Capital Markets

Financial and Risk Management Policies

ADB maintains conservative financial and risk management policies, within and even beyond Charter requirements.

1. Lending and Borrowing Limitation

In December 2008, the Board of Directors approved a new lending and borrowing limitation policy.

Lending Limitation: Under the new lending policy, the total amount of OCR disbursed loans, approved equity investments, and the maximum amount that could be demanded from ADB under its guarantee portfolio must not exceed the total amount of ADB's unimpaired subscribed capital, reserves and surplus.

Borrowing Limitation: The Board of Directors also approved a new borrowing limitation policy pursuant to which ADB's gross outstanding borrowings must not exceed the sum of callable capital of non-borrowing members, paid in capital and reserves (including surplus).

Lending Headroom
As of 31 December 2008

Borrowing Headroom
As of 31 December 2008

Outstanding borrowings and guarantees as percenteage of ADB's total callable capital

Strong Risk Bearing Capacity

ADB measures its risk bearing capacity through the equity-to-loan ratio (ELR) which is consistent with market practice of other MDBs. ELR measures the capital adequacy to withstand a major credit event affecting the loan and guarantee portfolios. The use of ELR was adopted in 2004 and a minimum target of 35% was set. ADB’s ELR of 44.7% as of 31 December 2007 was well above this target. In June 2008, ADB's Board approved a new capital adequacy framework wherein ADB will no longer assess its capital adequacy based on the fixed ELR target of 35%. Instead, ADB will annually assess its capital adequacy using a stress test methodology that entails, among other things, estimated non-accrual shocks and their impact on ADB's capital and income over the next 10 years. The new framework provides ADB with the ability to assess its capital adequacy based on changing portfolio risk profiles as well as on ADB's characteristics as an MDB, including callable capital structure, preferred creditor status, and developmental mandate. In this regard, the new framework is a more dynamic and comprehensive measure of ADB's risk bearing capacity. In addition, the annual assessment ensures that any deterioration in ADB's risk-bearing capacity will be highlighted early and addressed in a timely fashion.

2. Risk Management Infrastructure

ADB's risk management infrastructure is designed to ensure full and accurate identification, measurement, monitoring and management of all risks arising from its financing activities.

• Credit Risk – Borrowers: For sovereign operations, ADB continuously monitors creditworthiness of borrowing members and manages risks associated with its lending through a rigorous loss provision and capital adequacy framework. For nonsovereign operations, ADB manages and monitors risks associated with its lending by assessing credit risks of new transactions at their inception stage and of existing transactions periodically at both an individual transaction level and a portfolio level using an internal credit risk rating system. This rating system employs both qualitative and quantitative factors and produces objective and consistent measurement of credit risks. The rating result is then used as an input for ADB to ensure that: i) risk premium is appropriately priced; and ii) loss provisions and economic capital are adequately calculated. ADB also ensures that all exposures are in compliance with the exposure limit policy at all time.



• Credit Risk – Counterparties: ADB manages risk arising from its investment and funding operations by restricting activities to authorized dealers and counterparties that meet conservative credit guidelines. In general, ADB will undertake swap transactions with counterparties who:
• have met the required minimum counterparty credit rating
• have signed an International Swaps and Derivatives Association (ISDA) master agreement with ADB
• have signed a Credit Support Annex (CSA) with ADB

Derivatives' positions of ADB are marked-to-market daily and collateral calls with counterparties are made in accordance with CSA.

• Credit Risk – Issuers: ADB seeks to minimize issuer risk by maintaining a very high quality liquidity portfolio. Investments are mainly debt instruments issued by members and government-related agencies, banks and corporate entities. Investments in corporate paper are limited to instruments that meet minimum credit ratings provided by at least two reputable international credit rating agencies and subjected to single-issuer limits.



• Market Risk: ADB monitors and manages interest rate risks in the Treasury portfolio by employing various quantitative methods. It marks all positions to market, monitors interest rate risk metrics and employs stress testing and scenario analysis. ADB manages its currency risk by matching its loans and investments to the same currencies in which funds are received. Borrowed funds or funds to be invested may only be converted into other currencies provided that they are fully hedged through cross currency swaps or forward exchange agreements.



• Liquidity Risks: ADB manages liquidity risks through its liquidity policy that ensures the availability of sufficient cash flows to meet all financial commitments despite uncertain conditions in the capital markets.



• Operational Risk: ADB mitigates operational risks by maintaining a system of internal controls, monitoring procedures, and processes that are designed to keep operating risks within acceptable levels.
  
  ADB recently approved a strategy to strengthen its business continuity plan to reduce the impact of disruption affecting its business processes.