In 2006, we continued to build our market share in UK retail, commercial and corporate banking, increased our customer base in Europe and made good progress in building a platform for sustained growth in North America. We have also laid the foundations for a growing share in the vibrant financial services markets of the Asia Pacific region. The breadth of the Group’s businesses is reflected in our results: 42% of our operating profit came from our international operations.
Ferrovial Our Global Banking teams in both Spain and the UK worked together to secure the £15 billion of acquisition funding required by Spanish infrastructure company, Ferrovial, for the purchase of BAA. Our knowledge of both the Spanish and UK markets and global distribution capability were important attributes for Ferrovial in selecting RBS.
� RBS Corporate Banking in Manchester was the joint Mandated Lead Arranger of a £300 million revolving credit facility for Manchester Airport.
� NatWest Commercial Banking in Truro provided a £3 million funding package to help AE Rodda & Son, the largest manufacturer of Cornish clotted cream, to expand and keep up with demand from the major supermarkets.
� Total customer numbers increased by 6% to 1.7 million. Business customer numbers grew by 6% or 10,000, while personal customer numbers also grew by 6% or 90,000. Use of internet and telephone banking increased 47%.
Green Flag – Best Online Breakdown Cover Provider 2006 Your Money Awards
� We continue to reap the benefits of using UK Mail to distribute our correspondence around the country, with Royal Mail providing final delivery to our customers in a process known as ‘Downstream Access’. In 2006, 331 million items were delivered using this method, generating savings to the Group of over £10 million.
Learning Organisation Award – The One account Unisys Service Excellence Awards
� Our corporate responsibility is aligned with the interests of our customers, employees and shareholders. We succeed as a group by undertaking our business in a responsible and sustainable way.
� 87% of employees completed the Employee Opinion Survey in which RBS outperformed global peers in all 15 categories.
� Citizens Financial Group contributed $27 million to 4,500 non-profit organisations in 13 states in the US, as well as providing more than 70,000 volunteer hours, at a value of $1.2 million.
Retail comprises both the Royal Bank and NatWest retail brands, and a number of direct providers offering a full range of banking products and related financial services to the personal, premium and small business markets across several distribution channels.
Gross yield on interest-earning assets of the banking business 5.93 5.60 Cost of interest-bearing liabilities of the banking business (3.85) (3.35) Interest spread of the banking business 2.08 2.25 Benefit from interest-free funds 0.39 0.30 Net interest margin of the banking business 2.47 2.55
basis points from 2.83% to 2.35% of which 12 basis points would have been attributable to the effect of implementing IAS 32 and IAS 39 in 2004.
Comprising: Loan impairment losses 1,877 1,703 Other impairment losses 1 4 Charge to income statement 1,878 1,707
Net interest income from banking activities 3,798 3,439 Non-interest income 6,481 5,321 Total income 10,279 8,760 Direct expenses
Total assets* 472.3 409.2 Loans and advances to customers – gross*
Net interest income 4,711 4,510 Non-interest income 3,926 3,746 Total income 8,637 8,256 Direct expenses
Total banking assets 119.9 114.4 Loans and advances to customers – gross
Non-interest income rose by 4% to £3,492 million. There was strong growth in our investments and private banking businesses as well as business banking fees, mitigating the slowdown in personal loan related insurance income.
Ulster Bank made strong progress in both personal and corporate banking in the Republic of Ireland and in Northern Ireland, with total income rising by 15% to £988 million. Contribution increased by 14% to £602 million and operating profit by 20% to £388 million.
Gross claims 4,030 3,903 Reinsurers’ share (60) (76) Net claims 3,970 3,827
Group Technology costs were 1% higher at £966 million, as we achieved significant improvements in productivity balanced by investment in software development. In the biggest integration project undertaken since NatWest, we brought Ulster Bank onto the RBS technology platform.
Assets Cash and balances at central banks 6,121 4,759 Treasury and other eligible bills 5,491 5,538 Loans and advances to banks 82,606 70,587 Loans and advances to customers 466,893 417,226 Debt securities 127,251 120,965 Equity shares 13,504 9,301 Intangible assets 18,904 19,932 Property, plant and equipment 18,420 18,053 Settlement balances 7,425 6,005
Accruals, deferred income and other liabilities increased £1.4 billion, 10%, to £15.7 billion.
IFRS compared with US GAAP The Group’s financial statements are prepared in accordance with IFRS, which differ in certain material respects from US GAAP as described on pages 214 to 224.
UK banking sector, comparing a bank’s capital resources with its risk-weighted assets (the assets and off-balance sheet exposures are ‘weighted’ to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than 8% with a tier 1 component of not less than 4%. At 31 December 2006, the Group’s total RAR was 11.7% (2005 – 11.7%) and the tier 1 RAR was 7.5% (2005 – 7.6%).
These Committees are supported by Group Internal Audit and also by two dedicated group level functions, Group Risk Management (“GRM”), which has responsibility for credit, market, regulatory and enterprise risk and Group Treasury which is responsible for the management of the Group’s balance sheet, capital raising, intra group credit exposure, liquidity and hedging policies. Both functions report to GEMC and the Group Board through the Group Finance Director and play an active role in assessing and monitoring the effectiveness of the divisional risk management functions.
• Approving all credit risk models prior to implementation and reviewing existing models on at least an annual basis.
Reverse repurchase agreements as at 31 December 2006 were £117.1 billion (2005 – £90.7 billion), an increase of £26.4 billion (29%) during the year.
Distribution of credit risk assets by geography The Group operates in 43 countries, but with the majority of assets in the UK, North America and Europe.
Corporate portfolios consist of higher value, lower volume credits, which tend to be structured to meet individual customer requirements. Provisions are assessed on a case by case basis by experienced specialists, with input from professional valuers and accountants as appropriate. The Group operates a clear provisions governance framework which sets thresholds whereby suitable oversight and challenge is undertaken. These opinions and levels of provision are overseen by each division’s Provision Committee, with representation from Group Risk Management. In addition, significant cases are presented to, and challenged by, the Group Problem Exposure Review Forum.
Charge as a % of customer loans and advances – gross (1) 0.46% 0.46% 0.47%
Debt securities up to one year remaining maturity 41,957 5 68,127 11 54,068 10
The Group has been, and continues to be, actively involved in working with the various regulatory bodies to assist the development of an appropriate future regulatory liquidity regime which takes into account local national considerations but also gives due recognition to the integrated cross-border approach to the management of liquidity risk within most international banking groups.
Market risk management process GEMC approves the Group’s trading book market risk appetite, expressed in value-at-risk (“VaR”) and stress testing limits. These limits are delegated to individual trading businesses within Global Banking & Markets.
Chairman and Chief Executive Officer of Citizens Financial Group, Inc. 5. Lawrence Fish (age 62) Appointed to the Board in January 1993, Lawrence Fish is an American national. He is a career banker and was previously a director of the Federal Reserve Bank of Boston. He is a trustee of the Massachusetts Institute of Technology (MIT) and The Brookings Institution, and a director of Textron Inc. and numerous community organisations in the USA.
Group Finance Director 3. Guy Whittaker (age 50) C Appointed to the Board in February 2006, Guy Whittaker was formerly group treasurer at Citigroup Inc., based in New York, having previously held a number of management positions within the financial markets business at Citigroup. He was elected a Lady Beaufort Fellow of Christ's College Cambridge in 2004.
9. Jim Currie* (age 65) D.Litt R Appointed to the Board in November 2001, Jim Currie is a highly experienced senior international civil servant who spent many years working in Brussels and Washington. He was formerly director general at the European Commission with responsibility for the EU’s environmental policy and director general for Customs and Excise and Indirect Taxation. He is also a director of Total Upstream UK Limited and an international adviser to Eversheds. He is a special adviser to the president of the European Bank for Reconstruction and Development.
14. Joe MacHale* (age 55) A Appointed to the Board in September 2004, Joe MacHale is currently the senior independent director and chairman of the audit committee of Morgan Crucible plc, a non-executive director and chairman of the remuneration committee of Brit Insurance Holdings plc, and a trustee of MacMillan Cancer Support. He held a number of senior executive positions with J P Morgan between 1979 and 2001 and was latterly chief executive of J P Morgan Europe, Middle East and Africa Region.
Group Secretary and General Counsel 18. Miller McLean (age 57) FCIBS C Miller McLean was appointed Group Secretary in August 1994. He is a trustee of the Industry and Parliament Trust, non-executive chairman of The Whitehall and Industry Group and director of The Scottish Parliament and Business Exchange.
In the year since the RBS investment was completed in December 2005, good progress has been made in developing the partnership. The joint credit card business has already issued more than one million cards and both sides have agreed to expand its scope to include all credit cards and merchant acquiring in mainland China. Preparations have been made to open pilot offices for the joint private banking business in Beijing and Shanghai early in 2007. Co-operation in corporate banking led to the completion of over £1 billion of transactions in shipping, aviation and trade finance. RBS has provided advice in a number of key operational areas including risk management, IT and human resources.
Directors' indemnities In terms of section 309C of the Companies Act 1985 (as amended), the directors of the company, members of the Group Executive Management Committee and Approved Persons of the Group (under the Financial Services and Markets Act 2000) have been granted Qualifying Third Party Indemnity Provisions by the company.
The Board met nine times during 2006 and was supplied with comprehensive papers in advance of each Board meeting covering the Group’s principal business activities. Members of executive management attend and make regular presentations at meetings of the Board.
The report on the Board evaluation, which was designed to assist the Board in further improving its performance, was considered and discussed by the Board as a whole and a separate report on the outcomes of the evaluation of the Audit Committee was also considered and discussed by the Board. Careful consideration was given by all directors to the composition of the Board to assist the Nominations Committee in its future planning. The Board also considered the range and balance of its activities and was content that it was allocating appropriate time to such key matters as monitoring business performance, risk appetite and strategy.
Internal Control over Financial Reporting The Group is required to comply with Section 404 of the US Sarbanes-Oxley Act of 2002 and assess the effectiveness of internal control over financial reporting as of 31 December 2006.
The Audit Committee is responsible for making recommendations to the Board, for it to put the Audit Committee’s recommendations to shareholders for their approval at the Annual General Meeting in relation to the appointment, reappointment and removal of the external auditors. The Board has endorsed the Audit Committee’s recommendation that shareholders be requested to approve the reappointment of Deloitte & Touche LLP as external auditors at the Annual General Meeting in April 2007.
• Remuneration arrangements will be designed to support the company’s business strategy, to promote appropriate teamwork and to conform to best practice standards.
The above diagram has been prepared to illustrate the use of performance metrics in the total direct compensation package. For the Group Chief Executive, 21.5% of the package is fixed and 78.5% is performance related. For the executive directors, 27% is fixed and 73% is performance related. Values are entered on the basis of on-target annual performance; long term incentives are shown at the approximate expected value at grant. Pension and other benefits have been excluded. Financial metrics include profit growth, cost control and ROE.
Short-term annual incentives UK-based executive directors normally have a maximum annual incentive potential of between 160% and 200% of salary. For exceptional performance, as measured by the achievement of significant objectives, executive directors may be awarded incentive payments of up to 200% of salary, or 250% of salary, in the case of the Group Chief Executive and the Chief Executive, Corporate Markets. Awards will normally be based on the delivery of a combination of appropriate Group and individual financial and operational targets approved each year by the Remuneration Committee.
Group Finance Director – Guy Whittaker Guy Whittaker joined the Group on 1 February 2006. On recruitment, Mr Whittaker was compensated for the value of restricted stock and unvested options he forfeited on departure from his previous employer. This compensation took the form of a grant of ordinary shares in The Royal Bank of Scotland Group plc worth £1,000,000 and restricted stock worth £1,450,000, the latter vesting in three tranches between 2007 and 2009. In addition, Mr Whittaker forfeited his performance bonus from his previous employer and was compensated by a cash payment of £1,195,181 and a grant of restricted stock worth £962,785, the latter vesting in four tranches between 2007 and 2010. Mr Whittaker’s current remuneration package is in line with those of the Group’s other UK-based executive directors.
(2) From 28 April 2006, Sir George has been employed as an adviser to the Group. Under this employment agreement dated 26 April 2006, which runs until 31 July 2009, Sir George received a fee of £179,000 for his services under this agreement in 2006, comprising £150,000 in respect of certain duties performed in the connection with the handover of his responsibilities to Sir Tom McKillop in the three month period following the Annual General Meeting and thereafter at the rate of £75,000 per annum. Under this arrangement he also received medical insurance, life assurance cover and secretarial and administrative support necessary for the performance of his duties.
End of the period for Phantom 2000 units at Units awarded Market price qualifying conditions Benefits received Phantom 2000 units at 1 January 2006 during year on award to be fulfilled during year 31 December 2006
(4) The proportion of benefits represented by funded pension schemes for Sir Fred Goodwin, Gordon Pell and Lawrence Fish is 3%, 60% and 2% respectively. All benefits for Johnny Cameron, Mark Fisher and Fred Watt are in funded pension schemes.
Preference shares Mr Fish held 20,000 non-cumulative preference shares of US$0.01 each at 31 December 2006 (2005 – 20,000) and Mr Koch held 20,000 non-cumulative preference shares of US$0.01 each at 31 December 2006 (2005 – 20,000). No other director had an interest in the preference shares during the year.
The directors are required by Article 4 of the IAS Regulation (European Commission Regulation No 1606/2002) to prepare Group accounts, and as permitted by the Companies Act 1985 have elected to prepare company accounts, for each financial year in accordance with International Financial Reporting Standards as adopted by the European Union. They are responsible for preparing accounts that present fairly the financial position, financial performance and cash flows of the Group and the company. In preparing those accounts, the directors are required to: • select suitable accounting policies and then apply them consistently; • make judgements and estimates that are reasonable and prudent; and
Deferred tax assets are only recognised to the extent that it is probable that they will be recovered.
A financial liability is removed from the balance sheet when the obligation is discharged, or cancelled, or expires.
Prepayments, accrued income and other assets 20 8,136 8,798 3 147
Ordinary shares of the company with a fair value of £89 million (2005 – £78 million; 2004 – £73 million), are held by the Group’s pension schemes; £87 million (2005 – £76 million; 2004 – £71 million) in the Main scheme which also holds other financial instruments issued by the Group with a value of £258 million (2005 – £299 million; 2004 – £726 million).
The expected return on Main scheme assets at 31 December 2004 was adjusted to reflect the investment, in early January 2005, of payments made to the fund on 31 December 2004 and included as cash and other assets at that date.
Interim valuations of the Group’s schemes were prepared to 31 December by independent actuaries, using the following assumptions:
Gross gains of £34 million (2005 – £65 million) and gross losses of £19 million (2005 – £12 million) were realised on the sale of available-for-sale securities. Gross gains of £197 million and gross losses of £30 million were realised on the sale of investment securities in 2004.
Interest on non-accrual and restructured loans included in net interest income 16 Impaired and past-due financial assets 2006 2005
Disposals and write-off of fully amortised assets (108) — — (124) (232)
Contractual obligations to purchase, construct or develop investment properties or to repair, maintain or enhance investment properties 6 4
Amounts above include: Bonds and medium term notes 43,408 26,339 2,130 2,942 Certificates of deposit and other commercial paper 42,555 64,081 9 —
Life assurance business: Unit linked insurance contracts 379 325 Other linked insurance contracts 1,334 1,315 Other insurance contracts 496 659
Company 2005 – call date £m £m £m £m £m £m £m £m 28 Subordinated liabilities (continued)
US$1,250 million floating rate subordinated notes 2014 (callable July 2009) 643 732 AUD590 million 6% subordinated notes 2014 (callable October 2009) 235 254 AUD410 million floating rate subordinated notes 2014 (callable October 2009) 167 176 CAD700 million 4.25% subordinated notes 2015 (callable March 2010) 307 348
Notes: (1) On-lent to The Royal Bank of Scotland plc on a subordinated basis.
Series H US$300 million 7.25% (redeemable at option of issuer) 153 175 Series I US$300 million 8% (redeemed March 2006) — 175
Implementation of IAS 32 on 1 January 2005 — (2) — — (2) — Shares issued during the year 2 6 53 2 6 53 Shares repurchased during the year (13) — — (13) — —
Estimate of ultimate claims costs: At end of accident year 2,395 3,013 3,658 3,710 4,265 4,269 21,310
Four years later (40) (17) — — — — (57) Five years later (1) — — — — — (1)
Liability in respect of prior years 126 Claims handling costs 103
Contracts under which the Group does not accept significant insurance risk are classified as investment contracts. Long term business provisions are calculated in accordance with FRS 27 ‘Life Assurance’.
Estimations (assumptions) including future mortality, morbidity, persistency and levels of expenses are made in calculating actuarial reserves. Key metrics include: Valuation interest rate
Settlement balances and short positions 25,102 447 901 14,719 8,307 — 49,476
After 3 After 6 After 1 months months year Total Non Fair value but less but less but less interest interest through Banking Trading 3 months than than than Over 5 earning/ earning/ profit or book book or less 6 months 1 year 5 years years bearing Yield bearing loss total total Total
Assets Loans and advances to banks 1,378 178 — 1,457 4,235 7,248 6.33 4 7,252 Loans and advances to customers 286 — — — — 286 5.94 — 286 Investment in subsidiaries — — — — — — — 21,784 21,784 Other assets — — — — — — — 3 3
Designated as at fair value through profit or loss 10,499 10,499 11,068 11,068 — — — —
Service industries and business activities 9,607 100 7 7 9,721 — Agriculture, forestry and fishing 469 2 — — 471 —
Finance lease and instalment credit 10 — — — 10 — Interest accruals 44 — — — 44 — Total Rest of the World 11,546 7,594 153 9 19,302 2,277 35 Financial instruments (continued)
Other contingent liabilities – these include standby letters of credit, supporting customer debt issues and contingent liabilities relating to customer trading activities such as those arising from performance and customs bonds, warranties and indemnities.
Share capital Share capital & share premium Subordinated liabilities & share premium Subordinated liabilities £m £m £m £m £m £m £m £m
Assets – Liabilities – intangible Cost to before before assets – before acquire allocation of Allocation of allocation of Allocation of allocation of Allocation of fixed assets Manufacturing Manufacturing Manufacturing Manufacturing Manufacturing Manufacturing and intangible assets assets Assets liabilities liabilities Liabilities assets assets assets 2006 £m £m £m £m £m £m £m £m £m
(a) At 31 December 2006, the amounts outstanding in relation to transactions, arrangements and agreements entered into by authorised institutions in the Group, as defined in UK legislation, were £284,031 in respect of loans to eight persons who were directors of the company (or persons connected with them) at any time during the financial period and £1,234 to one person who was an officer of the company at any time during the financial period.
There is no concept of non-equity shares in IFRS. Instruments are classified between equity and liabilities in accordance with the substance of the contractual arrangements. A nonderivative instrument is classified as equity if it does not include a contractual obligation either to deliver cash or to exchange financial instruments with another entity under potentially unfavourable conditions, and, if the instrument will or may be settled by the issue of equity, settlement does not involve the issue of a variable number of shares. On implementation of IAS 32, non-equity shares with a balance sheet value of £3,192 million and £2,568 million of non-equity minority interests were reclassified as liabilities.
Long-term rate of return on assets 6.9 6.8 6.9 6.5 6.7
Company Elimination of foreign exchange differences and other non-cash items (28) (146) Net cash inflow from trading activities 2,499 2,381 Net cash flows from operating activities 4,531 4,413 49 Post balance sheet events There have been no significant events between the year end and the date of approval of these accounts which would require a change to or disclosure in the accounts.
Additional information 226 Financial summary 226 Amounts in accordance with IFRS
(2) Includes loss on sale of subsidiaries of £93 million in 2005.
(4) Includes purchased intangibles amortisation of £94 million for the year ended 31 December 2006 (2005 – £97 million; 2004 – £45 million).
Closing provisions for impairment as a % of total risk elements in lending and potential problem loans 62% 65% 72%
– including interest on deposits 1.90 2.04 1.83 – excluding interest on deposits 9.26 9.73 7.24
Finance lease receivables – in the US, the Group has financed lease receivables with non-recourse funding from third parties. The transactions are shown gross of third-party financing under IFRS but net under US GAAP.
In its supervisory role, the FSA sets requirements relating to matters such as consolidated supervision, capital adequacy, liquidity, large exposures, and the adequacy of accounting records and controls. Banks are required to set out their policy on ‘large exposures’ and to inform the FSA of this. The policy must be reviewed annually and any significant departures from policies must be discussed with the FSA. Large exposures must be monitored and controlled.
The FSA's high level principles require all regulated firms to treat their customers fairly. The FSA has undertaken a number of industry wide thematic reviews on this issue, and it has remained a primary supervisory theme throughout 2006. The FSA has indicated that it will include assessment of firms’ effectiveness in this area in regular risk assessments of firms.
1.6 Enforcement Where appropriate, the FSA may discipline and/or prosecute for breaches of the legislative or regulatory requirements. The FSA works closely with the criminal authorities and uses both civil and criminal powers. It can withdraw a firm's authorisation, discipline firms and individuals, prosecute for various offences and require funds to be returned to customers.
As at 31 December 2006, almost all of the company’s US$ denominated preference shares were held by shareholders registered in the US. All other shares were predominantly held by shareholders registered outside the US.
Banks and nominee companies 21,125 2,851.2 90.4 Investment trusts 163 0.6 —
Exchange controls The company has been advised that there are currently no UK laws, decrees or regulations which would prevent the import or export of capital, including the availability of cash or cash equivalents for use by the Group, or the remittance of dividends or other payments to non-UK resident holders of the company’s non-cumulative dollar preference shares.
Documents on display Documents concerning the company may be inspected at 36 St Andrew Square, Edinburgh, EH2 2YB.