Bank issued a second series of notes amounting to USD 580,000,000 with fixed interest rate 5.75% and 5 year maturity in March 2012. Bond issuance cost is amortized over the period of the notes. 15. ACCRUED INTEREST PAYABLE

The Bank accrues interest relating to the bond as of December 31, 2012. Interest payment dates are March 21, and September 21 each year. 16. RELATED PARTY TRANSACTIONS

Related parties and transactions with related parties are assessed in accordance with IAS 24 “Related Party Disclosures”. As discussed in Note 1, the Bank is 100% owned by the Government of Mongolia and its operations include the financing of projects within Mongolia, which include projects undertaken by governmental entities. Accordingly, the Bank enters into numerous transactions with related parties as a result of its ownership by the Government. According to IAS 24 “Related Party Disclosures” other related parties of the Bank comprise the Government of Mongolia, national companies and other organisations controlled by the Government. Trading Transactions During the year, the Bank has not entered into any of the following transactions with related parties: a. Interest and due to related parties b. Purchases and due to related parties Loans to Related Parties An analysis of the Bank loans to related parties is disclosed as follows:

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DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
2012 Loans to key management personnel Ministry of Finance MIAT 4 Power Station
th

2011 -

205,001,077 7,435,902 2,770,582 139,210,000 50,000,000 404,417,561

Erdenes Tavan Tolgoi State Bank

The remuneration and employee benefit paid to the executive officers, directors and members of Board for the year ended 31 December 2012 and 2011 amounted to MNT 226,527,231 and MNT 86,828,985, respectively. 17. CONTRIBUTED CAPITAL Components of share capital are as follows: 2012 Ordinary shares 73,300,000 73,300,000 2011 49,700,000 49,700,000

In accordance with Development Bank Law, the Bank’s share capital consists of contribution from government and other sources specified in law. As of December 31, 2012 and 2011, no shares had actually been issued. In May and December 2011, the Government contributed 16.7 billion and 33.0 billion, respectively in cash to the Bank’s capital. An additional contribution was made in 2012 amounting to MNT 23.6 billion. The additional contribution was not officially reflected in the State Registration Certificate as of December 31, 2012. The additional contribution was recorded in State Registration Certificate in February 2013. Ordinary Shares An analysis of this Bank’s ordinary shares are shown below: 2012 Authorized: Contribution Paid Contributions: At January 1, Contribution during the year At December 31 49,700,000 23,600,000 73,300,000 49,700,000 49,700,000 73,300,000 49,700,000 2011

INDEPENDENT AUDITOR’s REPORT

069

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
18. INTEREST INCOME   Loans and advances Deposits and placements with banks and other financial institutions Interest contribution from the Ministry of Finance 2012 7,494,603 5,335,613 23,957,122 36,787,338 2011 253,433 253,433

The Ministry of Finance has agreed to provide funding to pay the interest on the Euro Medium Term Notes Programme until such time as the Bank is in an operational position to fund the interest payments from its own sources. 19. INTEREST EXPENSE   Borrowings Amortization of bond issuance cost 2012 37,621,734 30,875 37,652,609 20. NON-INTEREST INCOME   Loan service fees 21. OPERATING EXPENSES   Personnel cost Professional fee Depreciation and amortization Social and health insurance Business travel and event Communication Repair and maintenance Utilities Training Armored guard and security Office supplies Advertising Rental Foreign exchange loss, net Others 2012 920,091 243,522 149,868 90,237 89,355 56,729 39,702 31,700 29,518 13,342 13,042 7,889 217 5,767,295 18,107 7,470,614 2011 357,819 20,000 59,462 41,107 29,459 9,992 91,988 21,291 1,063 7,767 10,714 32,242 64,141 (3,758) 36,766 780,053 2012 48,057 2011 2011 118,744 1,759 120,503

DeVeLoPment banK of monGoLia

AnnUaL rePort 2012

070

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
22. INCOME TAXES Components of income tax expense charged to profit or loss are as follows:   Deferred tax benefit Reconciliation of effective tax expense: 2012 (8,287,920) (2,071,980) 450,000 8,215,504 (7,323,184) 729,660 (3,420,349) (3,420,349) 2011 (647,123) (64,712) 56,405 (25,343) 33,650 (44,933) (44,933) 2012 3,420,349 2011 44,933

  Loss before tax Tax effect of progressive tax rate of 10% on the portion of taxable profit up to MNT 3 billion Lower tax rate effect Tax effect of non-deductible expense Tax effect of non-taxable income Unrecognized tax loss for carried forward Changes in deferred tax asset Deferred tax benefit

According to Mongolian tax laws, the Bank has an obligation to pay Government income tax at the rate of 10% of the portion of taxable profit up to MNT 3 billion and 25% of the portion of taxable profits above MNT 3 billion. Differences between IFRS and statutory taxation regulations in Mongolia give rise to temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and their tax bases. Deferred tax asset(liability) was recognized for deductible or taxable timing differences resulting from the revaluation of foreign currency denominated monetary assets and liabilities. Opening balance (6,522) 51,455 44,933 Opening balance Recognised in profit or loss (127,719) (19,564) 3,567,632 3,420,349 Recognised in profit or loss

2012: Deferred tax (liabilities)/assets in relation to: Loans and advance and accrued interest receivable Amortization of software Bond Deferred tax asset

Closing balance

(127,719) (26,086) 3,619,087 3,465,282 Closing balance

2011: Deferred tax (liabilities)/assets in relation to: Amortization of software Bond and accrued interest payable Deferred tax asset

-

(6,522) 51,455 44,933

(6,522) 51,455 44,933

INDEPENDENT AUDITOR’s REPORT

071

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
23. FINANCIAL RISK MANAGEMENT Introduction and overview The risk management function within the Bank is carried out in respect of the risks inherent in the Bank’s operations, which are credit risk, liquidity risk, interest rate risk, foreign exchange risk and operational risk, all of which are monitored and controlled by the various committees and teams established by the bank and reporting directly to the Board of Directors. This process of risk management is critical to the Bank’s continuing profitability and all of the Bank executives are accountable for the management of risks relating to their responsibilities. The day-to-day risk management process does not include business risks such as changes in the environment, technology and industry. These are addressed through the Bank’s strategic planning process. The Bank’s risk management policies are established to identify and analyze the risks faced by the Bank, to set appropriate risk limits and controls and to monitor risks and adherence to limits. Risk management policies and systems are reviewed regularly to reflect changes in market conditions, products and services offered. The Bank, through its training and management standards and procedures, conducts its risk management in a comprehensive manner with all employees being responsible for the risk arising in their role in financial or non-financial transactions. Monitoring and controlling risks is primarily performed based on limits established by the related Management Committees of the Bank. These limits reflect the business strategy and market environment of the Bank as well as the level of risk that the Bank is willing to accept. In addition, the Bank monitors and measures the overall risk bearing capacity in relation to the aggregate risk exposures across all risk types and activities. As part of its overall risk management, the Bank uses basic sensitivity analysis to manage exposures resulting from possible changes in interest rates, foreign currencies risks. Also, the individual mitigation plans for each type of risk are developed and implemented by each business unit, and the process is monitored by the Asset and Liability Committee. Risk management framework The Board of Directors has overall responsibility for the establishment and oversight of the Bank’s risk management framework. The Board has established an Executive Committee, the Asset and Liability Management Committee (“ALCO”) and Credit Committee, which are responsible for developing and monitoring the Bank’s risk management policies in their specified areas. Board of Directors The Board of Directors is responsible for the overall risk management approach and for approving the risk strategies and principles that establish the objectives guiding the Bank’s activities and implement the necessary policies and procedures. The risk strategy, including all significant risk policies, is approved and periodically reviewed by the Board of Directors. 23. FINANCIAL RISK MANAGEMENT (CONT’D) Executive Committee Executive Committee is responsible for conduct its Bank’s daily operation consistent with the Development Bank Law of Mongolia, Company Law and other related laws and regulations. Assets and Liabilities Committee (‘ALCO’) The ALCO is responsible for providing centralized asset and liability management of the funding, liquidity, foreign currency, maturity and interest rate risks to which the Bank is exposed. The purpose of the ALCO is to set up the asset and liability structure of the Bank’s balance sheet conducive for sustainable growth of the Bank, its profitability and liquidity through comprehensive management of the Bank’s assets and liabilities and monitoring of the liquidity, foreign currency, interest rate and other market risks. The ALCO Committee is chaired by the Chief Executive Officer.

DeVeLoPment banK of monGoLia

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072

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
Credit Committee The Credit Committee is responsible directly to the Board of Director. It is the credit decision making body of the Bank and operates within clearly defined parameters authorised by the Board of Director. The Committee has the following main functions: a) approval of clearly defined Credit Policies and Procedures and amendments and updates; b) approval of risk classification and provisioning levels; c) review of the quality, composition and risk profile of the entire credit portfolio on an ongoing basis; and d) approval of credit limits applicable in exposures to industrial sectors and geographical regions. Internal Audit Risk management processes throughout the Bank are audited at least annually by the Internal Audit function that examines both the adequacy of the procedures and the Bank’s compliance with established policies and procedures. Internal Audit discusses the results of all assessments with management, and reports its findings and recommendations to the Chief Executive Officer and the Board of Directors depending on the significance of the issues identified. 23. FINANCIAL RISK MANAGEMENT (CONT’D) Credit risk Credit risk is the risk of financial loss to the Bank if a customer or counterparty to a financial instrument fails to meet its contractual obligations, and arises principally from the Bank’s loans and advances and investment securities. The Bank manages and controls credit risk by setting limits on the amount of risk it is willing to accept for individual counterparties and industry concentrations, and by monitoring exposures in relation to such limits. The Bank has established a credit quality review process to provide early identification of possible changes in the creditworthiness of counterparties, including regular collateral revisions. Counterparty limits are established by the use of a credit risk classification system, which assigns to each counterparty a risk rating. Risk ratings are subject to regular revision. The credit quality review process allows the Bank to assess the potential loss as a result of the perceived risks to which it is exposed and take corrective action. The Board of Directors has delegated responsibility for the management of credit risk to its Credit Committee in collaboration with Risk Management Department. The Bank is required to implement its credit policies and procedures, with credit approval authorities delegated from the Board of Director. Each member of Credit Committee and Bank Officers are responsible for the quality and performance of its credit portfolio and for monitoring and controlling all credit risks in its portfolios, including those subject to central approval. Transactions exceeding the lending authority of a committee are referred up through the committee structure for final decision by a committee with the appropriate authority. All loans and aggregate exposures over MNT 5 billion are approved by the Board of Directors. Credit-related Commitments Risks The Bank makes available to its customers guarantees which may require that the Bank makes payments on their behalf. Such payments are collected from customers based on the terms of the particular letters of guarantee. They expose the Bank to similar risks to loans which risks are mitigated to the greatest extent possible by the same control processes and policies. The primary purpose of these instruments is to ensure that funds are available to a customer as required. Guarantees and standby letters of credit, which represent irrevocable assurances that the Bank will make payments in the event that a customer cannot meet its obligations to third parties, carry the same credit risk as loans.

INDEPENDENT AUDITOR’s REPORT

073

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
23. FINANCIAL RISK MANAGEMENT (CONT’D)

Credit risk (Cont’d) An analysis of the net amounts of loans and investment securities with respective allowances at the reporting date was shown below. 2012 Loans and advances Carrying amount Neither past due nor impaired Individually impaired In Arrear Non-qualitative loans: a) Substandard b) Doubtful c) Loss Gross amount Allowance Net carrying amount 489,704,568 489,704,568 167,052,000 167,052,000 489,704,568 2011 2012 Investments 167,052,000 2011

As of December 31, 2012, the management has determined the Bank does not have any impaired loans. Any credit shall be secured by collateral, guarantee from third party or other securities. Collateral shall be either tangible or intangible and the loan amount shall not exceed 90% of the collateral value. 23. FINANCIAL RISK MANAGEMENT (CONT’D) Credit risk (Cont’d) The Bank monitors concentrations of credit risk by sector. An analysis of concentrations of credit risk at the reporting date is shown below: 2012 Mining and quarrying Manufacturing Road construction Electricity and thermal energy Transportation Consumption lending (SME) Mortgage Total 139,210,000 85,287,006 202,943,077 2,770,582 7,435,903 2,058,000 50,000,000 489,704,568 2011 -

As stipulated in the Development Bank Law of Mongolia, the total value of loans, loan equivalent assets provided to one person or Bank of related persons shall not exceed the amount equal to 50 times of the Bank’s equity capital. Total amount of credit voucher, guarantee and securities shall not exceed the amount equal to 50 times of the equity capital. The criteria for concentration of loan as at 31 December 2012 are as follows:

DeVeLoPment banK of monGoLia

AnnUaL rePort 2012

074

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
Description The loan and assets equivalent to loans given to one borrower Total amount of credit voucher, guarantee and securities to third party 23. FINANCIAL RISK MANAGEMENT (CONT’D) Collateral and other credit enhancements The amount and type of collateral required depends on an assessment of the credit risk of the counterparty. Guidelines are implemented regarding the acceptability of types of collateral and valuation parameters. The main types of collateral obtained are as follows: a) b) c) d) e) Fixed asset: Land, Building, factory etc Movable properties: Vehicles and equipment etc; Special property rights: Mineral licenses, Project execution right etc., Time deposits, Securities/Bond and Stocks Guarantees issued from Government, reputable insurance companies, Development banks and investment bank and commercial banks with overall rating of “Stable” or above. f ) Assets and revenues generated as a result of performance by borrower and project contractors. g) Others Management monitors the market value of collateral, requests additional collateral in accordance with the underlying agreement, and monitors the market value of collateral obtained during its review of the adequacy of the allowance for impairment losses. It is the Bank’s policy to dispose of repossessed properties in an orderly fashion. The proceeds will be used to reduce or repay the outstanding claim. The Bank does not occupy repossessed properties for business use and has no such properties as at 31 December 2012. Impairment Assessment The main considerations for the loan impairment assessment include whether any payments of principal or interest are overdue by more than 30 days or there are any known difficulties in the cash flows of counterparties, credit rating downgrades, or infringement of the original terms of the contract. The Bank monitors the credit quality of loans primarily based on classification of loans based on provisioning guidelines approved by the Executive Director of Development Bank of Mongolia, which is used for impairment provision calculation in accordance with the Regulations on Asset Classification and Provisioning, approved by the Executive Director of Development Bank of Mongolia. These provisioning guidelines are based on an expected loss model. In accordance with these regulations, the Bank is required to determine the quality of loans and advances based on their qualitative factors and time characteristics (i.e. delays in repayment). Loans are classified into the following five groups: performing, in arrears, substandard, doubtful, and loss. Credit risk for off-balance sheet financial instruments is defined as the possibility of sustaining a loss as a result of another party to a financial instrument failing to perform in accordance with the terms of the contract. The Bank uses the same credit policies in assuming conditional obligations as it does for on balance sheet financial instruments, through established credit approvals, risk control limits and monitoring procedures. As at 31 December 2012, the bank has no credit related commitments. (2011 nil). Suitable ratios Restriction limits At 31 December 2012

< EQ 50 times < EQ 50 times

3,665,000,000 3,665,000,000

809,710,286 116,770,960

INDEPENDENT AUDITOR’s REPORT

075

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
23. FINANCIAL RISK MANAGEMENT (CONT’D) Liquidity risk Liquidity risk is the risk that the Bank will encounter difficulty in meeting obligations from its financial liabilities. The Bank’s approach to managing liquidity is to ensure, as far as possible, that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to the Bank’s reputation. The Bank manages each currency liquidity and aggregated liquidity of each currency as well. An adequate measuring system is required to alert Management to potential liquidity risks and liquidity analysis report shall be reported to the ALCO on regular basis. ALCO monitors and controls the liquidity risk. The Bank invests the funds in diversified portfolios of liquid assets, in order to be able to respond quickly and efficiently to unforeseen liquidity requirements. In addition, the Bank maintains a statutory deposit with the Central Bank of Mongolia equal to 11% of customer deposits (2011: 11%). The liquidity position is assessed and managed under a variety of scenarios, giving due consideration to stress factors relating to both the market in general and specifically to the Bank. The liquidity plan and maturity gap report is made by the Bank for each major currency (Over USD 1 million equivalent) as well as aggregated amount using cash flow approach. The bank should monitor and control the liquidity exposure measured by calculating the Bank’s Net Liquidity Gap and by comparing current ratios with targets. Exposure to liquidity risk The key measure used by the Bank for managing liquidity risk is the ratio of net liquid assets to deposits from customers/ banks. For this purpose net liquid assets are considered as including cash and cash equivalents, central bank bills, current accounts and deposits placed with Bank of Mongolia and other domestic and foreign banks less clearing delay. Details of the reported ratio of net liquid assets to deposits from customers/banks at the reporting date were as follows: 23. FINANCIAL RISK MANAGEMENT (CONT’D)

Liquidity risk (Cont’d) The following table provides an analysis of the financial assets and liabilities of the Bank into relevant maturity groupings based on the remaining periods to payment:
2012 At 31 December 164 2011 -

As at 31 December 2012 Financial assets Cash on hand Placements with banks and other financial institutions Deposits with local banks Balances with Bank of Mongolia Investment Loans and advances Accrued interest receivable Other assets

Less than Three to six three months months

Six months to one year

One year to five years

Over five years

Total

6,132 31,358,100 152,953,718 31,672,320 139,210,000 50,000,000 9,121,272 2,285,515

27,842,000 15,794,963 -

8,502,053 -

415,407,552 -

-

6,132 31,358,100 152,953,718 31,672,320 167,052,000 489,704,568 9,121,272 2,285,515

DeVeLoPment banK of monGoLia

AnnUaL rePort 2012

076

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)

Total financial assets Financial liabilities Current accounts of customers Accounts and other liabilities Accrued interest payable Long term debt Total financial liabilities Net financial assets/(liabilities)

416,607,057 6,960 1,095,371 12,896,260 13,998,591 402,608,466

43,636,963 43,636,963

8,502,053 -

415,407,552 2,329,764 804,421,467 806,751,231

-

884,153,625 6,960 3,425,135 12,896,260 804,421,467 820,749,822 63,403,803

8,502,053 (391,343,679)

23. FINANCIAL RISK MANAGEMENT (CONT’D) Liquidity risk (Cont’d) The following table provides an analysis of the financial assets and liabilities of the Bank into relevant maturity groupings based on the remaining periods to payment:
As at 31 December 2011 Less than Three to Six months One year to Over five three months six months to one year five years years Total

Financial assets Cash on hand Placements with banks and other financial institutions Deposits with local banks Balances with Bank of Mongolia Investment Loans and advances Accrued interest receivable Other assets Total financial assets Financial liabilities Accounts and other liabilities Accrued interest payable Short term debt Total financial liabilities Net financial assets/(liabilities) 1,139,593 102,400 1,241,993 67,579,419 26,520,391 26,520,391 1,139,593 102,400 26,520,391 27,762,384 48,059,028 1,352 16 66,708,144 2,000,000 108,233 3,667 68,821,412 7,000,000 7,000,000 1,352 16 66,708,144 9,000,000 108,233 3,667 75,821,412

- (19,520,391)

INDEPENDENT AUDITOR’s REPORT

077

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
23. FINANCIAL RISK MANAGEMENT (CONT’D) (a) Market risks Market risk is the risk that changes in market prices, such as interest rate and foreign exchange rates will affect the Bank’s income or the value of its holdings of financial instruments. The objective of market risk management is to manage and control market risk exposures within acceptable parameters, while optimizing the return on risk. Management of market risks The Bank is exposed to the effects of fluctuations in the prevailing levels of market interest rates on its financial position and cash flows. Interest rate risk is measured by the extent to which changes in market interest rates impact margins and net income. To the extent the term structure of interest bearing assets differs from that of liabilities, net of interest income will increase or decrease as a result of movements in interest rates. Interest rate risk is managed by increasing or decreasing positions within limits specified by the Bank’s management. These limits restrict the potential effect of movements in interest rates on interest margin and on the value of interest sensitive assets and liabilities. Overall authority for market risk is vested with the ALCO. Exposure to interest rate risks The principal risk to which the Bank’s financial assets and liabilities are exposed is the risk of loss from fluctuations in the future cash flows or fair values of financial instrument because of a change in market interest rates. Interest rate risk is managed principally through monitoring interest rate gaps and by having pre-approved limits for repricing bands. A summary of the Bank’s interest rate gap position on its financial assets and liabilities are as follows: 23. FINANCIAL RISK MANAGEMENT (CONT’D)

(d) Market risks(Cont’d)
Effective As of December 31, 2012 interest rate Financial assets Cash on hand 6,132 Placements with banks and other financial institutions Deposits with local banks Balances with Bank of Mongolia Investment Loans and advances Accrued interest receivable 3.8%-5.5% 7.34% 8%-11.25% 31,358,100 152,953,718 31,672,320 167,052,000 489,704,568 9,121,272 9,121,272 6,132 31,358,100 31,672,320 152,953,718 415,407,552 Total Non-interest sensitive Six Less than Three to months three six months to one months year One to five years Over five years

139,210,000 27,842,000

50,000,000 15,794,963 8,502,053 -

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DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)

Other assets Total financial assets

2,285,515

2,285,515

-

-

-

415,407,552

-

884,153,625 74,443,339 342,163,718 43,636,963 8,502,053 Financial liabilities

Current accounts of customers Accounts and other liabilities Accrued interest payable Long term debt Total financial liabilities 5.75%

6,960 3,425,135 12,896,260 804,421,467 820,749,822

6,960 1,095,371 12,896,260 13,998,591

-

-

-

2,329,764 804,421,467

-

806,751,231

Net financial assets/ (liabilities)

63,403,803

60,444,748 342,163,718 43,636,963 8,502,053 (391,343,679)

-

INDEPENDENT AUDITOR’s REPORT

079

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
23. FINANCIAL RISK MANAGEMENT (CONT’D)

Market risks (Cont’d)
As of December 31, 2011 Effective interest rate Total Noninterest sensitive Less than three months Three to six months Six months to one year One to five years Over five years

Financial assets Cash on hand Placements with banks and other financial institutions Deposits with local banks Balances with Bank of Mongolia 1,352 1,352 -

16 66,708,144

16 66,708,144

-

-

-

-

-

Investment Loans and advances Accrued interest receivable Other assets Total financial assets

9-10%

9,000,000 108,233 3,667

108,233 3,667

2,000,000 -

-

7,000,000 -

-

-

75,821,412 Financial liabilities

66,821,412

2,000,000

-

7,000,000

-

-

Accounts and other liabilities Accrued interest payable Short term debt 6.0%

1,139,593 102,400 26,520,391

1,139,593 102,400 -

-

-

26,520,391

-

-

Total financial liabilities 27,762,384 Net financial assets/ (liabilities) 1,241,993 26,520,391 -

48,059,028

65,579,419

2.000,000

- (19,520,391)

-

-

DeVeLoPment banK of monGoLia

AnnUaL rePort 2012

080

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
23. FINANCIAL RISK MANAGEMENT (CONT’D)

Market risks, (Cont’d) The management of interest rate risk against interest rate gap limits is supplemented by monitoring the sensitivity of the Bank’s financial assets and liabilities to various standard and non-standard interest rate scenarios. An analysis of the Bank’s sensitivity to a 100 basis point (bp) increase or decrease in market interest rates (assuming no asymmetrical movement in yield curves and a constant balance sheet position) is as follows: 100bp parallel Increase Sensitivity of projected net interest income 2012 At 31 December 2011 At 31 December (1,760,735) 1,760,735 298,729 (298,729) 100bp parallel Decrease

The Bank is exposed to effects of fluctuations in the prevailing foreign currency exchange rates on its financial position and cash flows. The Bank’s management sets limits on the level of exposure by currencies (primarily USD) and in total. These limits also comply with the minimum requirements of Bank of Mongolia
2012 MNT Denominated Foreign currency Total MNT Denominated 2011 Foreign currency Total

Financial assets Cash on hand Placements with banks and other financial institutions Deposits with local banks Balances with Bank of Mongolia Investment Loans and advances Accrued interest receivable Other current asset Financial liabilities Current accounts of customers Accounts and other liabilities Accrued interest payable Long term debt 22,124 2,992,576 Net financial assets/(liabilities) 2,970,452 6,960 454,683 12,896,260 804,399,343 6,960 3,425,135 12,896,260 804,421,467 20,000 27,525 1,119,593 102,400 26,492,866 1,139,593 102,400 26,520,391 27,762,384 48,059,028 2,409 31,358,100 133,451,750 31,221,632 255,001,077 2,827,989 2,285,515 456,148,472 19,501,968 450,688 167,052,000 234,703,491 6,293,283 3,723 6,132 31,358,100 152,953,718 31,672,320 167,052,000 489,704,568 9,121,272 2,285,515 263 16 39,021,587 9,000,000 108,233 3,667 1,089 27,686,557 1,352 16 66,708,144 9,000,000 108,233 3,667 75,821,412

428,005,153 884,153,625

48,133,766 27,687,646

817,757,246 820,749,822 63,403,803

47,525 27,714,859 48,086,241 (27,213)

453,155,896 (389,752,093)

INDEPENDENT AUDITOR’s REPORT

081

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
23. FINANCIAL RISK MANAGEMENT (CONT’D)

Market risk (Cont’d) A 10 percent strengthening of the MNT against the USD at 31 December 2011 and 2010 would have increased profit by the amounts shown below. This analysis assumes that all other variables, in particular interest rates, remain constant. The analysis is performed on the same basis for 2010. 2012 Profit before tax 38,975,209 2011 (2,721)

At 10 percent weakening of the MNT against the USD at 31 December 2011 and 2010 would have had the equal but opposite effect on the above currency to the amounts shown above, on the basis that all other variables remain constant. Capital Management The Bank sets and monitors capital requirements for the Bank as a whole. If necessary, the Bank uses the regulation of Bank of Mongolia maintain a minimum capital adequacy ratio of 12%, compiled on the basis of total capital and total assets as adjusted for their risk (“CAR”) and a minimum of 6% compiled on the basis of total tier 1 capital and total assets as adjusted for their risk (“TCAR”). Various limits are applied to elements of the capital base. The qualifying tier 2 capital cannot exceed tier 1 capital; and qualifying term subordinated borrowings capital may not exceed 50 percent of tier 1 capital. Risk-weighted assets are determined according to specified requirements that seek to reflect the varying levels of risk attached to assets and off-balance sheet exposures. The Bank’s policy is to maintain a strong capital base so as to maintain investor, creditor and market confidence and to sustain future development of the business. The impact of the level of capital on shareholders’ return is also recognized and the Bank recognizes the need to maintain a balance between the higher returns that might be possible with greater gearing and the advantages and security afforded by a sound capital position. The Bank has complied with all externally imposed capital requirements throughout the period. There have been no material changes in the Bank’s management of capital during the year. 23. FINANCIAL RISK MANAGEMENT(CONT’D)

Capital Management (Cont’d) The Ratios of the Bank’s capital adequacy as at 31 December 2012 and 2011, respectively, were as following: 2012 Tier I Capital Share Capital Treasury shares Retained earnings Adjustments Tier II Capital Revaluation reverse 73,300,000 (5,469,669) 67,830,331 67,830,331 2011 49,700,000 (602,190) 49,097,810 49,097,810

Total Tier I and Tier II capital

DeVeLoPment banK of monGoLia

AnnUaL rePort 2012

082

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
Breakdown of risk weighted assets as follows: 2012 Risk weighted factor (%) 20 50 100 150 Balance off Foreign currency exposure Capital ratios Total regulatory capital expressed as a percentage of total riskweighted assets (“CAR”) Total Tier I capital expressed as a percentage of total risk-weighted assets (“TCAR”) 24. FAIR VALUES OF FINANCIAL ASSTES AND LIABILITIES 2011

89,349,759 70,990,291 265,886,806 175,570 58,385,480 7,948,623 492,736,529 13.33%

3 10,122,732 (3,758) 10,118,977 485.2%

13.33%

485.2%

Determination of fair value and fair value hierarchy Amendments to IFRS 7 Financial Instruments: Disclosures require enhanced fair value and liquidity disclosures. In accordance with amendments to IFRS 7, the Bank follows the following hierarchy for determining and disclosing the fair value of financial instruments based on the level of significant inputs used in measurement. Level 1: Fair value is based on quoted prices in active markets for identical assets or liabilities Level 2: The inputs used for fair value measurement are market observable inputs, either directly or indirectly. Level 3: Valuation techniques are used to estimate fair value of which significant inputs are not based on observable market data. The Bank’s principal financial instruments comprise of cash on hand and in bank, investments, loans and advances, accrued interest receivable and payable, other current assets, accounts and other payable, long term debt. The management considers that the carrying amounts of financial assets and liabilities recognized in the financial statements approximately their fair value. As of December 31, 2012, the Bank’s financial instrument measured at fair value subsequent to initial recognition is receivable from Ministry of Finance which has been valued at Level 1 at MNT 2,168,468 thousand (In 2011: Nil).

INDEPENDENT AUDITOR’s REPORT

083

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)
25. COMMITMENT FOR EXPENDITURE Loan Commitments not yet paid Within a year Later than one year but not later than five years Contingent liabilities There were no commitments and contingent liabilities except above exploration commitments as at 31 December 2012 and 2011. Taxation The tax authority has requested the Bank to pay Value Added Tax amounting to MNT 195 million on certain legal, consulting and agent fees related to the issuance of the Euro Medium Term Notes Programme. The Bank has argued that these services were not performed in the territory of Mongolia and are therefore not subject to Value Added Tax. Management is of the opinion that the Bank complies with Mongolian Taxation Laws and believe the aforementioned dispute will not have a significant impact on the financial statements. 2012 599,947,650 112,133,161 2011 -

DeVeLoPment banK of monGoLia

AnnUaL rePort 2012

084

DEVELOPMENT BANK OF MONGOLIA NOTES TO FINANCIAL STATEMENTS AS AT AND FOR THE YEAR ENDED 31 DECEMBER 2012 (IN THOUSAND MONGOLIAN TUGRUGS)