Company Overview and Risk Management Analysis

Company Overview and Risk Management Analysis

Company Overview and Risk Management Analysis Simone Ansaldi Rebecca Frassini Laura Goglio Mattias Pizzagalli Jonida Resuli Universit degli Studi di Bergamo, December 2013 Risk Management and Derivatives Agenda Company overview

The Basel capital Accord Company analysis Risk factors Financial statement and Notes 2 Definition Leading global investment banking securities and investment management firm Provides a wide range of financial services

Offices in over 30 countries 49 % of the staff based outside America 41 % of the revenues generated outside America 3 Investments banking

Serves corporate and government clients around the world Provides financial advisory services Helps companies raise capital Try to develop and maintain long term relationships

Goal: deliver to the clients the entire resources of the firm Investment banking: financial advisory Strategic advisory assignments Help clients execute large, complex transactions Revenues from derivative transactions

Assist the clients in managing their asset and liability exposure and their capital Provide lending commitments and bank loan Bridge loan facilities Investment banking: underwriting

Helping companies raise capital to fund their businesses Match the capital of the investing clients with the needs of the clients Public offerings and private placements Revenues from derivative transactions Investment banking: equity underwriting Leading position in

Worldwide public common stock offerings Worldwide initial public offerings Investment banking: debt underwriting Investment-grade

High yield debt Bank loans Bridge loans Emerging and growth-market debt Structured securities (mortgage-related

securities) Institutional client services Helps clients to buy and sell financial products, raise funding and manage risk Acts as a market maker Offers market expertise

Makes markets and facilitates client transactions in: Fixed income Equity Currency

Commodity products Institutional client services (2) Clear client transactions Provides liquidity Play a critical role in price discovery (efficiency of the capital markets)

Willingness to make markets is crucial Relationships with clients are maintained Prices to clients globally are provided Institutional client services (3) 4 ways to generate revenues:

In large, highly liquid markets: high volume of transactions for modest spread and fees In less liquid markets: transactions for spread and fees somewhat larger Customized or tailor-made products that address the client's risk exposures Financing to the clients is provided Institutional client services (4) The activities are organized by asset class

including: Cash instruments: trading the underlying instrument Derivative: instruments that derive their value Ics: fixed income, currency and commodities client execution

Interest rate products: government bonds, money market instruments, IRS, options Credit products: investment-grade corporate securities, credit derivatives, bank and bridge loans Mortgages: commercial mortgage-related securities, loans and derivatives Currencies: including growth-market currencies Commodities: oil and natural gas, base, precious and other metals

Fixed income, currency and commodities client execution Equities: equity client execution, commissions and fees, securities services Fixed income, currency and commodities client execution Equities client execution:

Facilitates client transactions by providing liquidity with large blocks of stocks or options Engagement in insurance activities Structure and execute derivatives on indices, industry groups, financial measures and individual company stocks Developing of strategies and portfolio hedging and restructuring Asset allocation transactions Creation of tailored instruments to establish or undertake hedging strategies Fixed income, currency and

commodities client execution Commissions and fees: Generated from executing and clearing institutional client transactions on major stock, options and futures Access to electronic low touch equity trading platforms Most of the revenues continued to be derived from the high-touch handling Fixed income, currency and

commodities client execution Securities services: Financial services: through margin loans collateralized by securities and cash or collateral Securities lending services: borrowing and lending securities Other prime brokerage services: technology platform is provided, custody services

Investing and lending Long-term activities Investing directly in publicly and privately traded securities and loans Managing diversified global portfolio of investments in equity securities and debt Investment in the ordinary shares of ICBC

Equity-related investments Investing and lending (2) Corporate, infrastructure debt investments Credit to corporate clients through loan

facilities Investment entities with a defined exit strategy not related to the principal businesses Invest in distressed assets Investment management Provides investment and wealth advisory services to help clients preserve and grow their financial assets Managing client assets

Income and liability management Trust and estate planning Philanthropic giving and tax planning Use of global securities to address the clients' needs Management and other fees

Fees vary by asset class and affected by investment performance, asset inflows and redemptions Assets under management Incentive fees (when a return exceeds a specific benchmark) Business continuity program Business continuity and information security are high priorities

Key elements of the program: Crisis planning and management People recovery Business recovery System and data recovery

Process improvement Employees and competition Quality, commitment, professionalism, excellence, diversity, cooperation are the keys of success Competitors are other entities that provide investment banking, securities and investment management services (brokers, dealers,

investment advisors) Advantages are taken from competing successfully with larger financial institutions (which have more capital and stronger local presence) Competition and regulation Price competition

Competition in attracting and retaining qualified employees Dodd-frank act: enacted in July 2010 which provides extension on the rules adopted by the fed board Supervision and examination by the fed board Regulation BHC act restricts bank holding companies from engaging in business activities

Fed board has the authority to limit the ability to conduct activities and it is necessary its approval before engaging in financial activities The Volker rule prohibits proprietary trading sponsorship and investment in hedge funds The Volker rule Is expected to limit certain kind of

transactions with the sponsored funds Many aspects remain unclear and very complex In October 2011 the rules to implement the Volker rule were issued The Volker rule limitation on investments in hedge funds and private equity funds required to reduce investments to 3% or less Capital and liquidity requirements As a bank holding company, Goldman Sachs is subject to consolidated regulatory capital requirements by fed board

Changes in capital requirements Changes to the market risk capital rules became effective on January 1, 2013 and these require the addition of new model based capital requirements Basel 2 revises the regulatory capital framework for credit risk and equity investments and will be adopted once the regulators will approve GS to do so Changes in capital requirements

(2) The Collins amendment of the Dodd-frank act requires advanced approach banking organization to continue upon adoption of Basel 2 to calculate risk-based capital ratios under both Basel 2 and the fed reserve board's risk-based capital requirements Changes in capital requirements (4) More stringent capital standards:

New Basel 3 requirements In December 2011 the fed board proposed rules to implement the enhanced prudential standards contemplate by the Dodd-frank act which may affect if finalized, the ability of GS to transact or hedge Payment of dividends and stock repurchases Subject to the oversight of the fed board based on capital plans and stress tests to judge the

capital planning processes GS not object to its capital actions through the first quarter of 2013 Compensation practices Oversight by the fed board Risk must be taken in account

Incentives that balance risk and financial results Review of the incentive compensation policies Enforcement actions taken against the risk of the organization's safety caused by related risk management If the regulations are adopted the flexibility Regulation of GS bank USA

Undertake stress test is required, according to Dodd-frank act and submit them to the fed board Derivative push-out will prevent GS from conducting certain swaps-related activities Transactions between GS bank USA and its subsidiaries are regulated by the fed board Prompt corrective actions and capital ratios The us federal deposit insurance corporation improvement act of 1991 (FDCIA) establishes 5 capital categories:

Well-capitalized depositary institution: if it has a tier 1 capital ratio of at least 6%, a total capital ratio of at least 10% and a tier 1 leverage ratio of at least 5% Adequately capitalized Undercapitalized

Significantly undercapitalized Critically undercapitalized Prompt corrective action and capital ratios Capital ratios of GS bank USA are computed according to Basel 1 and will adopt Basel 2 only if it is approved by regulators An institution may be downgraded if it is

determined to be in a not safe position or as a result of bad rating Insolvency of an insured depository institution Transfer the depository institution's assets and liabilities to a new obligor Enforce the terms of the depository institution's contracts

Repudiation of any contracts to which the institution is a party Resolution plan: submitted to the regulators on June 29, 2012, which established GS bank USA is protected from risks Broker-dealer and securities regulation It is required to maintain orderly markets in the securities assigned According to Dodd-frank act any person who organizes an asset-backed security transaction

to retain a portion of any credit risk that the person conveys with a third party Swap, derivatives and commodities regulations Subject to regulation of us commodity exchange act The Dodd-frank act provides increased regulation, imposing the following requirements:

Real time public and regulatory reporting of trade information for swaps Registration of swap dealers Position limits the cap exposure to derivatives on certain physical commodities Mandated clearing through central counterparties for certain swaps New business conduct standards for swap dealers

Margin requirements for trades that are not cleared Entity level capital requirements for swap dealers Other regulations Some examples... Insurance subsidiaries: subject to state insurance regulation in the states in which they are domiciled Investment management: subject to significant regulation in numerous jurisdictions

around the world The Basel Capital Accord The Basel Committee The Basel Committee on Banking Supervision, established at the Bank for International Settlements, is a forum whose objective is to enhance the understanding of key supervisory issues and improve the quality of banking supervision worldwide

The Basel Capital Accord The Basel Capital Accord is a Framework set at the Basel Committee in 1988 and subsequently revised. The primary objectives are to promote the soundness of the international banking system and to provide an equitable basis for international cooperation among banks The Basel Capital Accords

Timeline 1988 Basel I Not adapt for big banks in concentrated markets Not in line with RM Evolutions 2003 2010 Basel II Basel III

Didnt avoid the financial crisis to happen Currently Implementing Procyclical No Standard for Liquidity Basel II - Main Failures It Allowed the Financial Crisis to Happen: Basel II failed in capturing major on- and off-balance sheet risks, as well as derivative exposures. It also didnt take into consideration potential losses due to Credit Evaluation Adjustments (CVA) due to M2M.

Procyclicality: During the Financial Crisis banks were forced to deleverage, sell problematic assets and dramatically decrease the credit issuance. All these actions had a pro cyclical effect and facilitated the spread of the financial crisis to the Real Economy. Basel II - Main Failures (contd) No Standard for Liquidity: During the early liquidity phase of the financial crisis, many banks that were in line with the capital requirements still experienced difficulties because they didnt manage their

liquidity in a prudent way, due to lapses in Liquidity Risk Management Basel III - The Three Pillars In 2010 the new Basel Framework has been issued, focusing on Basel Basel III III Framework Framework Pillar 2 Credit Risk Market Risk Operational Risk

Liquidity Risk Pillar 1 Capital & Liquidity Requirement s Supervisory Oversight Pillar 3 Market Disclosure Pillar 1 - Credit Risk

Based on 3 main Capital Ratios: Common Equity Tier 1 1. Common Equity Tier 1 Ratio = Risk Weighted Assets Tier 1 Capital 2. Tier 1 RatioRisk = Weighted Assets Total Capital 3. Tier 2 Ratio = Risk Weighted Assets

Tier 3 Ratio, required in Basel II, has been eliminated in Basel III Capital Ratios Timeline 2013 2014 2015 Common Equity Tier 1 Ratio 3.5%

4% 4.5% Tier 1 Ratio 4.5% 5.5% 6% Tier 2 Ratio 8% 8%

8% Classes of Capital (1/3) Common Equity Tier 1: 1. Common shares issued by the bank that meet the criteria for classification as common shares for regulatory purposes (or the equivalent for non-joint stock companies) 2. Stock surplus (share premium) resulting from the issue of instruments included in Common Equity Tier 1 3. Retained Earnings 4. Accumulated other comprehensive income and other disclosed reserves 5. Regulatory adjustments applied in the calculation of Common

Equity Tier 1 Classes of Capital (2/3) Additional Tier 1 Capital: 1.Instruments issued by the bank that meet the criteria for inclusion in Additional Tier 1 Capital (not included in Common Equity Tier 1) 2.Stock Surplus (share premium) resulting from the issue of instruments included in Additional Tier 1 capital 3.Instruments issued by consolidated subsidiaries of the bank and held by third parties that meet the criteria for inclusion in Additional Tier 1 capital and are not included in Common Equity Tier 1 4.Regulatory Adjustments applied in the calculation of Additional Tier 1 capital

Tier 1 Capital = Common Equity Tier 1 Capital + Additional Tier 1 Capital Classes of Capital (3/3) Tier 2 Capital: 1.Instruments issued by the bank that meet the criteria for inclusion in Tier 2 capital (not included in Tier 1 capital) 2.Stock surplus (share premium) resulting from the issue of instruments included in Tier 2 capital 3.Instruments issued by consolidated subsidiaries of the bank and held by third parties that meet the criteria for inclusion in Tier 2 capital and are not included in Tier 1 capital 4.Certain loan loss provisions 5.Regulatory adjustments applied in the calculation of Tier 2 capital

Total Capital = Tier 1 Capital + Tier 2 Capital Risk Weighted Assets RWAs may be calculated using three different kind of models: 1. SIMPLIFIED MODEL: Based on External Ratings and Standard Risk Weights according to the risk class 2. STANDARD INTERNAL RATING

BASED MODEL: The bank implements its own internal rating model based on its own calculations about the Probabilities of Default, while LGD, EAD and Maturities are given by the Authorities Risk Weighted Assets (contd) 1. ADVANCED INTERNAL RATING BASED MODEL: The bank calculates all the inputs of the model for the calculation of internal ratings (PD, LGD, EAD, M)

The Internal Models need to be approved by the Authorities and to be frequently updated Capital Conservation Buffer Outside periods of stress, banks shall hold a capital buffer above the regulatory minimum in order to be able to draw it down as losses are incurred The Capital Conservation Buffer, who needs to be composed of Common Equity Tier 1 Capital, is set at 2.5% above the regulatory requirement

In order to build the buffer banks should reduce discretionary distributions of earnings (dividends, share-backs, staff bonus payments) Countercyclical Buffer During periods of credit growth, banks shall set apart a Countercyclical buffer, in order to use it when the credit market deteriorates

The Countercyclical Buffer is decided from the Authorities on National basis, and it can be in a range from 0 to 2.5% of the Risk Weighted Assets Leverage Ratio During the financial crisis, even well capitalized banks experienced problems, due to their Leverage The Leverage Ratio has been introduced in order to avoid leverage-related

problems Capital Measure Total Exposure Leverage Ratio = Capital Measure is very similar to Common Equity Tier 1 Total Exposure: On-Balance Sheet Items, Repurchase

Agreements, Securities Finance, Derivatives, Off-Balance Sheet Items Pillar I - Market Risk Introduction of the concept of Credit Valuation Adjustments (CVA), which leads to the risk of change in values of the positions held (mark-tomarket) due to changes in the counterparts situation. The changes do not consider defaults, which are part of credit risk

Specific Capital Charges are applied in order to hedge the risk Pillar I - Market Risk (contd) Risk Measures: VaR: Potential Loss in value of inventory positions due to adverse market movements over a defined time horizon with a specified confidence level (95%)

Stress Tests: Examine the risk of specific portfolios as well as the potential impact of significant risk exposures across the firm Stressed VaR: Var using stressed parameters Pillar I - Operational Risk (1/3) Three Possible Approaches: 1. Basic Indicator Approach: Capital Requirements are a function of the overall Gross Income of the last 3 years and of a parameter alfa (15%)

Pillar I - Operational Risk (2/3) 1. Standardized Approach: Based on the Gross Income of the last three year of 8 Business Lines and on a BL-specific beta factor Pillar I - Operational Risk (3/3) 1. Advanced Measurement Approach: The biggest banks may choose on a range of more advanced models, using also other kind of internal data. The Advanced Models need to be approved by the supervisory Authority. The most famous model classes are:

A. The Scorecard Approach B. The Internal Measurement Approach C. The Loss Distribution Approach Pillar I - Liquidity Risk In order to avoid that banks, although well capitalized, may experience liquidity shortages in periods of stressed markets, the Basel Framework developed the following two Ratios: 1. The Liquidity Coverage Ratio 2. The Net Stable Founding Ratio Liquidity Coverage Ratio

(1/4) The Liquidity Coverage Ratio aims to ensure that a bank has an adequate stock of unencumbered High Quality Liquid Assets (HQLA) to meet its liquidity needs for a 30 calendar days liquidity stress scenario After 30 days it is assumed that corrective actions can be taken by management and supervisors, or that the bank can be resolved in an orderly way Liquidity Coverage Ratio (2/4)

Stock of HQLA Liquidity Coverage Ratio: Total Net Cash Flows Over the Next 30 Calendar Day Timeline Minimum LCR 2015 2016

2017 2018 2019 60% 70% 80% 90% 100%

Liquidity Coverage Ratio (3/4) HQLAs Features: 1. Low Risk 2. Ease and Certainty of Valuation 3. Low Correlation with Risky Assets 4. Listed on a Developed and Recognized Exchange Liquidity Coverage Ratio (4/4) HQLA Categories:

1.Level 1 Assets: Can be included without limit Coins and Banknotes, Central Bank Reserves, Other securities with 0% risk weight under the Basel II Standardized Approach 2. Level 2 Assets: Can only comprise up to the 40% of the stock Securities with 20% risk weight under Basel II Standardized Approach, Corporate Debt Securities and Covered Bonds not issued by the bank itself and with a minimum rating of AA- 3. Level 2B Assets: Included according to Supervisors choices, they can be maximum the 15% of the total HQLA and they are taken into account in calculating the 40% limit for Level 2 Assets Residential Mortgage Backed Securities (25% haircut) with a minimum rating of AA, Corporate Debt Securities (50% haircut) not issued by the bank itself Net Stable Founding Ratio

The Net Stable Founding Ratio aims to promote the resilience over a longer time horizon by creating additional incentives for banks to fund their activities with more stable sources of founding on an ongoing basis Still to be fully regulated Pillar II - Supervisory Review Process

Every Bank needs to develop an Internal Capital Assessment Process and set targets for capital that are in line with the banks particular Risk Profile and Control Environment Supervisors are responsible for evaluating how well banks are assessing their Capital Adequacy Needs relative to their Risks Pillar III - Market Discipline Banks need to provide disclosure in order to ensure that market participants can better

understand their risk profiles and the Adequacy of Capital Positions Disclosure Requirements and Recommendations are set in several areas More detailed requirements for banks who use Internal Models for Evaluating Risks Goldman Sachs and Basel Capital Requirements Risk Weighted Assets

Company analysis Stock chart Source: Wall street Journal 17/12/2013 Income statement Income statement Financial statement Financial statement Financial statement

Business environment Global economic conditions generally weakened in 2012 Improvement by central banks, resulted in tighter credit spreads, higher global equity prices and lower levels of volatility General political instability lead to higher risk aversion GDP declined in most countries and unemployment rate grew Critical accounting policies .

The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets are marked to bid prices and financial liabilities are marked to offer prices. Fair value measurements do not include transaction costs. Use of fair value fundamental for risk management practices Fair value evaluation US GAAP 3rd Inputs that cannot

be observe d in market 2nd Inputs other than level 1 inputs activityeither directly that are observable, or indirectly 1st Highest priority to unadjusted quoted prices in active markets for identical assets and liabilities Assets and liabilities at Fair Value

Low market volumes due to lower volatility levels and concern about the outlook result in a 16% drop in 2012 Market making revenues

The increase is linked to a general improvem ent in asset prices Commissio ns and fees 13% increase is

explained by higher revenues in debt underwriti ng Investment manageme nt We see a 19% increase in 2012 partially offset by

lower commissio ns an fees Noninterest revenues Net revenues Result of operations - Revenues 22% increase in this area is linked to the operating environment

characterized by broad market uncertainty and positive developments (central banks actions and government policies) that helped to They are influenced by compensation, headcount and level of business

activity. They remain unchanged compared with 2011, this is due to the actions the company started in order to be more efficient The increase in this area is primarily due to earning mix and decrease in the impact of

permanent benefits Provision for taxes Operating expenses Result of operations - Costs The activity is mainly oriented in the origination of loans to provide financing to

clients. Revenues has been positively impacted by tighter credit spreads and an increase in global equity prices. Investment management This segment includes: fixed income,

currency and commodities client execution and equities. 5% increase in the area is mainly due to strong net revenues on mortgages and securities services (hedge fund administratio

Investing & Lending It includes financial advisory and underwriting. Sector revenues increased by 13% since there has been a strong activity in debt underwriting

Institutional client services Investment banking Segment operating result The segment provides investment products across all major classes to assets to institutional and

individual clients. The positive increase in the area is linked to higher incentive fees received due to the Regulatory developments Principal areas of impact from regulatory reforms: Dodd-Frank prohibition on proprietary trading and the limitation on the sponsorship of, and

investment in, hedge funds and private equity funds by banking entities, including bank holding companies, referred to as the Volcker Rule increased regulation of and restrictions on overthe-counter (OTC) derivatives markets and transactions increased regulatory capital requirements Balance Sheet and Funding Sources One of GS most important management disciplines is the ability to manage the size and composition of its balance sheet. Size and composition of balance sheet reflect:

overall risk tolerance ability to access stable funding sources amount of equity capital it holds Balance Sheet Analysis and Metrics GS seeks to maintain a liquid balance sheet and have processes in place to dynamically manage assets and liabilities which include: Quarterly planning They combine projected total assets and composition of assets with expected funding sources and capital levels for the next quarter. It is important to allow risk managers to objectively evaluate balance sheet limit requests from business managers in the context of the

firms overall balance sheet constraints Businessspecific limits The Firmwide Finance Committee sets asset and liability limits for each business and aged inventory limits for certain financial instruments as a disincentive to hold inventory over longer periods of time. Monitoring of key metrics GS monitor key balance sheet metrics daily both by business and on a consolidated basis, including asset and liability size and composition, aged inventory, limit utilization, risk measures and capital usage.

Scenario analyses GS conduct scenario analyses to determine how it would manage the size and composition of its balance sheet and maintain appropriate funding, liquidity and capital positions in a variety of situations Balance Sheet Analysis and Metrics Adjusted assets Leverage ratio Adjusted leveraged ratio

Debt to equity ratio Adjusted assets equals total assets less low-risk collateralized assets generally associated with secured client financing transactions, federal funds sold and excess liquidity and cash and securities segregated for regulatory and other purposes. The leverage ratio equals total assets divided by total shareholders equity and measures the proportion of equity and debt the firm is using to finance assets. It equals adjusted assets divided by total shareholders equity. According to GS it is a more meaningful measure of capital adequacy than the leverage ratio. The debt to equity ratio equals unsecured long-term borrowings divided by total shareholders equity. Balance Sheet Analysis and

Metrics Risk-Weighted Assets RWAs under the Federal Reserve Boards risk-based capital requirements are calculated based on the amount of credit risk and market risk. Credit RWAs for credit risk reflect riskamounts for on-balance sheet and offbalance sheet exposures. Credit risk requirements for on-balance sheet assets, such as receivables and cash, are generally based on the balance sheet value. Credit

risk requirements for securities financing transactions are determined based upon the positive net exposure for each trade, and include the effect of Market RWAs for market risk are risk comprised of modelled and non-modelled risk requirements. Modelled risk requirements are determined by reference to the firms Value-at-Risk (VaR)

model. For certain portfolios of debt and equity positions, the modelled RWAs also reflect requirements for specific risk, which is the risk of loss on a position that could result from changes in risk factors unique to that Funding sources GS primary sources of funding are secured financings, unsecured long-term and short-term borrowings, and deposits. Long term unsecured

debtthrough (i.e. 144A medium-term note Saving deposit deposit sweep programs Short and termdemand unsecured debt through commercial papers and

Collateralized financing (i.e. securities loaned) promissory notes and time deposit programs) Funding sources Secured funding Secured funding is less sensitive to changes in credit quality than unsecured funding, due to GS posting of collateral to its lenders. Nonetheless, the company continually analyse the refinancing risk of its secured funding activities, taking into account trade tenors, maturity profiles, counterparty concentrations, collateral eligibility and

counterparty rollover probabilities. It seeks to mitigate refinancing risk by executing term trades with staggered maturities, diversifying counterparties and raising excess secured funding. Funding sources Equity capital Capital adequacy is of critical importance to GS. Its objective is to be conservatively capitalized in terms of the amount and composition of its equity base. Accordingly, GS has in place a comprehensive capital management policy that serves as a guide to determine the amount and composition of equity capital it maintains.

Risk Management GS gives a high level of importance to risk management, it has a comprehensive risk management processes through which it monitors, evaluates and manages the risks it assumes in conducting activities. These include: Market risk Credit risk Liquidity risk Operational risk Legal risk Regulatory risk Reputational risk Risk Management GS risk management framework is built around three core components:

Processes People Structure Fair value Credit and market risk limits Development of a comprehensive, reliable and timely risk management technology Effective risk management requires people to interpret risk data on an ongoing and timely basis and adjust risk

positions accordingly. Ultimate oversight of risk is the responsibility of the firms Board. The Board oversees risk both directly and through its Risk Committee. Within the firm, a series of committees with specific risk management mandates have oversight or decision-making responsibilities for risk management activities. Risk Management The governance structure:

Risk Management Liquidity risk management Liquidity is of critical importance to financial institutions. Most of the recent failures of financial institutions have occurred in large part due to insufficient liquidity. Accordingly, the firm has in place a comprehensive and conservative set of liquidity and funding policies to address both firmspecific and broader industry or market liquidity events. Risk Management Liquidity risk management Assessing anticipated holding periods for its assets

and their expected liquidity in a stressed environment. Contingenc y Funding Plan Maintaining substantial excess liquidity allows to meet a broad range of

potential cash outflows and collateral needs in a stressed Asset-Liability Management. Excess liquidity GS manages liquidity risk according to the following principles: It provides a framework for analysing

and responding to a liquidity crisis situation or periods of market stress. Risk Management Liquidity risk management Model liquidity outflow The model is based on a scenario that includes both a marketwide stress and a firm-specific stress, characterized by several market environments and firm-specific crisis potentially triggered by material losses, litigation, rating downgrade, etc. Critical parameters are: - Liquidity needs over a 30 day scenario - 2-notch downgrade of the firms long-term senior unsecured

credit ratings - Combinations of contractual outflows - No issuance of equity or unsecured debt - No support from government funding facilities Risk Management Liquidity risk management ALM GS ALM approach includes: - Manage the features of funding book with a focus on long-term diversified sources of funding in excess of current requirements - Active manage and monitor of the asset base with particular focus on liquidity - Raise secured and unsecured financing that has a long tenor relative to the liquidity profile of companys assets. Final goal is to ensure that the firm maintains sufficient

liquidity to fund its assets and meet its contractual contingent obligations in normal times as well as Risk Management Liquidity risk management Contingency Funding Plan The plan sets out the action GS would use to fund business activity in crisis situations and periods of market stress. It outlines a list of potential risk factors, key reports and metrics that are reviewed on an ongoing basis to assist in assessing the severity of, and managing through, a liquidity crisis and/or market dislocation. It also identifies key groups of individuals to foster effective coordination, control and distribution of

Risk Management Liquidity risk management Proposed Liquidity Framework The Basel Committee on Banking Supervisions international framework for liquidity risk measurement, standards and monitoring calls for imposition of a liquidity coverage ratio, designed to ensure that the banking entity maintains an adequate level of unencumbered high-quality liquid assets based on expected cash outflows under an acute liquidity stress scenario, and a net stable funding ratio, designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one-year time horizon. Derivatives and hedging activities

Derivatives are accounted for at fair value, net of cash collateral received or posted under credit support agreements. They are reported on a net-bycounterparty basis when a legal right of setoff exists. Derivative assets and liabilities are included in Financial instruments owned, at fair value and Financial instruments sold, but not yet purchased, at fair value, respectively. Derivatives and hedging activities Firms level 2 and level 3 derivatives are valued using derivative pricing models (e.g., models that incorporate option pricing methodologies, Monte Carlo simulations and discounted cash flows). Price transparency of derivatives can generally be characterized by product type: Interest rates

Credit Currency Commodit y Equity Generally prices are observable and transparent even for long-dated contracts. In general prices are transparent. Credit default swaps that reference loans, asset-backed securities and emerging market debt instruments tend to have less price transparency than thosebetween that reference corporate bonds.of The

primary difference the price transparency developed and emerging market currency derivatives is that emerging markets tend to be observable for contracts with shorter tenors. In general price transparency for commodity derivatives is greater for contracts with shorter tenors and contracts that are more closely aligned with major and/or benchmark commodity indices. Equity derivatives generally have observable market prices, except for contracts with long tenors or reference

prices that differ significantly from current market prices. Securitization activities > The firm securitizes residential and commercial mortgages, corporate bonds, loans and other types of financial assets by selling these assets to securitization vehicles (e.g., trusts, corporate entities and limited liability companies) and acts as underwriter of the beneficial interests that are sold to investors. The primary risks included in beneficial interests and other interests from the firms continuing involvement with securitization vehicles are: - The performance of the underlying collateral - The position of the firms investment in the capital

structure of the securitization vehicle - The market yield for the security. Market risk Possible adverse impact by condition in the global financial market and economic condition generally Negative general condition General uncertainty Lower public confidence Negative impact on client activities Losses Market risk Performance highly linked to the environment Main factors:

Global GDP Efficiently of capital market Level of investor confidence Stability of geopolitical conditions

Regulatory certainty Level of inflation Market risk Risk of loss in the value of our inventory due to changes in market prices. Inventory changes based on client demands and investment opportunities Inventory accounted at fair value, fluctuations on a daily basis INTEREST RATE RISK EQUITY

PRICE RISK CURRENCY RATE RISK COMMODIT Y RISK Market risk Asset Management Declining of asset value -> negative impact especially for.. Net long position Collateral

management Market risk - Volatility More volatility -> more trading and arbitrage opportunities, a volatile market can increase trading revenues BUT more risk and Goldman Sachs may be obliged to limiting the size to market making position -> less profitability Market risk How to manage Diversify exposure Control position sizes

Economic hedge in related securities or derivatives Market risk Effective management 1. accurate and timely information 2. dynamic limit setting framework 3. high level of communication Market risk Risk measures For shorterterm period Var

Sensitivity metrics For longerterm period Stress tests Market risk Value at Risk Potential loss in value of inventory positions due to adverse market movements one-day time horizon with a 95% confidence level BENEFITS Market risk Value at Risk

Consideration of risks including interest rates, equity prices, currency rates and commodity prices Previous moves may not produce accurate predictions of all future market moves Easy comparison No consideration of relative liquidity of different risk positions

Consideration of risk reduction due to diversification Trading gains/losses due to market movements may differ from the model LIMITS Estimation of aggregate risk Market risk Daily VaR

From 2011 to 2012 the decrease reflects a decrease in the interest rates category, commodity prices and currency rates categories due to lower levels of volatility and to reduced exposures. These decreases were partially offset by a decrease in the Market risk Daily Var Market risk Daily VaR Market risk Daily Trading Net Revenues Daily trading net revenues are compared with VaR calculated as of the end of the prior business day. Trading losses incurred on a single day did not exceed 95% one-day VaR during 2012.

Market risk - Sensitivity measure For position not included in VaR, estimation of the potential reduction in net revenues of a 10% decline in the underlying asset value. Market risk - Stress testing Sensitivity analysis Used to quantify the impact of a market move in a single risk factor across all position or the impact of the default of a single corporate entity Scenario

analysis Used to quantify the impact of a specified event, including how the event impacts multiple risk factors simultaneously Firmwide stress tests Combination of market, credit, operational and liquidity risks into a single combined scenario, used to assess capital adequacy Credit risk

Potential loss due to default or deterioration in credit quality of third parties who owe money, securities or other assets, or of issuers of securities or other instruments Credit risk Goldman Sachs could incur in loss if Counterparty in a security of other financial instrument defaults on GS Value of securities GS holds decrease due to decrease in credit quality / ratings

Credit risk Credit risk can be generated by: OTC derivatives Loans and lending commitments Securities financing transactions (i.e., resale and repurchase agreements and securities borrowing and lending activities) Credit risk Management process Approving transactions and setting credit exposure limits; monitoring compliance with established limits; measuring potential losses resulting from counterparty default; reporting of credit exposure to senior management, the Board and regulators; use of credit risk mitigants; communication and collaboration with other independent

control and support functions such as operations, legal and compliance. Credit risk Credit review Initial and ongoing analyses of counterparties Independent judgement on the ability of the counterparty to perform obligations Determination of the internal credit rating according to the determined profile Approval of credit review and rating by senior personnel within credit risk management Credit risk Measurement of exposure Risk measure and limits Measure of credit risk based on the potential

loss in an event of non-payment by a counterparty and limits are fixed to control the size of exposure Stress tests/scenario analysis, applying shock to counterparties credit rating or credit risk factors Credit risk Reduction of exposure According to the credit quality of the counterparty risk mitigants are employed like collateral provisions, guarantees, covenants, structural seniority of the bank loan claims and provisions in the legal documentation that allow the firm to adjust loan as market conditions change

Third parties garantees Credit derivatives or participation agreements Credit risk Credit exposure Credit risk Exposure by credit rating Credit risk Exposure by industry (1) Credit risk Exposure by industry (2) Credit risk Exposure by industry (3)

Credit risk European countries During 2011 and through 2012 many European banking system and member states have been experiencing significant credit deterioration Operational risk Risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. It includes operational risk arises from routine processing errors as well as extraordinary incidents. Operational risk Management process

MANAGEMEN T PROCESS ACTIVE PARTICIPATION SUPERVISION COMMUNICATI ON TRAINING Operational risk Management process It was designed to comply with the operational risk

measurement rules under Basel 2 and has evolved based on the changing needs of our businesses and regulatory guidance. Risk identification and reporting Risk Measurement Risk Monitoring Notes to Consolidated Financial Statements Note 3.Significant Accounting Policies Significant accounting policies of a firm? when and how to measure the fair value of assets and liabilities when to consolidate an entity

Entity as voting/varia ble interest controlling financial interest Consolidatio n Investment funds Numerous investment funds with third-party investors BUT not hold a majority of the economic interests Estimation

Management make certain estimates to the fair value accounting for intangible assets, provision for losses. These estimation are based on the best available information but actual results could be materially different. What is a fair value of a financial instrument? the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets are marked to bid prices and financial liabilities are marked to offer prices. Investment Banking

Expenses With underlying transactions deferred until the related revenue is recognized with financial advisory assignments recorded as noncompensation expenses, net of client

reimbursement s. Investment Management The firm earns management and incentive fees for investment management services Management fees: as % of net asset value, invested capital or commitments recognized over the period that the related service is provided. Incentive fees: as a % of a funds or separately managed accounts return, or excess return above a specified benchmark incentive fees are generally based on investment performance over a 12-month period Management and incentive fee revenues are included in Investment management revenues

Transfers of Assets Transfers of assets are accounted for as sales when the firm has relinquished control over the assets transferred. Firms continuing involvement with transferred assets: measured at fair value. the assets remain in Financial instruments owned, at fair value for transfers of assets not accounted for as sales Cash and Cash Equivalents The firm defines cash equivalents as highly liquid overnight deposits held in the ordinary course of business December 2011

December 2012 Cash and cash equivalent s $6.75 interestbearing deposits with banks $65.92 Cash and cash equivalent s $7.95

interestbearing deposits with banks $48.05 Note 4. Financial Instruments Owned/Sold, But Not yet Purchased, at Fair Value Fair Value Measurements The amount that would be received to sell an asset (paid to transfer a liability) in a transaction between market participants at the measurement date. Financial assets: marked to bid prices

financial liabilities: marked to offer prices. financi al assets portfol io financi al liabiliti es Evidence Best choice quoted price in an active market

Available Not available fair value is determined by reference to prices for similar instruments The fair value hierarchy unadjusted quoted prices in active markets Observable

valuation techniques Significant and unobservable valuation techniques 3 Levels of Cash Instruments corporat e debt securitie s equities and convertible debentures

non-U.S. government and agency obligations bank loans and bridge loans U.S. governme nt and federal agency obligation s

Cash instruments other Non-derivative financial instruments Level 1 Include: U.S. government obligations most non-U.S. government obligations

traded listed equities certain government agency obligations and money market instruments. These instruments are valued using quoted prices for identical unrestricted instruments in active markets. The firm defines active markets:

for equity instruments based on the average daily trading volume both in absolute terms and relative to the market capitalization for the instrument. for debt instruments based on both the average daily trading volume and the number of days with trading activity. Level 2 In this level cash instruments include: commercial paper, commodities certificates of deposit

time deposits, most government agency obligations certain mortgage-backed loans and securities certain bank

loans and bridge loans, certain non-U.S. government obligations restricted or less liquid listed equities

most corporate debt securities most state and municipal obligations and certain lending commitments. Level 3 Level 3 cash instruments are initially valued at transaction price, which is considered to be the best initial estimate of fair value. Valuation inputs and assumptions are changed when corroborated by substantive observable evidence, including values realized on sales of financial assets.

Investments in Funds That Calculate Net Asset value Per Share The firm uses NAV as its measure of fair value for fund investments when the fund investment does not have a readily determinable fair value NAV of the investment fund is calculated in a manner consistent with the measurement principles of investment company accounting, including measurement of the underlying investments at fair value. Investments in Funds That Calculate Net Asset Value Per Share

The firms investments in funds that calculate NAV primarily consist of investments in firm-sponsored funds where the firm co-invests with third-party investors The firms investments in hedge funds are generally redeemable on a quarterly basis with 91 days notice, subject to a maximum redemption level of 25% of the firms initial investments at any quarterend Fair value option The firm has elected to account for certain of its other financial assets and financial liabilities at fair value under the fair value option Primary reasons for electing the fair value option: reflect economic events in earnings on a timely basis;

mitigate volatility in earnings from using different measurement attributes address simplification and cost-benefit considerations Hybrid financial instruments Instruments which contain bifurcatable embedded derivatives and do not require settlement by physical delivery of non-financial assets If the firm elects to bifurcate the embedded derivative from the associated debt: the derivative is accounted for at fair value the host contract is accounted for at amortized cost adjusted for the effective portion of any fair value hedges. If the firm does not elect to bifurcate: the entire hybrid financial instrument is accounted for at fair value under the fair value option.

Resale and Repurchase Agreements and Securities Borrowed and Loaned. 1) collateral funding spreads 2) the amount and timing of expected future cash flows an 3) interest rates Are the significant inputs to the valuation of resale repurchase agreements and securities borrowed/loaned Fair Value of Other Financial Assets and Financial Liabilities by Level This 2 tables shows other financial assets and financial liabilities within the fair value hierarchy, accounted for at fair value primarily under the fair value option.

Transfers Between Levels of the Fair Value Hierarchy Transfers between levels of the fair value hierarchy are reported at the beginning of the reporting period in which they occur. ! No transfers of other financial assets and ! Yes transfer between level 2 and level 3.

financial liabilities between level 1 and level 2 during the year ended December 2012. Level 3 Rollforward If a financial asset or financial liability was transferred to level 3 during a reporting year, its entire gain or loss for the year is included in level 3 THANK YOU FOR LISTENING! ANY QUESTIONS??? References Ferguson R.W.Jr. (2003), Capital Standards for Banks: The Evolving Basel Accord, Federal Reserve Working Paper. Giacometti R; Paterlini S. (2013), Presentation on Operational Risk, Universit

degli Studi di Bergamo, December 2013. Goldman Sachs (2013), 10-K 2012 The Basel Committee on Banking Supervision (2011), Basel III: A global regulatory framework for more resilient banks and banking systems, Bank for International Settlements Publications. The Basel Committee on Banking Supervision (2013), Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools, Bank for International Settlements Publications. The Basel Committee on Banking Supervision (2001), The New Basel Capital Accord: an explanatory note, Bank for International Settlements Publications.

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