A number of factors are considered when determining the general allowance. A statistical analysis of past performance is undertaken to derive the mean (Expected Loss) and volatility (Unexpected Loss) of loss experience. This analysis calculates historical average losses for each homogeneous portfolio seg- ment (e.g. mortgages), while other models estimate loss for portfolios of corporate loans and investments that can be refer- enced to market data. Management’s professional judgments regarding portfolio quality, business mix and economic as well as credit market conditions are also considered. 

Our approach to establishing and maintaining the general allowance is also based on Guideline C-5 “General Allowance for Credit Risk” issued by the Office of the Superintendent of Financial Institutions Canada, which came into effect this year. 

Note 4 on page 74 of the financial statements and Tables 10 to 18 on pages 58 to 61 provide details of BMO’s loan portfolio, impaired loans and provisions and allowances for credit losses. 

To advance BMO’s strategic objectives, we have a well- diversified portfolio, focused mainly in North America, which comprises lending relationships with millions of clients, the majority of whom are consumers and small to medium-sized businesses. All accounts are reviewed on a regular basis, with individual commercial accounts reviewed annually, or more frequently if required. 

## Limits 

BMO’s credit risk governance policies ensure that an accept able level of credit risk diversification is maintained on an ongoing basis. The level of portfolio diversification is reflected in the graph found on page 24. Limits have been established for country exposure, industry and product exposure, single name exposure and transaction-specific exposure. These limits are approved 

## Market Risk 

BMO incurs market risk in its trading and underwriting activities, as a result of investments it makes and in connection with the management of its assets and liabilities (structural market risk). 

As part of our enterprise-wide risk management framework, we apply comprehensive governance and management processes to market risk-taking activities. These include: 

b oversight by senior governance committees, including the Mar- ket Risk Committee and Risk Management Committee through to the Risk Review Committee of the Board of Directors; 

b an independent market risk oversight function within the Risk Management Group; 

b effective processes to measure market risks and link them to the allocation of economic capital; 

b a well-developed limit-setting and monitoring process; 

b effective controls over processes and models used; and 

b a framework of scenario and stress tests for worst-case events. 

In addition, we monitor developments in industry practices relatingtothemanagementofmarketriskandincorporate improvements where appropriate. 

Overall, for regulatory capital purposes, as required by BMO’s regulator, the Office of the Superintendent of Financial 

at least annually by the Risk Review Committee of the Board of Directors. BMO’s credit risk governance structure helps to ensure that limits are observed and that any exceptions are identified promptly, reported appropriately, and resolved by management in a timely manner. 

## Processes and Models 

BMO utilizes processes and models to assess the correlation of risks before authorizing new exposures on large corporate credit transactions. Expected loss (EL) and unexpected loss (UL) are calculated for large individual transactions and for the portfolio as a whole. Estimates of EL and UL are used to forecast loan loss provisions and in establishing an appropriate level of gen- eral allowance for credit losses. Measures and assumptions underlying EL and UL calculations are supported by portfolio monitoring, historical experience, market data, and modelling of economic and business-specific events. The estimates of EL and UL rely upon: 

b management’s judgment; 

b the probabilities of default; 

b the amounts of outstanding exposures at the time of default; 

b the differences between the book value and the market value or realizable value of loans, if default occurred; and 

b the effects of economic and industry cycles on asset quality and loan values. 

EL, UL and historical credit risk information are inputs that determine the Capital at Risk for each of the relevant lines of business. Credit CaR measures, like all CaR measures, are based on a confidence level of 99.95% and a holding period of one year. 

Market risk is the risk of a negative impact on the balance sheet and income statement resulting from adverse changes in the value of finan- cial instruments as a result of changes in certain market variables. These include: interest rates, foreign exchange rates, equity or commodity prices and their implied volatilities, as well as credit spreads, credit migration and default. 

Market Value Exposure (MVE) is a measure of the adverse impact of potential changes in market variables on the market value of BMOGLYPH<213>s assets and liabilities, measured at a 99% confidence level over an appropriate holding period. The holding period considers current market conditions and composition of the portfolios to determine how long it would take to liquidate the portfolios without adversely affecting market prices. 

Earnings Volatility (EV) is a measure of the adverse impact of potential changes in market variables on projected 12-month after-tax net income, measured at a specific confidence level. 

Value at Risk (VaR) is measured for specific classes of risk: interest rate, currency, equity and commodity prices and implied volatilities. VaR is usually measured at a 99% confidence level and is a measure of the adverse impact of potential changes in market variables on the market value of a portfolio, over an appropriate holding period. 

