Internal audit, internal control, and risk management activities at Ziraat Bank are performed by the Board of Inspectors, the Internal Control & Compliance Department, and the Risk Management Department. These units’ duties and responsibilities, which are strictly segregated from one another, are coordinated by the Assistant General Manager for Internal Systems.

This organization is structured so as to embrace all Bank units and branches as well as Bank-owned subsidiaries subject to the Bank’s oversight. Its purpose is to minimize any risks that might adversely affect the thoroughgoing and secure conduct of banking operations, the fulfillment of long-term profit targets, the reliability of financial and administrative reporting, and/or the Bank’s reputation and financial stability.

INTERNAL AUDIT SYSTEM

The Board of Inspectors takes a risk-focused approach in the fulfillment of its responsibilities to ensure that the activities and operations of the Bank’s headquarters units, domestic and international branches, and subsidiaries comply with the requirements of laws and regulations and are compatible with the Bank’s own strategies, policies, principles, and objectives. The board conducts its activities in such a way as both to keep the Bank’s senior management informed and to contribute to their decision-making processes.

The board conducts its activities in line with internationally-accepted internal auditing standards. Besides checking the Bank’s operations for their compliance with statutorily mandated procedures, in 2020 the board also reviewed and assessed the effectiveness and efficiency of the transaction procedures involved in both primary and secondary processes. In addition, processes governed by Banking Regulation and Supervision Agency (BRSA) regulations pertaining to information systems and banking processes were also audited in line with the Bank’s own practices.

The activities of the Board of Inspectors in 2020 are as follows:

• The Central Audit Team continued its intensive operations in 2020 by performing scenario analyses which are influential in preventing irregularities from being committed. The team reviewed the effectiveness of its existing scenarios and developed new ones to cope with the possible abuses made possible by newly-introduced business processes. It has also continued to develop systematic procedures aimed at minimizing risks arising from the remaining manually-conducted processes involved in internal audit, and it has started to work for the integration of artificial intelligence technology into its own processes. Additionally, the instant follow-up of the transactions examined on the day (t-1) in 2019, through EVAM, continued in 2020.
• The R&D Team kept a close watch on all of the Bank’s other business units, revised and kept the auditing module up to date in light of changes in business processes and the regulatory framework, and modified auditing points as made necessary by laws, BRSA decisions, and changes demanded by Bank’s senior management and headquarters units.
• Improvements also continued to be made in all processes from the development of an auditing index to the determination of the significance level of audit findings. Systemic changes that make it possible for inspection findings concerning critically important transactions to be drawn to the attention of business units increased the effectiveness of the finding follow-up process and had a beneficial impact on the overall percentage of findings subjected to corrective action.
• The recommendations that inspectors in the field included in their reports or made with respect to a particular transaction or practice were also circulated among the business units concerned and the outcomes of such recommendations were observed.
• As a result of efforts for the Global Auditing Module that is aimed to be implemented at all Ziraat Finance Group members, the processing system to be used in this module and its application to various banking systems, the module was implemented at Ziraat Bank BH d.d. in 2018, and ad Ziraat Participation Bank in 2020. Studies are ongoing for the use of the module in other subsidiaries of the Bank.
• The first phase of the systemic developments enabling generation of web-based reports issued following Information Systems and Banking Processes audits was completed in August 2019. The second phase, which is aimed at implementing this feature also for audits conducted at the Bank’s subsidiaries, continued in 2020.
• The Inspection Scenario Team that was set up and charged with formulating scenarios both to identify and measure the general spread of shortcomings in bank processes and to develop and improve the effectiveness of such processes and with submitting these scenarios to the appropriate business unit so as to ensure that speedy and effective solutions for dealing with them are devised throughout the Bank continued to operate in 2020. System improvements were made to increase efficiency in sharing the scenario results with business units and following up on the actions taken.
• During 2020, the Central Inspection Team that was set up to increase the frequency and effectiveness of inspections by constantly and centrally monitoring designated branch groups performed centralized inspections on 204 of the Bank’s branches in accordance with the same criteria employed for on-site inspections.
• The Data Security Team, which operates with the intention of protecting the confidential information of customers and the Bank, continued to work in 2020 as well. With the introduction of the Windows 10 Operating System on the clients within the bank, an efficient and effective new software was installed on all computers to prevent data leakage, and portable memory and printer channels were started to be monitored against possible data security violations.
• The practice of recruiting qualified human resources for the Bank’s administrative staff by allowing inspectors to transfer to such positions continued in 2020.
• 25 Assistant Inspectors, who were successful in the “Assistant Inspector Entrance Exam” organized by the Bank, started to work in January 2020.
• Within the scope of combating Covid-19, a new type of coronavirus that affected Turkey as it did the whole world, the Board carefully followed the measures taken both in the country and the Bank in its studies within the scope of the 2020 audit plan and took the necessary measures.

In keeping with its strong sense of responsibility and awareness of its duties, the Board of Inspectors will continue to execute the internal auditing plan in line with goals and policies set forth by Ziraat Bank’s senior management and within the framework of current auditing approaches, to report its findings to the Board of Directors through the Audit Committee, and to observe what action is taken on the basis of its reports.

INTERNAL CONTROL AND COMPLIANCE SYSTEM

Internal control activities at Ziraat Bank are designed so as to embrace the operations of all headquarters units, all domestic and international branches and subsidiaries subject to consolidation as required by Article 9 Paragraph 3 of “Regulation on bank internal system and intrinsic capital adequacy assessment processes” which states “Internal control system is structured to include the bank’s domestic and foreign branches, headquarters units, subsidiaries subject to consolidation and all of their operations.”

Such activities are conducted so as to be compatible with the Bank’s primary objectives and strategies from the standpoint of their scope and methodology.

This more proactive structure helps ensure that Ziraat Bank’s operations exceed sectoral norms and that they are conducted in a manner that is compatible with both internal and external regulations as well as with the demands of competition.

Domestic branch checks are performed both on location and centrally within the framework of a program that is prepared taking into account branches’ current levels of risk exposure. Control functions, which for the most part are structured so as to be technology-intensive and centralized, are intended to ensure that commonly-occurring mistakes are quickly corrected at the appropriate business-unit level.

With the Instant Control system operational transactions, accounting records and lending operations in real time are checked. Transactions are evaluated in light of specific scenarios and if a transaction is deemed to be in error, it can be corrected the same day. Real-time transaction checking allows increased efficiency through preventive checks and embeds the internal control system within the Bank’s day-to-day operations instead of retrospective transaction controls. To this end, instant incident and action management tools such as EVAM scenarios that are developed by the internal controllers themselves are also employed effectively. Accordingly, it is adopted as a basic principle to avoid possible errors and omissions in recording assets and liabilities and capturing them in financial reports.

Artificial intelligence/machine learning models, the foundations of which were laid in 2019 by the internal control unit, which reflects its focus on technology to all of its processes, started to be used effectively in credit and accounting controls. Providing orientation to transactions with high probability of finding, machine learning algorithms support the risk-oriented control model, and thus mediate more effective controls with less resources. In addition, it is aimed to detect new risk areas early by performing anomaly analyzes with artificial intelligence/machine learning algorithms.

Headquarters unit control programs are prepared taking into account the units’ functions, potential risks, terms of reference, and impact on the Bank’s balance sheet. These programs are revised as needs may require. Business units are controlled by a sufficient number of Internal Controllers in line with these programs.
Internal control operations at Ziraat Bank branches located outside Turkey are carried out in line with control programs that are prepared for each year.

The findings ascertained as a result of all of these activities are periodically circulated among appropriate business units and the members of senior management.

Besides performing their internal control functions, internal control personnel also share their suggestions of ways to improve existing processes at the Bank and to mitigate the risks inherent in them. The aim of this practice is to preclude risks by spotting them in advance, to make the Bank more competitive by improving its business processes, and to increase customer satisfaction while also taking measures to cut costs.

Employment of internal controllers and continuity of employment have been ensured by the method of utilizing the Bank’s own human resources since 2015. With the participation of the human resources who worked in the Bank for a certain period of time to the Internal Control team, the adaptation of the team to the internal control processes has accelerated, the training period has been shortened and the team has started to get efficiency in a short time. On another front, banking and field experiences of the team contributed remarkably to internal control processes.

The practice of recruiting qualified human resources for the Bank’s administrative staff by allowing internal control personnel to transfer to such positions continued in 2020.

In addition to such matters, compliance reviews were also carried out by internal control personnel as required by article 18 of BRSA Regulation on bank internal system and intrinsic capital adequacy assessment processes. In the course of these reviews, all operations conducted or planned by the Bank as well as new transactions and products are checked to be sure that they comply with laws and regulations, with the Bank’s own policies and rules, and with generally-accepted banking practices. During such compliance reviews, existing Bank-internal rules and proposed changes in them are also examined and views concerning them are circulated among appropriate units.

Within the scope of the Compliance Program set up in by the Bank to comply with the legislation published under the Prevention of Laundering of Proceeds from Crime and Financing of Terrorism, activities to prevent such activities are carried out in accordance with national and international regulations.

In order to effectively combat Laundering of Proceeds from Crime and Financing of Terrorism, an effective risk-based approach is followed, the risks subject to combat are identified, classified, and effective and proportional controls are established based on the identified risks. New typologies developed by crime and terror groups are closely monitored, trend analyzes are made, and resource planning is made in accordance with the risk-based approach model. In this context, projects aimed at the more efficient use of technological opportunities are rapidly implemented besides the increase in human resources. In this field, studies are carried out to provide efficiency and speed with machine learning structures.

All domestic and international organizations operating within the Ziraat Finance Group carry out their activities in accordance with national and international regulations. In this context, necessary measures in the form of written policies and procedures are taken in order to prevent the use of the products and services provided by the Bank with the purpose of money laundering, terrorism and the proliferation of weapons of mass destruction, and controls are carried out in a way that the Bank does not expose to any operational, reputational risks and sanctions in these matters.

Internal training programs are carried on, which are organized between the Bank and compliance units of overseas branches and domestic and international subsidiaries and which are designed to exchange information regarding the development of joint standards, creation of joint processes, and acting in line with the shared policy target related to “Prevention of Laundering Proceeds of Crime and Financing of Terrorism”.

Additionally, regular contacts are established within the frame of the coordinated strategy conducted in relation to compliance activities with overseas branches and subsidiaries, as well as domestic subsidiaries. Along this line, meetings were held with compliance officers of subsidiaries and overseas branches/subsidiaries, during which joint studies were carried out to verify compliance with national and international obligations and to identify process and software needs, if any. These meetings and efforts will be ongoing also in the future.

Additionally, all employees were provided to get trainings on prevention of laundering of proceeds from crime and financing of terrorism.

Both the Internal Control and Compliance units will be utilizing the analytical infrastructure and technological means at the maximum extent possible and will carry on with their activities aimed at maximizing productivity and efficiency with a risk-based approach.

RISK MANAGEMENT SYSTEM

Ziraat Bank risk management activities are conducted subject to the requirements of BRSA’s Regulation on bank internal system and intrinsic capital adequacy assessment processes and other pertinent regulations as well as of BRSA Best Practices Guidelines. They are carried out with the aim of aligning the Bank’s risk management functions with best practices by fostering a risk culture throughout the entire and constantly improving system and human resources. The principal risk categories are defined as “Credit Risk”, “Market Risk”, “Operational Risk”, and “Balance Sheet Risks”, the last including the interest rate risks and liquidity risks to which the Bank is exposed on account of its banking business accounts. Care is given to ensure that all activities related to risk management system are coordinated through the involved participation of the operational units with which each type of risk is associated.

Under the heading of credit risk management, Basel III-compatible methods are used to define, measure, monitor, and report credit risk. The Bank has been calculating its core credit risk exposure and reporting it monthly on the basis of its solo and consolidated accounts to BRSA ever since this practice was mandated by law as of July 1, 2012. The credit limits approved by the Board of Directors are monitored and scenario analysis and stress tests are carried out by applying various shocks to credit risk factors. Counterparty Credits are measured for counterparty risk. In addition, with the participation of different units within the scope of Credit Risk Management Project with Advanced Methods, studies are being carried out to calculate credit risk based on internal rating and to use its outputs in different areas.

Within the scope of Credit Risk Management with Advanced Methods, model validations evaluating the compatibility, accuracy and durability of IRB model studies carried out within the framework of internal rating-based approach, creating macroeconomic models, making IRB models compatible with TFRS-9 and implementation of the results are carried out.

While Behavioral and Referential Probability of Default (PD) Modeling processes were organized by the Department of Credit Analytics and Processes, the Development of Loss in Default (THK) and Amount of Default (TT) Models were carried out by the Risk Management Department. After the completion of the relevant modeling studies, the necessary configuration for calculating the Amount Subject to Credit Risk with the Advanced Internal Rating based method was prepared by the consultant firm, and the tests of the relevant package program were completed by the unit. After the tests were completed and all model outputs were ready, the monitoring phase of the amount subject to credit risk calculated by Basic IR and Advanced IR methods was initiated.

Under the heading of market risk management, such risk is defined, measured, analyzed, monitored, and reported. Analyses are supported by conducting stress tests. Risk measurements are performed on all accounts whose inclusion in the Bank’s capital adequacy ratio calculation is mandatory as well as by means of the “value-at-risk” (VaR) methodology. The results of VaR measurements are validated by means of backtest analyses. The values on which market risk is calculated are periodically reviewed and compared with of Board of Directors-approved limits while senior management is kept informed about the results of mandatory and internal limit monitoring.

Under the heading of operational risk management, the operational risks to which the Bank is exposed are defined, classified, quantified, and analyzed. Operational risk signal and limit values approved by the Board of Directors are also monitored at regular intervals. Amount subject to Operational Risk is calculated using the Basic Indicator Approach pursuant to the Regulation on the Measurement and Assessment of Capital Adequacy of Banks. Operational risk incidents as a result of the lost data base in the banking software are being followed. Information technology risks and associated actions are followed up in coordination with the related units. Activities for business continuity plans and portfolio custodian services along with risk assessments for companies providing outsourced support services are being carried out.

Under the heading of balance sheet risk management, liquidity and interest rate risks arising from banking business accounts are identified, measured, analyzed, monitored, and reported. Analyses are also supported by means of stress tests and scenario analyses. Consolidated and unconsolidated Liquidity Coverage Ratio and the Interest Rate Risk Ratio Arising from the unconsolidated Banking Accounts are periodically reported to the BRSA. Liquidity risk as approved by the Board of Directors and signals and limits of the interest rate risk resulting from banking accounts are also monitored at regular intervals.

Besides the stress test analysis subjected to in-bank periodic reports, Internal Capital Adequacy Assessment Process (ICAAP) reports are also prepared and sent to BRSA at year-end. In the latter reports, the Bank’s capital and liquidity adequacy is analyzed over the following three-year period on the basis of a set of Base/Negative/Overly Negative scenarios not supplied by BRSA.

The results of the risk management analyses and the associated risk indicators are reported to the Board of Directors and to the Audit Committee at six-month intervals and to the Senior Management on a daily, weekly, and monthly basis.

Ziraat Bank will continue to make use of internationally-recognized advanced risk management techniques in order to carry out its risk management activities for all risk categories and to make such risk management an integral part of its strategic decision-making processes in the future as well.