34. Fair Value of Financial Instruments

Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.

The Group uses the following hierarchy for determining and disclosing the fair value of financial instruments by valuation technique:

― Level 1: quoted (unadjusted) prices in active markets for identical assets or liabilities

― Level 2: techniques for which all inputs which have a significant effect on the recorded fair value are observable, either directly or indirectly; and

― Level 3: techniques which use inputs which have a significant effect on the recorded fair value that are not based on observable market data.

The following tables show an analysis of financial instruments recorded at fair value by level of the fair value hierarchy:

At 31 December 2010 Level 1 Level 2 Level 3 Total
Financial assets        
Trading securities 65,704 464 - 66,168
Securities designated at fair value through profit or loss 81,486 21,945 3,444 106,875
Securities pledged under repurchase agreements 81,493 - - 81,493
Investment securities available for sale 1,193,158 5,866 11,897 1,210,921
Derivative financial instruments - 4,285 4,972 9,257
Total financial assets at fair value 1,421,841 32,560 20,313 1,474,714
Financial liabilities        
Derivative financial instruments - 1,553 - 1,553
Total financial liabilities at fair value - 1,553 - 1,553
At 31 December 2011 Level 1 Level 2 Level 3 Total
Financial assets        
Trading securities 94,546 4,745 2,682 101,973
Securities designated at fair value through profit or loss 32,219 14,395 5,379 51,993
Securities pledged under repurchase agreements 163,017 644 - 163,661
Investment securities available for sale 842,626 27,555 14,348 884,529
Derivative financial instruments 2,286 25,366 23,552 51,204
Total financial assets at fair value 1,134,694 72,705 45,961 1,253,360
Financial liabilities        
Securities sold, not yet purchased 65,875 1,358 259 67,492
Derivative financial instruments 546 25,538 581 26,665
Structured notes 556 12 930 1,498
Total financial liabilities at fair value 66,977 26,908 1,770 95,655

Level 2 includes debt securities of first-class borrowers that are not actively traded on the market. Fair value of the securities was calculated using techniques for which all inputs which have a significant effect on the recorded fair value are observable. Financial characteristics of comparable financial instruments actively traded on the market were used as inputs for the fair valuation models.

There were no transfers between Level 1 and Level 2 during the year ended 31 December 2011. Corporate bonds recorded in trading portfolio and in portfolio of investment securities available for sale at fair value of RR 858 mln were transferred from Level 1 to Level 2 during the year ended 31 December 2010.

The following table shows a reconciliation of the opening and closing amount of Level 3 financial assets and liabilities which are recorded at fair value as at 31 December 2011:

  At 1 January 2011 Total gains reported in income statement Total gains reported in other comprehen- sive income Purchases Business combinations Sales At 31 December 2011
Financial assets            
Trading securities - - - - 2,682 - 2,682
Securities designated at fair value through profit or loss 3,444 330   442 1,163   5,379
Investment securities available for sale 11,897 (151) 48 8,500   (5,946) 14,348
Derivative financial instruments 4,972 20,596 - - - (2,016) 23,552
Total level 3 financial assets 20,313 20,775 48 8,942 3,845 (7,962) 45,961
Financial liabilities          
Structured notes - - - - 930 - 930
Derivative financial instruments       581     581
Securities sold, not yet purchased - - - - 259 - 259
Total level 3 financial liabilities       581 1,189   1,770

For the year ended 31 December 2011 the gains in the amount of RR 21 443 mln reported in income statement on Level 3 financial assets were unrealised. All the gains reported in other comprehensive income on Level 3 financial assets were unrealised.

Total gains recognised as profit or loss on securities designated at fair value through profit or loss which are presented in the table above are reported in income statement within net (losses)/gains arising from securities designated at fair value through profit or loss.

Total gains recognised as profit or loss on investment securities available for sale which are presented in the table above are reported in income statement within net gains arising from investment securities available for sale.

Total gains recognised as profit or loss on derivative financial instruments which are presented in the table above are reported in income statement within net gains arising from operations with other derivatives.

Investments in shares of a company involved in construction business at fair value through profit and loss of RR 3 617 mln using a valuation technique based on non-observable inputs

The Group determined the fair value of the investments based on discounted cash flow model with the following principal assumptions underlying the estimation of the fair value: type of the weighted average cost of capital (hereinafter — “WACC”), volume of construction of housing premises and hotels, terms of construction and subsequent sale, sale price per square meter of housing premises and respective cost of sale and booking rates for hotel rooms.

When determining the sale prices per square meter of housing premises and booking rates for hotel rooms, the Group used comparable analogues and estimations of the annual increase in prices.

As at 31 December 2011 the estimated value of the WACC used by the Group comprised 17.02%.

Should the WACC used by the Group in the valuation model increase/decrease by 1%, the carrying value of the financial instrument would be RR 269 mln lower / RR 285 mln higher.

Valuation of available for sale shares in a stock exchange of RR 13 211 mln using valuation techniques based on non-observable inputs

The Group determined the fair value of the investments based on discounted cash flow model with the following principal assumptions underlying the estimation of the fair value: type of WACC and estimated future operating cash flows.

Should the WACC used by the Group in the valuation model increase/decrease by 1%, the carrying value of the financial instrument would be RR 1 082 mln lower / RR 921 mln higher.

Valuation of available for sale shares in a construction company of RR 731 mln using valuation techniques based on non-observable inputs

The Group determined fair value of investments based on discounted cash-flow model. The principal input of the model used is the estimation of fair value of assets and liabilities of the company.

Should the fair value of net assets used by the Group in the valuation model increase/decrease by 5%, the carrying value of the financial instrument would be RR 37 mln lower / RR 37 mln higher.

Valuation of available for sale shares in a construction company of RR 322 mln using valuation techniques based on non-observable inputs

The Group determined fair value of investments based on discounted cash flow model using the following key assumptions: type of WACC and estimated future operating cash flows which depend on forecasts on property prices.

Should the discount rate used by the Group in the valuation model increase/decrease by 1%, the carrying value of the financial instrument would be RR 63 mln lower / RR 66 mln higher. Should the rate of growth of property prices used by the Group in the valuation model increase/decrease by 1%, the carrying value of the financial instrument would be RR 101 mln lower / RR 105 mln higher.

Valuation of available for sale shares of a venture company of RR 81 mln using valuation techniques based on non-observable inputs

The Group determined fair value of investments based on discounted cash-flow model. The principal input of the model used is the discount rate used, production volumes and cost of production, terms and sale price of goods and costs of development.

As at 31 December 2011 the estimated value of the discount rate used by the Group and represented by required rate of return for venture investments comprised 42.45%. Should the discount rate used by the Group in the valuation model increase/decrease by 1%, the carrying value of the financial instrument would be RR 4 mln lower / RR 4 mln higher.

Valuation of forward foreign currency contracts and forward precious metals contracts of RR 20 089 mln using non-observable inputs

Fair values for forward foreign currency contracts and forward precious metals contracts are obtained from the interest rates parity model, using rates prevailing on the market of the Republic of Belarus and international markets with comparable business conditions.

The inputs used for estimation of fair values of foreign currency derivatives were the quotes of sovereign credit default swaps of the countries with the same credit rating as the rating of the Republic of Belarus (10.2%).

Claims in precious metals were estimated against the rate of attracting cashless precious metals in term deposits (6%).

The obligations in Belorussian Roubles were estimated against the prevailing rate of attracting funds in Belorussian Roubles at the reporting date (57.9%).

Should the input rate for Belorussian Roubles decrease/increase for 10 p.p. the carrying value of the foreign currency derivatives would be 2.7% lower / 2.2% higher.

Valuation of a put option on unquoted retail trading company shares of RR 1 180 mln using non-observable inputs

The fair value of the option was determined using the Black-Scholes option pricing model. The inputs of the model include current market price of underlying shares and its historical volatility, option strike price and market risk-free rate of return with the principal input being the price of the shares.

Fair value of the underlying shares as at 31 December 2011 was estimated using the discounted cash flow model and comprised RR 9 075 mln. Should the estimated value of shares used by the Group in the valuation model increase/decrease by 1%, the carrying value of the financial instrument would be RR 20 mln lower / RR 20 mln higher.

Valuation of a put/call option on shares of RR 2 614 mln using unobservable inputs

The fair value of the option was determined using the Black-Scholes option pricing model. The principal inputs of the model include share price volatility of publicly traded companies operating in the same industry, share price valuation made using the discounted cash flow model and market risk-free rate of return.

Valuation of shares in a company producing construction materials at fair value through profit or loss of RR 453 mln using market approach (deal comparables)

The shares are valued using market approach (using acquisition of similar companies as deal comparatives). We used parameters of similar companies (including ratios: Enterprise value to Sales and Enterprise value to Earnings before Interest, Taxes, Depreciation and Amortisation) to determine fair value of the investment.

The following table shows a reconciliation of the opening and closing amount of Level 3 financial assets and liabilities which are recorded at fair value as at 31 December 2010:

  At 1 January 2011 Total gains reported in income statement Total gains reported in other comprehen- sive income Purchases Business combinations Sales At 31 December 2011
Financial assets            
Trading securities - - - - 2,682 - 2,682
Securities designated at fair value through profit or loss 3,444 330   442 1,163   5,379
Investment securities available for sale 11,897 (151) 48 8,500   (5,946) 14,348
Derivative financial instruments 4,972 20,596 - - - (2,016) 23,552
Total level 3 financial assets 20,313 20,775 48 8,942 3,845 (7,962) 45,961
Financial liabilities          
Structured notes - - - - 930 - 930
Derivative financial instruments       581     581
Securities sold, not yet purchased - - - - 259 - 259
Total level 3 financial liabilities       581 1,189   1,770

Certain financial instruments were transferred from Level 3 to Level 2 during the year ended 31 December 2010 as additional observable market data became available.

For the year ended 31 December 2010 all the gains reported in income statement and reported in other comprehensive income on Level 3 financial assets were unrealised. Total gains recognised as profit or loss on securities designated at fair value through profit or loss which are presented in the table above are reported in income statement within net gains arising from securities designated at fair value through profit or loss. Total gains recognised as profit or loss on investment securities available for sale which are presented in the table above are reported in income statement within net gains arising from investment securities available for sale.

Total gains recognised as profit or loss on derivative financial instruments investment which are presented in the table above are reported in income statement within net gains arising from operations with other derivatives.

Investments in shares of a company involved in construction business at fair value through profit and loss of RR 3 340 mln using a valuation technique based on unobservable inputs

The Group determined the fair value of the investments based on discounted cash flow model with the following principal assumptions underlying the estimation of the fair value: type of the weighted average cost of capital (hereinafter — “WACC”), volume of construction of housing premises and hotels, terms of construction and subsequent sale, sale price per square meter of housing premises and respective cost of sale and booking rates for hotel rooms.

When determining the sale prices per square meter of housing premises and booking rates for hotel rooms the Group used comparable analogues and estimation of the annual increase in prices.

Should the WACC used by the Group in the valuation model increase/decrease by 1%, the carrying value of the financial instrument would be RR 229 mln lower / RR 247 mln higher.

Investments in shares of a company involved in machine building at fair value through profit and loss of RR 104 mln using a valuation technique based on unobservable inputs The Group determined fair value of investments based on estimation of fair value of net assets of the company as at the reporting date. The Group applied share of ownership to fair value of assets ratio to determine fair value of shares.

Valuation of available for sale shares in a construction company of RR 731 mln using valuation techniques based on unobservable inputs

The Group determined fair value of investments based on discounted cash-flow model. The principal input of the model used is the estimation of fair value of assets and liabilities of the company.

Should the fair value of net assets used by the Group in the valuation model increase/ decrease by 5%, the carrying value of the financial instrument would be RR 37 mln lower / RR 37 mln higher.

Valuation of available for sale shares in a stock exchange of RR 4 683 mln using valuation techniques based on unobservable inputs

The Group determined the fair value of the investments based on discounted cash flow model with the following principal assumptions underlying the estimation of the fair value: type of the weighted average cost of capital (hereinafter — “WACC”) and estimated future operating cash flows.

Should the WACC used by the Group in the valuation model increase/decrease by 1%, the carrying value of the financial instrument would be RR 336 mln lower / RR 395 mln higher.

Valuation of available for sale shares of a transportation company of RR 6 442 mln using valuation techniques based on unobservable inputs

The principal assumptions underlying the estimation of the fair value include the WACC, commission for transshipment/storage of the goods, annual volume of service and capacity utilisation.

The principal assumptions and the impact of reasonable possible changes in these assumptions on the fair value (with all other variables being determined as fixed values) are as follows:

― The volume of the commission for transshipment/storage of the goods will change in the range from -1.5% to +2%

― The annual production volume will increase by 10%

― Capacity utilisation ratio will be in the range from 60% to 70%.

As at 31 December 2010 the estimated value of the WACC denominated in US Dollars used by the Group comprised 11.13%.

Should the WACC used by the Group in the valuation model increase/decrease by 1%, the carrying value of the financial instrument would be RR 586 mln lower / RR 703 mln higher.

Valuation of available for sale shares of a venture company of RR 41 mln using valuation techniques based on unobservable inputs

The Group determined fair value of investments based on discounted cash-flow model.

The principal input of the model used is the discount rate used, production volumes and cost of production, terms and sale price of goods and costs of development.

As at 31 December 2010 the estimated value of the discount rate used by the Group and represented by required rate of return for venture investments comprised 41.96%.

Should the discount rate used by the Group in the valuation model increase/decrease by 1%, the carrying value of the financial instrument would be RR 3 mln lower / RR 3 mln higher.

Valuation of a put option on unquoted retail trading company shares of RR 1 189 mln using unobservable inputs

The fair value of the option was determined using the Black-Scholes option pricing model. The inputs of the model include current market price of underlying shares and its historical volatility, option strike price and market risk-free rate of return with the principal input being the price of the shares.

Fair value of the underlying shares as at 31 December 2010 was estimated using the discounted cash flow model and comprised RR 10 663 mln. Should the estimated value of shares used by the Group in the valuation model increase/decrease by 1%, the carrying value of the financial instrument would be RR 23 mln lower / RR 23 mln higher.

Valuation of a put option on shares of RR 2 187 mln using unobservable inputs

The fair value of the option was determined using the Black-Scholes option pricing model. The principal inputs of the model include current market price of underlying shares, share price volatility and market risk-free rate of return.

Should the share price volatility used by the Group in the valuation model increase/ decrease by 1%, the carrying value of the financial instrument would be RR 19 mln lower / RR 19 mln higher.

Valuation of a put/call option on shares of RR 1 596 mln using unobservable inputs The fair value of the option was determined using the Black-Scholes option pricing model. The principal inputs of the model include share price volatility of publicly traded companies operating in the same industry, share price valuation made using the discounted cash flow model and market risk-free rate of return.

Should the estimated value of shares used by the Group in the valuation model increase/ decrease by 1%, the carrying value of the financial instrument would be RR 16 mln lower / RR 16 mln higher.

Fair values of financial assets are as follows:

  At 1 January 2010 Total gains reported in income statement Total gains reported in other comprehen- sive income Purchases Transfers from Level 3 Transfers to Level 3 At 31 December 2010
Financial assets              
Securities designated at fair value through profit or loss 15,990 678   159 (13,383)   3,444
Investment securities available for sale 9,909 212 4,472 252 (2,948)   11,897
Derivative financial instruments _ 601 _ 2,131 _ 2,240 4,972
Total level 3 financial assets 25,899 1,491 4,472 2,542 (16,331) 2,240 20,313

Fair values of financial liabilities are as follows:

In mln of Russian Roubles 2011 2010
  Carrying value Fair value Carrying value Fair value
Financial assets carried at amortised cost        
Cash and cash equivalents:        
– Cash on hand 438,699 438,699 297,956 297,956
– Cash balances with the Bank of Russia (other than mandatory reserve deposits) 51,254 51,254 77,447 77,447
– Correspondent accounts and overnight placements with other banks with original maturities up to 30 days 113,865 113,865 309,704 309,704
– Reverse-repo agreements with original maturities up to 30 days 21,747 21,747 34,494 34,494
– Mandatory cash balances with the Central Banks 101,205 101,205 51,678 51,678
Due from other banks 35,097 35,097 13,035 13,035
Loans and advances to customers:        
– Commercial loans to legal entities 3,713,484 3,658,087 2,395,763 2,409,594
– Specialised loans to legal entities 2,269,922 2,215,426 1,842,704 1,875,248
– Consumer and other loans to individuals 906,655 930,315 599,604 621,434
– Mortgage loans to individuals 748,506 778,570 574,499 599,206
– Car loans to individuals 81,133 82,337 76,817 76,993
Securities pledged under repurchase agreements:        
– Investment securities held to maturity pledged under repurchase agreements 137,178 136,103 - -
Investment securities held to maturity 286,516 278,884 358,191 357,060
Other financial assets:        
– Receivables on plastic cards settlements 78,805 78,805 91,219 91,219
– Settlements on operations with securities 15,214 15,214 - -
– Settlements on currency conversion operations 6,497 6,497 6,196 6,196
– Trade receivables 2,653 2,653 5,259 5,259
– Accrued fees and commissions 3,884 3,884 1,164 1,164
– Funds in settlement 67 67 41 41
– Other financial assets 4,796 4,796 2,300 2,300
Total financial assets carried at amortised cost 9,017,177 8,953,505 6,738,071 6,830,028
In mln of Russian Roubles 2011   2010  
  Carrying value Fair value Carrying value Fair value
Financial liabilities carried at amortised cost        
Due to other banks:        
– Correspondent accounts and overnight placements of other banks 59,070 59,070 38,716 38,716
– Term placements of other banks 240,445 240,445 34,149 34,149
– Sale and repurchase agreements with other banks 232,870 232,870 61,803 61,803
Due to Individuals:        
– Current/demand accounts 1,077,039 1,077,039 785,750 785,750
– Term deposits 4,649,280 4,667,881 4,048,709 4,075,185
Due to corporate customers:        
– Current/settlement accounts of state and public organisations 142,182 142,182 116,827 116,827
– Term deposits of state and public organisations 39,560 39,508 40,475 40,691
– Current/settlement accounts of other corporate customers 1,230,174 1,230,174 1,082,754 1,082,754
– Term deposits of other corporate customers 793,898 837,023 576,616 610,231
Debt securities in issue:        
– Loan participation notes issued under the MTN programme 169,623 168,070 153,273 153,968
– Promissory notes 77,214 70,767 96,505 94,615
– Savings certificates 9,798 9,798 13,102 13,102
– Deposit certificates 700 700 1,889 1,889
– Other debt securities except for structured notes 9,874 9,978 7,930 8,081
Other borrowed funds:        
– Syndicated loans received 102,115 102,115 96,904 96,947
– Other long-term borrowings 141,905 141,905 74,351 74,351
Other financial liabilities:        
– Plastic card payables 45,777 45,777 25,425 25,425
– Trade payables 13,097 13,097 9,318 9,318
– Settlements on operations with securities 10,497 10,497 - -
– Funds in settlement 10,091 10,091 5,071 5,071
– Deposit insurance system fees payable 5,184 5,184 4,476 4,476
– Deferred commissions received on guarantees issued 1,373 1,373 1,222 1,222
– Other financial liabilities 6,476 6,476 2,109 2,109
Subordinated debt:        
– Subordinated debt received by the Group from the Bank of Russia 303,294 303,294 303,299 303,299
– Subordinated debt received by subsidiaries 224 228 214 213
Total financial liabilities carried at amortised cost 9,371,760 9,425,542 7,580,887 7,640,192

Financial instruments carried at fair value. Trading securities, other assets at fair value through profit or loss, financial derivatives and available for sale financial assets are carried in the consolidated statement of financial position at fair value. Cash and cash equivalents are carried at amortised cost which approximately equals their current fair value.

Refer to Note 3 for accounting policy on financial instruments carried at fair value.

Loans and receivables carried at amortised cost. The fair value of floating rate instruments is normally their carrying amount. Due to significant changes in market situation, interest rates for loans and advances to customers and due from other banks issued at fixed interest rates can be revised. Therefore, interest rates for loans issued just before reporting date do not differ significantly from interest rates for new credit instruments with similar credit risk and remaining maturity. If under the Group assessment interest rates for the loans issued before reporting date differ significantly from current interest rates for similar credit instruments, the fair value for these loan received discounted at current interest rates for new instruments with similar credit risk and remaining maturity. Discount rates used depend on currency, maturity of the instrument and credit risk of the counterparty.

Contractual interest rates on loans and advances to customers and due from other banks as at 31 December 2011 and 31 December 2010 were as follows:

  2011 2010
Due from other banks 1.5- 8,5% p.a. 2.5-10,0% p.a.
Loans and advances to customers:    
- Corporate loans 5.3-17,1% p.a. 5.4-18,0% p.a.
- Loans to individuals 8.0-21,0% p.a. 9.0-20,5% p.a.

Estimated fair value of other financial assets including trade debtors equals their carrying amount considering short-term nature of these assets.

Liabilities carried at amortised cost. The fair value is based on quoted market prices, if available. The estimated fair value of fixed interest rate instruments with stated maturity, for which a quoted market price is not available, was estimated based on expected cash flows discounted at current interest rates for new instruments with similar credit risk and remaining maturity. The fair value of liabilities repayable on demand or after a notice period (“demandable liabilities”) is estimated as the amount payable on demand, discounted from the first date that the amount could be required to be paid. Discount rates used were consistent with the Group’s credit risk and also depend on currency and maturity of the instrument and ranged from 0.1% p.a. to 17.0% p.a. (2010: from 0.03% p.a. to 18.0% p.a.).

Derivative financial instruments. All derivative financial instruments are carried at fair value as assets when the fair value is positive and as liabilities when the fair value is negative. Refer to Note 33.

    History

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