FirstRand : material risk factor disclosure 2022

1. The investments, business, profitability and results of operations of the issuer may be adversely affected as a result of political, social and economic risks in South Africa, the United Kingdom (UK) and certain countries in sub-Saharan Africa, and general global economic conditions

The issuer's operations are predominantly concentrated in South Africa, with the majority of its revenues derived from operations in South Africa. The issuer is, therefore, highly exposed to South African macroeconomic conditions and, as a result of their impact on the South African economy, global economic conditions. Any material deterioration in global or South African macroeconomic conditions could lead to a reduction in business activity, higher impairment charges, increased funding costs, and reduced revenues and profitability.

Beyond the South African economy, the issuer also has operations in the UK and several other countries in sub-Saharan Africa. A material deterioration in UK economic conditions or that of the other African countries in which it operates could also have a meaningful negative impact on the issuer's performance.

1.1 Global economic conditions

The South African economy is exposed to the global economy through the current and capital accounts of the balance of payments. South Africa's exports are impacted by economic activity of some of the world's largest economies including China, the United States, the

UK and Europe. Commodity prices and the rand exchange rate have a material impact on South African exports. The South African economy is also reliant on foreign capital inflows.

If global economic growth or global financial conditions deteriorate materially, this is likely to have a negative impact on macroeconomic conditions in South Africa.

While the global economy is recovering from Covid-19-related contraction, the longer-term consequences for the macro economy remain uncertain. This uncertainty has also been exacerbated by an increase in global inflation and geopolitical tensions. A fall in global production capacity will have a negative impact on South African economic activity through lower exports and higher import prices. It could also have negative consequences for capital flows towards South Africa. A macroeconomic shock will weigh on global risk appetite and capital flows to South Africa, and will likely result in financial market pressure and rand weakness.

Permanent global trade impediments (including tariffs), social tensions, natural disasters and environmental damage represent risk factors that could permanently derail global demand for South African goods and global risk appetite towards South Africa.

In addition, a fall in precious metal and/or base metal prices could also result in a deterioration in the value of the rand, higher interest rates and higher bond yields.

1.2 South African economic conditions

Even before the Covid-19 crisis, the South African macroeconomic environment was characterised by low private sector investment growth, weak employment growth, high levels of public sector debt and downward pressure on domestic demand. In addition, domestic consumer and business confidence was low. Despite a bounceback in activity from the depths of the Covid-19-related contraction, the issuer expects the longer-term trends to remain in place.

Structural changes, including financial and business reforms at state-owned enterprises (SOEs), an improvement in the quality of education, much higher fixed capital investment and labour market reforms are now more critical to change the long-term trajectory of the country. The solvency and liquidity challenges at some SOEs remain a significant concern.

1.3 South African political conditions

The issuer currently anticipates that there will be strong political debates around the need to implement measures to balance fiscal sustainability with socio-economic pressures in the country. These will include debates around the implementation of measures that will lift South Africa's potential growth rate. In addition, the issuer expects debates in respect of various sensitive issues such as land expropriation and the mandate of the South African Reserve Bank (SARB). The impact of Covid-19 on employment and poverty will likely fuel further debate on transfers (either through taxes or intertemporally through borrowing) to the vulnerable in South African society. Ongoing political developments may impact private sector investment, foreign investment and business confidence towards South Africa.

The country's high unemployment rate and unequal wealth and income distribution may fuel socio-economic pressure and encourage the government to change its current macroeconomic policies.

1.4 South African conditions specific to the

banking sector

The South African banking sector remains well capitalised, funded, regulated and managed. The South African financial sector is widely regarded as one of the country's key pillars of economic strength. The banking sector is, however, highly exposed to South African macroeconomic conditions, including the sovereign, and will be impacted by negative macroeconomic developments and a deterioration in the government's fiscal position.

Weak economic growth and increased unemployment have pushed household and corporate income growth towards decade lows. A deterioration in the country's institutions, especially the independence of the SARB and policy conduct at National Treasury, could also have a negative impact on the banking sector.

The issuer's financial performance has been and is likely to remain linked to the performance of the South African and global economy.

1.5 UK economic conditions

Economic activity in the UK is being negatively affected by inflation pressures and its impact on the cost of living. The issuer expects unemployment to increase and higher unemployment and related risk to household disposable income could have negative consequences for the operating environment.

Other risks to the UK economy include:

• that the UK services sectors may be unable to comply with the terms of the Brexit agreement. Failure could

result in a slowdown in UK business and consumer confidence, the pound and overall economic activity; and

• a reversal of the policy support that was put in place to cushion households and businesses in the face of the Covid-19 growth slowdown and subsequent inflation pressures.

1.6 Economic conditions in broader Africa

Several other countries in which the issuer operates on the sub-Saharan African continent face macroeconomic risks that could have a negative impact on the issuer's operating environment. These include:

• Zambia: Volatility in copper prices and production, drought, inflation, and slow progress on external commercial and official debt restructuring are risk factors that could slow down domestic reforms and the growth momentum domestically. Price pressures across the economy are a risk to consumption growth. There is significant risk to sovereign debt sustainability and associated macroeconomic pressure if reform momentum slows.
• Nigeria: A lack of diversification in export and fiscal revenues remains a weakness for the country's outlook. Elections in 2023, low oil production due to operational issues, volatile global oil prices and the high costs of the fuel subsidy pose downside risks to growth and government finances, alongside significant policy uncertainty on the exchange rate and foreign currency convertibility.
• Ghana: There are significant risks to sovereign debt sustainability from domestic and external factors. Broad-based inflation, tighter monetary policy and currency pressures pose a risk to growth, alongside austerity measures to stabilise government finances, either domestically driven or prescribed under an International Monetary Fund (IMF) programme from 2023 onwards. The Ghanaian economy is exposed to fluctuations in oil, gold and cacao prices and production volatility. A fall in the price of these commodities has negative consequences for the operating environment and outlook.

• Namibia, Eswatini and Lesotho: These economies are particularly exposed to the South African economy and the rand. A severe fall in South African growth and trade, and/or rand weakness will have adverse consequences for their outlooks. All three countries face higher inflation and have to follow the SARB in tightening policy rates, with risks to consumption growth. In addition, a dependency on Southern African Customs Union revenues increases the fiscal vulnerability of all three governments.
• Botswana: Persistently high inflation is posing a risk to growth. A significant fall in diamond prices and/or activity in the South African economy will have adverse consequences for the Botswana operating environment.
• Mozambique: High levels of inflation, policy uncertainty, commodity prices and global economic activity pose a risk to the Mozambican outlook. Insurgent activity in northern Mozambique is another risk factor in the operating environment, particularly in terms of delays to large liquefied natural gas projects coming online.

2. Risk management

The issuer, in common with other issuers in South Africa and elsewhere, is exposed to commercial and market risks in its ordinary course of business, the most significant of which are credit risk, market risk in the trading book, operational risk, equity investment risk and insurance risk.

Credit risk is the risk of loss due to the non-performance of a counterparty in respect of any financial or other obligation. For fair value portfolios, the definition of credit risk is expanded to include the risk of losses through fair value changes arising from changes in credit spreads. Credit risk also includes credit default risk, pre-settlement risk, country risk, concentration risk, securitisation risk and climate risk (physical and transitional risks).

Counterparty credit risk is the risk of a counterparty to a contract, transaction or agreement defaulting prior to the final settlement of the transaction's cash flows.

Counterparty credit risk measures a counterparty's ability to satisfy its obligations under a contract that has positive economic value to the group at any point during the life of the contract. It differs from normal credit risk in that the economic value of the transaction is uncertain and dependent on market factors that are typically not under the control of the issuer or the client.

The issuer distinguishes between traded market risk and non-traded market risk. Traded market risk is the risk of adverse revaluation of any financial instrument as a consequence of changes in market prices or rates. For non-traded market risk, the issuer distinguishes between interest rate risk in the banking book (IRRBB) and structural foreign exchange risk. IRRBB relates to the sensitivity of a bank's balance sheet and earnings to unexpected, adverse movements in interest rates. Foreign exchange risk is the risk of an adverse impact on the issuer's financial position or earnings or other key ratios as a result of movements in foreign exchange rates impacting balance sheet exposures.

Operational risk is the risk of loss resulting from inadequate or failed internal processes, people or systems, or from external events.

Equity investment risk is the risk of an adverse change in the fair value of an investment in a company, fund or listed, unlisted or bespoke financial instrument.

Insurance risk arises from the inherent uncertainties of liabilities payable under an insurance contract. These uncertainties can result in the occurrence, amount or timing of the liabilities differing from expectations.

Insurance risk can arise throughout the product cycle and is related to product design, pricing, underwriting and claims management.

Any failure to control these risks adequately, or unexpected developments in the future economic environment, could have an adverse effect on the financial condition and reputation of the issuer.

2.1 Credit risk

Credit risk arises primarily from advances and certain debt investment securities. Other sources of credit risk include reinsurance assets, cash and cash equivalents, accounts receivable, off-balance sheet exposures and derivative balances.

The issuer's lending and trading businesses are subject to inherent risks relating to the credit quality of its counterparties and the recoverability of loans and advances due from these counterparties. Changes in the credit quality of the issuer's lending and trading counterparties or those arising from systemic risk in the financial sector could reduce the value of the issuer's assets, resulting in increased credit impairments.

Many factors affect the ability of the issuer's clients to repay their loans, including adverse changes in consumer confidence levels due to local, national and global factors; levels of consumer spending; bankruptcy rates and increased market volatility. These factors might be difficult to predict and are completely beyond the issuer's control. The issuer performs regular stress tests on its credit portfolios to identify the key factors impacting the credit risk profile in order to anticipate possible future outcomes, and to implement necessary actions to constrain risk.

The issuer continues to apply origination strategies which are aligned to its broader financial resource management processes and macroeconomic outlook. Based on the issuer's credit risk appetite, measuring return on equity (ROE), net income after cost of capital (NIACC) and earnings volatility, credit risk management principles include holding the appropriate level of capital and pricing for risk on an individual and portfolio basis. The scope of credit risk identification and management practices across the group, therefore, spans the credit value chain, including risk appetite, credit origination strategy, risk

quantification and measurement, as well as collection and recovery of delinquent accounts. Credit risk is managed through the implementation of comprehensive policies, processes and controls to ensure a sound credit risk management environment with appropriate credit granting, administration, measurement, monitoring and reporting. Credit risk appetite measures are set in line with overall risk appetite. The aim is to deliver an earnings profile that will perform within acceptable levels of volatility determined by the issuer.

Global developments, manifesting in increased inflation and interest rate outlook, and local developments (e.g. electricity supply constraints) impacting the growth outlook negatively are being monitored closely, and could warrant additional risk responses.

2.2 Concentration risk

Credit concentration risk is the risk of loss arising from an excessive concentration of exposure to a single counterparty, industry, market, product, financial instrument, type of security, country or region, or maturity. This concentration typically exists when a number of counterparties are engaged in similar activities and have similar characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions.

The issuer's business is significantly focused on the South African market and the issuer, therefore, faces a geographic concentration risk. Operations in South Africa are subject to various risks which include political, social and economic risks, such as general economic volatility, low growth, relatively high inflation, exchange rate risks, exchange controls, crime and diseases (including, for example, HIV/AIDS). The existence of such factors may have a negative impact on South African economic conditions generally, and more specifically on the business and results of the issuer in ways that cannot be predicted.

Any adverse changes affecting the South African economy are likely to have an adverse impact on the issuer's ability to grow revenues as well as on credit impairments and, therefore, on its financial condition.

2.3 Liquidity risk

Structural characteristics impacting the funding profile of South African banks

South Africa is an emerging market with significant socio-economic challenges, including high levels of poverty and social security needs. Addressing these challenges requires a high level of funding which constrains domestic savings and results in low household savings rates.

In addition to a low domestic savings rate, South Africa's financial system is characterised by structural features which pose additional liquidity challenges to the domestic banking system. A key characteristic is the fact that the available savings in the economy are mostly contractual savings and funded pension liabilities. These savings are concentrated in institutions such as pension and provident funds, life insurers and providers of asset management services. In addition, they tend to have a higher allocation to the equities market relative to fixed income assets (relative to developed market norms) and are invested at banks in the form of institutional funding, comprising wholesale funding from financial institutions across a range of deposits, money market securities and capital market instruments.

Furthermore, the operational liquidity management needs of institutions are largely met by their investments in the banking sector via the money market. These institutional deposits have a higher liquidity risk than retail deposits.

Given the relative reliance on institutional deposits, liquidity risk in the South African banking system is structurally higher than in most other markets.

However, this risk is to some extent mitigated by the following market dynamics:

• the closed rand system, where rand transactions are cleared and settled through registered banks and clearing institutions domiciled in South Africa. FirstRand Bank Limited is one of the major clearing/settlement banks;
• concentration of customer current accounts with the large South African banks;
• the prudential exchange control framework; and
• South African banks' low dependence on foreign currency funding.

These factors contributed to South Africa's resilience during the 2007-2008 global financial crisis, and more recently the liquidity stress sustained during the initial stages of the Covid-19 pandemic. The prudential liquidity requirements instituted post the global financial crisis improved the bank's ability to better withstand the stress. The various liquidity enhancing actions introduced by the SARB also helped to support the markets through this stress.

While the immediate effects of the pandemic have now abated, the issuer continues to monitor and stress test its liquidity access and maintain adequate liquidity buffers. The pandemic has given way to renewed global and local macroeconomic risks as outlined above, which may lead to increased funding costs and/or changes in the

composition of available funding pools. These may impact the cost and availability of funding.

Foreign currency funding risks

The low level of discretionary savings in South Africa, and its high investment and social welfare requirements, increase the economy's reliance on and vulnerability to foreign capital inflows, driven by the country's fiscal and current accounts.

The issuer seeks to mitigate exposure to foreign currency funding by operating a prudent foreign currency management framework and operating within limits on its foreign currency borrowing that are more conservative than the macroprudential limits applied by the SARB. The issuer seeks to avoid exposing itself to undue liquidity risk and to maintain liquidity risk within the risk appetite approved by the board and risk committees.

The issuer believes that its level of access to domestic and international interbank and capital markets will allow it to meet its short-term and long-term liquidity needs due to the strategy, flexibility and diversification of its liquidity risk management policy in both foreign and domestic currencies. However, any maturity mismatches may have a materially adverse effect on its financial condition.

Funding and other risks relating to securitisations

Securitisation is the process whereby assets (such as illiquid loans and other receivables) are packaged, underwritten and sold in the form of asset-backed securities to investors. The issuer makes use of securitisations to complement its overall funding strategy. This can, however, constitute a significant proportion of a particular asset class within the broader group balance sheet.

While an important component of its overall funding strategy, the issuer limits the use of securitisation to ensure appropriate strategy diversification and agility. Further, the issuer does not aim to execute securitisations specifically for credit or capital relief purposes, however investor appetite and pricing will dictate the distribution of lower-rated subordinated tranches. These would typically be retained within the wider FirstRand group. Consequently, the FirstRand group retains all risks and rewards associated with the underlying assets. In addition, the use of securitisation transactions as part of the issuer's funding strategy generates risks such as:

• funding and liquidity risk in respect of any potential repurchase of the transferred assets (for example, in circumstances where there is a breach of contractual representations and warranties relating to the underlying assets);
• operational risks related to the servicing of the transferred assets; and
• interest rate and other risks through derivatives transacted with the securitisation entities.

The issuer engages in securitisation transactions to manage and mitigate rather than add to the funding and liquidity risk profile.