ANNUAL REPORT OF THE BOARD OF DIRECTORS ON THE AFFAIRS OF THE NATIONAL DEVELOPMENT BANK PLC

ANNUAL REPORT OF THE BOARD OF DIRECTORS ON THE AFFAIRS OF THE COMPANY AND STATEMENT OF COMPLIANCE OF THE CONTENTS OF THE ANNUAL REPORT AS REQUIRED BY SECTION 168 OF THE COMPANIES ACT NO. 07 OF 2007

1. GENERAL

The Directors of National Development Bank PLC (‘Bank’) have pleasure in presenting to the shareholders this Report together with the Audited Financial Statements and the Audited Consolidated Financial Statements for the year ended 31 December 2017 of the Bank and the Group and the Auditors’ Report on those Financial Statements, conforming to the requirements of the Companies Act No. 07 of 2007, Banking Act No. 30 of 1988 and amendments thereto and the Directions issued thereunder, the Listing Rules of the Colombo Stock Exchange and the recommended best practices.

The Report was approved by the Board of Directors on 20 February 2018. The requisite number of copies of the Annual Report will be submitted to the Colombo Stock Exchange and to the Sri Lanka Accounting and Auditing Standards Monitoring Board within the statutory deadlines.

The Bank, originally established by an Act of Parliament in 1979 as the National Development Bank of Sri Lanka, was incorporated under the Companies Act No. 17 of 1982 as National Development Bank Limited in 2005 pursuant to the provisions of the National Development Bank of Sri Lanka (Consequential Provision) Act No. 01 of 2005. National Development Bank Limited was thereafter reregistered under the Companies Act No. 07 of 2007 as National Development Bank PLC and was accorded with the registration No. PQ 27. The registered office of the Bank is at No. 40, Navam Mawatha, Colombo 02.

The ordinary shares of the Bank are quoted on the Main Board of the Colombo Stock Exchange since 1993. The Rated, unsecured, subordinated, redeemable debentures issued by the Bank are listed on the Colombo Stock Exchange.

The Bank’s national long term rating which was affirmed as A+ (lka)/ Stable Outlook by Fitch Ratings Lanka Limited in January 2017 was once again affirmed at the same level in December 2017, reflecting the stability maintained by the Bank over the year. The Bank's listed debentures were assigned a rating of A(lka).

As required by Section 168 of the Companies Act No. 07 of 2007, the following information is disclosed in this Annual Report prepared for the year ended 31 December 2017.

Details of appropriation of the Profit of the Bank are given below;

2. REVIEW OF BUSINESS

2.1 Vision, Mission and Corporate Conduct

The vision, mission and values of the Bank are given on page 4 of this Report.

The Bank and the Group practices high ethical standards in carrying out their business activities in line with the vision of the Bank.

All employees of the Bank abide by the Bank’s Code of Conduct and the directors and the Key Management Personnel of the Bank additionally abide by the Code of Corporate Governance of the Bank.

2.2 Review on Operations of the Group and the Bank

A review of the operations of the Bank and the Group as required by Section 168(1) (a) of the Companies Act are discussed in the Chairman’s Message, Chief Executive Officer’s Review (pages 10 to 17) and the Management Discussion and Analysis (pages 37 to 108). These reports form an integral part of the Annual Report of the Board of Directors.

2.2.1 Principal Business Activities of the Bank and its Group Companies

As required by Section 168 (1) (a), the principal activities of the Bank and Group are described in the Business Model on pages 18 to 19 and pages 26 to 27 of our Annual Report.

2.2.2 Future Developments and Current Standing

The Bank opened 3 new branches during the year and 5 ATMs including 2 off-site ATMs during the year affirming the Bank’s continuous focus on improving its reach across the country as part of its business strategy. The Bank introduced four new deposits products during the year, namely NDB Savings Planner, NDB Araliya (for female customers), NDB Achara (for senior citizens) and NDB Business Class (for business customers). The Bank also relaunched its Children's Savings product during the year. With these new additions to its deposit product suite, the Bank caters to the financial needs of an individual in any stage in life.

In enhancing the convenience of banking services offered to our customers through both the physical branch network and digital banking services, we adopted a combination of these two in" phygital banking". Our mobile banking app was the fore-runner in the digital sphere. We also commenced branchless banking supported with tablet devices during the year.

Our credit card product took an invigorated approach offering a set of best deals to our customers. The Bank's full suite of products along with the capital market products offered by the Group companies rendered a one-stop shop solution to our customers during the year.

Further as required by Section 168 (1) (a), an overview of the future developments of the Bank and the Group are discussed in the Chairman’s Message, Chief Executive Officer’s Review (pages 10 to 17) and the Integrated Management Discussion and Analysis (pages 37 to 108). These reports form an integral part of the Annual Report of the Board of Directors

2.3 Financial Statements of the Group and the Bank

The Financial Statements are prepared in accordance with the Sri Lanka Accounting Standards (SLFRS/LKAS) and is given in detail on pages 293 to 408 of this Annual Report.

The Financial Statements of the Bank and the Group for the year ended 31 December 2017 are duly signed by the Assistant Vice-President – Finance and Planning, the Group Chief Financial Officer, two Directors and the Company Secretary in accordance with Section 168 (1) (b) of the Companies Act No. 07 of 2007 and are given on page 295.

2.4 Directors’ Responsibility for Financial Reporting

The Directors are responsible for the preparation of the Financial Statements of the Bank to reflect a true and fair view of the state of its affairs. The Directors are of the view that these Financial Statements have been prepared in conformity with the requirements of the Sri Lanka Accounting Standards, Companies Act No. 07 of 2007, the Banking Act No. 30 of 1988 (as amended), the Listing Rules of the Colombo Stock Exchange and the Mandatory Code of Corporate Governance for Licensed Commercial Banks issued by the Central Bank of Sri Lanka.

The Directors are satisfied that the Financial Statements, presented on pages 293 to 408 give a true and fair view of the state of affairs of the Bank and the Group as at 31 December 2017 as well as the profit for the year then ended.

The Statement of Directors’ Responsibility for Financial Reporting is given on pages 281 and 282. And forms an integral part of the Annual Report of the Board of Directors.

2.5 Directors Statement of Internal Control

The Board has issued a report on the internal control mechanism of the Bank as per Section 3 (8) (ii) (b) of the Banking Act Direction No. 11 of 2007 on Corporate Governance. The Board has confirmed that the financial reporting system has been designed to provide reasonable assurance regarding the reliability of the financial reporting and the preparation of the Financial Statements for external purposes has been done in accordance with relevant accounting principles and regulatory requirements. The above report which forms an integral part of the Report of the Board of Directors is given on pages 283 and 284 of the Annual Report.

The Board has obtained an Assurance Report from the External Auditors on the Directors’ Statement on Internal Control which is given on page 286 of this Annual report.

2.6 Auditors’ Report

The Bank’s Auditors, Messrs Ernst and Young, carried out an audit on the Financial Statements of the Bank and the Consolidated Financial Statements of the Group for the year ended 31 December 2017 and their report on those Financial Statements are given on page 289 of the Annual Report.

2.7 Significant Accounting Policies and Changes during the Year

The significant accounting policies adopted in the preparation of the Financial Statements are given on pages 302 to 408. The significant changes to accounting policies adopted if any, in the preparation of the Financial Statements are given on pages 302 to 408.

2.8 Entries in the Interest Register

As required by Section 168 (1) I of the Companies Act No. 07 of 2007, the Bank and all its subsidiaries maintain Interest Registers. We wish to confirm that all Directors have made declarations as required by Section 192 (1) and (2) of the Companies Act aforesaid and all related entries were made in the Interest Register during the year under review. The share ownership of Directors is disclosed on page 117. The Interest Register is available for inspection by shareholders or their authorized representatives as required by Section 119 (1) (d) of the Companies Act No. 07 of 2007.

2.9 Directors’ Remuneration and Other Benefits

As required by Section 168 (1) (f) of the Companies Act No. 07 of 2007, the Directors’ remuneration and other benefits in respect of the Bank and the Group for the financial year ended 31 December 2017, are disclosed in Note 12 of the Financial Statements on pages 315 and 316.

2.10 Corporate Donations by the Bank

The Bank and the Group made Donations amounting to LKR 20 million and LKR 23.5 million respectively, for the year 2017 (2016 – LKR 26.7 million and LKR 29.7 million respectively), in terms of the Resolution passed at the last Annual General Meeting. The information given above forms an integral part of the Annual Report of the Board of Directors in terms of Section 168 (1) (g) of the Companies Act No. 07 of 2007.

The Bank’s Corporate Social Responsibility Unit initiates most of the CSR activities together with the participation of employees from all departments. The primary responsibility of the CSR Unit is to ensure that CSR activities are conducted in a manner to ensure sustainable business development.

3. GROSS INCOME

The gross income of the Group for 2017 was LKR 43,018 million (2016- LKR 33,777 million) of which the Bank’s gross income was LKR 42,521 million (2016- LKR 33,282 million) The sources of external operating income, net operating profit and asset allocation of the Group among different business segments together with their proportions are given in Note 51 to the Financial Statements on page 369 and 370.

4. TOTAL OPERATING INCOME

The total operating income of the Group for 2017 was LKR 16,683 million (as compared with LKR 13,677 million for 2016), while the Bank’s total operating income was LKR 16,152 million (as compared with LKR 13,151 million for 2016). An analysis of the income is given on pages 310 to 314 to the Financial Statements.

5. RESULTS AND APPROPRIATIONS

5.1 Performance of the Bank and the

Group and Transfers to Reserves The Group’s Operating Profit Before Value Added Tax on Financial Services and Taxation including that of its subsidiaries and its share of profit from associate companies amounted to LKR 7,192 million (compared to LKR 5,094 million in 2016). After deducting LKR 3,759 million (compared to LKR 2,279 million in 2016) for Valued Added Tax on Financial Services and Taxation, the Profit After Tax for the year amounted to LKR 3,432 million (compared to LKR 2,815 million in 2016). The Group profit attributable to shareholders amounted to LKR 3,490 million (compared to LKR 2,691 million in 2016).

The Bank’s Profit Before Value Added Tax on Financial Services and Taxation amounted to LKR 7,547 million (compared to LKR 5,335 million in 2016). After deducting LKR 3,196. million (compared to LKR 2,165 million in 2016) for taxation, the Profit After Tax for the year amounted to LKR 4,352. million (compared to LKR 3,170 million in 2016).

Details are given in the Statement of Profit or Loss on page 293.

5.2 Dividends on Ordinary Shares

An interim dividend of LKR 2.00 per share was paid on 10th November 2017 to the shareholders of the Bank for the financial year 2017. The Directors on 20th February 2018 authorized and approved a final dividend of LKR 7.00 per share to be paid in the form of a cash dividend amounting to LKR 2.00 per share and scrip dividend of LKR 5.00 for the financial year ended 31 December 2017. The total dividend paid to the shareholders for the financial year ended 31 December 2017 was LKR 9.00 (2016-LKR 8.00).

In declaring the dividends the Directors ensured due compliance by the Bank of the solvency provisions contained in Section 56 (3) of the Companies Act No. 07 of 2007 and the listing rules of CSE. The Board provided the Statement of Solvency to the auditors and obtained Certificates of Solvency from the auditors in respect of the said dividend payments conforming to the statutory provisions.

These dividends were partly paid out of dividend income received and partly out of operational profits, the latter being subject to withholding tax.

Details of appropriation of the Profit of the Bank are given below;

5.3 Reserves

A summary of the Banks and Group’s reserves is given below;

5.4 Provision for Taxation

The income tax rate applicable on the Bank’s domestic operations and FCBU on-shore and off-shore banking operations was 28% (2016 – 28 %.). The Bank’s profit was also liable for Value Added Tax on Financial Services and Nation Building Tax and the regulatory tax rate for the year are as follows.

Deferred Tax is provided for all known temporary differences based on the Liability Method in accordance with Sri Lanka Accounting Standard (LKAS 12) – Income Taxes. The Bank and the Group made accumulated deferred tax provisions during the year, arising on revaluation of freehold land and investment property, in line with LKAS 12, Income Taxes, and the new Inland Revenue Act which would be effective from 1 April 2018.

6 PROPERTY, PLANT AND EQUIPMENT, INTANGIBLE ASSETS AND LEASEHOLD PROPERTY

The details of Property, Plant & Equipment are given in Notes 33 and 34 to the Financial Statements. Total Capital expenditure incurred by the Bank and the Group on acquisition of property, plant & equipment and intangible assets amounted to LKR 588 million and LKR 740 million, respectively (2016- Bank - LKR 871. million and Group - LKR 907 million).

7. INVESTMENT PROPERTY

Investment properties of any group companies when significantly occupied by other companies in the group are classified under Property, Plant and equipment in the Consolidated Financial Statements in accordance with LKAS 40 on “Investment Property”. There were no acquisitions of Investment Properties during the year as well as the previous year.

The details of Investment Property are given in Note 32 to the Financial Statements.

8. ISSUE OF SHARES AND DEBENTURES

8.1 Issue of Shares and Debentures by the Bank

Details of the shares issued by the Bank in the years 2016 and 2017 are given in the table below;

8.2 Issue of Shares and Debentures

No shares or debentures have been issued by any subsidiaries or associates of the Bank during the financial year 2017.

8.3 Stated Capital and Debentures

The stated capital of the Bank at the beginning of the year was LKR 1,246,479,177/- and at the end of the year was LKR 2,208,519,564/- and comprised of 165,185,506 ordinary shares at the beginning of the year and 171,485,705 ordinary shares at the end of the year. The details of the Stated Capital are given in Note 43 on page 360.

During the period of January 2017 to December 2017 a total number of 6,300,199 shares were issued by the Bank to the shareholders of the Bank as at 3rd March 2017, by way of a Scrip Dividend.

The details of the debentures issued by the Bank in 2013 and 2015 are disclosed under Note 42 on pages 358 and 359.

9. SHARE INFORMATION

9.1 Distribution Schedule of Shareholdings

Information on the distribution of the number of holders in each class of equity securities and the percentage of their holdings as per the CSE listing rules are given in Investor information on pages 115 to 117 of the Annual Report.

9.2 Information on Earnings, Dividend, Net Assets and Market Value

The information relating to earnings, dividends, net assets and market price per share is given in the financial highlights on page 6 of the Annual Report.

The ratios relating to dividends, net asset value, market value per share and ratios relevant to debt Securities are disclosed in Investor information on pages 119 to 122 of this Annual Report.

10. SUBSTANTIAL SHAREHOLDINGS

The Bank had 8,330 registered shareholders as at 31 December 2017. The distribution, public holding, 20 largest shareholders and the share price during 2017 are set out in page 116 of this Annual Report.

11. DIRECTORS

11.1 Information on Directors of the Bank and the Group

11.1.1 List of Directors

In terms of the provisions of the Articles of Association of the Bank, the Board of Directors, as at 31 December 2017, consisted of ten (10) Directors, including the Chairman and was madeup as follows:

Compliance by the Board of Directors of the Banking Direction No. 11 of 2007 on Corporate Governance for Licensed Commercial Banks in Sri Lanka issued by the Central Bank of Sri Lanka is set out in pages 207 to 254 of the Annual Report. In terms thereof the classification of Directors as Executive, Non-Executive, Independent and Non- Independent as at 31 December 2017 is as follows:

In terms of an approval received from the Board of Directors of the Colombo Stock Exchange on 30 March 2010, Licensed Commercial Banks have been granted a total exemption from the requirement to comply with Section 7.10 (Corporate Governance) of the Continuing Listing Requirements under the CSE Listing Rules with effect from 1 January 2010.

Compliance by the Board of Directors of the Code of Best Practice on Corporate Governance 2013 issued by The Institute of Chartered Accountants of Sri Lanka and the Securities and Exchange Commission of Sri Lanka is set out in pages 220 to 254 of the Annual Report. In terms thereof, the classification of Directors as Executive, Non- Executive, Independent and Non-Independent as at 31 December 2017 is given below:

11.1.2 New Appointments and Resignations

The new Appointment to the Board of Directors of the Bank during the year 2017 were as follows;

I. P L D N Seneviratne (appointed w.e.f 1 January 2017)
II. R Semasinghe (appointed w.e.f 26 September 2017)
Resignations during the year 2017;

I. N S Welikala (retired w.e.f 30 April 2017)
II. Mrs. D M A Harasgama (resigned w.e.f 30 June 2017)

11.1.3 List of Directors of Subsidiaries and Associates of the Bank

The Directors of the Group companies are set out on pages 437 and 438 of the Annual Report.

11.1.4 Recommendations for Re-election

In terms of the provisions of the Articles of Association of the Bank, one-third of the elected Directors (i.e. - excluding the representative of the Ministry of Finance and the ex-officio executive Director) and directors appointed during the year to fill casual vacancies shall retire from office and such directors shall be eligible for re-election by the shareholders at each Annual General Meeting of the Bank.

Directors to Retire by Rotation
The Directors to retire by rotation at an Annual General Meeting shall be those who (being subject to retirement by rotation) have been longest in office since their last election or appointment. If one third of the Directors eligible for retirement by rotation is not a multiple of three, the nearest to but not greater than one third shall retire. Accordingly, the Nominations Committee and the Board have recommended that T L F Jayasekara and Mrs. Kimarli Fernando be considered for re-election by the shareholders at the Annual General Meeting of the Bank.

Directors who served on the Board for a period exceeding 9 years;

As per the Banking Act Direction No. 11 of 2007 the total period of service of a Director (excluding the executive director) shall not exceed 9 years. The Bank has no directors who have served the Bank for over 9 years.

11.1.5 Directors’ Meetings

Details of Director’s meetings which comprised of Board Meetings and all Board Sub-Committee meetings are presented on page 216.

11.1.6 Board Sub-Committees

There are seven permanent committees of the Board as at 31st December 2017, namely, Integrated Risk Management Committee, Audit

Committee, Strategic Issues Committee, Human Resources and Remuneration Committee, Nomination Committee, Related Party Transactions Review Committee and the Credit Committee. Details of the members of these committees are given on page 437.

The Corporate Governance and Legal Affairs Committee of the Board was dissolved and the oversight on legal issues and control related matters have been delegated by the Board to be overseen by the Integrated Risk Management Committee. A Credit Committee was formed by the Board of Directors of the Bank during 2017, having considered the current needs and focused attention of the Board. As such the Credit Committee focuses on in- depth evaluation and guidance on significant credit proposals, thus enabling the entire Board to focus more time on matters such as corporate governance, strategy, impact of macroeconomic changes etc. This change was made after significant deliberation by the Board with regard to several matters such as focused/in-depth attention, better use of the expertise of directors, time management, the need for all the directors to deliberate on Corporate Governance related matters etc.

The seven committees include four mandatory Committees (Nominations Committee, Human Resources and Remuneration Committee, Board Audit Committee, Integrated Risk Management Committee) formed by the Board in compliance with the Banking Act Direction No.11 of 2007 issued by the Monetary Board on Corporate Governance for Licensed Commercial Banks in Sri Lanka, one Committee (Related Party Transactions Review Committee) formed in compliance with Section 9 of the Listing Rules of the Colombo Stock Exchange as well as two other committees formed by the Board taking into account the needs of the Bank. The Committees ensure and assist the Board in ensuring that the activities of the Bank are conducted, conforming to the required laws, rules and regulations, the highest ethical standards and in the best interest of all the Stakeholders.

11.1.7 Appraisal of Board Performance

The Bank has in place a robust scheme whereby the Directors perform a self-assessment of the Board’s conduct annually by answering a Self-assessment Questionnaire. The responses to the Self-assessment Questionnaire are evaluated by the Chairman and Deputy Chairman and any action, recommendations and/ or concerns are discussed with the Board and accordingly noted and action taken where deemed appropriate. This self-assessment process has been extended to Board subcommittees as well to ensure due review, evaluation, focus etc. of the said Subcommittees.

12. OTHER DIRECTORSHIPS OF DIRECTORS

Information of the other Directorship of the Directors of the Bank as at 31 December 2017 is given below: