pwc About this Chairman's Corporate Consolidated Financial Company Financial Report Foreword Management Report Appendices Governance Statements Statements Key audit matter Three-stage expected credit loss impairment model In connection with the implementation of IFRS 9 as from 1 January 2018, Rabobank implemented a three- stage expected credit loss impairment model as follows: Recognition of allowances measured at an amount equal to 12-month expected credit losses (stage 1); Recognition of allowances measured at an amount equal to the lifetime expected credit losses for loans and advances for which credit risk has significantly increased since initial recognition, but that are not credit-impaired (stage 2); and Financial assets that are credit-impaired (stage 3). Rabobank determines loan impairments in stage 1 and 2 on a modelled basis whereas the loan impairments in stage 3 are determined on either a modelled basis or on a specific loan-by-loan basis. Modelled loan impairments For the modelled loan impairments Rabobank utilises point in time probability of default (PD), loss given default (LGD) and exposure at default (EAD) models for the majority of the loan portfolio. Three global macroeconomic scenarios (consisting of a baseline, a baseline minus and a baseline plus scenario) are incorporated into these models and probability weighted in order to determine the expected credit losses. In case of data quality issues, or when unexpected external developments are not sufficiently covered by the outcome of the impairment models, adjustments maybe made (so called: top level adjustments). Individually credit-impaired loans For credit-impaired loans that are assessed on an individual basis, the impairment allowance is based on the weighted average of the net present value of expected future cash flows (including forward looking information and the valuation of underlying collateral) in three different scenarios: a sustainable cure, an optimizing and a liquidation scenario. Judgements and estimation uncertainty The judgements and estimation uncertainty in the impairment allowance of loans and advances is primarily linked to the following aspects: Significant increase in credit risk: judgement is required to transfer assets from stage 1 to stage 2; Our audit work and observations The valuation of future cash flows and existence and valuation of collateral, based on the appropriate use of key parameters for the specific impairment allowance; The methodology and controls applied in measuring and determining significant increase in credit risk; The governance over development, validation, calibration and implementation of the PD, EAD and LGD impairment models; The review and approval process that management has in place for the outputs of the impairment models, and the top level adjustments that are applied to model outputs; and The completeness and accuracy of the transfer of data from underlying source systems to the expected loss calculations. The majority of these controls were designed and operated effectively. For certain controls, specifically around the loan quality classification process in the small and medium size business loans domain, remedial control activities and impact assessments were performed by management. Based on the testing of controls and additional testing of remedial actions, we determined that it was appropriate to place reliance on the above controls for the purpose of our audit. Assessment of model based impairment allowances In our audit (using our internal model experts), we evaluated the reasonableness of model methodology, assessed model validation reports prepared by Rabobank's model validation department, evaluated the macro economic scenarios using our internal economic department, performed recalculation of the loan loss provision for a sample of loans and performed backtesting procedures on key model parameters per 1 January 2018 and 31 December 2018. Also we tested input data and data lineage in respect of the critical data elements and challenged management that they provided us with reasonable explanations and evidence supporting the key model parameters (including the significant increase in credit risk, PD, LGD and EAD). Based on the above we assessed the methodology and inputs to be in line with market and industry practice. Finally, we evaluated the top level adjustments per 1 January 2018 and 31 December 2018 by obtaining evidence that these adjustments were necessary to balance underlying model and data limitations and we found the provided supporting evidence to be reasonable. Coöperatieve Rabobank UA. - EH44X5NCPJUJ-1288894667-935 Page 7 of 17

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Annual Reports Rabobank | 2018 | | pagina 249