Interim Consolidated Financial Statements

1 January - 30 September 2016
Unaudited

Arion Bank

CONTENTS

Page

Endorsement and Statement by the Board of Directors and the CEO ... 3
Interim Consolidated Statement of Comprehensive Income ... 6
Interim Consolidated Statement of Financial Position ... 7
Interim Consolidated Statement of Changes in Equity ... 8
Interim Consolidated Statement of Cash Flows ... 9
Notes to the Interim Consolidated Financial Statements ... 11

Arion Bank Interim Consolidated Financial Statements 30 September 2016

ENDORSEMENT AND STATEMENT BY THE BOARD OF DIRECTORS AND THE CEO

The Interim Financial Statements of Arion Bank for the period from 1 January to 30 September 2016 include the Interim Financial Statements of Arion Bank ("the Bank") and its subsidiaries, together referred to as "the Group".

Outlook

Iceland's economic indicators continue to be strong. Economic growth was 4.1% in the first half of 2016, inflation continues to be below the Central Bank's inflation target and unemployment measured 2.6% in the third quarter of 2016. The economic outlook has improved and Arion Research forecasts that economic growth will remain strong, especially in the coming year. Inflation is expected to remain below the Central Bank's inflation target throughout 2017 but is expected to rise in 2018 and peak at 3.5% in the second quarter of 2018. Important steps towards lifting the capital controls were taken this autumn when parliament passed into law a bill that significantly eases the controls on residents and legal entities, both domestic and foreign.

Standard & Poor's upgraded Arion Bank's credit rating from BBB- with a positive outlook to BBB with a positive outlook in October. The upgrade reflects the improving conditions in the Icelandic economy, the deleveraging of Icelandic households and corporations and the positive impact of the continued liberalization of capital controls. It also takes into account Arion Bank's enhanced access to international funding markets and improved capital following the sale of legacy equity positions.

Kaupthing ehf., now a holding company, has expressed its interest in exploring its options in respect to its 87% shareholding in Arion Bank, held by its subsidiary Kaupskil ehf. On 15 June Arion Bank and Kaupthing issued the following press release: "In the context of the continued strong development of the Icelandic economy, Arion Bank and Kaupthing, its majority owner, are currently assessing a range of strategic alternatives with regards to Kaupthing's shares held in the Bank. This may include a possible IPO; however, no decision has been made at this point in time with respect to any specific transaction and timing thereof".

Operations during the period

Net earnings amounted to ISK 17,262 million for the period ended 30 September 2016, and the Group's equity amounted to ISK 207,006 million at the end of the period. Return on equity was 11.2% for the period. The capital ratio, based on the reported capital base on 30 September 2016, was 26.1% and the corresponding Tier 1 ratio was 25.5%. According to the Financial Undertakings Act No. 161/2002 the official capital ratio shall be based on the audited or reviewed capital base. Since the interim financial statements for the first nine months are not audited the official capital ratio is based on the audited capital base on 30 June 2016 and risk-weighted assets on 30 September 2016. The official capital ratio on 30 September 2016 was 25.2% and the Tier 1 ratio was 24.5%, which comfortably meets the requirements set by law and the Financial Supervisory Authority (FME). The liquidity position was also strong at period end and well above the regulatory minimum.

On 30 September 2016 Arion Bank acquired all shares in the insurance company Vörður tryggingar hf., the fourth largest insurance company in Iceland, following the approval of the Icelandic Competition Authority. At period end assets and liabilities of Vörður tryggingar hf. are included in the Interim Consolidated Statement of Financial position. In July Arion Bank sold the majority of its shareholding in the subsidiary Kolufell ehf. The main asset of Kolufell ehf. was investment property. The remaining shareholding is classified as Financial instruments.

In June the Bank's subsidiary Valitor Holding hf. completed the sale of its shareholding in Visa Europe Ltd. to Visa Inc. The profit from the sale was ISK 5,291 million, after taking into account conditional payments to Landsbankinn hf. and two savings funds, which formed part of the agreement when Arion Bank acquired a 39.21% shareholding in Valitor Holding hf. in 2014. The profit was recognized as Net financial income in the Statement of Comprehensive Income in the second quarter of 2016. The shareholding was classified as Financial assets available for sale at year end 2015.

The main changes on the Balance Sheet from year end 2015 relate to changes in the structure of funding, increased lending and increased liquidity. Loans to customers have increased by ISK 35.6 billion, or 5.2%, during the period. New lending is mainly to corporates in several sectors, most in real estate, industry, energy and manufacturing and wholesale and retail.

The Bank's equities and bond portfolios performed well during the third quarter of 2016 after difficult conditions prevailed on the Icelandic equities and bond markets during the first six months. The Bank holds substantial equity positions in listed companies on the Icelandic market and sustained some losses during the first nine months, after a number of favorable years. The Icelandic krona strengthened against most foreign currencies and the effect is some currency loss.

In January, the subsidiary BG12 slhf. sold its entire shareholding in Bakkavor Group Ltd. The main effect from the sale was recognized as a valuation change in the Statement of Comprehensive Income in 2015. During the first quarter of 2016 the total effect through the Statement of Comprehensive Income was ISK 498 million.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

ENDORSEMENT AND STATEMENT BY THE BOARD OF DIRECTORS AND THE CEO

One of Arion Bank's main tasks in recent years has been to improve the quality of its loan portfolio and to reduce the amount of problem loans. The Bank has succeeded in this respect as the distribution of loans between individuals and companies is satisfactory and the ratio of problem loans has decreased to 2.0%.

With strong emphasis on digital banking and mobile service solutions in recent years Arion Bank has made changes to the network of branches in Iceland in order to enhance service, increase efficiency and reduce costs, for example in its business premises, changes in the opening hours of its branches and sharing of services and other measures which increase operational synergies. In May 2016 Arion Bank opened a new branch at Keflavík International Airport, which offers a wide range of opportunities for services to increasing numbers of tourists. Arion Bank will continue to seek opportunities to change and increase efficiency in its branch network.

In January Arion Bank reached an agreement with Kaupthing under which Arion Bank issued a bond in the amount of USD 747.8 million (ISK 97 billion). The bond was issued under Arion Bank's EMTN programme and is a 7-year instrument, callable on interest payment dates during the first two years. The bond bears floating LIBOR plus 2.6% interest for the first two years and will then be repriced at market terms. The bond offsets loans in foreign currency, taken by Arion Bank from the Central Bank of Iceland and later purchased by Kaupthing, and Kaupthing deposits in foreign currency at Arion Bank. The bond issue forms part of the capital control liberalization process relating to Kaupthing, first announced by the Ministry of Finance and Economic Affairs on 8 June 2015.

In April Arion Bank issued a total of EUR 300 million (ISK 42 billion) in new senior unsecured bonds. Orders totaling over EUR 500 million from more than 70 investors were received. The 3-year bonds have a fixed coupon of 2.5% and were sold at rates corresponding to a 2.7% margin over interbank rates. This represents the second euro benchmark issue by Arion Bank. Part of the new issuance, EUR 221 million (ISK 31 billion), was used to partially prepay the EMTN bond held by Kaupthing.

Arion Bank settled the subordinated liabilities with the Ministry of Finance with a prepayment at the end of September.

In 2016 the Bank started to issue privately placed bonds under its EMTN programme. This is an important step for the Bank in diversifying its funding sources. Arion Bank will continue the issuance of private placements, depending on the prevailing market conditions and the Bank's funding needs.

Arion Bank continued to issue covered bonds which are secured in accordance with the Covered Bond Act No. 11/2008. In the first nine months of 2016 the Bank issued a total of ISK 20.4 billion of covered bonds in the domestic market, of which ISK 10.6 billion were inflation-linked bonds and ISK 9.8 billion were fixed rate bonds. Arion Bank will continue to issue covered bonds on a regular basis on the domestic market in 2016.

The Group had 1,189 full-time equivalent positions at the end of the period compared with 1,147 at the end of 2015; 887 of these positions were at Arion Bank, compared with 876 at the end of 2015. A new wage round was conducted in the Icelandic labour market, effective 1 January, last. The wage increases are substantial and put an increased burden on Icelandic banks, which also must to deal with high capitalization and stringent tax burden. In September Arion Bank laid off around 6% of its workforce. The layoffs came from all divisions of the Bank.

Group ownership

On behalf of its creditors, Kaupthing ehf., through its subsidiary Kaupskil ehf., holds 87% of the shares in Arion Bank hf. The remaining shareholding of 13% is held by Icelandic State Financial Investments on behalf of the Icelandic government.

The Board of Directors has eight members, four women and four men. The ratio of men to women is therefore in compliance with the law which states that companies with more than 50 employees should ensure that the ratio of either sex on the board of directors should not be less than 40%. Seven directors are appointed by Kaupskil ehf. and one by Icelandic State Financial Investments.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

ENDORSEMENT AND STATEMENT BY THE BOARD OF DIRECTORS AND THE CEO

Endorsement of the Board of Directors and the Chief Executive Officer

The Interim Financial Statements of Arion Bank for the period ended 30 September 2016 have been prepared in accordance with International Financial Reporting Standards (IAS 34 Interim Financial Statements) as adopted by the European Union and additional requirements in the Icelandic Financial Statements Act, Financial Undertakings Act and Rules on Accounting for Credit Institutions.

It is our opinion that the Interim Financial Statements give a true and fair view of the financial performance of the Group for the period ended 30 September 2016 and its financial position as at 30 September 2016.

Furthermore, in our opinion the Interim Financial Statements and the Endorsement of the Board of Directors and the CEO give a fair view of the development and performance of the Group's operations and its position and describe the principal risks and uncertainties faced by the Group.

The Board of Directors and the CEO have today discussed the Interim Financial Statements of Arion Bank for the period ended 30 September 2016 and confirm them by means of their signatures.

Reykjavík, 16 November 2016

Arion Bank Interim Consolidated Financial Statements 30 September 2016

INTERIM CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE PERIOD FROM 1 JANUARY TO 30 SEPTEMBER 2016

	Notes	2016	2015	2016	2015
		1.1. -30.9.	1.1. -30.9.	1.7.-30.9.	1.7.-30.9.
Interest income		46,246	42,808	14,851	15,148
Interest expense		(24,188)	(22,521)	(7,419)	(8,036)
Net interest income	6	22,058	20,287	7,432	7,112
Fee and commission income		17,436	15,609	6,191	5,373
Fee and commission expense		(7,223)	(4,883)	(2,725)	(2,081)
Net fee and commission income	7	10,213	10,726	3,466	3,292
Net financial income	8	4,339	10,176	844	453
Share of profit of associates	24	710	6,956	16	2,739
Other operating income	9	2,642	2,232	781	709
Operating income		39,962	50,377	12,539	14,305
Salaries and related expense	10	(12,252)	(10,320)	(3,826)	(3,153)
Other operating expense	11	(10,393)	(9,016)	(3,423)	(3,012)
Bank levy	12	(2,190)	(2,168)	(705)	(779)
Net impairment	13	6,827	(114)	5,882	(33)
Earnings before tax		21,954	28,759	10,467	7,328
Income tax expense	14	(5,261)	(3,639)	(3,170)	(1,272)
Net earnings from continuing operations		16,693	25,120	7,297	6,056
Net gain from discontinued operations, net of tax	15	569	277	206	15
Net earnings		17,262	25,397	7,503	6,071
Other comprehensive income
Net gain on AFS financial assets, net of tax		(2,903)	-	-	-
Exchange difference on translating foreign subsidiaries	32	281	47	187	277
Net other comprehensive income to be reclassified to profit or loss in subsequent periods		(2,622)	47	187	277
Total comprehensive income		14,640	25,444	7,690	6,348
Attributable to
Shareholders of Arion Bank		14,154	25,606	7,701	6,539
Non-controlling interest		486	(162)	(11)	(191)
Total comprehensive income		14,640	25,444	7,690	6,348
Earnings per share from continuing operations
Basic and diluted earnings per share attributable to the shareholders of Arion Bank (ISK)	16	8.10	12.64	3.65	3.12

The Notes on pages 11 to 57 are an integral part of these Interim Consolidated Financial Statements.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

INTERIM CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 30 SEPTEMBER 2016

Assets	Notes	30.9.2016	31.12.2015
Cash and balances with Central Bank	17	85,645	48,102
Loans to credit institutions	18	68,257	87,491
Loans to customers	19	715,907	680,350
Financial instruments	20-22	128,357	133,191
Investment property	22	5,113	7,542
Investments in associates	24	869	27,299
Intangible assets	25	11,077	9,285
Tax assets	26	241	205
Other assets	27	23,014	17,578
Total Assets		1,038,480	1,011,043
Liabilities
Due to credit institutions and Central Bank	21	9,375	11,387
Deposits	21	431,929	469,347
Financial liabilities at fair value	21	5,097	7,609
Tax liabilities	26	5,754	4,922
Other liabilities	28	52,565	49,461
Borrowings	21, 29	326,754	256,058
Subordinated liabilities	21, 30	-	10,365
Total Liabilities		831,474	809,149
Equity
Share capital and share premium	32	75,861	75,861
Other reserves	32	1,926	4,548
Retained earnings		129,153	112,377
Total Shareholders' Equity		206,940	192,786
Non-controlling interest		66	9,108
Total Equity		207,006	201,894
Total Liabilities and Equity		1,038,480	1,011,043

The Notes on pages 11 to 57 are an integral part of these Interim Consolidated Financial Statements.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

INTERIM CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE PERIOD FROM 1 JANUARY TO 30 SEPTEMBER 2016

	Share capital and share premium	Other reserves	Retained earnings	Total shareholders’ equity	Non-controlling interest	Total equity
Equity 1 January 2016	75,861	4,548	112,377	192,786	9,108	201,894
Net earnings	-	-	16,776	16,776	486	17,262
Other comprehensive income	-	(2,622)	-	(2,622)	-	(2,622)
Total comprehensive income	-	(2,622)	16,776	14,154	486	14,640
Disposal of non-controlling interest	-	-	-	-	(9,528)	(9,528)
Equity 30 September 2016	75,861	1,926	129,153	206,940	66	207,006
Equity 1 January 2015	75,861	1,632	83,218	160,711	1,501	162,212
Net earnings	-	-	25,559	25,559	(162)	25,397
Other comprehensive income	-	47	-	47	-	47
Total comprehensive income	-	47	25,559	25,606	(162)	25,444
Dividend paid	-	-	(12,809)	(12,809)	-	(12,809)
Acquisition of non-controlling interest	-	-	-	-	(52)	(52)
Equity 30 September 2015	75,861	1,679	95,968	173,508	1,287	174,795

In June 2016 the Icelandic parliament passed an amendment to the Icelandic Act on Financial Statements, with an effective date of 1 January 2016. The amendment will affect the presentation of Equity in the Financial Statements and thus may affect future dividend payments to shareholders of Arion Bank. The Group is currently assessing the impact of the amendment on the presentation of Equity. The Annual Financial Statements 2016 will present Equity in accordance with the amendments.

The Notes on pages 11 to 57 are an integral part of these Interim Consolidated Financial Statements.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

INTERIM CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE PERIOD FROM 1 JANUARY TO 30 SEPTEMBER 2016

	2016	2015
Operating activities	1.1.-30.9.	1.1.-30.9.
Net earnings	17,262	25,397
Non-cash items included in net earnings and other adjustments	(25,759)	(24,521)
Changes in operating assets and liabilities	3,352	39,629
Interest received	35,777	29,085
Interest paid	(11,466)	(9,639)
Dividend received	603	6,798
Income tax paid	(3,507)	(2,321)
Net cash from operating activities	16,262	64,428
Investing activities
Acquisition of associates	(13)	(115)
Proceeds from sale of associates	27,112	7,868
Dividends received from associates	41	506
Acquisition of subsidiary	(5,300)	-
Disposal of subsidiary	293	-
Acquisition of intangible assets	(745)	(324)
Acquisition of property and equipment	(924)	(400)
Proceeds from sale of property and equipment	215	110
Net cash from investing activities	20,679	7,645
Financing activities
Payment of subordinated liabilities	(8,785)	(19,883)
Dividend paid to shareholders of Arion Bank	-	(12,809)
Disbursement of share capital and dividend to non controlling interest	(9,386)
Acquisition of non-controlling interest	-	(58)
Net cash used in financing activities	(18,171)	(32,750)
Net increase in cash and cash equivalents	18,770	41,403
Cash and cash equivalents at beginning of the year	110,000	91,715
Cash and cash equivalents acquired through business combinations	1,068	-
Effect of exchange rate changes on cash and cash equivalents	(5,159)	(1,320)
Cash and cash equivalents	124,679	131,798
Non-cash investing transactions
Assets acquired through foreclosure on collateral from customers with view to resale	1,297	1,425
Settlement of loans through foreclosure on collateral from customers with view to resale	(1,297)	(1,425)
Non-cash changes due to funding agreement with Kaupthing
Deposits	41,409	-
Borrowings	(41,409)	-

Financial effects due to the acquisition of Vörður tryggingar hf. is further described in Note 3.

The Notes on pages 11 to 57 are an integral part of these Interim Consolidated Financial Statements.

Arion Bank Interim Consolidated Financial Statements 30 September 2016
Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE PERIOD FROM 1 JANUARY TO 30 SEPTEMBER 2016

	2016	2015
	1.1.-30.9.	1.1.-30.9.
Non-cash items included in net earnings and other adjustments
Net interest income	(22,058)	(20,287)
Net impairment	(6,827)	114
Income tax expense	5,261	3,639
Bank levy	2,190	2,168
Net foreign exchange loss	829	393
Net gain on financial instruments	(4,565)	(3,771)
Depreciation and amortisation	1,346	1,218
Share of profit of associates and fair value change	(710)	(6,956)
Investment property, fair value change	(25)	-
Net gain from discontinued operations, net of tax	(569)	(277)
Other changes	(631)	(762)
Non-cash items included in net earnings and other adjustments	(25,759)	(24,521)
Changes in operating assets and liabilities
Mandatory reserve with Central Bank	3,240	185
Loans to credit institutions, excluding bank accounts	(7,625)	750
Loans to customers	(34,058)	(22,547)
Financial instruments and financial liabilities at fair value	6,133	(12,903)
Investment property	1,449	(213)
Other assets	1,123	1,949
Due to credit institutions and Central Bank	(1,922)	(11,177)
Deposits	638	47,915
Borrowings	42,682	38,401
Other liabilities	(8,308)	(2,731)
Changes in operating assets and liabilities	3,352	39,629
Cash and cash equivalents
Cash and demand deposits	85,645	73,289
Due from credit institutions	48,429	67,259
Mandatory reserve with Central Bank	(9,395)	(8,750)
Cash and cash equivalents	124,679	131,798

The Notes on pages 11 to 57 are an integral part of these Interim Consolidated Financial Statements.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS CONTENTS

	page	page
General information	12	Investment in associates 31
Operating Segment Reporting	14	Intangible assets 32
Operations by quarters	17	Tax assets and tax liabilities 32
Notes to the Interim Consolidated Statement of Comprehensive Income		Other assets 32
Net interest income	18	Other liabilities 33
Net fee and commission income	18	Borrowings 33
Net financial income	19	Subordinated liabilities 34
Other operating income	19	Pledged assets 34
Personnel and salaries	20	Equity 34
Other operating expense	20
Bank levy	20	Other information
Net impairment	21	Legal matters 35
Income tax expense	21
Net gain from discontinued operations, net of tax	21
Earnings per share	21	Related party 38
Notes to the Interim Consolidated Statement of Financial Position		Risk Management Disclosures
Cash and balances with Central Bank	22	Risk Management 39
Loans to credit institutions	22	Credit risk 39
Loans to customers	22	Market risk 44
Financial instruments	23	Liquidity and Funding risk 49
Financial assets and financial liabilities	24	Capital management 55
Fair value hierarchy	26
Offsetting financial assets and financial liabilities	30	Significant Accounting Policies 57

Arion Bank Interim Consolidated Financial Statements 30 September 2016

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

GENERAL INFORMATION

Arion banki hf., the Parent Company, was established 18 October 2008 and is incorporated and domiciled in Iceland. The registered office of Arion banki hf. is located at Borgartún 19, Reykjavík. The Interim Financial Statements for the period ended 30 September 2016 comprise the Parent Company and its subsidiaries (together referred to as "the Group").

1. Basis of preparation

Statement of compliance

The Interim Financial Statements are consolidated and have been prepared in accordance with International Financial Reporting Standard, IAS 34 Interim Financial Reporting, as adopted by the European Union and additional requirements in the Icelandic Financial Statements Act, Financial Undertakings Act and rules on Accounting for Credit Institutions. The Interim Financial Statements do not include all the information and disclosures required in the Annual Financial Statements, and should be read in conjunction with Arion Bank's Annual Financial Statements for the year 2015. The statements are available at Arion Bank's website www.arionbanki.is.

The Interim Financial Statements were approved and authorised for issue by the Board of Directors of Arion Bank on 16 November 2016.

Basis of measurement

The Interim Financial Statements are prepared on the historical cost basis except for the following:

financial assets and financial liabilities held for trading are measured at fair value;
financial assets and financial liabilities at fair value are measured at fair value;
financial assets classified as available-for-sale are measured at fair value;
investment properties are measured at fair value; and
non-current assets and disposal groups classified as held for sale are stated at the lower of their carrying amount and fair value, less costs to sell.

Functional and presentation currency

The Interim Financial Statements are presented in Icelandic Krona (ISK), which is the Parent Company's functional currency, rounded to the nearest million, unless otherwise stated. At the end of the period the exchange rate of the ISK against the USD was 113.80 and 127.92 for the EUR (31.12.2015: USD 130.08 and EUR 141.28).

2. Significant accounting estimates and judgements in applying accounting policies

The preparation of the Interim Financial Statements requires management to make judgements, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates.

Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognised in the period in which the estimate is revised and in any future periods affected.

The key sources of estimation uncertainty are within impairment losses and reversal of impairment losses on loans.

Arion Bank Interim Consolidated Financial Statements 30 September 2016
Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

3. The Group

Shares in main subsidiaries in which Arion Bank held a direct interest at the end of the period

	Operating activity		Equity interest
	Operating activity	Currency	30.9.2016	31.12.2015
Arion Bank Mortgages Instit. Investor Fund, Borgartún 19, Reykjavík, Iceland	Retail banking	ISK	100.0%	100.0%
BG12 slhf., Katrínartún 2, Reykjavík, Iceland	Holding company	ISK	62.0%	62.0%
EAB 1 ehf., Borgartún 19, Reykjavík, Iceland	Holding company	ISK	100.0%	100.0%
Eignarhaldsfélagið Landey ehf., Ögurhvarf 4a, Kópavogur, Iceland	Real estate	ISK	100.0%	100.0%
Kolufell ehf., Borgartún 19, Reykjavík, Iceland	Real estate	ISK	-	68.9%
Okkar líftryggingar hf., Laugavegur 182, Reykjavík, Iceland	Life insurance	ISK	100.0%	100.0%
Stefnir hf., Borgartún 19, Reykjavík, Iceland	Asset management	ISK	100.0%	100.0%
Valitor Holding hf., Dalshraun 3, Hafnarfjörður, Iceland	Payment solutions	ISK	100.0%	100.0%
Vörður tryggingar hf., Borgartún 25, Reykjavík, Iceland	Insurance	ISK	100.0%	-

In July 2016 Arion Bank sold majority of shareholding in the subsidiary Kolufell ehf. The main asset of Kolufell ehf. was investment property. The profit from the sale and valuation change on the remaining shareholding amounts to ISK 493 million and is recognised in the Statement of Comprehensive Income. The remaining shareholding is classified as Financial instruments.

On 30 September 2016 Arion Bank acquired 100% shareholding in the insurance company Vörður tryggingar hf. Vörður tryggingar hf. is classified as subsidiary of Arion Bank from the day of acquisition. The effects on the Statement of Financial Position is as follows:

Assets	30.9.2016
Cash and balances with Central Bank	(5,300)
Loans to credit institutions	1,069
Financial instruments	8,773
Intangible assets	2,139
Tax assets	147
Other assets	2,355
	9,183
Liabilities
Tax liabilities	7
Other liabilities	9,176
	9,183

The acquisition had no impacts on the Statement of Comprehensive Income during the period. Net earnings of Vörður tryggingar hf. in 2015 was ISK 658 million.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

OPERATING SEGMENT REPORTING

Segment information is presented in respect of the Group's operating segments based on the Group's management and internal reporting structure. Segment performance is evaluated based on earnings before tax. In presenting the geographic information, segment revenue has been based on the geographic location of customers or assets.

Inter segment pricing is determined on an arm's length basis. Operating segments pay and receive interest to and from Treasury on an arm's length basis to reflect the allocation of capital, funding cost and relevant risk premium.

Operating segments

The Group comprises the following operating segments:

Asset Management comprises Institutional Asset Management, Private Banking, Investment Services and Pension Fund Administration. Asset Management manages financial assets on behalf of its customers according to a pre-determined investment strategy. In addition the division is the main distributor of funds managed by Stefnir hf. to individuals, companies and institutional investors as well as distributing funds managed by international fund management companies. Asset Management also administers pension funds. Stefnir hf. is an independently operating financial company owned by Arion Bank. Stefnir manages a broad range of mutual funds, investment funds and institutional investor funds.

Corporate Banking provides comprehensive financial services and integrated solutions across the banks divisions, to larger corporate clients in Iceland. Corporate Banking provides a full range of lending products, deposit accounts as well as value added electronic corporate solutions to meet the needs of each customer.

Investment Banking is divided into Corporate Finance, Capital Markets and Research. Corporate Finance arranges the buying and selling of companies and advises on all other major financial decisions undertaken by companies and investors. Corporate Finance advises on financial restructuring of companies and manages IPO's and stock market listings. Capital Markets buy and sell securities and FX for Arion bank's clients. Capital Markets manage securities issuance for clients and advise on hedges used in business operations often in co-operation with Corporate Finance. Research is an independent research team covering the Icelandic economy and securities markets.

Retail Banking, including Arion Bank Mortgages Institutional Investor Fund, provides a comprehensive range of services. This includes among other deposits and loans, savings, payment cards, pension savings, insurance, securities and funds. To maximize operational efficiency the branch network is divided into five clusters, with the smaller branches capitalizing on the strength of larger units within each cluster. Retail Banking's 24 branches all around Iceland have a total of more than 100,000 customers.

Treasury has the overall responsibility for the Bank's liquidity, currency and interest rate management. Other functions of Treasury are funds transfer pricing and hedging and pricing of financial products.

Other divisions and Subsidiaries include market making in domestic securities and currencies. The subsidiaries are Eignarhaldsfélagið Landey ehf., Okkar liftryggingar hf., Valitor Holding hf., Vörður tryggingar hf., BG12 slhf., EAB 1 ehf. and other smaller entities of the Group.

Headquarters include Overhead, Risk Management, Finance (excluding Treasury), Legal, IT and Operations.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

Operating segments

1.1.-30.9.2016	Asset Management	Corporate Banking	Investment Banking	Retail Banking	Treasury	Other divisions and Subsidiaries	Head-quarters and Elimination	Total
Net interest income	415	4,915	1,031	11,444	3,818	866	(431)	22,058
Net fee and commission income	2,864	739	1,072	2,528	(258)	2,887	381	10,213
Net financial income	(86)	118	(103)	87	(178)	4,901	(400)	4,339
Share of profit of associates	-	-	613	-	-	155	(58)	710
Other operating income	12	69	321	16	85	1,810	329	2,642
Operating income	3,205	5,841	2,934	14,075	3,467	10,619	(179)	39,962
Operating expense	(1,039)	(451)	(747)	(4,577)	(151)	(5,118)	(10,562)	(22,645)
Bank levy	-	-	-	-	-	-	(2,190)	(2,190)
Net impairment	(1)	60	1,601	5,250	3	(87)	1	6,827
Earnings before tax	2,165	5,450	3,788	14,748	3,319	5,414	(12,930)	21,954
Net seg. rev. from ext. customers	1,268	11,765	2,732	22,561	(9,584)	11,035	185	39,962
Net seg. rev. from other segments	1,937	(5,924)	202	(8,486)	13,051	(416)	(364)	-
Operating income	3,205	5,841	2,934	14,075	3,467	10,619	(179)	39,962
Depreciation and amortisation	-	-	-	238	-	504	604	1,346
30.9.2016
Total assets	5,106	253,507	18,705	472,439	194,455	64,603	29,665	1,038,480
Total liabilities	360	194,996	15,911	401,839	162,965	35,146	20,257	831,474
Allocated equity	4,746	58,511	2,794	70,600	31,490	29,457	9,408	207,006
1.1.-30.9.2015
Net interest income	333	4,407	29	10,190	4,782	497	49	20,287
Net fee and commission income	2,787	757	1,638	2,147	(251)	3,169	479	10,726
Net financial income	117	-	7,099	175	464	476	1,845	10,176
Share of profit of associates	-	-	3,017	-	-	414	3,525	6,956
Other operating income	8	44	420	16	-	1,495	249	2,232
Operating income	3,245	5,208	12,203	12,528	4,995	6,051	6,147	50,377
Operating expense	(1,033)	(386)	(746)	(4,302)	(184)	(4,276)	(8,409)	(19,336)
Bank levy	-	-	-	-	-	-	(2,168)	(2,168)
Net impairment	-	1,435	1,492	(2,733)	407	(762)	47	(114)
Earnings before tax	2,212	6,257	12,949	5,493	5,218	1,013	(4,383)	28,759
Net seg. rev. from ext. customers	1,261	10,885	12,773	22,371	(9,266)	6,245	6,100	50,377
Net seg. rev. from other segments	1,984	(5,677)	(570)	(9,843)	14,261	(194)	39	-
Operating income	3,245	5,208	12,203	12,528	4,995	6,051	6,139	50,377
Depreciation and amortisation	-	-	-	217	-	419	582	1,218
30.9.2015
Total assets	5,492	238,439	43,943	440,274	212,676	49,857	18,795	1,009,476
Total liabilities	1,166	182,968	31,660	386,929	192,964	30,149	8,845	834,681
Allocated equity	4,326	55,471	12,283	53,345	19,712	19,708	9,950	174,795

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

4. Operating segments, continued

Geographic information

1.1.-30.9.2016	Iceland	Nordic	United Kingdom	Other Europe	North America	Other	Total
Net interest income	23,746	845	89	(3,232)	582	28	22,058
Net fee and commission income	8,681	50	440	957	81	4	10,213
Net financial income	(966)	(12)	4,996	308	13	-	4,339
Share of profit of associates	212	-	498	-	-	-	710
Other income	2,642	-	-	-	-	-	2,642
Operating income	34,315	883	6,023	(1,967)	676	32	39,962
1.1.-30.9.2015
Net interest income	20,028	545	23	(507)	176	22	20,287
Net fee and commission income	9,420	165	415	679	44	3	10,726
Net financial income	7,727	(44)	(17)	2,482	31	(3)	10,176
Share of profit of associates	6,956	-	-	-	-	-	6,956
Other income	2,232	-	-	-	-	-	2,232
Operating income	46,363	666	421	2,654	251	22	50,377

Discontinued operations are excluded from the profit and loss segment information.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

5. Operations by quarters

2016	Q3	Q2	Q1	Total
Net interest income	7,432	7,353	7,273	22,058
Net fee and commission income	3,466	3,528	3,219	10,213
Net financial income	844	3,796	(301)	4,339
Share of profit of associates	16	17	677	710
Other operating income	781	626	1,235	2,642
Operating income	12,539	15,320	12,103	39,962
Salaries and related expense	(3,826)	(4,318)	(4,108)	(12,252)
Other operating expense	(3,423)	(3,736)	(3,234)	(10,393)
Bank levy	(705)	(743)	(742)	(2,190)
Net impairment	5,882	1,448	(503)	6,827
Earnings before tax	10,467	7,971	3,516	21,954
Income tax expense	(3,170)	(1,354)	(737)	(5,261)
Net earnings from continuing operations	7,297	6,617	2,779	16,693
Net gain from discontinued operations, net of tax	206	259	104	569
Net earnings	7,503	6,876	2,883	17,262
2015
Net interest income	7,112	7,392	5,783	20,287
Net fee and commission income	3,292	3,677	3,757	10,726
Net financial income	453	2,184	7,539	10,176
Share of profit of associates	2,739	6	4,211	6,956
Other operating income	709	1,032	491	2,232
Operating income	14,305	14,291	21,781	50,377
Salaries and related expense	(3,153)	(3,675)	(3,492)	(10,320)
Other operating expense	(3,012)	(3,108)	(2,896)	(9,016)
Bank levy	(779)	(659)	(730)	(2,168)
Net impairment	(33)	(1,863)	1,782	(114)
Earnings before tax	7,328	4,986	16,445	28,759
Income tax expense	(1,272)	(647)	(1,720)	(3,639)
Net earnings from continuing operations	6,056	4,339	14,725	25,120
Net gain from discontinued operations, net of tax	15	79	183	277
Net earnings	6,071	4,418	14,908	25,397

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

NOTES TO THE INTERIM CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

6. Net interest income

	2016	2015	2016	2015
Interest income	1.1.-30.9.	1.1.-30.9.	1.7.-30.9.	1.7.-30.9.
Cash and balances with Central Bank	3,249	1,779	1,220	821
Loans	39,097	37,790	12,312	13,163
Securities	3,401	2,593	1,164	984
Other	499	646	155	180
Interest income	46,246	42,808	14,851	15,148
Interest expense
Deposits	(12,515)	(11,968)	(3,771)	(4,508)
Borrowings	(11,061)	(9,855)	(3,251)	(3,361)
Subordinated liabilities	(529)	(603)	(343)	(100)
Other	(83)	(95)	(54)	(67)
Interest expense	(24,188)	(22,521)	(7,419)	(8,036)
Net interest income	22,058	20,287	7,432	7,112
Net interest income from assets and liabilities at fair value	3,401	2,593	1,164	942
Interest income from assets not at fair value	42,845	40,215	13,687	14,165
Interest expense from liabilities not at fair value	(24,188)	(22,521)	(7,419)	(7,995)
Net interest income	22,058	20,287	7,432	7,112
Interest spread (the ratio of net interest income to the average carrying amount of interest bearing assets)	3.1%	3.0%	3.1%	3.1%

Interest income from money market loans is classified as Cash and balances with Central Bank. Priorly it was classified as Loans. Comparative figures have been adjusted accordingly.

7. Net fee and commission income

	Net Income		Income	Expense	Income
	1.1.-30.9.2016		1.1.-30.9.2015
Asset management	3,101	(201)	2,900	3,099	(210)
Cards	10,559	(6,515)	4,044	8,545	(4,384)
Collection and payment services	1,123	(59)	1,064	991	(63)
Investment banking	732	(36)	696	1,274	(36)
Lending and guarantees	1,180	-	1,180	1,070	-
Other	741	(412)	329	630	(190)
Net fee and commission income	17,436	(7,223)	10,213	15,609	(4,883)
	1.7.-30.9.2016			1.7.-30.9.2015
---	---	---	---	---	---
Asset management	1,063	(61)	1,002	1,028	(87)
Cards	3,833	(2,492)	1,341	3,239	(1,885)
Collection and payment services	401	(22)	379	330	(21)
Investment banking	178	(12)	166	180	(15)
Lending and guarantees	403	-	403	388	-
Other	313	(138)	175	208	(73)
Net fee and commission income	6,191	(2,725)	3,466	5,373	(2,081)

Asset management fees are earned by the Group on trust and fiduciary activities where the Group holds or invests assets on behalf of the customers.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

Net financial income

	2016	2015	2016	2015
	1.1.-30.9.	1.1.-30.9.	1.7.-30.9.	1.7.-30.9.
Dividend income	603	6,798	3	-
Net gain on financial assets and financial liabilities classified as held for trading	(141)	740	(20)	654
Net gain on financial assets and financial liabilities designated at fair value through profit or loss	(585)	3,031	1,004	814
Realised gain on financial assets available-for-sale	5,291	-	-	-
Net foreign exchange loss	(829)	(393)	(143)	(1,015)
Net financial income	4,339	10,176	844	453
Net gain on financial assets and financial liabilities designated at fair value through profit or loss
Equity instruments designated at fair value	(613)	2,818	636	700
Interest rate instruments designated at fair value	28	213	368	114
Net gain on financial assets and financial liabilities designated at fair value through profit or loss	(585)	3,031	1,004	814

In November 2015 Visa Inc. and Visa Europe Ltd. announced a definitive agreement on the acquisition by Visa Inc. of Visa Europe Ltd. Arion Bank was a member of Visa Europe Ltd. through its subsidiary Valitor Holding hf. In June 2016 the sale was formally completed, resulting in a total profit of ISK 5,291 million after taking into account conditional payments to Landsbankinn hf. and two savings funds, which formed part of the agreement when Arion Bank acquired a 39.21% shareholding in Valitor Holding hf. in 2014. The shareholding in Visa Europe Ltd. was classified as Financial assets available for sale.

Other operating income

	2016	2015	2016	2015
	1.1.-30.9.	1.1.-30.9.	1.7.-30.9.	1.7.-30.9.
Fair value changes on investment property	25	555	-	129
Realised gain on investment property	429	207	-	81
Earned premiums, net of reinsurance	977	810	346	280
Other income	1,211	660	435	219
Other operating income	2,642	2,232	781	709

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

10. Personnel and salaries	2016	2015	2016	2015
	1.1.-30.9.	1.1.-30.9.	1.7.-30.9.	1.7.-30.9.
Number of employees
Average number of full time equivalent positions during the period	1,185	1,131	1,205	1,147
Full time equivalent positions at the end of the period	1,189	1,151	1,189	1,151
The Bank's number of employees
Average number of full time equivalent positions during the period	893	849	901	843
Full time equivalent positions at the end of the period	887	850	887	850
Salaries and related expense
Salaries	9,811	8,201	3,047	2,535
Defined contribution pension plans	1,391	1,138	456	349
Salary related expense	1,336	1,179	412	331
Capitalisation of salaries	(286)	(198)	(89)	(62)
Salaries and related expense	12,252	10,320	3,826	3,153
Salaries and related expense for the Bank
Salaries	7,307	5,882	2,342	1,808
Defined contribution pension plans	1,036	876	329	288
Salary related expense	1,101	868	348	246
Salaries and related expense	9,444	7,626	3,019	2,342

During the period the Group made a provision of ISK 294 million (9M 2015: ISK 164 million) for performance plan payments, including salary related expense, thereof the Bank made a provision of ISK 264 million (9M 2015: ISK 111 million). Forty percent of the payment is deferred for three years in accordance with FME rules on remuneration policy for financial undertakings. At the end of the period the Group's accrual for performance plan payments amounts to ISK 975 million (31.12.2015: ISK 1,056 million), thereof the Bank's accrual amounts to ISK 826 million (31.12.2015: ISK 852 million).

11. Other operating expense	2016	2015	2016	2015
	1.1.-30.9.	1.1.-30.9.	1.7.-30.9.	1.7.-30.9.
Administration expense	8,096	6,841	2,680	2,267
Depositors' and investors' guarantee fund	602	631	181	211
Depreciation of property and equipment	707	672	265	213
Amortisation of intangible assets	639	546	219	172
Claims incurred, net of reinsurance	314	265	74	123
Other expense	35	61	4	26
Other operating expense	10,393	9,016	3,423	3,012

12. Bank levy

The Bank levy is 0.376% on total debt excluding tax liabilities, in excess of ISK 50 billions. Non-financial subsidiaries are exempt from this tax. The tax is assessed on financial institutions to meet the funding of a special index and interest relief provided to individual tax payers.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

Net impairment

	2016	2015	2016	2015
	1.1.-30.9.	1.1.-30.9.	1.7.-30.9.	1.7.-30.9.
Increase in book value of loans to corporates	2,129	2,111	301	87
Increase in book value of loans to individuals	8,525	1,667	6,948	679
Net change in impairment of loans to corporates	(1,973)	767	(1,427)	248
Net change in impairment of loans to individuals	(2,205)	(3,148)	(185)	(861)
Net change in collective impairment on loans	351	(1,486)	245	(186)
Impairment of intangible assets	-	(25)	-	-
Net impairment	6,827	(114)	5,882	(33)

Income tax expense

Current tax expense	5,318	3,844	3,035	1,424
Deferred tax expense	(57)	(205)	135	(152)
Income tax expense	5,261	3,639	3,170	1,272

Reconciliation of effective tax rate

Earnings before tax	21,954		28,759
Income tax using the Icelandic corporation tax rate	20.0%	4,391	20.0%
Additional 6% tax on financial institutions	5.2%	1,132	3.0%
Non-deductible expenses	0.4%	91	2.1%
Tax exempt revenue	(3.6%)	(781)	(12.8%)
Non-deductible taxes	2.0%	438	0.0%
Other changes	(0.0%)	(10)	0.3%
Effective tax rate	24.0%	5,261	12.7%

Financial institutions pay 6% additional tax on taxable profit exceeding ISK 1 billion.

Tax exempt revenues consist mainly of profit from equity positions.

Net gain from discontinued operations, net of tax

	2016	2015	2016	2015
	1.1.-30.9.	1.1.-30.9.	1.7.-30.9.	1.7.-30.9.
Income from real estates and other assets	925	529	326	151
Expense related to real estates and other assets	(356)	(252)	(120)	(136)
Net gain from discontinued operations, net of tax	569	277	206	15

Earnings per share

	Discontinued operations
	Excluded		Included
	2016	2015	2016	2015
	1.1.-30.9.	1.1.-30.9.	1.1.-30.9.	1.1.-30.9.
Net earnings attributable to the shareholders of Arion Bank	16,207	25,282	16,776	25,559
Weighted average number of outstanding shares for the period, million	2,000	2,000	2,000	2,000
Basic earnings per share	8.10	12.64	8.39	12.78

There were no instruments at the end of the period that could potentially dilute basic earnings per share (31.12.2015: none).

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

NOTES TO THE INTERIM CONSOLIDATED STATEMENT OF FINANCIAL POSITION

17. Cash and balances with Central Bank

30.9.2016 31.12.2015

Cash on hand 7,483 4,921

Cash with Central Bank 68,767 30,546

Mandatory reserve deposit with Central Bank 9,395 12,635

Cash and balances with Central Bank 85,645 48,102

The mandatory reserve deposit with Central Bank is not available for the Group to use in its daily operations.

18. Loans to credit institutions

Bank accounts 48,429 74,533

Money market loans 10,700 7,976

Other loans 9,128 4,982

Loans to credit institutions 68,257 87,491

19. Loans to customers

	Individuals		Corporates		Total
	Gross carrying amount	Book value	Gross carrying amount	Book value	Gross carrying amount	Book value
30.9.2016
Overdrafts	15,603	13,730	22,015	20,223	37,618	33,953
Credit cards	10,852	10,567	1,243	1,214	12,095	11,781
Mortgage loans	283,423	280,455	14,729	14,499	298,152	294,954
Other loans	35,314	29,895	358,004	345,324	393,318	375,219
Loans to customers	345,192	334,647	395,991	381,260	741,183	715,907
31.12.2015
Overdrafts	16,840	14,833	24,248	22,387	41,088	37,220
Credit cards	10,842	10,560	1,054	997	11,896	11,557
Mortgage loans	271,895	268,048	12,889	12,601	284,784	280,649
Other loans	38,058	31,178	334,849	319,746	372,907	350,924
Loans to customers	337,635	324,619	373,040	355,731	710,675	680,350

The total book value of pledged loans that were pledged against amounts borrowed was ISK 158 billion at the end of the period (31.12.2015: ISK 199 billion). At the end of the period pledged loans comprised mortgage loans to individuals. At year end 2015 pledged loans comprised mortgage loans to individuals, loans to real estate companies, wholesale and retail and industry and energy companies.

Further analysis of loans is provided in Risk Management Disclosures.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

19. Loans to customers, continued

Changes in the provision for losses on loans to customers

1.1.-30.9.2016	Specific	Collective	Total
Balance at the beginning of the year	25,341	4,984	30,325
Provision for losses	4,178	(351)	3,827
Write-offs	(9,063)	-	(9,063)
Payment of loans previously written off	187	-	187
Balance at the end of the period	20,643	4,633	25,276

1.1.-30.9.2015

Balance at the beginning of the year	22,214	4,467	26,681
Provision for losses	2,381	1,486	3,867
Write-offs	(4,443)	-	(4,443)
Payment of loans previously written off	264	-	264
Balance at the end of the period	20,416	5,953	26,369

Significant accounting estimates and judgements

Key sources of estimation uncertainty are impairment losses on loans.

The Group reviews its loan portfolios to assess impairment at least quarterly as further described in Note 54 in the Annual Financial Statements for 2015. The specific component of the total allowance for impairment applies to financial assets evaluated individually for impairment and is based on management's best estimate of the present value of the cash flows that are expected to be received. In estimating these cash flows, management makes judgements about a debtor's financial situation and the net realisable value of any underlying collateral. Each impaired asset is assessed on its merits, the workout strategy and estimate of cash flows considered recoverable are independently reviewed by the Credit Risk function.

20. Financial instruments

	30.9.2016	31.12.2015
Bonds and debt instruments	74,993	78,794
Shares and equity instruments with variable income	32,197	35,504
Derivatives	4,953	2,401
Securities used for hedging	16,214	16,492
Financial instruments	128,357	133,191

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

Financial assets and financial liabilities

30.9.2016	Amortised cost	Trading	Designated at fair value	Total
Loans
Cash and balances with Central Bank	85,645	-	-	85,645
Loans to credit institutions	68,257	-	-	68,257
Loans to customers	715,907	-	-	715,907
Loans	869,809	-	-	869,809
Bonds and debt instruments
Listed	-	4,880	66,132	71,012
Unlisted	-	105	3,876	3,981
Bonds and debt instruments	-	4,985	70,008	74,993
Shares and equity instruments with variable income
Listed	-	3,480	11,246	14,726
Unlisted	-	1,336	12,799	14,135
Bond funds with variable income, unlisted	-	655	2,681	3,336
Shares and equity instruments with variable income	-	5,471	26,726	32,197
Derivatives
OTC derivatives	-	4,953	-	4,953
Derivatives	-	4,953	-	4,953
Securities used for hedging
Bonds and debt instruments, listed	-	6,252	-	6,252
Shares and equity instruments with variable income, listed	-	9,853	-	9,853
Shares and equity instruments with variable income, unlisted	-	109	-	109
Securities used for hedging	-	16,214	-	16,214
Other financial assets	10,091	-	-	10,091
Financial assets	879,900	31,623	96,734	1,008,257
Liabilities at amortised cost
Due to credit institutions and Central Bank	9,375	-	-	9,375
Deposits	431,929	-	-	431,929
Borrowings	326,754	-	-	326,754
Liabilities at amortised cost	768,058	-	-	768,058
Financial liabilities at fair value
Short position in bonds	-	2,805	-	2,805
Short position in equity	-	32	-	32
Derivatives	-	2,260	-	2,260
Financial liabilities at fair value	-	5,097	-	5,097
Other financial liabilities	34,826	-	-	34,826
Financial liabilities	802,884	5,097	-	807,981

Financial assets classified as available for sale at year-end 2015 were sold in June 2016, see Note 8.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

Financial assets and financial liabilities, continued

31.12.2015
	Amortised cost	Trading	Designated at fair value	Available for sale	Total
Loans
Cash and balances with Central Bank	48,102	-	-	-	48,102
Loans to credit institutions	87,491	-	-	-	87,491
Loans to customers	680,350	-	-	-	680,350
Loans	815,943	-	-	-	815,943
Bonds and debt instruments
Listed	-	2,526	74,757	-	77,283
Unlisted	-	99	1,412	-	1,511
Bonds and debt instruments	-	2,625	76,169	-	78,794
Shares and equity instruments with variable income
Listed	-	2,138	13,869	-	16,007
Unlisted	-	1,668	10,665	5,852	18,185
Bond funds with variable income, unlisted	-	1,090	222	-	1,312
Shares and equity instruments with variable income	-	4,896	24,756	5,852	35,504
Derivatives
OTC derivatives	-	2,401	-	-	2,401
Derivatives	-	2,401	-	-	2,401
Securities used for hedging
Bonds and debt instruments, listed	-	1,519	-	-	1,519
Shares and equity instruments with variable income, listed	-	14,276	-	-	14,276
Shares and equity instruments with variable income, unlisted	-	697	-	-	697
Securities used for hedging	-	16,492	-	-	16,492
Other financial assets	4,581	-	-	-	4,581
Financial assets	820,524	26,414	100,925	5,852	953,715
Liabilities at amortised cost
Due to credit institutions and Central Bank	11,387	-	-	-	11,387
Deposits	469,347	-	-	-	469,347
Borrowings	256,058	-	-	-	256,058
Subordinated liabilities	10,365	-	-	-	10,365
Liabilities at amortised cost	747,157	-	-	-	747,157
Financial liabilities at fair value
Short position in bonds	-	4,616	-	-	4,616
Derivatives	-	2,993	-	-	2,993
Financial liabilities at fair value	-	7,609	-	-	7,609
Other financial liabilities	38,667	-	-	-	38,667
Financial liabilities	785,824	7,609	-	-	793,433

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

21. Financial assets and financial liabilities, continued

Bonds and debt instruments designated at fair value specified by issuer	30.9.2016	31.12.2015
Financial and insurance activities	8,080	9,258
Public sector	55,071	59,246
Corporates	6,857	7,665
Bonds and debt instruments designated at fair value	70,008	76,169

The total amount of pledged bonds was ISK 18.2 billion at the end of the period (31.12.2015: ISK 21.5 billion). Pledged bonds comprise Icelandic and foreign Government Bonds that were pledged against funding received and included in Due to credit institutions and Central Bank as well as short positions included in Financial liabilities at fair value.

22. Fair value hierarchy

The Group uses the following hierarchy for determining and disclosing the fair value of assets and liabilities by valuation technique:

Level 1: quoted (unadjusted) prices in active markets for identical assets or liabilities;

Level 2: valuation techniques for which all significant inputs are market observable, either directly or indirectly; and

Level 3: valuation techniques which include significant inputs that are not based on observable market data.

For assets and liabilities that are recognised at fair value on a recurring basis, the Group determines whether transfers have occurred between Levels in the hierarchy by re-assessing categorisation (based on the lowest level input that is significant to the fair value measurement as a whole) at the end of each reporting period.

Assets and liabilities recorded at fair value by level of the fair value hierarchy

30.9.2016	Level 1	Level 2	Level 3	Total
Assets at fair value
Bonds and debt instruments	27,398	47,506	89	74,993
Shares and equity instruments with variable income	13,477	18,694	26	32,197
Derivatives	-	4,953	-	4,953
Securities used for hedging	16,073	141	-	16,214
Investment property	-	-	5,113	5,113
Assets at fair value	56,948	71,294	5,228	133,470

Liabilities at fair value

Short position in bonds	2,805	-	-	2,805
Short position in equity	32	-	-	32
Derivatives	-	2,260	-	2,260
Liabilities at fair value	2,837	2,260	-	5,097

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

22. Fair value hierarchy, continued

31.12.2015	Level 1	Level 2	Level 3	Total
Assets at fair value
Bonds and debt instruments	32,813	45,799	182	78,794
Shares and equity instruments with variable income	14,331	15,299	5,874	35,504
Derivatives	-	2,401	-	2,401
Securities used for hedging	15,706	786	-	16,492
Investment property	-	-	7,542	7,542
Assets at fair value	62,850	64,285	13,598	140,733
Liabilities at fair value
Short position in bonds	4,616	-	-	4,616
Derivatives	-	2,993	-	2,993
Liabilities at fair value	4,616	2,993	-	7,609

Transfers from Level 2 to Level 1 amounted to ISK 69 million during the period (2015: ISK 8,106 million). There have been no transfers from Level 1 to Level 2 during the period (2015: none).

The level of the fair value hierarchy of assets is determined at the end of each reporting period.

Movements in Level 3 assets measured at fair value	Investment property		Financial assets		Total
	30.9.2016	31.12.2015	30.9.2016	31.12.2015	30.9.2016	31.12.2015
Balance at the beginning of the year	7,542	6,842	6,056	1,276	13,598	8,118
Net fair value changes	25	422	2,822	5,857	2,847	6,279
Additions	618	1,026	-	77	618	1,103
Disposal	(1,664)	(843)	(8,764)	(1,154)	(10,428)	(1,997)
Disposals through the sale of a subsidiary	(1,408)	-	-	-	(1,408)	-
Transfers into Level 3	-	95	13	-	13	95
Transfers out of Level 3	-	-	(12)	-	(12)	-
Balance at the end of the period	5,113	7,542	115	6,056	5,228	13,598
Line items where effects of Level 3 assets are recognised in the Interim Statement of Comprehensive Income	2016	2015
---	---	---
	1.1.-30.9.	1.1.-30.9.
Net interest income	2	21
Net financial income	5,250	(17)
Other operating income	454	762
Net loss on AFS financial assets, net of tax	(2,903)	-
Effects recognised in the Statement of Comprehensive Income	2,803	766

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

22. Fair value hierarchy, continued

Carrying values and fair values of financial assets and financial liabilities not carried at fair value

30.9.2016	Carrying value	Fair value	Unrealised gain (loss)
Financial assets not carried at fair value
Cash and balances with Central bank	85,645	85,645	-
Loans to credit institutions	68,257	68,257	-
Loans to customers	715,907	719,666	3,759
Other financial assets	10,091	10,091	-
Financial assets not carried at fair value	879,900	883,659	3,759
Financial liabilities not carried at fair value
Due to credit institutions and Central bank	9,375	9,375	-
Deposits	431,929	431,929	-
Borrowings	326,754	341,049	(14,295)
Other financial liabilities	34,826	34,826	-
Financial liabilities not carried at fair value	802,884	817,179	(14,295)

31.12.2015

Financial assets not carried at fair value

Cash and balances with Central bank	48,102	48,102	-
Loans to credit institutions	87,491	87,491	-
Loans to customers	680,350	688,196	7,846
Other financial assets	4,581	4,581	-
Financial assets not carried at fair value	820,524	828,370	7,846

Financial liabilities not carried at fair value

Due to credit institutions and Central bank	11,387	11,387	-
Deposits	469,347	469,347	-
Borrowings	256,058	264,839	(8,781)
Subordinated liabilities	10,365	10,365	-
Other financial liabilities	38,667	38,667	-
Financial liabilities not carried at fair value	785,824	794,605	(8,781)

Financial assets and financial liabilities predominantly bear interest at floating rates. For assets and liabilities not at floating rates fair value is determined by Level 2 methods for which the valuation input is market observable interest rates.

Retail mortgages are estimated by using the discount cash flow method with the interest rates offered on new loans, taking into account mortgaging. Defaulted loans are presented at book value as no future cash flow is expected on them. Instead they are written down according to their estimated potential recovery value. Other loans, including corporate loans, are presented at book value as they are generally of a shorter duration than retail mortgages and the interest rate risk on them is therefore limited.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

22. Fair value hierarchy, continued

Derivatives	Notional value	Fair value
		Assets	Liabilities
30.9.2016
Forward exchange rate agreements, unlisted	46,540	224	495
Interest rate and exchange rate agreements, unlisted	148,093	3,418	1,126
Bond swap agreements, unlisted	2,451	16	9
Share swap agreements, unlisted	9,727	1,273	522
Options - purchased agreements, unlisted	88	22	108
Derivatives	206,899	4,953	2,260
31.12.2015
Forward exchange rate agreements, unlisted	49,435	231	287
Interest rate and exchange rate agreements, unlisted	103,369	1,948	710
Bond swap agreements, unlisted	3,811	43	28
Share swap agreements, unlisted	13,099	178	1,934
Options - purchased agreements, unlisted	66	1	34
Derivatives	169,780	2,401	2,993

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

23. Offsetting financial assets and financial liabilities

Financial assets subject to enforceable master netting arrangements and similar arrangements

	Assets subject to netting arrangements			Netting potential not recognized in the balance sheet
	Gross assets before balance sheet	Balance sheet nettings with gross	Assets recognised on balance	Financial	Collateral received	Assets after consideration of netting potential	Assets not subject to enforceable netting arrangements	Total assets recognised on balance sheet
30.9.2016
Reverse repurchase agreements	18,784	(540)	18,244	(2,926)	-	15,318	-	18,244
Derivatives	2,832	-	2,832	(662)	-	2,170	2,121	4,953
Total assets	21,616	(540)	21,076	(3,588)	-	17,488	2,121	23,197
31.12.2015
Reverse repurchase agreements	22,100	(490)	21,610	(4,929)	-	16,681	-	21,610
Derivatives	964	-	964	(400)	-	564	1,437	2,401
Total assets	23,064	(490)	22,574	(5,329)	-	17,245	1,437	24,011

Financial liabilities subject to enforceable master netting arrangements and similar arrangements

	Liabilities subject to netting arrangements			Netting potential not recognized in the balance sheet
	Gross liabilities before balance sheet	Balance sheet nettings with gross	Liabilities recognised on balance	Financial	Collateral pledged	Liabilities after consideration of netting potential	Liabilities not subject to enforceable netting arrangements	Total liabilities recognised on balance sheet
30.9.2016
Repurchase agreements	2,926	-	2,926	(2,926)	-	-	-	2,926
Derivatives	2,491	-	2,491	(662)	-	1,829	(231)	2,260
Total liabilities	5,417	-	5,417	(3,588)	-	1,829	(231)	5,186
31.12.2015
Repurchase agreements	4,929	-	4,929	(4,929)	-	-	-	4,929
Derivatives	400	-	400	(400)	-	-	2,593	2,993
Total liabilities	5,329	-	5,329	(5,329)	-	-	2,593	7,922

Accounting policies for offsetting are provided in Note 54 in the Annual Financial Statements for 2015.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

24. Investments in associates

The Group's interest in its principal associates	30.9.2016	31.12.2015
Auōkenni hf., Borgartún 31, Reykjavík, Iceland	22.4%	22.4%
Bakkavor Group Ltd., West Marsh Road, Spalding, Lincolnshire, United Kingdom	-	46.0%
Farice ehf., Smáratorg 3, Kópavogur, Iceland	39.3%	39.3%
Reiknistofa bankanna hf., Katrínartún 2, Reykjavík, Iceland	23.0%	23.0%
Urriðaland ehf., Laugavegur 182, Reykjavík, Iceland	41.4%	41.4%
220 Fjörður ehf., Fjarðargötu 13-15, Hafnarfjörður, Iceland	38.5%	38.5%
Investments in associates
Carrying amount at the beginning of the year	27,299	21,966
Acquisitions	13	262
Dividend received	(41)	(611)
Transfers	-	(6,458)
Disposals	(27,112)	(17,148)
Exchange difference	-	(178)
Share of profit of associates and reversal of impairment	710	29,466
Investment in associates	869	27,299

In January 2016 the Bank's subsidiary BG12 slhf. sold its entire shareholding in Bakkavor Group Ltd. The main effect related to the sale was a valuation change recognised in the Statement of Comprehensive Income in 2015. During the period the total effects from the sale through the Statement of Comprehensive Income was ISK 498 million.

The Group accounts for investments in associates based on the equity method less applicable impairment. The impairment testing uses management valuation techniques and assumptions such as EBITDA multiples. Alternative assumptions could potentially result in significantly different carrying values but the management is of the opinion that the impaired value is based on the most probable outcomes under current market conditions.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

25. Intangible assets

Intangible assets comprise four categories: Goodwill, Infrastructure, Customer relationships and related agreements and Software. Goodwill arises on the acquisition of subsidiaries. Infrastructure and Customer relationships and related agreements originate as a premium in connection with the acquisition of business activities in subsidiaries, while Software originates from the acquisition of software licenses and the introduction of the software into the Group's operations.

30.9.2016	Goodwill	Infra-structure	Customer relationship and related agreements	Software	Total
Balance at the beginning of the year	2,407	3,021	854	3,003	9,285
Acquisition through business combination	33	-	-	33	66
Additions and transfers	1,943	-	110	480	2,533
Additions, internally developed	-	-	-	286	286
Exchange difference	(322)	-	(20)	(112)	(454)
Amortisation	-	-	(165)	(474)	(639)
Intangible assets	4,061	3,021	779	3,216	11,077
31.12.2015
Balance at the beginning of the year	2,171	3,046	1,539	2,840	9,596
Additions and transfers	506	-	(435)	530	601
Additions, internally developed	-	-	-	289	289
Exchange difference	(270)	-	(40)	(57)	(367)
Impairment	-	(25)	(2)	-	(27)
Amortisation	-	-	(208)	(599)	(807)
Intangible assets	2,407	3,021	854	3,003	9,285

26. Tax assets and tax liabilities

	30.9.2016		31.12.2015
	Assets	Liabilities	Assets	Liabilities
Current tax	-	5,443	-	3,272
Deferred tax	241	311	205	1,650
Tax assets and tax liabilities	241	5,754	205	4,922

27. Other assets

	30.9.2016	31.12.2015
Non-current assets and disposal groups held for sale	4,773	5,082
Property and equipment	6,856	6,766
Accounts receivable	5,333	2,433
Unsettled securities trading	1,982	685
Sundry assets	4,070	2,612
Other assets	23,014	17,578

Vast majority of the Non-current assets and disposal groups held for sale consist of real estates that are generally the result of foreclosures on companies and individuals.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

Other liabilities
30.9.2016 31.12.2015

Accounts payable ... 18,068 23,296
Provision for settled FX loans ... - 2,882
Unsettled securities trading ... 727 754
Depositors' and investors' guarantee fund ... 2,866 2,873
Insurance claim ... 11,495 2,574
Withholding tax ... 517 1,643
Bank levy ... 5,007 2,811
Sundry liabilities ... 13,885 12,628
Other liabilities ... 52,565 49,461

Borrowings
| Forst issued | Maturity | type | Terms of interest | Maturity | |
| --- | --- | --- | --- | --- | --- |
| | | | | Total | Total |
| Covered bond in ISK | 2013 | 2019 | At maturity | 4,451 | 4,483 |
| Covered bond in ISK | 2014 | 2021 | At maturity | 6,256 | 5,096 |
| Covered bond in ISK | 2015 | 2022 | At maturity | 17,424 | 7,737 |
| Covered bond in ISK | 2014 | 2029 | At maturity | 22,936 | 15,279 |
| Covered bond in ISK | 2006 | 2033 | Amortizing | 16,836 | 17,108 |
| Covered bond in ISK | 2012 | 2034 | Amortizing | 2,177 | 2,249 |
| Covered bond in ISK | 2008 | 2045 | Amortizing | 6,199 | 6,182 |
| Covered bond in ISK | 2006 | 2048 | Amortizing | 78,200 | 77,916 |
| Covered bonds | | | | 157,479 | 136,050 |
| Senior unsecured bond in NOK | 2013 | 2016 | At maturity | - | 1,547 |
| Senior unsecured bond in USD | 2016 | 2017 | At maturity | 3,431 | - |
| Senior unsecured bond in EUR | 2009 | 2018 | Amortizing | 897 | 1,177 |
| Senior unsecured bond in ISK | 2010 | 2018 | Amortizing | 1,365 | 1,600 |
| Senior unsecured bond in EUR | 2015 | 2018 | At maturity | 38,980 | 43,350 |
| Senior unsecured bond in EUR | 2016 | 2019 | At maturity | 38,718 | - |
| Senior unsecured bond in RON | 2016 | 2019 | At maturity | 1,032 | - |
| Senior unsecured bond in SEK | 2016 | 2019 | At maturity | 3,652 | - |
| Senior unsecured bond in NOK | 2015 | 2020 | At maturity | 11,531 | 11,900 |
| Senior unsecured bond in USD | 2016 | 2023 | At maturity | 56,723 | - |
| Bonds issued | | | | 156,329 | 59,574 |
| Central Bank, secured, various curr. .. | 2010 | 2022 | At maturity | - | 56,024 |
| Bills issued | | | | 12,616 | 4,081 |
| Other | | | | 330 | 329 |
| Other loans/bills | | | | 12,946 | 60,434 |
| Borrowings | | | | 326,754 | 256,058 |

Book value of listed bonds was ISK 262,976 million at the end of the period (31.12.2015: ISK 196,927 million). Market value of those bonds was ISK 272,695 million (31.12.2015: ISK 205,720 million).

The Group did not repurchase own debts during the period (2015: ISK 10 billion).

Arion Bank Interim Consolidated Financial Statements 30 September 2016
Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

30. Subordinated liabilities

	Maturity
	Issued	Maturity	type	Terms of interest	30.9.2016
Tier II capital in various currencies ...	2010	2020	At maturity	Floating, EURIBOR/LIBOR + 5.00% .	-
Subordinated liabilities					-

Arion Bank settled the subordinated liabilities with the Ministry of Finance with a prepayment in September.

31. Pledged assets

Pledged assets against liabilities

Assets, pledged as collateral against borrowings 192,225 222,046

Assets, pledged as collateral against loans from credit institutions and short positions 18,244 21,611

Pledged assets against liabilities 210,469 243,657

The Group has pledged assets against borrowings, both issued covered bonds and other issued bonds and loan agreements. The total value of those pledged assets was ISK 192 billion at the end of the period (31.12.2015: ISK 222 billion). At the end of the period those assets were pool of mortgage loans to individuals but at year end 2015 pledged loans comprised mortgage loans to individuals, loans to real estate companies, wholesale and retail and industry and energy companies. The book value of those borrowings was ISK 157 billion at the end of the period (31.12.2015: ISK 192 billion).

The Group has pledged bonds against short term lending from the Central Bank of Iceland and against short positions, related to swap agreements, to hedge market risk of those assets.

32. Equity

Share capital and share premium

According to the Bank's Articles of Association, total share capital amounts to ISK 2,000 million, with par value of ISK 1 per share. The holders of ordinary shares are entitled to receive dividends as approved by the general meeting and are entitled to one vote per share at Shareholders' meetings.

	Number (million)	30.9.2016	Number (million)	31.12.2015
Issued share capital	2,000	75,861	2,000	75,861

Share premium represents excess of payment above nominal value that Shareholders have paid for shares issued by Arion Bank hf.

Other reserves 30.9.2016 31.12.2015

Statutory reserve 1,637 1,637

Available-for-sale reserve - 2,903

Foreign currency translation reserve 289 8

Other reserves 1,926 4,548

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

OTHER INFORMATION

33. Legal matters

The Group has formal controls and policies for managing legal claims. Once professional advice has been obtained and the amount of loss reasonably estimated, the Group makes adjustments, if appropriate, to account for any adverse effects which the claims may have on its financial standing. When the Group is of the opinion that it is to the detriment of the Group's case to disclose potential amounts relating to legal claims, it elects not to do so. At the end of the period, the Group had several unresolved legal claims.

Contingent liabilities

Investigation and legal proceedings regarding alleged breaches of competition law

The Icelandic Competition Authority (ICA) has opened a formal investigation into the alleged abuse of an alleged collective dominant position by the three largest retail banks in Iceland, including Arion Bank. The investigation was initiated by separate complaints from BYR hf. and MP Banki hf. made in 2010. The complaints from BYR hf. and MP Banki hf. concern the terms of the banks' mortgage arrangements, which, according to the complaint, deter individuals from moving their business to other banks and thereby restrict competition. The ICA has sent the bank a letter proposing concluding the matter with an agreement. The Bank is looking into the conditions of the proposed agreement.

With a writ issued in June 2013, Kortaþjónustan ehf. claimed damages from Arion Bank hf., Íslandsbanki hf., Landsbankinn hf., Borgun hf. and Valitor hf. to the amount of ISK 1.2 billion plus interest, due to damage Kortaþjónustan hf. contends the five parties caused the company due to violations of the Competition Act. The Bank has put forward its arguments in the case and has demanded the rejection of Kortaþjónustan's claims. Kortaþjónustan's court-appointed evaluator has given a report on Kortaþjónustan's alleged loss. The Bank and other defendants in the case have demanded that a reassessment be carried out.

Legal proceedings regarding damages

The former chairman of the Board of BM Vallá hf., together with Lindarflót ehf., have filed two cases against the Bank claiming damages in the amount of more than ISK 4 billion plus interest. The plaintiffs claim that the Bank caused them, as shareholders of BM Vallá hf. and Fasteignafélagið Ártún ehf., damage by not allowing the companies to be financially restructured and thereby forcing the companies into bankruptcy. The Bank believes it likely that it will be acquitted of the plaintiffs' claims in both cases and has not therefore made any provision.

In its judgment in case No. 612/2012, pronounced on 24 April 2013, the Supreme Court ruled that Valitor hf. had not been authorized to rescind an agreement between the company and Datacell ehf. In January 2015 Datacell ehf. and Sunshine Press Productions ehf. brought legal action against Valitor hf. for the payment of compensation relating to damage which the companies considered they had sustained on account of the aforementioned rescinding by Valitor hf. of the agreement. Court-appointed assessors were subsequently asked to assess the damage in question at the request of the plaintiffs. The assessors announced their conclusions in March 2016. Valitor hf. has filed a motion for dismissal of the case. If the district court will not approve of that motion then Valitor request for other court-appointed appraisers to gain a second opinion.

Other legal matters

Mortgage documents

Courts cases are being prosecuted against the Bank in which it is demanded that the mortgaging of part of a property be invalidated on the basis that the signature of the mortgagor on the mortgage documents was not correct. Recently the district court, in respect of a case which did not involve the Bank, invalidated a mortgage under similar circumstances to these. The Bank is assessing the possible impact of a negative outcome on the Bank's loan portfolio.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

33. Legal matters, continued

The uncertainty regarding the book value of foreign currency loans

Some uncertainty over the legality of FX loans has continued in 2016 and the Group constantly monitors judgments involving itself and others to refine its provisions on foreign currency loans. Although there is much more clarity in the matters of FX loans there still remains uncertainty regarding foreign currency linked loans in certain respects, such as regarding the recalculation of particular loans. Nevertheless, the Group considers its portfolio of foreign currency linked loans to be fully provisioned for the most likely outcome.

Legal matters concluded

In April 2013 the ICA imposed an ISK 500 million fine on Valitor hf. for abusing its dominant position on the payment card market and violating conditions set out in an earlier decision of the ICA. The Supreme Court ruled in April 2016 on upholding the ICA's decision from April 2013. Valitor paid the fine in 2013.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

OFF BALANCE SHEET INFORMATION

34. Obligations

Financial guarantees, unused overdraft and loan commitments the Group has granted its customers	30.9.2016	31.12.2015
Financial guarantees	22,128	19,162
Unused overdrafts	46,311	42,100
Loan commitments	72,205	126,068

Depositors' and Investors' Guarantee fund

The Icelandic parliament has discussed a bill on a new Depositors' and Investors' Guarantee Fund, without conclusion of the matter. Even though the law has not been amended Icelandic bank's have made quarterly payments to a separate division within the fund since 2010. Despite this change in execution and due to uncertainty of the shape of future legislation the liability brought forward from previous years is not changed from the balance of ISK 2,669 million. The Group has granted the Fund a guarantee for obligations amounting to ISK 3,210 million.

35. Assets under management and under custody

	30.9.2016	31.12.2015
Assets under management	1,008,543	996,648
Assets under custody	1,378,987	1,427,269

Assets under management represent the total market value of the financial assets which the Group manages on behalf of its customers.

The Group, acting as custodian, is responsible for safeguarding a firm's or individual's financial assets, hold in safekeeping securities such as stocks, bonds and securities funds, arrange the settlement of trades and movements of securities, process corporate actions such as income on bonds and dividends on shares; and pricing on securities.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

RELATED PARTY

36. Related party

The Group has a related party relationship with Kaupskil ehf., being the ultimate controlling party with 87% stake in Arion Bank, the Board of Directors of Kaupskil ehf. and Kaupthing hf., being the parent company of Kaupskil ehf.

Icelandic State Financial Investments (ISFI, a separate state institution under the Ministry of Finance) manages a 13% stake in Arion Bank and thus has influence over the Group. ISFI and related entities are defined as related parties.

The Board of Directors of Arion Bank and key Management personnel of the Bank are defined as related parties, as well as close family members of individuals referred to above and legal entities controlled by them. The Group's associates are also defined as related parties.

No unusual transactions took place with related parties during the period. Transactions with related parties have been conducted on an arm's length basis. There have been no further guarantees provided or received for related party receivables or payables.

30.9.2016

Balances with related parties	Assets	Liabilities	Net balance
Shareholders with control over the Group	178	(7,814)	(7,636)
Board of Directors and key Management personnel	297	(65)	232
Associates and other related parties	164	(138)	26
Balances with related parties	639	(8,017)	(7,378)

31.12.2015

Balances with related parties

Shareholders with control over the Group	212	(50,158)	(49,946)
Board of Directors and key Management personnel	232	(59)	173
Associates and other related parties	2,132	(241)	1,891
Balances with related parties	2,576	(50,458)	(47,882)

Through the ownership of ISFI the Group has a related party relationship with Landsbankinn hf. Landsbankinn hf. provides banking services to the Bank's subsidiary Valitor hf. and has a traditional bank to bank relationship with Arion Bank hf. The Group holds assets amounting to ISK 8,575 million (31.12.2015: ISK 14,038 million) by Landsbankinn hf. and liabilities amounting to ISK 1,677 million at the end of the period (31.12.2015: ISK 1,499 million). Those amounts are not included in the table above.

Kaupthing hf. holds senior unsecured bonds, issued by Arion Bank in January 2016, for the amount of ISK 56,723 million at the end of the period. This amount is not included in the table above.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

RISK MANAGEMENT DISCLOSURES

The Group faces various risks arising from its day to day operations. Managing risk is therefore a core activity within the Group. The key to effective risk management is a process of on-going identification of significant risk, quantification of risk exposure, actions to limit risk and constant monitoring of risk. This process of risk management and the ability to evaluate, manage and correctly price the risk encountered is critical to the Group's continuing profitability as well as to be able to ensure that the Group's exposure to risk remains within acceptable levels.

Further information regarding risk management is available in the Annual Financial Statements for 2015 and in the Pillar 3 Risk Disclosures for 2015, published on the Bank's website, www.arionbanki.is. The Pillar 3 Risk Disclosures are not audited.

37. Credit risk

Credit risk is the risk that the Group will incur a loss because its customers or counterparties fail to discharge their contractual obligations.

Credit risk arises anytime the Group commits its funds, resulting in capital or earnings being dependent on counterparty, issuer or borrower performance. Loans to customers and credit institutions are the largest source of credit risk. Credit risk is also inherent in other types of assets, such as bonds and debt instruments, and off-balance sheet items such as commitments and financial guarantees.

Exposure to credit risk

The following table shows the maximum exposure to credit risk for the components of the Interim Statement of Financial Position, at the end of the reporting period before the effect of mitigation due to collateral agreements or other credit enhancements.

Maximum exposure to credit risk related to on-balance sheet items	30.9.2016	31.12.2015
Cash and balances with Central Bank	85,645	48,102
Loans to credit institutions	68,257	87,491
Loans to corporates	381,260	355,731
Loans to individuals	334,647	324,619
Financial instruments	93,032	86,770
Other assets with credit risk	10,091	4,581
Total on-balance sheet maximum exposure to credit risk	972,932	907,294
Maximum exposure to credit risk related to off-balance sheet items
Financial guarantees	22,128	19,162
Unused overdrafts	46,311	42,100
Loan commitments	72,205	126,068
Total off-balance sheet maximum exposure to credit risk	140,644	187,330
Maximum exposure to credit risk	1,113,576	1,094,624

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

37. Credit risk, continued

Loans to customers specified by sectors	30.9.2016	31.12.2015
Individuals	46.7%	47.7%
Real estate activities and construction	15.8%	15.1%
Fishing industry	11.1%	11.1%
Information and communication technology	4.1%	4.7%
Wholesale and retail trade	8.0%	7.6%
Financial and insurance activities	4.9%	4.9%
Industry, energy and manufacturing	4.0%	3.1%
Transportation	0.8%	0.9%
Services	2.5%	2.9%
Public sector	1.3%	1.2%
Agriculture and forestry	0.8%	0.8%
	100.0%	100.0%

Collateral and other credit enhancements

The amount and type of collateral required depends on an assessment of the credit risk of the counterparty and the exposure type. The main types of collateral obtained are as follows:

Retail loans to individuals: Mortgages on residential properties.
Corporate loans: Real estate, fishing vessels and other fixed and current assets, including inventory and trade receivables, cash and securities.
Derivative exposures: Cash, treasury notes and bills, asset backed bonds, listed equity and funds that consist of eligible securities.

The value of collateral is based on estimated market value. The valuation of real estate is built on market price, official valuation of the Icelandic Property Registry, or the opinion of internal or external specialists. The valuation of fishing vessels takes into account related fishing quota.

Collateral value is monitored and additional collateral requested in accordance with the underlying agreement. Collateral value is reviewed in line with the adequacy of the allowance for impairment losses.

The collateral value in the table below is capped by the exposure amount.

Collateral held against different types of financial assets

30.9.2016	Cash and securities	Real estate	Fishing vessels	Other collateral	Total
Cash and balances with Central Bank	-	-	-	-	-
Loans to credit institutions	-	-	-	-	-
Loans to customers
Individuals	574	294,608	8	5,598	300,788
Real estate activities and construction	519	104,872	28	1,066	106,485
Fishing industry	69	8,068	60,280	6,242	74,659
Information and communication technology	189	2,397	-	18,770	21,356
Wholesale and retail trade	346	24,378	2	20,564	45,290
Financial and insurance activities	15,478	6,662	203	770	23,113
Industry, energy and manufacturing	3,442	15,215	-	6,594	25,251
Transportation	46	850	218	1,332	2,446
Services	35	5,516	39	3,246	8,836
Public sector	65	3,911	-	84	4,060
Agriculture and forestry	5	4,823	-	165	4,993
Financial instruments	6,298	-	-	-	6,298
Financial guarantees	1,161	3,754	1,114	2,872	8,901
Collateral held against different types of financial assets	28,227	475,054	61,892	67,303	632,476

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

Credit risk, continued

31.12.2015	Cash and securities	Real estates	Fishing vessels	Other collateral	Total
Cash and balances with Central Bank	-	-	-	-	-
Loans to credit institutions	-	-	-	-	-
Loans to customers
Individuals	428	289,862	24	4,107	294,421
Real estate activities and construction	1,032	89,039	8	1,025	91,104
Fishing industry	53	7,956	57,945	7,037	72,991
Information and communication technology	76	2,369	-	18,630	21,075
Wholesale and retail trade	210	20,424	7	22,912	43,553
Financial and insurance activities	15,947	4,367	-	1,577	21,891
Industry, energy and manufacturing	461	12,792	3	4,416	17,672
Transportation	91	875	173	3,891	5,030
Services	13	4,847	40	2,623	7,523
Public sector	73	3,732	-	99	3,904
Agriculture and forestry	5	3,493	-	112	3,610
Financial instruments	7,474	-	-	-	7,474
Financial guarantees	885	4,232	623	1,445	7,185
Collateral held against different types of financial assets	26,748	443,988	58,823	67,874	597,433

Collateral repossessed

During the period the Group took possession of assets due to foreclosures. The total amount of real estates the Group took possession of during the period and still holds at period end amount to ISK 1,289 million (31.12.2015: ISK 2,761 million) and other assets ISK 8 million (31.12.2015: ISK 7 million). The assets are held for sale, see Note 27.

Credit quality

Credit quality by class of financial assets	Neither past due nor impaired	Past due but not impaired	Individually impaired	Total
30.9.2016
Cash and balances with Central Bank	85,645	-	-	85,645
Loans to credit institutions	68,257	-	-	68,257
Loans to customers
Loans to corporates	362,102	17,475	1,683	381,260
Loans to individuals	305,461	25,092	4,094	334,647
Financial instruments	86,198	-	-	86,198
Other assets with credit risk	10,091	-	-	10,091
Credit quality by class of financial assets	917,754	42,567	5,777	966,098
31.12.2015
Cash and balances with Central Bank	48,102	-	-	48,102
Loans to credit institutions	87,491	-	-	87,491
Loans to customers
Loans to corporates	337,153	17,302	1,276	355,731
Loans to individuals	291,277	26,532	6,810	324,619
Financial instruments	82,714	-	-	82,714
Other assets with credit risk	4,581	-	-	4,581
Credit quality by class of financial assets	851,318	43,834	8,086	903,238

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

37. Credit risk, continued

Neither past due nor impaired loans

The Bank uses internal credit rating models to monitor the development of credit risk and to estimate customers' probability of default (PD). The Bank rates customers with one of three models. For large corporates the Bank uses quantitative information based on financial statements as well as qualitative data. Credit ratings of individuals and SMEs are based on statistical models using historical information which has been found to be predictive. The models are updated annually and recalibrated with current data with the aim of improving their predictive power. Year-on-year changes in risk classification of loans may in part be due to model refinement.

The table below shows loans to customers that are neither past due nor impaired, broken down by the Bank's classification scale, where 5 denotes the highest risk.

30.9.2016	Risk classification					Not rated	Total
	1	2	3	4	5
Individuals	62,281	162,100	55,677	17,190	4,580	3,633	305,461
Real estate activities and construction	41,249	30,765	23,690	5,416	389	4,958	106,467
Fishing industry	25,940	37,434	9,702	3,429	716	-	77,221
Information and communication technology	18,550	3,683	970	5,337	1	11	28,552
Wholesale and retail trade	11,005	20,048	18,544	2,419	192	1,733	53,941
Financial and insurance activities	11,475	3,143	8,566	221	-	10,966	34,371
Industry, energy and manufacturing	8,291	8,564	9,517	521	83	-	26,976
Transportation	985	3,447	537	(7)	20	533	5,515
Services	2,015	5,210	4,810	1,058	2,549	3	15,645
Public sector	357	4,561	2,016	1,040	55	679	8,708
Agriculture and forestry	478	1,124	2,173	608	21	302	4,706
Neither past due nor impaired loans	182,626	280,079	136,202	37,232	8,606	22,818	667,563
31.12.2015
Individuals	54,822	148,472	63,027	18,553	4,693	1,710	291,277
Real estate activities and construction	36,550	23,792	29,776	3,790	154	3,279	97,341
Fishing industry	21,807	33,232	7,657	5,415	1,249	1,341	70,701
Information and communication technology	17,346	4,252	8,949	126	-	-	30,673
Wholesale and retail trade	9,447	18,356	18,260	2,064	198	33	48,358
Financial and insurance activities	3,012	17,784	11,308	223	-	456	32,783
Industry, energy and manufacturing	3,088	14,256	2,930	324	135	-	20,733
Transportation	3,320	1,094	1,040	274	28	-	5,756
Services	2,326	4,805	9,918	539	19	-	17,607
Public sector	357	3,396	2,342	1,038	133	545	7,811
Agriculture and forestry	336	1,558	2,887	609	-	-	5,390
Neither past due nor impaired loans	152,411	270,997	158,094	32,955	6,609	7,364	628,430

Exposures that are 'Not rated' are typically due to newly formed entities and entities for which the Bank's rating models are not applicable.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

37. Credit risk, continued

Past due but not impaired loans by class of loans

30.9.2016	Up to 3 days	4 to 30 days	31 to 60 days	61 to 90 days	More than 90 days	Total
Loans to corporates	4,428	7,549	2,169	839	2,490	17,475
Loans to individuals	3,193	9,845	5,767	591	5,696	25,092
Past due but not impaired loans	7,621	17,394	7,936	1,430	8,186	42,567

31.12.2015

Loans to corporates	9,638	3,779	1,681	662	1,542	17,302
Loans to individuals	3,706	9,437	5,237	554	7,598	26,532
Past due but not impaired loans	13,344	13,216	6,918	1,216	9,140	43,834

Loans past due up to three days are mainly overdrafts that were not renewed in time. The majority of the past due but not impaired loans are considered fully secured with collateral or have been acquired at discount. Loans acquired at discount are not considered to be impaired unless the specific allowance exceeds the discount received.

Impaired loans to customers specified by sector	30.9.2016		31.12.2015
	Impair-ment amount	Gross carrying amount	Impair-ment amount	Gross carrying amount
Individuals	8,195	12,289	10,593	17,403
Real estate activities and construction	1,521	1,964	1,515	1,867
Fishing industry	515	614	257	373
Information and communication technology	377	392	308	332
Wholesale and retail trade	619	932	681	893
Financial and insurance activities	176	212	5,953	6,011
Industry, energy and manufacturing	1,267	1,384	828	1,025
Transportation	4,567	4,575	4,433	4,440
Services	3,167	3,710	504	682
Public sector	64	64	143	215
Agriculture and forestry	175	284	126	186
Impaired loans to customers specified by sector	20,643	26,420	25,341	33,427

Large exposure

A large exposure is defined as an exposure to a group of financially related borrowers which exceeds 10% of the Group's capital base according to FME rule No. 625/2013. The legal maximum for individual large exposures is 25% of the capital base, net of eligible collateral.

The Group has no large exposure at the end of the period before taking account of eligible collateral (31.12.2015: One large exposure of ISK 22 billion without eligible collateral).

	30.9.2016		31.12.2015
No.	Gross	Net	Gross	Net
1	<10%	<10%	11%	11%
Sum of large exposure gross and net > 10%	0%	0%	11%	11%

No large exposure exceeds the legal limit of 25% of the Group's capital base at the end of the period.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

38. Market risk

Market risk is the current or prospective risk that changes in financial market prices and rates will cause fluctuations in the value and cash flows of financial instruments.

Market risk arises from imbalances in the Group's balance sheet as well as in market making activities and position taking in bonds, equities, currencies, derivatives, and other commitments which are marked to market.

Interest rate risk

Interest rate risk arises from the possibility that changes in interest rates will affect future cash flows or the fair value of financial instruments. The Group's operations are subject to interest rate risk associated with a mismatch between interest bearing assets and interest bearing liabilities. This mismatch is characterised by a gap between the interest fixing period of assets and liabilities, with a large amount of liabilities being demand deposits while the interest rates of assets are predominantly fixed to some extent, resulting in a repricing risk for the Group. The Group also faces interest basis risk between interest bearing assets and interest bearing liabilities due to different types of floating rate indices in different currencies.

Interest rate risk in the banking book

The following table shows the Group's interest bearing assets and liabilities by interest fixing periods. The figures for loans to customers and borrowings are shown on a fair value basis, see Note 22, and are therefore different from the amounts shown in these Interim Financial Statements. Defaulted loans are presented at book value, which is based on the value of the underlying collateral, and are therefore assumed to be independent of interest adjustment periods and placed in the 'Up to 3 months' category.

30.9.2016	Up to 3 months	3-12 months	1-5 years	5-10 years	Over 10 years	Total
Assets
Balances with Central Bank	78,162	-	-	-	-	78,162
Loans to credit institutions	68,257	-	-	-	-	68,257
Loans to customers	388,982	60,646	134,838	3,835	131,365	719,666
Financial instruments	46,195	1,942	6,213	6,496	2,591	63,437
Assets	581,596	62,588	141,051	10,331	133,956	929,522
Liabilities
Due to credit institutions and Central Bank	9,344	-	31	-	-	9,375
Deposits	378,046	39,417	12,315	1,348	803	431,929
Borrowings	86,106	8,430	85,768	27,906	132,839	341,049
Liabilities	473,496	47,847	98,114	29,254	133,642	782,353
Derivatives and other off-balance sheet items (net position)	(81,495)	-	83,694	-	-	2,199
Net interest gap	26,605	14,741	126,631	(18,923)	314	149,368

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

38. Market risk, continued

31.12.2015	Up to 3 months	3-12 months	1-5 years	5-10 years	Over 10 years	Total
Assets
Balances with Central Bank	43,181	-	-	-	-	43,181
Loans to credit institutions	87,491	-	-	-	-	87,491
Loans to customers	347,571	64,594	127,907	5,255	142,869	688,196
Financial instruments	43,925	10,002	8,556	7,786	242	70,511
Assets	522,168	74,596	136,463	13,041	143,111	889,379
Liabilities
Due to credit institutions and Central Bank	11,387	-	-	-	-	11,387
Deposits	464,998	3,501	848	-	-	469,347
Borrowings	72,010	4,509	48,705	12,982	126,633	264,839
Subordinated liabilities	10,365	-	-	-	-	10,365
Liabilities	558,760	8,010	49,553	12,982	126,633	755,938
Derivatives and other off-balance sheet items (net position)	(46,330)	(1,802)	49,346	-	-	1,214
Net interest gap	(82,922)	64,784	136,256	59	16,478	134,655

Interest rate risk in the trading book

The following table shows the total basis point value (BPV) of the Group's bond and derivatives in the trading book at market value (MV). BPV denotes the change in value given a basis point (0.01%) yield change.

	30.9.2016			31.12.2015
Trading financial instruments, long positions	MV	Duration	BPV	MV	Duration	BPV
ISK, CPI Indexed linked	4,757	2.9	(1.4)	4,544	3.6	(1.6)
ISK, Non Indexed linked	9,818	(0.5)	0.5	5,849	(1.8)	1.1
FX	83,327	(0.5)	4.3	64,226	(0.6)	3.9
Total	97,902	(0.3)	3.4	74,619	(0.5)	3.4
Trading financial instruments, short positions
ISK, CPI Indexed linked	439	4.1	(0.2)	393	9.7	(0.4)
ISK, Non Indexed linked	10,198	0.3	(0.3)	7,953	0.3	(0.3)
FX	80,697	(0.4)	3.6	64,172	(0.5)	2.9
Total	91,334	(0.3)	3.1	72,518	(0.3)	2.3

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

38. Market risk, continued

Indexation risk

The Group is exposed to indexation risk when there is a mismatch between index-linked assets and liabilities.

Transaction maturity profile of indexed assets and liabilities

| 30.9.2016
Assets, CPI indexed linked | Up to 1
year | 1 to 5
years | Over 5
years | Total |
| --- | --- | --- | --- | --- |
| Loans to customers | 13,508 | 96,302 | 213,824 | 323,634 |
| Financial instruments | 6,399 | - | - | 6,399 |
| Off-balance sheet position | 852 | 6,543 | - | 7,395 |
| Assets, CPI indexed linked | 20,759 | 102,845 | 213,824 | 337,428 |
| Liabilities, CPI indexed linked | | | | |
| Deposits | 71,617 | 12,026 | 2,114 | 85,757 |
| Borrowings | 2,222 | 14,547 | 123,616 | 140,385 |
| Other | 395 | 686 | 798 | 1,879 |
| Liabilities, CPI indexed linked | 74,234 | 27,259 | 126,528 | 228,021 |
| Net on-balance sheet position | (54,327) | 69,043 | 87,296 | 102,012 |
| Net off-balance sheet position | 852 | 6,543 | - | 7,395 |
| CPI Balance | (53,475) | 75,586 | 87,296 | 109,407 |

31.12.2015

Assets, CPI indexed linked

Loans to customers	13,629	76,393	209,485	299,507
Financial instruments	3,412	-	-	3,412
Off-balance sheet position	749	7,940	-	8,689
Assets, CPI indexed linked	17,790	84,333	209,485	311,608

Liabilities, CPI indexed linked

Deposits	72,352	12,899	1,916	87,167
Borrowings	2,128	14,164	112,350	128,642
Off-balance sheet position	-	-	782	782
Liabilities, CPI indexed linked	74,480	27,063	115,048	216,591
Net on-balance sheet position	(57,439)	49,330	94,437	86,328
---	---	---	---	---
Net off-balance sheet position	749	7,940	-	8,689
CPI Balance	(56,690)	57,270	94,437	95,017

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

38. Market risk, continued

Currency risk

Currency risk is the risk of loss due to adverse movements in foreign exchange rates. The Group is exposed to currency risk through a currency mismatch between assets and liabilities. ISK denominated deposits are a primary source of funding for the Group whereas a substantial part of the Group's assets consists of foreign currency denominated loans to customers. Net exposures per currency are monitored centrally in the Bank.

Breakdown of assets and liabilities by currency

30.9.2016

Assets	ISK	EUR	USD	GBP	DKK	NOK	Other	Total
Cash and balances with Central Bank	84,407	333	346	180	87	36	256	85,645
Loans to credit institutions	24,528	10,662	10,534	6,260	2,100	8,279	5,894	68,257
Loans to customers	589,563	66,275	36,896	3,227	7,831	5	12,110	715,907
Financial instruments	95,760	18,337	9,634	1,089	179	3,331	27	128,357
Investment property	5,113	-	-	-	-	-	-	5,113
Investments in associates	869	-	-	-	-	-	-	869
Intangible assets	7,849	-	-	-	3,228	-	-	11,077
Tax assets	241	-	-	-	-	-	-	241
Other assets	21,787	666	413	85	30	31	2	23,014
Assets	830,117	96,273	57,823	10,841	13,455	11,682	18,289	1,038,480
Liabilities and equity
Due to credit inst. and Central Bank	7,022	2,211	64	3	-	1	74	9,375
Deposits	400,682	13,164	9,190	5,660	978	1,418	837	431,929
Financial liabilities at fair value	4,092	543	70	1	-	266	125	5,097
Tax liabilities	5,512	-	-	-	242	-	-	5,754
Other liabilities	42,312	4,785	2,233	1,986	572	245	432	52,565
Borrowings	172,822	78,595	60,154	-	-	11,531	3,652	326,754
Subordinated liabilities	-	-	-	-	-	-	-	-
Shareholders' equity	206,940	-	-	-	-	-	-	206,940
Non-controlling interest	66	-	-	-	-	-	-	66
Liabilities and equity	839,448	99,298	71,711	7,650	1,792	13,461	5,120	1,038,480
Net on-balance sheet position	(9,331)	(3,025)	(13,888)	3,191	11,663	(1,779)	13,169
Net off-balance sheet position	8,125	3,309	13,825	(3,301)	(9,433)	1,541	(14,066)
Net position	(1,206)	284	(63)	(110)	2,230	(238)	(897)

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

38. Market risk, continued

31.12.2015

Assets	ISK	EUR	USD	GBP	DKK	NOK	Other	Total
Cash and balances with Central Bank	47,357	252	167	37	96	37	156	48,102
Loans to credit institutions	20,923	24,741	19,478	7,260	3,182	4,125	7,782	87,491
Loans to customers	568,196	44,532	37,395	6,487	11,357	9	12,374	680,350
Financial instruments	84,752	24,852	13,227	6,145	63	3,248	904	133,191
Investment property	7,542	-	-	-	-	-	-	7,542
Investments in associates	1,043	-	-	26,256	-	-	-	27,299
Intangible assets	5,575	-	-	-	3,710	-	-	9,285
Tax assets	205	-	-	-	-	-	-	205
Other assets	16,711	482	170	177	22	14	2	17,578
Assets	752,304	94,859	70,437	46,362	18,430	7,433	21,218	1,011,043
Liabilities and equity
Due to credit inst. and Central Bank	9,471	381	74	6	1	-	1,454	11,387
Deposits	388,228	18,041	50,913	6,865	1,523	2,156	1,621	469,347
Financial liabilities at fair value	6,791	584	104	10	4	-	116	7,609
Tax liabilities	4,500	-	-	-	422	-	-	4,922
Other liabilities	41,098	2,648	1,484	1,432	832	347	1,620	49,461
Borrowings	142,060	44,526	33,442	8,511	-	13,447	14,072	256,058
Subordinated liabilities	-	3,942	2,603	3,820	-	-	-	10,365
Shareholders' equity	192,786	-	-	-	-	-	-	192,786
Non-controlling interest	9,108	-	-	-	-	-	-	9,108
Liabilities and equity	794,042	70,122	88,620	20,644	2,782	15,950	18,883	1,011,043
Net on-balance sheet position	(41,738)	24,737	(18,183)	25,718	15,648	(8,517)	2,335
Net off-balance sheet position	9,619	(13,684)	20,273	(1,470)	(17,856)	5,481	(2,363)
Net position	(32,119)	11,053	2,090	24,248	(2,208)	(3,036)	(28)

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

39. Liquidity and Funding risk

Liquidity risk is defined as the risk that the Group, though solvent, either does not have sufficient financial resources available to meet its liabilities when they fall due, or can secure them only at excessive cost. Liquidity risk arises from the inability to manage unplanned decreases or changes in funding sources.

Maturity gap analysis

Group's assets and liabilities at carrying amount by residual maturity

30.9.2016Assets	Carrying amount	On demand	Up to 3 months	3-12 months	1-5 years	Over 5 years	With no maturity
Cash and balances with Central Bank	85,645	76,250	-	9,395	-	-	-
Loans to credit institutions	68,257	33,013	31,688	3,556	-	-	-
Loans to customers	715,907	10,411	57,454	83,666	253,381	310,995	-
Financial instruments	128,357	11,237	5,812	3,936	51,741	13,471	42,160
Derivatives - assets leg	64,134	-	11,570	27,638	24,392	534	-
Derivatives - liabilities leg	(59,181)	-	(10,313)	(27,014)	(21,591)	(263)	-
Investment property	5,113	-	-	-	-	-	5,113
Investments in associates	869	-	-	-	-	-	869
Intangible assets	11,077	-	-	-	-	-	11,077
Tax assets	241	-	-	-	241	-	-
Other assets	23,014	2,296	5,885	1,199	711	-	12,923
Assets	1,038,480	133,207	100,839	101,752	306,074	324,466	72,142
Liabilities
Due to credit institutions and Central Bank	9,375	9,316	-	34	25	-	-
Deposits	431,929	288,634	87,987	40,856	12,334	2,118	-
Financial liabilities at fair value	5,097	-	3,466	578	714	339	-
Derivatives - assets leg	(49,691)	-	(4,424)	(36,428)	(8,445)	(394)	-
Derivatives - liabilities leg	51,951	-	5,053	37,006	9,159	733	-
Short position bonds and derivatives	1,845	-	1,845	-	-	-	-
Short position securities used for hedging	992	-	992	-	-	-	-
Tax liabilities	5,754	-	349	5,094	311	-	-
Other liabilities	52,565	16,303	11,952	1,305	5,260	6	17,739
Borrowings	326,754	-	6,848	11,839	111,896	196,171	-
Liabilities	831,474	314,253	110,602	59,706	130,540	198,634	17,739
Off-balance sheet items
Financial guarantees	22,128	2,863	2,225	7,410	2,648	6,982	-
Unused overdraft	46,311	937	9,439	17,834	18,101	-	-
Loan commitments	72,205	36	16,402	14,618	36,163	4,986	-
Off-balance sheet items	140,644	3,836	28,066	39,862	56,912	11,968	-
Net assets (liabilities)	66,362	(184,882)	(37,829)	2,184	118,622	113,864	54,403

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

Liquidity and Funding risk, continued

31.12.2015	Carrying amount	On demand	Up to 3 months	3-12 months	1-5 years	Over 5 years	With no maturity
Assets
Cash and balances with Central Bank	48,102	35,467	-	12,635	-	-	-
Loans to credit institutions	87,491	50,151	37,340	-	-	-	-
Loans to customers	680,350	3,984	42,429	90,014	234,035	309,888	-
Financial instruments	133,191	4,765	1,711	10,861	54,392	10,985	50,477
Derivatives - assets leg	56,171	-	24,671	1,478	29,509	513	-
Derivatives - liabilities leg	(53,770)	-	(24,262)	(1,421)	(27,688)	(399)	-
Investment property	7,542	-	-	-	-	-	7,542
Investments in associates	27,299	-	-	-	-	-	27,299
Intangible assets	9,285	-	-	-	-	-	9,285
Tax assets	205	-	-	-	205	-	-
Other assets	17,578	1,017	2,592	174	793	-	13,002
Assets	1,011,043	95,384	84,072	113,684	289,425	320,873	107,605
Liabilities
Due to credit institutions and Central Bank	11,387	9,881	-	1,481	25	-	-
Deposits	469,347	268,727	95,191	89,937	13,575	1,917	-
Financial liabilities at fair value	7,609	-	6,346	536	631	96	-
Derivatives - assets leg	(49,199)	-	(36,552)	(5,662)	(6,518)	(467)	-
Derivatives - liabilities leg	52,192	-	38,282	6,198	7,149	563	-
Short position bonds and derivatives	1,309	-	1,309	-	-	-	-
Short position bonds used for hedging	3,307	-	3,307	-	-	-	-
Tax liabilities	4,922	-	-	3,274	1,648	-	-
Other liabilities	49,461	17,002	14,724	5,192	3,529	6	9,008
Borrowings	256,058	-	7,081	4,308	69,933	174,736	-
Subordinated liabilities	10,365	-	-	-	3,942	6,423	-
Liabilities	809,149	295,610	123,342	104,728	93,283	183,178	9,008
Off-balance sheet items
Financial guarantees	19,162	3,402	2,371	7,589	3,954	1,846	-
Unused overdraft	42,100	842	10,071	14,984	15,768	435	-
Loan commitments	126,068	-	50,628	35,542	34,506	5,392	-
Off-balance sheet items	187,330	4,244	63,070	58,115	54,228	7,673	-
Net assets (liabilities)	14,564	(204,470)	(102,340)	(49,159)	141,914	130,022	98,597

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

39. Liquidity and Funding risk, continued

Net Stable Funding Ratio

The net stable funding ratio (NSFR) measures the amount of available stable funding (ASF) at the Group against the required stable funding (RSF) as per the definition of the Central Bank of Iceland rules No. 1032. In general, RSF is determined by applying different weights to different asset classes depending on the level of liquidity. ASF however is calculated by applying weights to the Group's liabilities depending on maturity and/or stickiness. In 2016, the ratio for foreign currency shall be at least 90% and from 2017 the ratio shall exceed 100%.

Calculations of the NSFR are based on consolidated figures for the Bank and Arion Bank Mortgages Institutional Investor Fund. When calculating the FX ratio, a negative FX imbalance is subtracted from the numerator and a positive FX imbalance is subtracted from the denominator. The FX imbalance discrepancy between the Group's official FX imbalance and the imbalance reported in the NSFR is due to the fact that the Bank's subsidiaries have a substantial positive FX imbalance but are settled in ISK.

30.9.2016	ISK	FX	Total
Available stable funding	609,285	167,542	776,827
Required stable funding	547,024	94,140	641,164
FX imbalance		1,293
Net stable funding ratio	111%	180%	121%
31.12.2015
Available stable funding	540,864	129,273	670,137
Required stable funding	539,841	95,511	635,352
FX imbalance		(11,363)
Net stable funding ratio	100%	123%	105%

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

39. Liquidity and Funding risk, continued

Liquidity coverage ratio

The liquidity coverage ratio (LCR) is part of the standards introduced in the Basel III Accord. The LCR is the result of a stress test that is designed to ensure that banks have the necessary assets on hand to withstand short-term liquidity disruptions. More accurately, LCR represents the balance between highly liquid assets and the expected net cash outflow of the Group in the next 30 days under stressed conditions.

To qualify as highly liquid assets under the LCR rules, assets must be non-pledged, liquid and easily priced on the market, repable at the Central Bank and not issued by the Group or related entities.

The Central Bank has set rules for minimum LCR. In 2016 the LCR requirement is 100% in foreign currency and 90% in total (ISK and foreign currency). The latter requirement will be 100% from 2017.

The following table shows the breakdown for the Group's LCR calculations broken down on currencies; ISK, FX and total. All amounts are weighted by their respective LCR weights as defined by the Central Bank.

30.9.2016	ISK	FX	Total
Liquid assets level 1 *	140,685	15,706	156,391
Liquid assets level 2 **	-	4,971	4,971
Liquid Assets	140,685	20,677	161,362
Deposits	102,233	15,022	117,255
Market Borrowing	3,648	585	4,233
Other Cash outflows	12,312	6,599	18,911
Cash outflows	118,193	22,206	140,399
Short term deposits with other banks ***	16,464	33,562	50,026
Other Cash inflows	6,461	765	7,226
Cash inflows	22,925	34,327	57,252
Liquidity coverage ratio (LCR) ***	148%	372%	194%
31.12.2015
---	---	---	---
Liquid assets level 1 *	99,483	24,088	123,571
Liquid assets level 2 **	-	5,869	5,869
Liquid Assets	99,483	29,957	129,440
Deposits	122,275	21,640	143,915
Market Borrowing	1,502	122	1,624
Other Cash outflows	16,296	34,749	51,045
Cash outflows	140,073	56,511	196,584
Short term deposits with other banks ***	3,768	57,881	61,649
Other Cash inflows	9,193	29,457	38,650
Cash inflows	12,961	87,338	100,299
Liquidity coverage ratio (LCR) ***	78%	212%	134%

Level 1 assets receive a 100% weight in LCR calculations and include the Group's Cash and balances with Central Bank, domestic bonds eligible as collateral at the Central Bank, foreign government bonds and the liquidity facility from the Icelandic government.
** Level 2 assets include the Group's covered bonds with a minimum rating of AA- and receive a 85% weight in LCR calculations.
*** Short term deposits in other banks are defined as cash inflows in LCR calculations.
*** LCR is defined as: LCR = Weighted liquid assets / (weighted cash outflows - weighted cash inflows) where weighted cash inflows are capped at 75% of weighted cash outflows.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

39. Liquidity and Funding risk, continued

Composition of liquid assets

The following table shows the composition of the Bank's liquidity buffer. The Bank's liquidity facility with the Icelandic Government is set to expire at year-end 2016, which will affect the Bank's LCR.

30.9.2016	ISK	USD	EUR	Other	Total
Cash and balances with Central Bank	84,407	346	333	559	85,645
Short term deposits in other banks	16,464	8,510	7,508	17,544	50,026
Domestic bonds eligible as collateral at the Central Bank	26,766	-	-	-	26,766
Foreign government bonds	-	7,135	7,333	-	14,468
Government liquidity facility	29,512	-	-	-	29,512
Covered bonds with a minimum rating of AA-	-	-	1,945	3,903	5,848
Liquidity reserve	157,149	15,991	17,119	22,006	212,265
31.12.2015
Cash and balances with Central Bank	47,357	167	252	326	48,102
Short term deposits in other banks	3,768	16,741	20,824	20,316	61,649
Domestic bonds eligible as collateral at the Central Bank	22,614	-	-	-	22,614
Foreign government bonds	-	10,658	8,700	3,984	23,342
Government liquidity facility	29,513	-	-	-	29,513
Covered bonds with a minimum rating of AA-	-	-	2,122	4,783	6,905
Liquidity reserve	103,252	27,566	31,898	29,409	192,125

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

39. Liquidity and Funding risk, continued

LCR deposit categorization

As per the LCR methodology, the Group's deposit base is split into different categories depending on customer type. A second categorization is used where term deposits refer to deposits with a residual maturity greater than 30 days. Deposits that can be withdrawn within 30 days are marked stable if the customer has a business relationship with the Group and the amount is covered by the Deposit Insurance Scheme. Other deposit funds are considered less stable. A weight is attributed to each category, representing the expected outflow under stressed conditions, i.e. the level of stickiness.

The table below shows the breakdown of the Group's deposit base according to the LCR categorization, with the associated expected stressed outflow weights. Some similar categories are grouped together. The table contains deposits at the Bank and at banking subsidiaries. Thus, amounts due to Central Bank and amounts due to credit institutions at non-banking subsidiaries are excluded.

LCR categorization - amounts and LCR outflow weights

30.9.2016	Deposits maturing within 30 days				Term deposits*	Total deposits
	Less Stable	Weight (%)	Stable	Weight (%)
Retail	95,232	10%	39,617	5%	58,594	193,443
SME	41,557	10%	4,225	5%	4,501	50,283
Corporations	52,991	40%	931	20%	5,369	59,291
Sovereigns, central-banks and PSE	18,729	40%	-	-	1,612	20,341
Financial entities being wound up	-	100%	-	-	-	-
Pension funds	31,857	100%	-	-	22,200	54,057
Domestic financial entities	27,041	100%	-	-	21,847	48,888
Foreign financial entities	2,312	100%	-	-	-	2,312
Other foreign parties	6,999	100%	3,309	25%	2,346	12,654
Total	276,718		48,082		116,469	441,269
31.12.2015
Retail	86,095	10%	39,598	5%	53,599	179,292
SME	37,884	10%	3,928	5%	4,327	46,139
Corporations	36,300	40%	823	20%	4,945	42,068
Sovereigns, central-banks and PSE	11,900	40%	-	-	1,304	13,204
Financial entities being wound up	16,948	100%	-	-	47,062	64,010
Pension funds	41,609	100%	-	-	35,104	76,713
Domestic financial entities	32,727	100%	-	-	11,016	43,743
Foreign financial entities	5,193	100%	-	-	-	5,193
Other foreign parties	3,707	100%	3,260	25%	1,923	8,890
Total	272,363		47,609		159,280	479,252

Here term deposits refer to deposits with maturities greater than 30 days.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

40. Capital management

Capital ratio

The focus of capital management at the Group is to optimize the capital structure in the medium term and consequently maintain the Group's capitalization comfortably above the regulatory minimum, including capital buffers, and SREP requirements.

The Group's capital ratios are calculated in accordance with Act No. 161/2002 on Financial Undertakings. In September 2016, amendments were made to the Act, effectively adopting parts of CRR into law. The regulation had not been fully implemented at 30 September 2016. As a result, the Act is not entirely aligned with CRR, see details in footnotes below. Capital ratios for 31 December 2015 are based on the preceding Basel II definitions. The Group uses the standardised approach to calculate the capital requirements for credit risk, credit valuation adjustment, market risk and operational risk.

Capital Base	30.9.2016	31.12.2015
Total equity	207,006	201,894
Non-controlling interest not eligible for inclusion in CET1 capital	(66)	(9,108)
Intangible assets	(11,077)	(9,285)
Tax assets	(241)	(205)
Equity holdings in financial sector entities *	(1,699)	(3,151)
Common equity Tier 1 capital**	193,923	180,145
Non-controlling interest not eligible for inclusion in CET1 capital	66	9,108
Tier 1 capital	193,989	189,253
Subordinated liabilities	-	10,365
Regulatory adjustments to Tier 2 capital ***	-	(771)
Equity holdings in financial sector entities *	-	(3,118)
General credit risk adjustments	4,633	-
Tier 2 capital	4,633	6,476
Total capital base	198,622	195,729

Risk weighted assets

Credit risk, loans	621,495	637,919
Credit risk, securities and other	42,408	43,115
Market risk FX	2,578	38,401
Market risk other	10,926	7,035
Credit valuation adjustment	815	-
Operational risk	81,441	81,441
Total risk weighted assets	759,663	807,911
Of which domestic	691,293	694,803

Capital ratios

CET1 ratio	25.5%	22.3%
Tier 1 ratio	25.5%	23.4%
Capital adequacy ratio	26.1%	24.2%
CET1 ratio, based on reviewed retained earnings at 30 June	24.5%	22.3%
Tier 1 ratio, based on reviewed retained earnings at 30 June	24.5%	23.4%
Capital adequacy ratio, based on reviewed retained earnings at 30 June	25.2%	24.2%

The Act No 161/2002 on financial undertakings states that the Bank's CET 1 holdings of instruments in financial sector entities are to be deducted from CET1, while CRR specifies a 10% threshold for such deductions. Such deductions were previously split between Tier 1 and Tier 2 capital but now apply to the corresponding type of capital instrument.
** The newly amended Act on Financial Undertakings does not specify all capital deductions as listed in CRR. A minor deduction due to additional value adjustments is expected to come into effect with the full implementation of the regulation.
*** Straight-line amortization for maturities within five years.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

40. Capital management, continued

The following table outlines the implementation of the capital buffer requirements in accordance with the Act on financial undertakings, as prescribed by the Financial Stability Council and approved by FME.

Capital buffer requirement, % of RWA	1.6.2016	1.1.2017	1.3.2017	1.11.2017
Capital conservation buffer	1.75%	2.50%	2.50%	2.50%
Capital buffer for systematically important institutions	2.00%	2.00%	2.00%	2.00%
Systemic risk buffer *	3.00%	3.00%	3.00%	3.00%
Countercyclical capital buffer *	-	-	1.00%	1.25%
Combined capital buffer requirement	6.75%	7.50%	8.50%	8.75%

The Bank carries out an on-going process, the Internal Capital Adequacy Assessment Process (ICAAP), with the aim to ensure that the Bank has in place sufficient risk management processes and systems to identify, manage and measure the Group's total risk exposure. The ICAAP is aimed at identifying and measuring the Group's risk across all risk types and ensure that the Group has sufficient capital in accordance to its risk profile. FME supervises the Group, receives the Group's internal estimation on the capital adequacy and sets capital requirements for the Group as a whole following the Supervisory Review and Evaluation Process (SREP). The Group's capital base exceeds the FME's SREP requirements.

The Bank's Pillar 2A capital add-on, which is the result of the ICAAP/SREP, may be comprised of 56.25% CET1 capital, 18.75% AT1 capital and 25% Tier 2 capital. With the current capital structure, the Pillar 2A requirement is solely met with CET1 capital.

30.9.2016	Fully implemented
Total capital requirement, % of RWA	Current	1.11.2017
Pillar 1 capital requirement	8.0%	8.0%
Pillar 2A capital requirement	4.3%	4.3%
Combined buffer requirement	6.5%	8.4%
Total regulatory capital requirement	18.8%	20.7%
Available capital	26.1%	26.1%
CET1 requirement, % of RWA
Pillar 1 CET1 requirement	4.5%	4.5%
Pillar 2A CET1 requirement	2.4%	2.4%
Combined buffer requirement	6.5%	8.4%
CET1 regulatory capital requirement	13.4%	15.3%
Available CET1 capital	25.5%	25.5%

*The capital buffers for systemic risk and countercyclical effects only apply to domestic assets.

Leverage ratio

The leverage ratio is seen as a complementary measure to the risk-based Capital adequacy ratio. The minimum leverage ratio requirement is 3% as stated in Act no. 161/2002 of financial undertakings.

	30.9.2016	31.12.2015
On-balance sheet exposures	1,010,192	982,348
Derivative exposures	7,298	3,789
Securities financing transaction exposures	12,683	16,287
Off-balance sheet exposures	83,711	127,675
Total exposure	1,113,884	1,130,099
Tier 1 capital	193,989	189,253
Leverage ratio	17.4%	16.7%

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

SIGNIFICANT ACCOUNTING POLICIES

The accounting policies adopted in the preparation of these Interim Financial Statements are consistent with those followed in the preparation of the Annual Financial Statements for the year 2015.

43. Going concern assumption

The Group's management has made an assessment of the ability to continue as a going concern and is satisfied that the Group has the resources to continue. In making this assessment, management has taken into consideration the risk exposures facing the Group which are further described in the Risk Management Disclosures. The Interim Financial Statements are prepared on a going concern basis.

Arion Bank Interim Consolidated Financial Statements 30 September 2016

Amounts are in ISK millions

Arion Bank hf. • Borgartúni 19 • 105 Reykjavík • kt. 581008-0150

AI assistant

Arion Banki — Interim / Quarterly Report 2016

2189_rns_2016-11-16_cef4f3e9-c10d-4f6b-a879-bfd82eb52640.pdf

Interim Consolidated Financial Statements

ENDORSEMENT AND STATEMENT BY THE BOARD OF DIRECTORS AND THE CEO

Outlook

Operations during the period

ENDORSEMENT AND STATEMENT BY THE BOARD OF DIRECTORS AND THE CEO

Group ownership

Endorsement of the Board of Directors and the Chief Executive Officer

INTERIM CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE PERIOD FROM 1 JANUARY TO 30 SEPTEMBER 2016

NOTES TO THE INTERIM CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE PERIOD FROM 1 JANUARY TO 30 SEPTEMBER 2016

GENERAL INFORMATION

1. Basis of preparation

Statement of compliance

Basis of measurement

Functional and presentation currency

2. Significant accounting estimates and judgements in applying accounting policies

3. The Group

OPERATING SEGMENT REPORTING

Operating segments

4. Operating segments, continued

5. Operations by quarters

NOTES TO THE INTERIM CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

6. Net interest income

7. Net fee and commission income

12. Bank levy

NOTES TO THE INTERIM CONSOLIDATED STATEMENT OF FINANCIAL POSITION

17. Cash and balances with Central Bank

18. Loans to credit institutions

19. Loans to customers

19. Loans to customers, continued

1.1.-30.9.2015

Significant accounting estimates and judgements

20. Financial instruments

21. Financial assets and financial liabilities, continued

22. Fair value hierarchy

22. Fair value hierarchy, continued

22. Fair value hierarchy, continued

31.12.2015

22. Fair value hierarchy, continued

23. Offsetting financial assets and financial liabilities

24. Investments in associates

25. Intangible assets

26. Tax assets and tax liabilities

27. Other assets

30. Subordinated liabilities

31. Pledged assets

32. Equity

OTHER INFORMATION

33. Legal matters

Contingent liabilities

Investigation and legal proceedings regarding alleged breaches of competition law

Legal proceedings regarding damages

Other legal matters

Mortgage documents

33. Legal matters, continued

Legal matters concluded

OFF BALANCE SHEET INFORMATION

34. Obligations

35. Assets under management and under custody

RELATED PARTY

36. Related party

30.9.2016

31.12.2015

RISK MANAGEMENT DISCLOSURES

37. Credit risk

Exposure to credit risk

37. Credit risk, continued

Collateral and other credit enhancements

37. Credit risk, continued

37. Credit risk, continued

31.12.2015

Large exposure

38. Market risk

Interest rate risk

Interest rate risk in the banking book

38. Market risk, continued

Interest rate risk in the trading book

38. Market risk, continued

Arion Banki Interim / Quarterly Report 2016