Helping Customers out of Financial Difficulty: • Ulster Bank is committed to working with all customers in financial difficulty to find a solution. The Bank continued to invest in its Problem Debt Management Unit and further developed a range of solutions to make it easier for customers to enter into arrangements. As a consequence, the number of mortgage customers in arrears of 90 days or more has decreased every month since March 2013.
2013 compared with 2012 Excluding the impact of the creation of RCR, operating result improved by £494 million or 48% primarily due to a higher income and lower impairment losses on the mortgage portfolio.
The loan:deposit ratio reduced from 130% to 120% during 2013 reflecting continued customer deleveraging and low levels of demand for new lending. Retail and SME deposit balances increased by 2% during 2013, offset by a reduction in wholesale customer balances, resulting in a 2% decline in total deposit balances.
Risk-weighted assets decreased by 15% reflecting a smaller performing loan book and stabilising credit metrics.
Analysis of income by product Mortgages and home equity 716 856 744 458 540 463
Analysis of impairments by sector Residential mortgages 44 (2) 44 28 (1) 28
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) by sector Residential mortgages 0.5% — 0.5% 0.5% — 0.5%
Risk elements in lending - retail 1.5 1.3 1.0 0.9 0.8 0.6
Risk-weighted assets - credit risk - non-counterparty 83.8 82.0 83.0 50.7 50.8 53.6
Note: (1) Provision coverage percentage represents loan impairment provisions as a percentage of risk elements in lending.
• On 7 January 2014, RBSCFG announced the sale of its Chicagoarea retail branches, small business operations and select middle market relationships in the Chicago market to U.S. Bank National Association, the lead bank of U.S. Bancorp. RBSCFG will maintain a presence in Chicago through its commercial business lines and several national consumer business lines not included in the sale(1). The sale, expected to close in mid-2014 (subject to regulatory approval), includes 94 Charter One branches in the Chicago area, $5.3 billion in local deposits and $1.1 billion in locally originated loans for a deposit premium of approximately $315 million, or 6%. The proceeds will be reinvested in the remaining franchise, where we have stronger market positions and better long-term growth prospects.
Moreover, RBSCFG continued to grow its core franchise by consistently delivering a differentiated customer experience and leveraging its strong market presence (top 5 deposit market share in 8 of its top 10 Metropolitan Statistical Areas).
Furthermore, the strategic alliance with Oppenheimer allowed Commercial bankers to deliver M&A ideas and solutions that are helping us provide comprehensive solutions to our clients. This alliance won the Barlow Research Associates’ Monarch Innovation Award for “Most Innovative Product”. The award highlights RBSCFG’s commitment to making it easier for middle market companies to develop financial strategies that encompass both commercial banking and investment banking products and services.
(2) Source: SNL Financial. Based on most recent regulatory data as of Q3 2013. Market includes all US banks required to file regulatory reports.
Average loans and advances were flat, with commercial loan growth of 5% despite competition for lending opportunities offset by run-off of longterm fixed-rate consumer products.
Excluding the £47 million ($75 million) gross gain on the sale of Visa B shares in 2012, non-interest income was down £39 million ($83 million), or 4% at £1,073 million ($1,679 million), reflecting lower mortgage banking fees as refinancing volumes have slowed, and lower deposit fees. This was partially offset by higher securities gains and commercial banking fee income.
Excluding the £88 million ($138 million) litigation settlement in 2012 relating to a class action lawsuit regarding the way overdraft fees were assessed on customer accounts prior to 2010 and the £8 million ($13 million) litigation reserve associated with the sale of Visa B shares, total expenses of £2,186 million ($3,421 million) were broadly in line with prior year. This largely reflects a mortgage servicing rights impairment recapture driven by the increase in long-term rates offset by the cost of regulatory compliance and new technology investments and a one-off £21 million ($33 million) pension gain in 2012.
Impairment losses increased by £65 million ($99 million) to £156 million ($244 million) for the year and represented 0.3% of loans and advances to customers.
2012 compared with 2011 US Retail & Commercial posted an operating profit of £754 million ($1,196 million), up £217 million ($336 million), or 40%, from 2011. Excluding the £88 million ($138 million) litigation settlement in Q1 2012 and the £39 million ($62 million) net gain on the sale of Visa B shares in Q2 2012, operating profit was up £266 million ($412 million), or 50%, largely reflecting lower impairment losses due to an improved credit environment.
Net interest income was up £53 million ($47 million), or 3%, driven by targeted commercial loan growth, deposit pricing discipline and lower funding costs. This was partially offset by consumer loan run-off and lower asset yields reflecting prevailing economic conditions.
Gross loans and advances to customers were down £0.3 billion. In US dollar terms loans and advances to customers were up $3.1 billion, or 4%, due to strong growth in commercial loan volumes.
Net interest income from banking activities 159 113 79 Net fees and commissions receivable 220 318 603 Income from trading activities 2,910 3,911 3,602 Other operating income (net of related funding costs) 33 141 131 Non-interest income 3,163 4,370 4,336
Notes: (1) Includes £18 million pertaining to the creation of RCR and related strategy. (2) The ongoing businesses include the Rates, Currencies, Asset backed products and credit markets areas. (3) Divisional return on equity is based on divisional operating profit after tax divided by average notional equity (based on 10% of the monthly average of divisional RWAs, adjusted for capital deductions), for the ongoing businesses. (4) Compensation ratio is based on staff costs as a percentage of total income.
Total third party assets (excluding derivatives mark-to-market) 212.8 284.5 313.9 Net derivative assets (after netting) 15.5 21.9 37.0
Performance ratios (ongoing business) Return on equity (2) 6.8% 11.5% 4.3% Cost:income ratio 79% 65% 85%
Total third party assets (excluding derivatives mark-to-market) 198.8 259.3 278.6 Risk-weighted assets 52.1 79.1 95.5
Notes: (1) Provision coverage percentage represents loan impairment provisions as a percentage of risk elements in lending. (2) Divisional return on equity is based on divisional operating profit after tax, divided by average notional equity (based on 10% of the monthly average of divisional RWAs, adjusted for capital deductions), for ongoing businesses. (3) Compensation ratio is based on staff costs as a percentage of total income.
Markets continued In 2013, Markets launched and executed a strategic repositioning of the business, aimed at reducing risk, tightening controls, consolidating the geographic footprint and reducing complexity by refocusing on the franchise’s core strengths in fixed income products. The division met or exceeded all internal targets for reducing controllable costs, risk weighted assets and balance sheet, while meeting revenue and operating profit expectations. Controls were enhanced, trading was integrated into four financial hubs, the front-to-back operating model was simplified and an agreement was reached for the sale of the Investor Products and Equity Derivatives business. Market share in the four core product areas (Rates, Currencies, Asset Backed Products and Credit) remained broadly stable with high profile client transactions executed across the globe. As a result of the strategic repositioning, Markets ended 2013 better positioned for the changing regulatory and external environment.
Lower income in 2013 compared with 2012 reflected both the strategic scaling back of the balance sheet and risk reduction in a difficult market environment. Client activity was limited by the uncertainty that surrounded the much anticipated tapering of the Federal Reserve’s programme of quantitative easing. This contrasted with 2012 when markets were boosted by the European Central Bank’s Long Term Refinancing Operation. Nevertheless, Markets’ core businesses remained resilient and continued to produce positive results. Currencies income increased significantly year on year and Corporate Debt Capital Markets reaffirmed its leading position in the GBP market.
Currencies income increased as the franchise remained resilient and FX Options benefited from opportunities in volatile FX and emerging markets.
Asset Backed Products continued to perform well, although income was affected by investor concerns regarding tapering of the Federal Reserve’s programme of quantitative easing and a reduction in the balance sheet and risk resources deployed by the business.
The increase in impairments was driven predominantly by provisions against a single exposure in 2013.
2012 compared with 2011 Operating profit increased by 68% reflecting 2% growth in income and 20% decrease in direct expenses, most notably through a reduction in staff costs.
The division focused on controlling costs throughout 2012, driving total expenses down by 16%. Lower staff expenses, down 26%, reflect lower headcount and lower levels of variable compensation, including reductions and clawbacks following the Group’s LIBOR settlements reached on 6 February 2013, with the compensation ratio falling from 44% to 32%. Headcount reductions totalled 2,700 in the year, including that resulting from the exit of businesses announced in January. Other expenses fell by 3% as rigorous controls on discretionary expenditure and the exiting of product areas continued to take effect, partially offset by higher legal expenses.
Not reflected in Markets operating results in 2012 were the following items: £381 million for regulatory fines; £350 million for its share of the provision for interest rate swap redress; and approximately £700 million in restructuring costs associated with the strategic changes that took place during 2012.
This has been principally driven by higher unallocated Treasury and funding costs, £175 million higher, including volatile items under IFRS and lower gains on Treasury available-for-sale securities, down £156 million from £880 million in 2012 to £724 million in 2013.
Central items included various legacy litigation and conduct provisions totalling £127 million for 2013, a reduction of £33 million compared with 2012, and a property-related impairment of £65 million which have been offset by the non-repeat of £175 million costs incurred in 2012 in relation to the technology incident and credits totalling £80 million recognised in relation to the Group’s share of profit from its stake in Saudi Hollandi, which was held as a disposal group in 2012.
Significant central costs included the Group technology incident cost of £175 million, a £160 million provision for various litigation and legacy conduct issues, as well as unallocated Treasury costs of circa £390 million. VAT recoveries of £85 million and Group Pension fund adjustment of circa £50 million in 2011 were not repeated.
Net interest income (61) 346 828 Net fees and commissions 55 105 54 Loss from trading activities (148) (654) (721) Other operating income - rental income 142 421 743
Analysis of (loss)/income by business Banking & portfolios (496) 40 1,251
Loss from trading activities Monoline exposures (46) (205) (670) Credit derivative product companies (5) (205) (85)
Notes: (1) Includes losses on disposals of £221 million for 2013 (2012 - £14 million; 2011 - £127 million). (2) Asset-backed products include super asset backed structures and other asset-backed products. (3) Pertaining to the creation of RCR and related strategy. (4) Includes disposal groups.
Total third party assets (excluding derivatives) 28.0 57.4 92.5 Total third party assets (including derivatives) 31.2 63.4 103.6
Third party assets (excluding derivatives) Banking & portfolios 25.9 51.1 80.1
Third party assets (excluding derivatives) £bn £bn £bn £bn £bn £bn £bn
Notes: (1) Excludes disposal groups. (2) Provision coverage percentage represents loan impairment provisions as a percentage of risk elements in lending. (3) Disposals of £0.8 billion have been signed as at 31 December 2013 but are pending completion (2012 and 2011 - £0.2 billion).
UK (excluding NI) 4.7 8.9 11.4 Ireland (ROI and NI) 2.3 5.8 7.7
UK Corporate Manufacturing and infrastructure 60 19 76 Property and construction 228 88 224
Commercial real estate 9 (12) 40 Commercial and other (3) (12) (3) Total US Retail & Commercial 156 177 303
Telecoms, media and technology 24 32 68 Banking and financial institutions (49) (58) (98)
Gross loans and advances to customers (excluding reverse repurchase agreements) by 2013 2012 2011 donating division and sector £bn £bn £bn
UK Corporate Manufacturing and infrastructure — 0.1 0.1 Property and construction 1.7 3.6 5.9
US Retail & Commercial Auto and consumer 0.2 0.6 0.8 Cards — — 0.1 SBO/home equity 1.5 2.0 2.5
Commercial real estate 0.2 0.4 1.0 Commercial and other 0.1 0.1 0.4 Total US Retail & Commercial 2.3 3.5 5.4
Other Wealth — — 0.2 Central items — — (0.2) Total Other — — —
Gross loans and advances to customers (excluding reverse repurchase agreements) 35.6 55.4 79.3
Non-Core has successfully achieved and surpassed its five year Strategic Plan target, reducing third party assets from the opening £258 billion position to end 2013 significantly below the original c.£40 billion target at £28 billion. Over the life of Non-Core this represents an overall reduction of £230 billion, or 89%. This was achieved through a mixture of disposals, run-off and impairments. By the end of 2013, the Non-Core funded balance sheet was c.4% of the Group’s funded balance sheet compared with 21% when the division was created. RWAs have reduced from £171 billion to £29 billion, or 83%, over the life of Non-Core.
2013 is the final reporting period for the Non-Core division. Approximately £12 billion of assets which were managed by Non-Core are to be returned to the relevant Core divisions, with the remaining assets transferring to RCR from 1 January 2014.
2013 compared with 2012 Third party assets declined by £29 billion, or 51%, reflecting run-off of £15 billion, disposals of £11 billion and impairments of £5 billion, of which £3.1 billion is driven by the new RCR strategy to exit these assets over a shorter timeframe than previous plans.
The reduction in net interest income of £407 million was driven by a 31% fall in interest earning assets driven by run-off and disposals.
Risk-weighted assets were £33 billion lower, principally driven by disposals, run-off and restructuring of existing positions.
Headcount declined by 29% to 2,900 reflecting the divestment activity and run-off across the business.
RBS Capital Resolution Background In June 2013, in response to a recommendation by the Parliamentary Commission on Banking Standards, the UK Government announced it would review the case for an external ‘bad bank’, based on three objectives as originally outlined by the Chancellor: • accelerating the return of RBS to the private sector; • supporting the British economy; and • best value for the taxpayer.
Following this announcement, RBS worked closely with HM Treasury (‘HMT’) and its advisers to identify a pool of assets with particularly high long-term capital intensity, credit risk, low returns and/or potential stress loss in varying scenarios. The balance of this identified pool was £47 billion as at 30 June 2013. The pool was forecast to be c.£38 billion of assets as at 31 December 2013, which together with derivatives were forecast to attract c.£116 billion of RWA equivalents(1).
Going forward, as part of its external reporting, the Group will provide comprehensive and transparent disclosures on the progress of RCR, including funding and capital employed and released. Furthermore, a Board Oversight Committee (‘BOC’) has been set up reporting directly to the Group Board, to report on adherence to asset management principles and recommend changes to strategy where appropriate. The BOC comprises a quorum of any two of the Chairman of the Group Board, the Senior Independent Director, the Chair of the Group Audit Committee and the Chair of the Board Risk Committee.
While there are inevitable uncertain market and execution risks associated with running down such assets, it is RBSs aspiration, subject to shareholder value, to remove most of these assets and capital from the balance sheet in three years. RCR will target a reduction in funded assets to c.£23 billion by the end of 2014; to between £15 billion and £11 billion by the end of 2015 and to less than £6 billion by the end of 2016. RCR is expected to be Common Equity Tier 1 (‘CET1’) accretive over its life and is neutral for shareholder value, taking into account future regulatory capital requirements.
• there were materially higher levels of disposal activity and recoveries (£5 billion) in Non-Core than had been forecast based on 30 June 2013 data, with a capital impact of £14 billion reduction in RWAe.
At 1 January 2014, 48% of the portfolio’s funded assets are from NonCore (excluding Ulster Bank), 17% from Ulster Bank (Core and NonCore ) and the remainder are from UK Corporate, International Banking and Markets.
Note: (1) RWA equivalent (RWAe) is an internal metric that measures the equity capital employed in divisions. RWAe converts both performing and non-performing exposures into a consistent capital measure, being the sum of the regulatory RWAs and the regulatory capital deductions, the latter converted to RWAe by applying a multiplier. The Group applies a CET 1 ratio of 10%, consistent with that used for divisional return on equity measure; this results in an FLB3 RWAe conversion multiplier of 10.
Estimated balance at 30 June 2013 46.8 Disposals (a) (6.0) Run-off (b) (4.8) Impairments (c) (5.2) Other (d) (1.9) Balance at 31 December 2013 28.9
Notes (a) disposals in the second half of the year, predominantly in Non-Core. (b) represents repayments and amortisations, partially offset by draw down of facilities across the portfolios. (c) includes all impairments in the second half of 2013, predominately in Non-Core, and reflects increased impairments relating to the creation of RCR and the related strategy. (d) other includes fair value adjustments, foreign exchange movements (£1.2 billion) and finalisation of the asset pool.
Estimated balance at 30 June 2013 136.8 Disposals (a) (11.9) Run-off (b) (10.9) Impairments (c) (45.1) Other (d) (3.9) Balance at 31 December 2013 65.0
Notes: (a) includes all aspects relating to disposals including associated removal of deductions from regulatory capital. (b) represents RWAe on repayments and amortisations, partially offset by draw down of facilities across the portfolios. (c) RWAe impairment charge. (d) other includes fair value adjustments; changes to inputs for RWA calculation (including LGD, PD, and slotting category); the implementation of a new RWA model or modification of an existing model approved by the PRA, foreign exchange movements and finalisation of the asset pool.
The £18 billion decrease in funded assets in the second half of the year resulted in a significantly higher reduction of £72 billion in RWAe. This was due to: • impairments of £5 billion recognised in the second half of 2013 resulted in a lower capital deduction for the excess of expected loss over provisions. Allowing for a restriction in provisions allowable against expected losses, the benefit was £4.5 billion or £45 billion of RWAe. • disposals of £6 billion resulting in RWAe of £12 billion. • run-off of £5 billion with a corresponding RWAe of £11 billion.
Estimated funded assets (third party assets excluding derivatives or TPA) and RWAe of RCR Analysis of the funded assets and RWAe of RCR at 31 December 2013 and the related position at 30 June 2013 (the starting point for the identification of the portfolios of RCR), are set out below. Non-performing (1) Performing (1) Total
Gross Net Capital Gross Net Capital Gross Net Capital TPA TPA RWAe RWA deducts TPA TPA RWAe RWA deducts (2) TPA TPA RWAe RWA deducts 31 December 2013 £bn £bn £bn £bn £m £bn £bn £bn £bn £m £bn £bn £bn £bn £m
Cash and balances at central banks 82,659 79,290 79,269 Net loans and advances to banks 27,555 29,168 43,870 Reverse repurchase agreements and stock borrowing 26,516 34,783 39,440 Loans and advances to banks 54,071 63,951 83,310 Net loans and advances to customers 390,825 430,088 454,112 Reverse repurchase agreements and stock borrowing 49,897 70,047 61,494 Loans and advances to customers 440,722 500,135 515,606 Debt securities subject to repurchase agreements 55,554 91,173 79,480 Other debt securities 58,045 66,265 129,600
Liabilities Bank deposits 35,329 57,073 69,113 Repurchase agreements and stock lending 28,650 44,332 39,691 Deposits by banks 63,979 101,405 108,804
Accruals, deferred income and other liabilities 16,017 14,801 23,204 Retirement benefit liabilities 3,210 3,884 2,239
Total liabilities and equity 1,027,878 1,312,295 1,506,867 *Restated - see page 102.
Debt securities were down £43.8 billion, 28%, to £113.6 billion, driven mainly by reductions within Markets and Group Treasury in holdings of UK and Eurozone government securities and financial institution bonds.
The decrease in assets and liabilities of disposal groups, down £11.0 billion, 78%, to £3.0 billion, and £6.8 billion, 67%, to £3.4 billion respectively, primarily reflects the deconsolidation of Direct Line Group following the further sale of shares and ceding of control in 2013. The remaining interest, classified as an associate, is included in assets of disposal groups at 31 December 2013. In addition, disposal groups include loans and deposits in Illinois branches for sale in US Retail & Commercial.
Deposits by banks decreased £37.4 billion, 37%, to £64.0 billion, with decreases in inter-bank deposits, down £21.7 billion, 38%, to £35.3 billion and repurchase agreements and stock lending (‘repos’), down £15.7 billion, 35%, to £28.7 billion, as a result of the Group’s lower funding requirements and reduced derivative cash collateral.
Owner’s equity decreased by £9.9 billion, 14%, to £58.7 billion, driven by the £9.0 billion attributable loss for the year together with movements in cash flow hedging reserves, £1.7 billion and foreign exchange reserves, £0.2 billion. Partially offsetting these reductions were share issuances of £0.4 billion, the termination of the contingent capital facility, £0.3 billion, the recognition of actuarial gains in respect of the Group’s defined benefit pension schemes, net of tax, £0.2 billion and other reserve movements, £0.1 billion.
Loans and advances to customers declined £15.5 billion, 3%, to £500.1 billion. Within this, reverse repurchase agreements were up £8.6 billion, 14%, to £70.0 billion. Customer lending decreased by £24.0 billion, 5%, to £430.1 billion, or £22.6 billion to £451.2 billion before impairments. This reflected reductions in Non-Core of £22.6 billion, along with declines in International Banking, £14.3 billion, UK Corporate, £2.9 billion, Markets, £1.0 billion and Ulster Bank, £0.7 billion, together with the effect of exchange rate and other movements, £4.7 billion. These were partially offset by the transfer from disposal groups of £18.9 billion of customer balances relating to the UK branch-based businesses, together with underlying growth in UK Retail, £2.6 billion, US Retail & Commercial, £1.9 billion and Wealth, £0.2 billion.
Settlement balance assets and liabilities decreased £2.0 billion to £5.7 billion and £1.6 billion to £5.9 billion respectively reflecting the overall reduction in the size of the balance sheet.
Intangible assets decreased £1.3 billion, 9%, to £13.5 billion, primarily as a result of write-down of the Direct Line Group goodwill, £0.4 billion, and the transfer of the remaining £0.5 billion of goodwill together with £0.2 billion of other intangible assets to assets of disposal groups at 31 December 2012.
Customer accounts increased £18.3 billion, 4%, to £521.3 billion. Within this, repos decreased £0.8 billion, 1%, to £88.0 billion. Excluding repos, customer deposits were up £19.1 billion, 5%, at £433.2 billion, primarily reflecting the transfer from disposal groups of £21.5 billion of customer accounts relating to the UK branch-based businesses together with underlying increases in UK Retail, £6.0 billion, International Banking, £2.0 million, US Retail & Commercial, £1.8 billion, UK Corporate, £0.8 billion, Ulster Bank, £0.7 billion and Wealth, £0.7 billion. This was partially offset by decreases in Markets, £9.7 billion, and Non-Core, £0.9 billion, together with exchange and other movements £3.8 billion.
Short positions were down £13.4 billion, 33%, to £27.6 billion mirroring decreases in debt securities.
Retirement benefit liabilities increased by £1.6 billion, 73%, to £3.9 billion with net actuarial losses of £2.3 billion on the Group's defined benefit pension schemes, primarily arising from significant reductions in the real discount rates in the Sterling, Euro and US dollar currency zones. These were partially offset by the £0.6 billion excess of employer contributions paid over the current year pension charge.
Owner’s equity decreased by £6.7 billion, 9%, to £68.7 billion, driven by the £6.1 billion attributable loss for the period together with movements in foreign exchange reserves, £0.9 billion, the recognition of actuarial losses in respect of the Group’s defined benefit pension schemes, net of tax, £1.8 billion, and other reserve movements of £0.2 billion. Partially offsetting these reductions were gains in available-for-sale reserves, £0.6 billion, and cash flow hedging reserves, £0.8 billion, share capital and reserve movements in respect of employee share schemes, £0.8 billion and other share issuances of £1.0 billion.
2012 The major factors contributing to the net cash outflow from operating activities of £45,113 million were the decrease of £48,736 million in operating assets and liabilities, the net operating loss before tax of £5,388 million from continuing and discontinued operations, loans and advances written off net of recoveries of £3,925 million and other noncash items of £1,491 million. These were partially offset by the elimination of foreign exchange differences of £7,140 million, provisions for impairment losses of £5,283 million and depreciation and amortisation of £1,854 million.
2011 The major factors contributing to the net cash inflow from operating activities of £3,325 million were the elimination of foreign exchange differences of £2,702 million, depreciation and amortisation of £1,875 million and inflow from other items of £3,106 million, partially offset by the net operating loss before tax of £914 million from continuing and discontinued operations and the decrease of £3,444 million in operating assets and liabilities.
Capital resources The following table analyses the Group's regulatory capital resources on a fully consolidated basis at 31 December as monitored by the Prudential Regulation Authority (PRA) for regulatory purposes. 2013 2012 2011 2010 2009 £m £m £m £m £m
It is the Group's policy to maintain a strong capital base, to expand it as appropriate and to utilise it efficiently throughout its activities to optimise the return to shareholders while maintaining a prudent relationship between the capital base and the underlying risks of the business. In carrying out this policy, the Group has regard to the supervisory requirements of the PRA. The PRA uses risk asset ratio (RAR) as a measure of capital adequacy in the 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 2013, the Group's total RAR was 16.5% (2012 - 14.5%) and the Tier 1 RAR was 13.1% (2012 -12.4%). For further information refer to Risk and Balance sheet management: Capital management on pages 192 to 208.
Reconciliations of managed to statutory income statements Basis of preparation of managed results The financial information on a managed basis, prepared using the Group’s accounting policies, shows the underlying performance of the Group which excludes certain one-off and other items which are listed on page 102. This information is provided to give a better understanding of the results of the Group’s operations.
Operating profit before impairment losses 6,129 (5,940) 189 Impairment losses (8,432) — (8,432)
Own credit adjustments (120) 120 — Payment Protection Insurance costs (900) 900 — Interest Rate Hedging Products redress and related costs (550) 550 — Regulatory and legal actions (2,394) 2,394 — Integration and restructuring costs (656) 656 — Gain on redemption of own debt 175 (175) — Write-down of goodwill (1,059) 1,059 — Amortisation of purchased intangible assets (153) 153 — Strategic disposals 161 (161) — Bank levy (200) 200 — Write-down of other intangible assets (344) 344 — RFS Holdings minority interest 100 (100) — Operating loss before tax (8,243) — (8,243) Tax charge (382) — (382) Loss from continuing operations (8,625) — (8,625) Profit from discontinued operations, net of tax - Direct Line Group 127 — 127
Analysis of balance sheet pre and post disposal groups In accordance with IFRS 5 assets and liabilities of disposal groups are presented as a single line on the face of the balance sheet. As allowed by IFRS, disposal groups are included within risk measures in the Risk and balance sheet management section.
Cash and balances at central banks 82,659 2 82,661 79,290 18 79,308 79,269 127 79,396 Net loans and advances to banks 27,555 22 27,577 29,168 2,112 31,280 43,870 87 43,957 Reverse repos 26,516 41 26,557 34,783 — 34,783 39,440 — 39,440 Loans and advances to banks 54,071 63 54,134 63,951 2,112 66,063 83,310 87 83,397 Net loans and advances to customers 390,825 1,765 392,590 430,088 1,863 431,951 454,112 19,405 473,517 Reverse repos 49,897 — 49,897 70,047 — 70,047 61,494 — 61,494 Loans and advances to customers 440,722 1,765 442,487 500,135 1,863 501,998 515,606 19,405 535,011 Debt securities 113,599 24 113,623 157,438 7,186 164,624 209,080 — 209,080 Equity shares 8,811 — 8,811 15,232 5 15,237 15,183 5 15,188 Settlement balances 5,591 — 5,591 5,741 — 5,741 7,771 14 7,785 Derivatives 288,039 1 288,040 441,903 15 441,918 529,618 439 530,057 Intangible assets 12,368 30 12,398 13,545 750 14,295 14,858 15 14,873 Property, plant and equipment 7,909 32 7,941 9,784 223 10,007 11,868 4,749 16,617 Deferred tax 3,478 1 3,479 3,443 — 3,443 3,878 — 3,878 Other financial assets — — — — 924 924 1,309 — 1,309 Prepayments, accrued income and other assets 7,614 936 8,550 7,820 742 8,562 9,667 456 10,123 Assets of disposal groups 3,017 (2,854) 163 14,013 (13,838) 175 25,450 (25,297) 153 Total assets 1,027,878 — 1,027,878 1,312,295 — 1,312,295 1,506,867 — 1,506,867
Gross of Gross of Gross of Balance Disposal disposal Balance Disposal disposal Balance Disposal disposal sheet groups (1) groups sheet groups (2) groups sheet groups (3) groups £m £m £m £m £m £m £m £m £m
Gross loans and advances to customers 415,978 1,774 417,752 451,224 1,875 453,099 473,872 20,196 494,068 Customer loan impairment provisions (25,153) (9) (25,162) (21,136) (12) (21,148) (19,760) (791) (20,551) Net loans and advances to customers (4) 390,825 1,765 392,590 430,088 1,863 431,951 454,112 19,405 473,517
Gross loans and advances to banks 27,618 22 27,640 29,282 2,112 31,394 43,993 87 44,080 Bank loan impairment provisions (63) — (63) (114) — (114) (123) — (123) Net loans and advances to banks (4) 27,555 22 27,577 29,168 2,112 31,280 43,870 87 43,957
Gross unrealised gains on debt securities 1,541 — 1,541 3,946 230 4,176 4,978 — 4,978 Gross unrealised losses on debt securities (887) — (887) (1,832) (15) (1,847) (3,408) — (3,408)
Risk governance 176 Governance structure 176 Risk management 177 Conduct and Regulatory Affairs 177 Business model 178 Risk events and lessons learned 179 Top and emerging risk scenarios 181 Stress testing
To enable the Group Board to carry out its objectives, it delegates authority to various committees as required and appropriate. A number of key committees specifically consider risk across the Group: Group Board - Sets and owns the Group’s risk appetite, which is cascaded across its divisions, functions and material legal entities. The Group Board also sets the Group’s strategic direction and carries out regular assessments to ensure that strategic plans are consistent with risk appetite.
Board Risk Committee - Provides oversight and advice on current and potential risk exposures, risk strategy and tolerance. The Committee also promotes a risk awareness culture within the Group.
Executive Risk Forum - Provides executive input to the Group Board and the Group Executive Committee on risk management issues such as risk appetite, risk policies and risk management strategies. It has full authority to act on all material and/or enterprise-wide risk and control matters across the Group and implements Group Board and Group Executive Committee risk management decisions.
Group Risk Committee - Oversees and acts on material and enterprisewide risk and control matters across the Group. It reviews and challenges risks and limits across the functional areas. It reviews risks and issues on both a thematic and specific basis, focusing on forward-looking, emerging risks. It considers the overall risk profile across the Group and identifies any key issues for escalation to the Executive Risk Forum. It operates under delegated authority from the Executive Risk Forum.
Risk management The Group Chief Risk Officer leads RBS Risk Management through the strategic setting and execution of its responsibilities. The Group Chief Risk Officer reports directly to the Group Chief Executive and the Board Risk Committee, with a right of access to the Chairman of the Board Risk Committee.
In RBS Risk Management, the following Group risk functional heads report directly to the Group Chief Risk Officer and are responsible for Group-wide risk appetite and standards under their respective disciplines: • Group Head of Operational Risk; • Group Chief Credit Officer; • Head of Enterprise Risk Management; • Head of Global Country Risk; and
The following functional heads report directly to the Group Head of Conduct and Regulatory Affairs, each of whom is responsible for the firmwide risk appetite and standards of their respective disciplines: the Global Head of Compliance; the Global Head of Financial Crime; and the Director, RBS Regulatory Affairs.
A Chief Compliance Officer in each division (reporting to the Global Head of Compliance) provides advisory support to assist the divisions’ management of conduct, regulatory affairs and financial crime.
Three lines of defence The three lines of defence is an industry-wide model for the management of risk, understood as a clear set of principles by which to implement a cohesive operating model across an organisation. The model’s main purpose is to define accountabilities and responsibilities for managing risk across the organisation.
In addition, Ulster Bank and Citizens Bank, offer loan and investment products, as well as transactional services, to individuals and corporations. The customers of Ulster Bank are in Ireland while those of Citizens Bank are in the US. The Group delivers its products through a diverse array of channels, including extensive branch networks, in-store branches and call centres, in addition to online and mobile channels.
It is the aim of the Group to become a bank that customers, and all other stakeholders, can depend on. It intends to do so by focusing on its core retail and corporate customers in its main market of the UK. It plans to simplify its products and services as well as the processes it uses to deliver them, enhancing their appeal. Simplifying processes should also lower costs, enabling the bank to provide customers with better products and services at lower prices.
Risk governance* continued Business model continued Over the last few years, the Group has either exited or sold a number of businesses in order to align its cost structure with its smaller scope and scale. In addition, it is reducing costs through rationalisation, integration and simplification. For example, UK Retail is rationalising its service delivery channels and simplifying the operations that support them, using the resulting cost savings to invest in new technology and providing additional channels for customers such as mobile banking. A number of other divisions are taking similar steps.
The Group also faces a range of other risks. As measured by riskweighted assets (RWAs), the most significant of these is credit risk, which consists of counterparty and non-counterparty credit risk. Credit risk arises from its lending activities in all divisions. Counterparty credit risk arises from its security financing and derivative trading activities. This is concentrated in Markets.
The second most significant source of risk is market risk, which arises from the Group’s trading activities (traded market risk) and from the impact of changes in market prices on the value of its other financial assets and liabilities (non-traded market risk). Traded market risk is concentrated in Markets while non-traded market risk is distributed across the Group and with the exception of US Retail & Commercial and Markets, these divisions transfer this risk to Group Treasury for management.
Operational risk, which arises from all of the Group’s business activities, is the third most significant source of risk as measured by RWAs. Its importance is increasing as a result of changes driven by regulation as well as the Group’s strategy.
The activities of several divisions, particularly Markets and International Banking, but also Ulster Bank and US Retail & Commercial, expose the Group to country risk.
Risk events and lessons learned LIBOR related settlements The Group reached settlements with the Financial Services Authority (FSA) in the United Kingdom, the United States Commodity Futures Trading Commission (CFTC) and the United States Department of Justice (DOJ) on 8 February 2013 in relation to investigations into submissions, communications and procedures around the setting of the London Interbank Offered Rate (LIBOR). The Group agreed to pay penalties of £87.5 million, $325 million and $150 million to the FSA, CFTC and DOJ respectively. As part of the settlement with the DOJ, RBS plc entered into a Deferred Prosecution Agreement on one count of wire fraud relating to Swiss Franc LIBOR, and one count for an anti-trust violation relating to Yen LIBOR. RBS Securities Japan Limited also agreed to enter a plea of guilty to one count of wire fraud relating to Yen LIBOR.
Industry-wide investigations were made into the setting of certain benchmark rates across a range of currencies. Regulators found wrongdoing on the part of 21 RBS employees, predominantly in the setting of the bank's Yen and Swiss Franc LIBOR submissions.
Both before and after these findings were issued, management took action to strengthen significantly the systems and controls governing its LIBOR submissions: the Group created an independent and ring-fenced rate-setting team; all relevant staff were obliged to undertake a comprehensive training programme; and new preventative and detective controls put in place, including monitoring and statistical checking of submissions by independent personnel in the Group. A rate setting review board was also created to oversee the submission process.
For more information on LIBOR related settlements, refer to page 477.
Top and emerging risk scenarios As part of its risk management process, the Group identifies and monitors its top and emerging risk scenarios. These are events that, should they materialise, would lead to a significant unexpected negative outcome, thereby causing the Group as a whole, or a particular division, to fail to meet one or more strategic objectives. In assessing the potential impact of risk materialisation, the Group takes into account both financial and reputational considerations.
Management is concerned with a range of risk scenarios. However, a small number attracted particular attention from senior management during the past year. These were grouped into four broad categories: • Macroeconomic risks; • Conduct, regulatory and legal risks; • Risks related to the Group’s operations; and • Political risk.
The Group’s top and emerging risks are as follows: Macroeconomic risks
Mitigants Optimisation of the Group’s shipping and a significant proportion of commercial real estate portfolios is part of Capital Resolution Group strategy.
(ii) Increased impairments arising from a more severe than expected economic downturn The Group’s return to profitability depends on the economic recovery of its major markets. If their recovery is slower than expected, the Group’s return to profitability and private ownership may also be deferred. All divisions could be affected.
Mitigants The Group develops business plans to take into account the possibility of slow economic growth and implemented strategies, such as cost reductions, to reduce its vulnerability.
Impact on the Group As asset values were lower and liabilities higher when valued most recently, the Group may be required to set aside additional capital in support of the schemes. The amount of additional capital required depends on the size of the shortfall when the assets are valued as well as the efficacy, and acceptability to the regulator, of management actions undertaken to address it.
Mitigants The trustee is responsible for the investment of the main scheme’s assets, which are held separately from the assets of the Group.
Mitigants In order to address this risk, during the year the Group continued to embed good conduct at the heart of the business to ensure fair outcomes for customers.
(ii) Losses or reputational damage arising from litigation Given its diverse operations, the Group is exposed to the risk of litigation. For example, during the course of 2013, it was subject to shareholder litigation, securities related litigation, various class actions claims, including those related to LIBOR and foreign exchange trading, and mass consumer claims such as those related to Payment Protection Insurance and interest rate hedging products. This risk affects all of the Group's divisions.
Mitigants The Group defends claims against it to the best of its ability and it cooperates fully with various governmental and regulatory authorities.
(iii) Increased costs arising from a failure to demonstrate compliance with existing regulatory requirements related to conduct, particularly with respect to mis-selling The Group is subject to regulation governing the conduct of its business activities. For example, it must ensure that it sells its products and services only to informed customers. This affects all divisions.
Impact on the Group If the Group sells products to uninformed customers, or fails to handle complaints well, it may be subject to fines, incur remediation costs or even be subject to criminal charges. It may also suffer significant damage to its reputation.
Mitigants The Group has participated in an industry-wide cyber attack simulation. It has also initiated a large scale programme to improve controls over user access. In addition, it has reviewed its websites and taken steps to rationalise them, put additional anti-virus protections in place and taken steps to educate staff on information protection.
Impact on the Group If the Group does not complete these projects successfully, the interests of customers may be affected, necessitating customer redress. The Group may also incur regulatory fines, lose market share and suffer damage to its reputation.
Impact on the Group If it cannot retain or attract the necessary staff members, the Group may be unable to implement its business strategies or meet regulatory requirements on time, or at all. It may also experience control failures. The Group’s reputation may suffer as a result.
The Group and the Royal Bank, its principal operating subsidiary, are both headquartered and incorporated in Scotland. The Scottish Government is holding a referendum in September 2014 on the question of Scottish independence from the UK. Although the outcome of the referendum is uncertain, subject to any mitigating factors, the uncertainties resulting from an affirmative vote in favour of independence would be likely to significantly impact the Group’s credit ratings and could also impact the fiscal, monetary, legal and regulatory landscape to which the Group is subject. Were Scotland to become independent, it may also affect Scotland’s status in the European Union.
Stress testing Governance Stress testing is the evaluation of a bank’s financial position under severe but plausible stress scenarios. Stress testing also refers to the broader framework under which these tests are developed, evaluated and used within the Group’s decision-making process in the context of the wider economic environment.
The Group’s stress testing framework is designed to embed stress testing as a key risk management technique into mainstream risk reporting, capital planning and business processes at divisional, legal entity and Group levels.
The Board Risk Committee receives reports detailing stress tests undertaken as part of the financial planning process. It reviews and challenges the stress scenarios and considers their impact on the Group's financial position. These reports outline relevant management actions as well as the extent to which such actions mitigate the effects of the stress scenario on the Group’s capital adequacy.
Another test run in 2013 is a high inflation-no growth scenario. Inflationary pressures surge as a result of the growth in central bank balance sheets in recent years. Sovereign bond yields rise steeply as market sentiment sours, and there is a reduction in disposable income and corporate profits, leading to a global recession. Recovery begins only in late 2014. As the bank’s risk profile improves as a result of deleveraging, it should be better able to withstand extreme stress scenarios.
Risk governance* continued Stress testing continued Methodologies Stress testing is part of the financial planning process and is conducted and presented to senior management semi-annually. Once simply conducted principally to meet regulatory requirements, it is now an integral part of enterprise risk management and used to assess the impact of business decisions on the Group's capital position.
Risk-type specific stress testing is also conducted. For example, within the market risk management framework, a comprehensive programme of stress tests covers a variety of historical and hypothetical scenarios. Reverse stress testing, explicitly identifying and assessing scenarios most likely to render the bank’s business model unviable, is also conducted as required by the PRA. In order to cross the business model failure threshold, an instantaneous one year global shock of a similar scale as the 2008 financial crisis is required, but the impact of such a scenario is more likely to be felt over multiple years. Future revenues, and the gradual disposal of Non-Core assets, would partially offset losses, making failure much less likely.
Risk appetite 184 Strategic risk objectives 185 Risk appetite measures 185 - Divisional risk appetite statements 185 - Risk control frameworks and limits 186 Culture, values and remuneration 186 - Objectives for risk culture 186 - Risk culture policies 186 - Training 186 - Challenge mechanisms 186 - Risk-based key performance indicators 187 - Risk coverage
The Group’s risk appetite is set and owned by the Group Board which identifies and establishes the level and types of risks the Group is able and willing to take in order to meet its: • Strategic objectives - the Group’s strategic plan is built on the core foundations of serving customers well, building a sustainable risk profile and creating long-term value for its shareholders; and
The Board Risk Committee reviews the Group’s risk appetite framework and targets on an annual basis to ensure they remain aligned with strategic objectives, business performance, emerging risks and changes in the external environment.
Given this central aim, in 2009 the Group Board set out four key strategic objectives, aligned with the Group’s strategic plan.
• Deliver stable earnings growth. To ensure that strategic growth is based around a longer-term risk versus reward consideration, with significantly lower volatility in underlying profitability than was seen during the financial crisis.
• Ensure stable and efficient access to funding and liquidity. To ensure that the Group has sufficient funding to meet its obligations, taking account of the constraint that some forms of funding may not be available when they are most needed.
• Maintain stakeholder confidence. To ensure that stakeholders have confidence in the Group’s recovery plan, its ability to deliver its strategic objectives and the effectiveness of its business culture and operational controls.
Each objective is essential in its own right, but also mutually supportive of the others. The strategic risk objectives are the bridge between the Group-level business strategy and the frameworks, limits and tolerances that are used to set risk appetite and manage risk in the business divisions on a day-to-day basis.
• Quantitative risk appetite targets - Risk appetite is also aligned with potential risk exposures and vulnerabilities under severe but plausible stress conditions. Quantitative targets, to be met under stress conditions, are set around the Group’s strategic risk objectives for maintaining capital adequacy, delivering stable earnings growth and ensuring stable and efficient access to funding and liquidity.
• Risk control frameworks and limits - Risk control frameworks set detailed tolerances and limits for material risk types (e.g. credit risk, market risk, conduct risk and operational risk) that are used to manage risk on a day-to-day basis. These limits support and are required to be consistent with the high-level risk appetite targets.
More effective processes for reporting the results have also been developed, presenting the Board and senior management with a more holistic and dynamic view of key risk exposures.
Divisional risk appetite statements Risk appetite is set at the Group level then cascaded and embedded across all business areas. Each division is required to develop, own and manage a risk appetite statement aligned with the Group’s risk appetite and: • Covers all identified material risks; • Enables each business to understand its acceptable levels of risk; and
Risk control frameworks and limits Risk control frameworks and their associated limits are an integral part of the risk appetite framework and a key part of embedding risk appetite targets in day-to-day risk management decisions. The risk control frameworks manage risk concentrations on a ‘bottom-up’ basis through portfolio and product limit setting, expressing a clear tolerance for material risk types that is aligned to business activities. These are aligned with a ‘top-down’ approach via a calibration of their aggregate contribution with the Group’s risk appetite targets (i.e. earnings volatility, capital and liquidity consumption and impact on stakeholder confidence).
The Group Policy Framework directly supports the qualitative aspects of risk appetite, helping to rebuild and maintain stakeholder confidence in the Group’s risk control and governance. Its integrated approach is designed to ensure that an appropriate standard of control is set for each of the material risks the Group faces, with an effective assurance process put in place to monitor and report on performance. Risk appetite has its own policy standard within the Group Policy Framework that sets out clear roles and responsibilities to measure, cascade and report performance against risk appetite, as well as to provide assurances that business is being conducted within approved risk limits and tolerances.
Risk culture policies The Group’s values - of “serving customers well”, “working together”, “doing the right thing” and “thinking long term” - act as a clear starting point for a strong and effective risk culture. A wide range of communication and engagement activities (detailed below) has been undertaken to discuss the meaning of each value with employees and how they affect and guide day-to-day activities.
Challenge mechanisms A simple decision making guide (called the “YES check”) has been included within the Code of Conduct. It is a simple, intuitive set of five questions, designed to ensure the values guide day-to-day decisions: • Does what I am doing keep our customers and the Bank safe and secure?
Risk-based key performance indicators The Group’s policy standards require all current Code Staff roles to use a balanced scorecard approach to performance management. This ensures recognition of the longer-term business requirements and a balance between financial and non-financial metrics, including an evaluation of adherence to internal controls and risk management. Since 2011, all Code Staff roles have had specific risk objectives in their performance plan.
Unvested awards are subject to clawback and may be reduced, or forfeited in full, at the discretion of the Group Performance and Remuneration Committee. For Code Staff roles, the Committee can apply clawback if the company, business area and team, or the individual subsequently incurs significant loss (either financial or reputational), or if the Group as a whole suffers a material failure of risk management or material downturn in its financial performance.
There is significant focus on risk in performance assessment with all executives and Code Staff receiving specific risk feedback through an independent “360-degree” feedback process. As part of the line manager’s assessment of individual performance divisional control functions, including risk, provide independent input to the line manager.
Risk coverage The Group continued to strengthen its approach to risk management amid a challenging and ever-changing external environment in 2013. Areas of progress included: • The completion of the phased roll-out of the Group's conduct risk policies and of a more effective operating model, supported by the development and delivery of awareness initiatives and targeted training; • The implementation of the enhanced country risk appetite framework, including top-down risk appetite, and of enhanced assurance processes; • The introduction of a new integrated operating model for managing regulatory developments, which combines divisional and functional teams to leverage expertise more effectively; and
The main risk types faced by the Group are presented below, together with a summary of the key areas of focus and how the Group managed these risks in 2013. In preparing disclosures related to these risks, the Group has considered the recommendations of the Enhanced Disclosure Task Force issued in October 2012. A summary of the recommendations and list of disclosures that meet these recommendations has been included on page 557.
The Group’s Core Tier 1 ratio on a Basel 2.5 basis was 10.9% and on a fully loaded Basel III (FLB3) basis was 8.6% at 31 December 2013. The Group is targeting a FLB3 Common Equity Tier 1 ratio of c.11% by the end of 2015 and 12% or above by the end of 2016. The timely run-down of RCR and the successful divestment of Citizens are key to the achievement of the Group’s capital plans.
Refer to the Capital management section on pages 192 to 208 for further information.
The risk that the Group is unable to meet its financial liabilities as they fall due.
Character and impact: Dependent on company-specific factors such as maturity profile and composition of sources and uses of funding, the quality and size of the liquid asset buffer as well as broader market factors, such as wholesale market conditions alongside depositor and investor behaviour.
Liquidity and funding metrics continued to strengthen with short-term wholesale funding of £32.4 billion, covered more than four times by a liquidity portfolio of £146.1 billion. Liquidity coverage and net stable funding ratios also improved.
Refer to the Liquidity and funding risk section on pages 209 to 226 for further information.
Arises from: Deterioration of the credit quality of customers or counterparties of the Group, leaving them unable to meet their contractual obligations.
Character and impact: Losses can vary materially across portfolios and may include the risk of loss due to the concentration of credit risk related to a specific product, asset class, sector or counterparty.
It has the potential to affect adversely the Group’s financial performance and capital.
During 2013, loan impairment charges were £8.4 billion, of which £4.5 billion related to the creation of RCR and the related strategy. Excluding the increased impairments related to RCR, loan impairment losses fell by £1.4 billion. Impairment provisions covered risk elements in lending of £39.4 billion by 64%, up from 52% a year earlier. Credit risk RWAs fell by 16% to £313.4 billion, within which counterparty risk RWAs more than halved to £22.3 billion, reflecting risk reduction and core product focus in Markets as well as Non-Core disposals and run-off.
Credit risk is managed using a suite of credit approval, risk concentration, early warning and problem management frameworks as well as associated risk management tools.
The focus in 2013 was on the calibration of the credit control framework to align with Group risk appetite targets and the enhancement of existing Basel models.
It has the potential to materially affect financial performance in Markets, International Banking, Non-Core and Group Treasury where the Group has the majority of its exposures. The Group’s non-trading activities in retail and commercial businesses can also be affected through interest rate risk and foreign exchange non traded exposures.
Refer to the Market risk section on pages 318 to 340 for further information.
The Group Country Risk Committee manages country risk matters including: risk appetite; risk management strategy and framework; risk exposure and policy; sovereign ratings; sovereign loss given default rates; and country Watchlist colours, with escalation where needed to the Executive Risk Forum.
Regular, detailed reviews are carried out on all portfolios to ensure their composition remains in line with the Group’s country risk appetite and reflects economic and political developments.
A country risk Watchlist process identifies emerging issues and assists in the development of mitigation strategies. In 2013, the scope of this process was widened to include all countries with Group exposure.
Balance sheet exposure to eurozone periphery countries continued to fall, and was down by 11% to £52.9 billion at the end of 2013, of which 70% related to Ireland, primarily reflecting exposures in Ulster Bank.
Character and impact: Failures in product design, training and competence, complaint handling and transaction reporting can lead to an increase in complaints, compensation claims and regulatory censure.
Conduct risk is managed through the Group’s Conduct Risk Committee, under delegated authority from the Executive Risk Forum. The Committee is responsible for governance, leadership and risk appetite.
Refer to the Conduct risk section on pages 355 and 356 for further information.
Risk type Definition Features How the Group manages risk and the focus in 2013 Pension risk The risk to a firm caused by its contractual or other liabilities to, or with respect to, its pension schemes, whether established for its employees or for those of a related company or otherwise. It also means the risk that the firm will make payments or other contributions to, or with respect to, a pension scheme because of a moral obligation, or because the firm considers that it needs to do so for some other reason.
Arises from: Variation in value of pension scheme assets and liabilities owing to changes to life expectancy, interest rates, inflation, credit spreads, and equity and property prices.
Arises from: The Group’s day-to-day operations and is relevant to every aspect of the Group’s business.
Operational risk is managed by the Operational Risk Executive Committee. It is responsible for identifying and managing emerging operational risks, and for reviewing and monitoring operational risk profile strategies and frameworks, ensuring they are in line with risk appetite.
Regulatory risk The risk of material loss or liability, legal or regulatory sanctions, or reputational damage, resulting from the failure to comply with (or adequately plan for changes to) relevant official sector policy, laws, regulations, or major industry standards, in any location in which the Group operates.
Arises from: The Group’s regulatory, business or operating environment, and in how it responds to these.
Other enhancements were also made during 2013 included the creation of a more centralised approach to assurance activities and the introduction of a new ‘Centres of Excellence’ model for the management of regulatory developments, bringing together divisional and functional resources to manage issues more effectively.
Refer to the Regulatory risk section on page 360 and 361 for further information.
Arises from: Actions taken (or, in some cases, not taken) by the Group, as well as its wider policies and practices.
Refer to the Reputational risk section on pages 361 and 362 for further information.
Business risk The risk of losses as a result of adverse variance in the Group’s revenues and/or costs relative to its business plan and strategy.
Arises from: Internal factors such as volatility in pricing, sales volumes and input costs, and/or by external factors such as exposure to macroeconomic, regulatory and industry risks.
In 2013, the management and measurement of business risk was enhanced with an increased focus on stress testing.
Refer to the Business risk section on pages 362 and 363 for further information.
The Group is focusing on reducing strategic risk following a wide-ranging review to analyse core activities and formulate an appropriate plan, including rationalisation where necessary, to address the business challenges of the next five years.
Capital management* Definition The Group aims to maintain an appropriate level of capital to meet its business needs and regulatory requirements, and operates within an agreed risk appetite. The appropriate level of capital is determined based on the dual aims of: (i) meeting minimum regulatory capital requirements; and (ii) ensuring the Group maintains sufficient capital to uphold customer, investor and rating agency confidence in the organisation, thereby supporting the business franchise and funding capacity.
The Group continues to meet the minimum leverage ratio under both the Basel III and Capital Requirements Regulation (CRR) bases.
Regulatory developments CRD IV The European Union has implemented the Basel III proposals through the CRR and the Capital Requirements Directive (CRD), collectively known as CRD IV. CRD IV was implemented on 1 January 2014. The European Banking Authority’s technical standards which will provide clarification of the CRD IV, are still to be finalised through adoption by the European Commission and implemented within the UK.
Basel II requires RWAs to be calculated for credit, market and operational risk with various approaches available to banks, with differing levels of sophistication. The minimum capital requirement is calculated as 8% of RWAs.
Minimising surplus profits and capital The Group has a process in place which requires surplus distributable profits of all Group subsidiaries, after making allowance for sufficient capital to support current and prospective growth in the following halfyear, to be repatriated by way of a dividend on a half yearly basis and paid in cash before the period end. Surplus is defined as subsidiary capital of more than £1 million in excess of the regulatory minimum for UK banks and in accordance with the Group's policy, including capital buffers, or the industry specific/overseas regulatory requirements. However, fungibility of capital is subject to the approval of the local regulator.
Capital allocation Capital resources are allocated to the Group’s businesses based on key performance parameters agreed by the Group Board in the annual strategic planning process. Principal among these is a profitability metric, which assesses the effective use of the capital allocated to the business. Projected and actual return on equity is assessed against target returns set by the Group Board. The allocations also reflect strategic priorities, the intensity of regulatory capital use and the usage of other key Group resources such as balance sheet liquidity and funding.
Economic profit is also planned and measured for each division during the annual planning process. It is calculated by deducting the cost of equity utilised in the particular business from its operating profit and measures the value added over and above the cost of equity.
The ability to change severity levels supports management of earnings volatility and capital risk. Economic models are used in the Internal Capital Adequacy Assessment Process, assessing risk profiles within the risk appetite framework, functional risk management e.g. credit exposures at both Group and business levels, assessing business line profitability on a risk adjusted basis and the management and allocation of capital.
Estimated FLB3 (1) 2013 2012 CET1 capital £36.8bn £37.9bn RWAs £429.1bn £494.6bn CET1 ratio 8.6% 7.7% Leverage ratio 3.5% 3.1%
Basel III basis, improved by 60 basis points and 90 basis points respectively in the year. The benefit of lower RWAs was partially offset by the significant attributable loss for the year. The establishment of RCR and the related impairments reduced the ratios by c.10 basis points and c.20 basis points respectively.
(£36.8 billion) as a result of balance sheet and risk reduction, and in Non-Core (£31.2 billion) reflecting disposal of capital intensive portfolios and run-off.
Capital management* continued Capital resources continued Current capital resources and CRR capital estimate A reconciliation between capital as reported under the current basis (Basel 2.5), transitional basis (PRA) and full basis (final CRR) is set out below.
Current Transitional Full Current Transitional Full Current basis basis basis basis basis basis basis
(Basel 2.5) (PRA) (final CRR) (Basel 2.5) (draft CRR) (draft CRR) (Basel 2.5) £m £m £m £m £m £m £m
Non-controlling interests Non-controlling interests 473 — — 1,770 1,770 1,770 686 Regulatory adjustments to non-controlling interests — — — (1,367) (1,367) (1,770) (259)
50% of APS first loss — — — — — — (2,763)
Innovative/hybrid Tier 1 securities 4,207 — — 4,125 — — 4,667 Qualifying Tier 1 capital and related share premium subject to phase out from AT1 capital — 5,831 — — 4,571 — — Qualifying Tier 1 capital included in consolidated AT1 capital issued by subsidiaries and held by third parties — 1,749 — — 4,042 — —
Non-controlling Tier 2 capital — — — — — — 11
Tier 2 deductions 50% of securitisation positions (748) — — (1,107) — — (2,019) 50% of standardised expected losses less impairment provisions (25) — — (2,522) (3,077) — (3,451)
Supervisory deductions Unconsolidated investments - Direct Line Group (1) — — — (2,081) — — (4,354)
At 1 January 2013 47,320 9,815 12,152 (2,487) 66,800 Attributable loss net of movements in fair value of own credit (8,961) — — — (8,961) Share capital and reserve movements in respect of employee share schemes 200 — — — 200 Ordinary shares issued 264 — — — 264 Foreign exchange reserve (217) — — — (217) Foreign exchange movements — (93) (106) — (199) Actuarial gains recognised in retirement benefit schemes (net of tax) 200 — — — 200 Termination of contingent capital facility 320 — — — 320 Increase in non-controlling interests 70 — — — 70 Decrease/(increase) in capital deductions (1) 2,244 (1,293) 2,175 2,215 5,341 Decrease in goodwill and intangibles 1,177 — — — 1,177 Defined benefit pension fund (551) — — — (551) Dated subordinated debt issues — — 1,862 — 1,862 Dated subordinated debt maturities, redemptions and amortisation — — (2,666) — (2,666)
Notes: General: In accordance with the PRA’s Policy Statement PS7/13 issued in December 2013 on the implementation of CRD IV, all regulatory adjustments and deductions to CET1 have been applied in full (i.e. no transition) with the exception of unrealised gains on AFS securities which will be included from 2015.
Estimates, including RWAs, are based on the current interpretation, expectations, and understanding of the CRR requirements, anticipated compliance with all necessary enhancements to model calibration and other refinements, as well as further regulatory clarity and implementation guidance from the UK and EU authorities. The actual CRR impact may differ from these estimates when the final technical standards are interpreted and adopted.
(3) Where the deductions from AT1 capital exceed AT1 capital, the excess is deducted from CET1 capital. The excess of AT1 deductions over AT1 capital in year one of transition is due to the application of the current rules to the transitional amounts.
(5) Based on current interpretations of the final draft of the RTS on credit risk adjustments, issued in July 2013, the Group’s standardised latent provision has been reclassified to specific provision and is therefore no longer included in Tier 2 capital.
Risk-weighted assets: (1) Current securitisation positions are shown as risk-weighted at 1,250%. (2) RWA uplifts include the impact of credit valuation adjustments and asset valuation correlation on banks and central counterparties. (3) RWAs reflect implementation of the full internal model method suite, and include methodology changes that took effect immediately on CRR implementation. (4) Non-financial counterparties and sovereigns that meet the eligibility criteria under CRR are exempt from the credit valuation adjustments volatility charges. (5) The CRR final text includes a reduction in the risk-weight relating to small and medium-sized enterprises.
Capital management* continued Estimated leverage ratio The Basel III agreement introduced a leverage ratio as a non-risk based backstop limit intended to supplement the risk-based capital requirements. It aims to constrain the build up of excess leverage in the banking sector, introducing additional safeguards against model risk and measurement errors.
The PRA’s Supervisory Statement SS3/13 also states that the Group and the other major UK banks and building societies are expected to maintain a 3% end point Tier 1 leverage ratio, after taking into account the adjustments required by the PRA.
The leverage ratios set out below are based on: • Tier 1 capital as set out in the final CRR text; and
December 2010 Basel III text; further specificity being sourced from the instructions in the July 2012 Quantitative Impact Study and the related Frequently Asked Questions.
The estimated leverage ratio, based on the Basel Committee on Banking Supervision (BCBS) proposal issued in January 2014, is detailed below.
Exposure capital Leverage Exposure capital Leverage Estimated leverage ratio £bn £bn Leverage % £bn £bn Leverage %
CRR transitional approach for computing the capital base. Thus the majority of CET1 capital deductions will apply with immediate effect. This causes a year-on-year reduction of around £10 billion in Tier 1 capital, causing the reduction in transitional measure leverage ratios.
Loans and advances to banks and customers 418.4 418.4 418.4 459.3 459.3 459.3
Regulatory deductions and other adjustments (2) (4.9) (4.9) (6.6) (14.9) (14.9) (20.9) Potential future exposure on derivatives (3) 131.3 130.4 128.0 133.1 130.9 125.8
End point leverage exposure measure 1,062.1 1,093.5 1,082.0 1,202.3 1,222.9 1,236.9 Transitional adjustments to assets deducted from regulatory Tier 1 capital 2.9 2.9 2.9
Notes: (1) Under the Basel III view, the balance sheet value is reduced for allowable netting under the Basel II framework (excluding cross-product netting) which mainly relates to cash positions under a master netting agreement. In the CRR calculation, the balance sheet value is replaced with the related regulatory exposure value which has netting of both cash positions and related collateral of securities financing transactions (SFTs). The BCBS view permits the effects of master netting agreements for calculation of counterparty exposure but with very tight restrictions upon the recognition of those agreements for offset of cash received.
(2) Regulatory deductions: to ensure consistency between the numerator and the denominator, items that are deducted from capital are also deducted from total assets. For the BCBS basis, the shortfall in the stock of eligible provisions relative to expected losses is adjusted.
(3) Potential future exposure (PFE) on derivatives: the regulatory add-on which is calculated by assigning percentages based on the type of instrument and the residual maturity of the contract to the nominal amounts or underlying values of derivative contracts. Under the latest BCBS proposal, variation margin is permitted to be offset against the replacement cost for derivative exposures (but not the PFE) where specific conditions are met. Refer to the table below for further analysis.
Derivative notionals The table below analyses derivative notional values by product and maturity. Credit Credit derivative 5% derivative 10% <1 year 1-5 years >5 years add on factor (1) add on factor (1) Total 2013 £bn £bn £bn £bn £bn £bn
Interest rate 12,515 12,980 7,988 33,483 Exchange rate 3,411 795 492 4,698 Equity 51 52 4 107 Commodities 2 — 2 4 Credit risk 470 83 553
Note: (1) Credit derivatives in the trading book receive a PFE of 10%. Any credit derivatives in respect of a company in which a direct holding would give the Group 10% or more of the voting rights, receive a
UK UK International US Retail & Retail Corporate Banking (1) Commercial Markets Other Total 2013 £bn £bn £bn £bn £bn £bn £bn
Unconditionally cancellable items (2) 3.1 0.5 0.6 1.7 — 0.3 6.2 Other contingents and commitments 9.6 36.3 95.4 16.8 8.9 12.7 179.7 12.7 36.8 96.0 18.5 8.9 13.0 185.9 2012 Unconditionally cancellable items (2) 3.0 0.5 0.8 1.8 — 0.6 6.7 Other contingents and commitments 9.3 33.9 102.6 15.6 12.3 7.1 180.8 12.3 34.4 103.4 17.4 12.3 7.7 187.5
At 1 January 2013 323.2 48.0 371.2 Foreign exchange movement (1.7) (0.3) (2.0)
Market risk Markets Other Total Operational risk Total £bn £bn £bn £bn £bn
Note: (1) Market risk model updates in 2013 primarily related to valuation adjustments.
At 1 January 2013 45.7 86.3 12.3 51.9 36.1 56.5 101.3 5.8 395.9 60.4 3.3 459.6 Business and market movements (1.8) (9.6) (0.3) (6.0) (5.7) (0.4) (35.1) 2.7 (56.2) (22.2) 0.6 (77.8)
Key points • RWAs were down £74.1 billion or 16% overall, of which £57.8 billion related to credit risk, £12.3 billion to market risk and £4.0 billion to operational risk.
° Counterparty RWAs were down £25.7 billion or 54% to £22.3 billion in Markets (£17.2 billion) and Non-Core (£7.8 billion). Methodology changes, significantly all in Markets, reflected extension of product coverage improvements in models and reduction in weighting applied for exposure at default. This was partially offset by the impact of higher loss given defaults for hedge funds.
• Market risk RWAs were down £12.3 billion or 29% to £30.3 billion significantly all in Markets reflecting balance sheet and risk reduction £9.0 billion and model changes of £1.5 billion.
• Operational risk RWAs were down £4.0 billion or 9% to £41.8 billion primarily due to reductions in Markets.
Capital management* continued Risk-weighted assets continued FLB3 and Basel 2.5 The following tables set out RWAs under future and current rules. Estimated FLB3 Basel 2.5 2013 £bn £bn
International Banking 50.3 49.0 Ulster Bank 30.1 30.7 US Retail & Commercial 58.8 56.1
Reconciliation between accounting and regulatory consolidation The table below provides a reconciliation between accounting and regulatory consolidation.
Deconsolidation of banking Deconsolidation of banking Accounting of insurance and associates/ Regulatory Accounting of insurance and associates/ Regulatory balance sheet other entities (1) other entities (2) consolidation balance sheet other entities (1) other entities (2) consolidation £m £m £m £m £m £m £m £m
Prepayments, accrued income and other assets 7,614 (488) (533) 6,593 7,820 (77) (320) 7,423
Cash and balances at central banks 82.7 0.4 83.1 — — — — 1.7 84.8 — 84.8 Reverse repurchase agreements and stock borrowing 76.4 — 76.4 — — (51.3) — — 25.1 — 25.1 Loans and advances 418.4 4.7 423.1 — 25.2 (28.4) (0.4) (7.9) 411.6 75.6 487.2 Debt securities 113.6 1.1 114.7 (56.7) 0.3 — (1.5) 2.0 58.8 0.1 58.9 Equity shares 8.8 — 8.8 (7.2) 0.1 — — (0.1) 1.6 — 1.6 Settlement balances 5.6 — 5.6 (5.6) — — — — — — — Derivatives 288.0 — 288.0 — 1.8 (242.8) — (2.1) 44.9 — 44.9 Intangible assets 12.4 — 12.4 — — — (12.4) — — — — Property, plant and equipment 7.9 (0.9) 7.0 — — — — 0.7 7.7 — 7.7 Deferred tax 3.5 — 3.5 — — — — — 3.5 — 3.5 Prepayments, accrued income and other assets 7.6 (1.0) 6.6 — — — (1.1) (5.5) — — — Assets of disposal groups 3.0 — 3.0 — — — — (3.0) — — — Total assets 1,027.9 4.3 1,032.2 (69.5) 27.4 (322.5) (15.4) (14.2) 638.0 75.7 713.7
Notes: (1) Represents proportional consolidation of associates and deconsolidation of certain subsidiaries, as required by regulatory rules. Refer to previous page for additional details. (2) The exposures in regulatory trading book businesses are subject to market risk and are therefore excluded from EAD. Refer to the Market risk section on page 318. (3) Impairment loss provisions on loans and advances and securities, and credit valuation adjustment on derivatives. (4) Includes: - Reverse repos: reflects regulatory approach for securities financing transactions including netting of collateral and cash legs. - Loans and advances: cash collateral pledged with counterparties in relation to net derivative liability positions. - Derivatives: impact of master netting arrangements.
RWA density The table below analyses EAD, RWAs and related RWA density by sector cluster. EAD RWAs
Off- On- Off- RWA density (3) EAD post CRM (1) On-balance Off- balance balance balance EAD
Non-CCR Drawn sheet Undrawn balance sheet sheet Undrawn sheet EAD drawn credit risk CCR (2) Total balance EAD Undrawn EAD sheet EAD RWAs RWAs RWAs RWAs post CRM balance
Notes: (1) CRM: Credit risk mitigation. (2) CCR: Counterparty credit risk. (3) RWA density represents RWAs as a percentage of EAD. (4) SPVs: Special purpose vehicles. (5) TMT: Telecoms, media and technology.
Overview • During 2013 the Group’s deposit surplus continued to build and liquidity reserves were maintained at strong levels, further strengthening the balance sheet. This allowed the Group to easily absorb the minimal outflows following the announcement of the S&P credit rating downgrade (A-/A-2 from A/A-1, with a negative outlook) in November 2013.
• Following the continued success of the Group’s Non-Core run-down and the reduction in the size of the Markets business, the Group’s loan:deposit ratio improved by 600 basis points in the year to 94%. In response, the Group has been actively managing down excess cash, through liability management exercises and deposit re-pricing.
• The Group’s credit profile improved significantly during the year, evidenced by the narrowing of the credit spreads. The spread of the most recent subordinated debt issue in December 2013 was 125 basis points lower than a comparable issuance in 2012.
• Continued reduction in the utilisation of wholesale funding and improvements in the characteristics and behavioural properties of the deposit base. Short-term wholesale funding excluding derivative collateral (STWF) reduced by 22% in the year to £32.4 billion, covered more than four times by the liquidity portfolio and the ratio of customer deposits to total funding improved to 75% from 70%.
• The Group maintains an adequate liquid asset portfolio appropriate to the business activities of the Group and its risk profile.
• The Group has in place robust strategies, policies, systems, and procedures for identifying, measuring, monitoring and managing liquidity risk.
• The Group has a comprehensive liquidity risk management framework in place to ensure the Group maintains an appropriate level of financial resources to meet its financial obligations as and when they fall due.
The risk management framework identifies the sources of liquidity risk and the steps the Group can take when these risks exceed certain actively monitored limits. These actions include when and how to use the Group’s liquidity reserves and what other adjustments to the Group’s balance sheet should be undertaken to manage these risks within the Group’s risk appetite.
The Group’s appetite for liquidity risk is set by the Board as a percentage of the Individual Liquidity Adequacy Assessment (ILAA) stressed outflows and then managed on a daily basis by various functions within the business with liquidity risk controlled at legal entity, country, regional and divisional levels.
In addition, the Group’s US operations meet liquidity requirements set out by the Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Financial Industry Regulatory Authority. In the Netherlands, RBS N.V. is subject to the De Nederlandsche Bank liquidity oversight regime. In the Republic of Ireland, Ulster Bank Ireland Limited is subject to oversight from the Central Bank of Ireland.
Under the EU Capital Requirements Regulation to implement the recommended guidance of Basel 3, the European Banking Authority (EBA) is tasked with issuing a set of technical standards for implementing the LCR within the EU, to be ratified by the European Commission before 30 June 2014. The LCR metric will come into effect as a minimum standard from 1 January 2015.
The PRA has issued a statement proposing to retain the existing ILG framework until 31 December 2014, whilst the EBA’s implementation of the LCR is finalised.
Several regulatory regimes outside the EU where the Group operates have also published consultation papers with guidance for implementation of the LCR, including the Joint Banking Supervisors of the US. We anticipate further consultations for LCR standards to be published across other jurisdictions in which the Group operates during the course of 2014. Additionally, the BCBS has issued a proposal for revising the guidance on NSFR, expected to be finalised in 2014.
Measurement and monitoring In implementing the Group’s liquidity risk management framework, a suite of tools are used to monitor, limit and stress test the risks within the balance sheet. The limits control the amount and composition of funding sources, asset and liability mismatches and funding concentrations, in addition to the level of liquidity risk.
To foster appropriate pricing behaviour, decision making and balance sheet composition Group Treasury uses transfer pricing of liquidity and funding costs, limits and parameters. This ensures liquidity and funding risk is reflected in the measurement of divisional business performance and ensures divisions are being correctly incentivised to source the most appropriate mix of funding.
Within the liquidity portfolio the Group holds cash at central banks, high quality government securities and collateral eligible for use in central bank operations, such as the Bank of England’s Discount Window Facility.
A stress event can occur when either firm-specific or market-wide factors or a combination of both lead to depositors and investors to withdraw or not to renew funding on maturity. This could be caused by many factors including fears over the viability of the firm. Additionally, liquidity stress can be brought on by customers choosing to draw down on loan agreements and facilities.
Simulated liquidity stress testing is performed at least quarterly for each division as well as the major operating subsidiaries in order to evaluate the strength of the Group’s liquidity risk management.
Stress tests are designed to examine the impact of a variety of firmspecific and market-wide scenarios on the future adequacy of the Group’s liquidity reserves. Stress test scenarios are designed to take into account the Group’s experiences during the financial crisis, recent market conditions and events. These scenarios can be run at any time in response to the emergence of firm-specific or market-wide risks that could have a material impact on the Group’s liquidity position. In the past these have included credit rating changes and political and economic conditions changing in particular countries.
In determining the adequacy of the Group’s liquidity resources the Group focuses on the outflows it anticipates as a result of any stress scenario occurring. These outflows are measured over certain time periods which extend from two weeks to three months. The Group is expected to be able to withstand these stressed outflows through its own resources (primarily through the use of the liquidity portfolio) without having to resort to extraordinary central bank or governmental assistance.
The Group’s liquidity risk appetite is measured by reference to the liquidity portfolio as a percentage of stressed contractual and behavioural outflows under the worst of three severe stress scenarios, as prescribed by the PRA. These are a market-wide stress, an idiosyncratic stress and a combination of both. At 31 December 2013, the Group’s liquidity portfolio was 145% of the worst case stress requirements.
• Secured financing and increased haircuts - Loss of secured funding capacity at contractual maturity date and incremental haircut widening, depending upon collateral type.
• Franchise viability - Group liquidity stress testing includes additional liquidity in order to meet outflows that are non-contractual in nature, but are necessary in order to support valuable franchise businesses.
• Management action - Unencumbered marketable assets that are held outside of the Core liquidity portfolio and are of verifiable liquidity value to the firm, are assumed to be monetised (subject to haircut/valuation adjustment).
Liquidity reserves Liquidity risks are mitigated by the Group’s centrally managed liquidity portfolio. The size of the portfolio is determined under the Group’s liquidity risk management framework with reference to the Group’s risk appetite.
Certain of the Group's significant operating subsidiaries - RBS N.V., RBS Citizens Financial Group, Inc. and Ulster Bank Ireland Limited - hold locally managed portfolios of liquid assets that comply with local regulations but differ from PRA rules. These portfolios are the responsibility of the local Treasurer who reports to the Group Treasurer.
Primary liquid assets generally comprise eligible liquid assets, such as cash and balances at central banks, treasury bills and other high quality government and US agency bonds.
The composition of the liquidity portfolio is influenced by quality of counterparty, maturity mix and currency mix. The PRA rules dictate certain minimum quality standards for the UK DLG liquidity portfolio. The liquidity value of the portfolio is determined with reference to current market prices and the haircuts necessary to generate cash from the asset.
The Group in consultation with the PRA and subject to the requirements of the PRA’s ILG can change the composition of its liquidity portfolio. The change in composition may relate to market specific factors, changes in internal liquidity risk mix or regulatory guidance.
Liquidity metrics* The table below sets out the key liquidity and related metrics monitored by the Group. 2013 2012
Notes: (1) The Group’s liquidity risk appetite is based on the internal Individual Liquidity Adequacy Assessment which is measured by reference to the liquidity portfolio as a percentage of stressed outflows under the worst of three severe stress scenarios of a market-wide stress, an idiosyncratic stress and a combination of both. Liquidity risk adequacy is determined by surplus of liquid assets over three months stressed outflows under the worst case stresses. This assessment is performed in accordance with PRA guidance.
UK DLG (1) CFG (1) Other Total Average Total Average Total Average £m £m £m £m £m £m £m £m £m
Notes: (1) The PRA regulated UK Defined Liquidity Group (UK DLG) comprises the Group’s five UK banks: The Royal Bank of Scotland plc, National Westminster Bank Plc, Ulster Bank Limited, Coutts &
(2) Includes assets eligible for discounting at the Bank of England and other central banks.
Cash 83 — 79 — 79 — — Inter-bank lending 28 — 29 — 44 — — Debt securities > 1 year - governments AAA to AA- 47 2 64 3 77 4 5 - other eligible bonds 31 6 48 10 73 15 20 - other bonds 16 16 19 19 14 14 100 Debt securities < 1 year 20 — 26 — 45 — — Derivatives 288 — 442 — 530 — — Reverse repurchase agreements 76 — 105 — 101 — — Customer loans and advances > 1 year - residential mortgages 135 88 145 94 145 94 65 - other 114 114 136 136 173 173 100 Customer loans and advances < 1 year - retail loans 18 15 18 15 19 16 85 - other 126 63 131 66 137 69 50 Other (3) 46 46 70 70 70 70 100 Total assets 1,028 350 1,312 413 1,507 455 Undrawn commitments 213 11 216 11 240 12 5 Total assets and undrawn commitments 1,241 361 1,528 424 1,747 467
Maintaining access to global capital markets provides the Group’s funding base with diversity. Over time the Group’s wholesale funding mix has been diversified by currency, geography, maturity and type. The Group accesses the wholesale funding markets directly or through its main operating subsidiaries via established funding programmes. The use of different entities to access the market from time to time allows the Group to further diversify its funding mix and in certain limited circumstances demonstrate to regulators that specific operating subsidiaries enjoy market access in their own right.
The Group may access various funding facilities offered by central banks from time to time. The use of such facilities can be both part of a wider strategic objective to support initiatives to help stimulate economic growth or as part of the Group’s broader liquidity management and funding strategy. Overall usage and repayment of available central bank facilities will fit within the Group’s overall liquidity risk appetite and concentration limits.
During 2013, the Group repaid €8.5 billion of the original €10 billion borrowed under the European Central Bank’s Long Term Refinancing Operation. The remaining balance is used to fund certain of the Group’s Eurozone banking subsidiaries and the usage of this facility will be evaluated on an ongoing basis. The Group has not drawn down any additional funds under the Bank of England’s Funding for Lending Scheme during the year and has repaid the initial drawing of £750 million in order to manage its excess cash position. The Group remains committed to supporting the objectives of the Funding for Lending scheme.
Customer deposits (1) 407 373 Customer loans and advances (1) Bank deposits (short-term only) (1) 14 18 Loan and advances to banks (1) Trading liabilities (2) 67 93 Trading assets (2) Other liabilities and equity (3) 100 90 Other assets (3) Repurchase agreements 85 76 Reverse repurchase agreements Term wholesale funding (1) 69 90 Primary liquidity portfolio Funded balance sheet 742 740 Funded balance sheet Derivatives 286 288 Derivatives 1,028 1,028
Notes: (1) Excludes held for trading. (2) Financial instruments classified as held-for-trading (HFT) excluding security financing transactions and derivatives. (3) Includes non-HFT financial instruments and non-financial assets/liabilities.
Wholesale funding The table below summarises funding metrics. Short-term wholesale funding (1) Total wholesale funding Net inter-bank funding (2)
Notes: (1) Short-term wholesale balances denote those with a residual maturity of less than one year and include longer-term issuances. (2) Excludes derivative cash collateral. (3) Primarily short-term balances.
Debt securities in issue conduit asset-backed commercial paper (ABCP) — — — — — — 11,164 — 11,164
Key points • Wholesale funding reduced by nearly 29% in the year to £127 billion principally reflecting strategic downsizing in Markets.
Funding risk continued Analysis continued Total funding by currency GBP USD EUR Other Total 2013 £m £m £m £m £m
Deposits by banks 7,418 8,337 17,004 2,570 35,329 Debt securities in issue commercial paper 4 897 682 — 1,583 certificates of deposit 336 1,411 476 54 2,277 medium-term notes 6,353 11,068 23,218 6,525 47,164 covered bonds 984 — 8,057 — 9,041 securitisations 1,897 2,748 3,109 — 7,754 Subordinated liabilities 1,857 10,502 8,984 2,669 24,012 Wholesale funding 18,849 34,963 61,530 11,818 127,160 % of wholesale funding 15% 28% 48% 9% 100%
ABCP and CDs MTNs bonds Securitisations Total liabilities notes in issue in issue 2013 £m £m £m £m £m £m £m £m %
Key points • 72% of the Group’s repo balance related to AA- or above collateral reducing the exposure to re-financing risk.
• Of the £125.8 billion gross repos, £49.6 billion related to firm financing.
Retail & Commercial* The table below shows the behavioural and contractual maturity analysis of Retail & Commercial customer deposits.
Less than More than 1 year 1-5 years 5 years Total 2013 £bn £bn £bn £bn *unaudited
Less than 6 months More than excluding 1 month 1-3 months 3-6 months -1 year Subtotal 1-3 years 3-5 years 5 years HFT HFT Total
Cash and balances at central banks 82,661 — — — 82,661 — — — 82,661 — 82,661 Bank reverse repos 652 110 — — 762 — — — 762 25,795 26,557 Customer reverse repos — — — — — — — — — 49,897 49,897 Loans to banks 11,831 3,171 1,552 443 16,997 69 13 546 17,625 9,952 27,577 Loans to customers - Personal 7,776 8,942 4,141 7,108 27,967 24,008 20,107 100,664 172,746 239 172,985 - Corporate 20,310 11,741 13,175 16,970 62,196 43,207 34,227 38,746 178,376 5,561 183,937 - Financial Institutions 6,072 1,435 2,264 2,346 12,117 5,173 1,915 3,093 22,298 13,370 35,668 Debt securities 1,608 954 1,787 2,324 6,673 7,425 8,782 34,161 57,041 56,582 113,623 Equity shares — — — — — — — 1,612 1,612 7,199 8,811 Settlement balances 5,591 — — — 5,591 — — — 5,591 — 5,591 Derivatives 546 — — 1,282 1,828 2,148 427 129 4,532 283,508 288,040 Total financial assets 137,047 26,353 22,919 30,473 216,792 82,030 65,471 178,951 543,244 452,103 995,347
Bank repos 3,045 1,297 — — 4,342 1,181 — — 5,523 23,127 28,650 Customer repos 3,059 1,125 — — 4,184 — — — 4,184 52,300 56,484 Deposits by banks 10,676 1,882 1,382 125 14,065 82 109 1,309 15,565 19,764 35,329 Customer accounts - Personal 160,261 10,370 5,562 7,262 183,455 6,789 1,449 20 191,713 — 191,713 - Corporate 158,138 4,458 2,369 1,476 166,441 2,690 728 681 170,540 1,809 172,349 - Financial Institutions 41,632 1,265 636 498 44,031 661 450 38 45,180 8,427 53,607 Debt securities in issue 2,383 3,221 2,667 6,844 15,115 15,729 6,388 22,027 59,259 8,560 67,819 Settlement balances 5,313 — — — 5,313 — — — 5,313 — 5,313 Short positions — — — — — — — — — 28,022 28,022 Derivatives 1 130 271 — 402 933 1,190 1,703 4,228 281,299 285,527 Subordinated liabilities 16 124 150 1,060 1,350 3,944 4,078 14,640 24,012 — 24,012 Other liabilities 1,764 — — — 1,764 2 16 1 1,783 — 1,783 Total financial liabilities 386,288 23,872 13,037 17,265 440,462 32,011 14,408 40,419 527,300 423,308 950,608
Short positions — — — — — — — — — 27,591 27,591
From time to time the Group encumbers assets to serve as collateral to support certain wholesale funding initiatives. The three principal forms of encumbrance are own asset securitisations, covered bonds and securities repurchase agreements.
The Group categorises its assets into three broad groups; assets that are: • already encumbered and used to support funding currently in place via own asset securitisations, covered bonds and securities repurchase agreements.
• not currently encumbered but can for instance be used to access funding from market counterparties or central bank facilities as part of the Group’s contingency funding.
Excluding balances relating to derivative transactions 19 22 26 Excluding balances relating to derivative and securities financing transactions 11 13 19
Key points • The Groups total encumbrance ratio dropped to 17%.
• 31% of the Group’s residential mortgage portfolio was encumbered as at 31 December 2013.
• In addition to the £451.4 billion on-balance sheet assets available to support future funding and collateral requirements there is £12.7 billion net off-balance sheet collateral available from reverse repurchase and derivative collateral transactions.
Securitisations Covered Secured encumbered % of related Liquidity Other Cannot be and conduits bonds Derivatives Repos deposits assets (1) assets portfolio Other realisable (3) encumbered (4) Total 2013 £bn £bn £bn £bn £bn £bn % £bn £bn £bn £bn £bn
Notes: (1) Encumbered assets are those on the balance sheet that have been pledged to provide security for the liability shown above and are therefore not available to secure funding or to meet other collateral needs. (2) Unencumbered readily realisable assets are those assets on the balance sheet that can be readily used to meet funding or collateral requirements and comprise: (a) Liquidity portfolio: cash balances at central banks, high quality debt securities and loans that have been pre-positioned with central banks. In addition, the liquidity portfolio includes securitisations of own assets which has reduced over the years and has been replaced by loans. (b) Other readily realisable assets: other liquidity reserves, including assets that have been enabled for use with central banks; and unencumbered debt securities.
(3) Unencumbered other realisable assets are those assets on the balance sheet that have no restrictions for funding and collateral purposes but are not readily realisable in their current form. These assets include loans that could be prepositioned with central banks but have not been subject to internal and external documentation review and diligence work.
Cash and balances at central banks — — — — — — — 70.2 9.1 79.3 Loans and advances to banks 5.3 0.5 12.8 — — 18.6 59 — 12.7 31.3 Loans and advances to customers - UK residential mortgages 16.4 16.0 — — — 32.4 30 58.7 18.0 109.1 - Irish residential mortgages 10.6 — — — 1.8 12.4 81 — 2.9 15.3 - US residential mortgages — — — — — — — 7.6 14.1 21.7 - UK credit cards 3.0 — — — — 3.0 44 — 3.8 6.8 - UK personal loans 4.7 — — — — 4.7 41 — 6.8 11.5 - other 20.7 — 22.5 — 0.8 44.0 16 6.5 217.1 267.6 Reverse repurchase agreements and stock borrowing — — — — — — — — 104.8 104.8 Debt securities 1.0 — 8.3 91.2 15.2 115.7 70 22.3 26.6 164.6 Equity shares — — 0.7 6.8 — 7.5 49 — 7.7 15.2 Settlement balances — — — — — — — — 6.7 6.7 Derivatives — — — — — — — — 441.9 441.9 Intangible assets — — — — — — — — 14.3 14.3 Property, plant and equipment — — — — — — — — 10.0 10.0 Deferred tax — — — — — — — — 3.5 3.5 Prepayments, accrued income and other assets — — — — — — — — 8.7 8.7 61.7 16.5 44.3 98.0 17.8 238.3 165.3 908.7 1,312.3
Note: (1) In accordance with market practice the Group employs its own assets and securities received under reverse repo transactions as collateral for repos.
Credit risk 228 Definition 228 Sources of credit risk 228 Credit risk governance 229 Risk management 229 - Product/asset class concentration framework 229 - Credit risk assessment 230 - Controls and assurance 230 Risk measurement 231 Credit risk assets 232 - Divisional analysis 233 - Sector and geographical regional analyses 236 - Asset quality 237 Risk mitigation 238 - Lending 241 - Counterparty credit risk 242 Early problem identification and problem debt management 242 - Wholesale 243 - Wholesale forbearance 245 - Retail 245 - Retail forbearance 250 - Recoveries 250 - Group impairment loss provisioning 250 - Provisioning methodology 251 - Impact of forbearance on provisioning 251 - Write-offs 252 Key loan portfolios 252 - Commercial real estate 258 - Residential mortgages 261 - Personal lending 262 - Interest only retail loans 265 - Ulster Bank Group (Core and Non-Core)
Sources of credit risk The Group is exposed to credit risk as a result of a wide range of business activities. The most significant source of credit risk is lending. The second most significant source is counterparty credit risk, which results from the Group’s activities in the derivatives and securities financing transaction markets.
Derivatives and securities financing transactions expose the Group to counterparty credit risk, which is the risk of loss arising from a failure of a customer to meet obligations which vary in value by reference to a market factor.
Credit risk governance A strong credit risk management function is vital to support the ongoing profitability of the Group. The potential for loss is mitigated through a robust credit risk culture in the business units and through a focus on sustainable lending practices. The Group’s credit risk management function is responsible for credit approval and managing concentration risk, as well as credit risk control frameworks and acts as the ultimate authority for the approval of credit. This, together with strong independent oversight and challenge, enables the business to maintain a sound credit environment.
The Executive Risk Forum (ERF) considers and approves material aspects of the Group’s credit risk management framework, such as credit risk appetite and limits for portfolios of strategic significance. The ERF has delegated approval authority to the Group Credit Risk Committee, a functional sub-committee of the Group Risk Committee, to act on credit risk matters. These include, but are not limited to, credit risk appetite and limits (within the overall risk appetite set by the Board and the ERF), credit risk strategy and frameworks, credit risk policy and the oversight of the credit profile across the Group. There are separate Group Credit Risk Committees for the retail and wholesale portfolios and these are chaired by the GCCO.
Risk appetite and concentration framework Risk appetite is set using specific quantitative targets under stress, including earnings volatility and capital adequacy. The Group’s credit risk framework has therefore been designed around the factors that influence the Group’s ability to meet those targets. These include product and asset class, industry sector, single name and country concentrations. Any of these factors could generate higher earnings volatility under stress and, if not adequately controlled, could undermine capital adequacy. Tools such as stress testing and economic capital are used to measure credit risk volatility and develop links between Group risk appetite targets and the credit risk control framework. The frameworks are supported by a suite of Group-wide and divisional policies that set out the risk parameters within which divisions must operate. The Group also manages its exposures to counterparty credit risk closely, using portfolio limits and specific tools to control more volatile or capital intensive business areas.
Single name concentration A single name concentration (SNC) framework addresses the risk of outsized exposure to a borrower or borrower group. The framework includes elevated approval authority, additional reporting and monitoring, and the requirement for plans to address exposures in excess of appetite.
Aggregate SNC exposures remain outside of the Group’s longer-term appetite. However, material reductions have been achieved since the framework was introduced. This trend continued during the year, with a 21% decrease in the number of excesses since December 2012.
Country concentration The country concentration framework is described in the Country risk section on pages 341 to 353.
The GCCO has established a framework of individual delegated authorities, which are set out in the Group Credit Risk Policy. The framework requires at least two individuals to approve each credit decision, one from the business and one from the credit risk function. Both must hold appropriate delegated authority, which is dependent on their experience and expertise. Only a small number of senior executives hold the highest authority provided under the framework. While both parties are accountable for the quality of each decision taken, the credit risk approver holds ultimate sanctioning authority.
In all circumstances the risks associated with any proposal to provide, increase, review or change the terms or conditions of credit facilities must be assessed prior to a credit decision being made. Assessments of credit risk must, at a minimum, specifically address the following elements: • The amount, terms, tenor, structure, conditions, purpose and appropriateness of all credit facilities; • Compliance with applicable Group and/or divisional credit policies; • The customer’s ability to meet obligations, based on an analysis of financial information and a review of payment and covenant compliance history; • The source of repayment and the customer’s risk profile, including sector analysis and sensitivity to economic and market developments, and credit risk mitigation; • Refinancing risk - that is the risk of loss arising from the failure of a customer to settle an obligation on expiry of a facility through the drawdown of another credit facility provided by the Group or by another lender; • Consideration of all other risks such as environmental, social and ethical, regulatory and reputational risks; and
• The portfolio impact of the transaction, including the impact on any credit risk concentration limits or agreed divisional risk appetite.
The first component is the Group Credit Policy Standard, which is part of the Group Policy Framework. It sets out the rules the Group’s businesses must follow to ensure that credit risks are identified and effectively managed through the credit lifecycle.
The third component of the Group’s credit assurance framework is the Credit Quality Assurance (CQA) function. CQA independently reviews the Group’s lending activities to identify control breaches, assess portfolio quality and recommend process improvements. These findings are escalated to senior management and plans to address shortcomings are recorded and tracked in the Group’s operational risk system. CQA’s activities are overseen by GAC and the results of its reviews are regularly shared with the Group’s main regulators.
• Counterparty exposures - measured using marked-to-market value of derivatives after the effect of enforceable netting agreements and regulatory approved models but before the effect of collateral. Counterparty exposures include rate risk management, which includes exposures arising from foreign exchange transactions, interest rate swaps, credit default swaps and options. Exposures are mitigated by off-setting in-the-money and out-of-the-money transactions where such transactions are governed by legally enforceable netting agreements and exposures are calculated by regulatory approved models. Exposures are shown before deducting collateral.
CRA exclude issuer risk (primarily debt securities) and securities financing, repurchase and reverse repurchase arrangements. CRAs take account of regulatory netting although, in practice, obligations are settled under legal netting arrangements that provide a right of legal set-off but do not meet the offset criteria under IFRS.
• Retail models - Each customer account is scored and models are used to assign a PD. Inputs vary across portfolios and include both internal account and customer level data, as well as data from credit bureaus. This score is used to support automated credit decision making through the use of a statistically derived scorecard.
Changes to credit models The Group reviews and updates models on an ongoing basis, reflecting more recent data, changes to products and portfolios, and updated regulatory requirements. Extensive changes were made to wholesale models in 2012 and 2013. This process continues with further changes, notably in banks and corporate exposure classes, planned for 2014.
Model changes affect year-on-year comparisons of risk measures in certain disclosures. Where meaningful, the Group in its commentary has differentiated between instances where movements in risk measures reflect the impact of model changes, and those that reflect movements in the size of underlying credit portfolios or their credit quality.
Economic capital The credit economic capital model is an extensive framework that allows for the calculation of portfolio credit loss distributions and associated metrics over a given risk horizon for a variety of business purposes.
Credit risk assets* The table below provides a bridge between balance sheet captions and the related components of credit risk assets (CRA). Methodology Within Not within Netting differences Balance the scope of the scope Credit and and sheet market risk (1) of CRA (2) adjustments (3) collateral (4) reclassifications (5) CRA 2013 £bn £bn £bn £bn £bn £bn £bn
Cash and balances at central banks 82.7 — (3.9) — — 1.7 80.5 Reverse repurchase agreements and stock borrowing 76.4 — (76.4) — — — — Loans and advances 418.4 — (3.0) 25.2 (28.4) (7.5) 404.7 Debt securities 113.6 (56.7) (56.9) — — — — Equity shares 8.8 (7.2) (1.6) — — — — Settlement balances 5.6 (5.6) — — — — — Derivatives 288.0 — — 1.8 (242.8) 9.9 56.9 Other assets (6) 34.4 — (25.6) — — (7.8) 1.0 Total assets 1,027.9 (69.5) (167.4) 27.0 (271.2) (3.7) 543.1
Notes: (1) The exposures in regulatory trading book businesses are subject to market risk and are hence excluded from CRA. Refer to the market risk section on page 318. (2) Includes cash in ATMs and branches, items in the course of collection, reverse repurchase agreements, securities and other assets (refer to note below). (3) Includes impairment loss provisions related to loans and advances and credit valuation adjustment on derivatives. (4) Comprises: - Loans and advances: cash collateral pledged with counterparties in relation to net derivative liability positions. - Derivatives: impact of master netting arrangements.
(5) Comprises: - Cash and balances at central banks: notice balances with central banks included in loans and advances, reclassified as central bank exposure in CRA. - Loans and advances: includes offset related to cash management pooling arrangements not allowed under IFRS and reclassification of central bank balances. This is partially offset by reclassification of disposal groups and prepayments, accrued income and other assets as customer balances. - Derivatives: reflects difference between netting arrangements and netting within regulatory model sets, and balances with central counterparties after netting but before variation margin presented net on the balance sheet. - Other assets: includes amounts reclassified to loans and advances from disposal groups and prepayments, accrued income and other assets and residual value of operating leases.
Credit risk continued Credit risk assets* continued Divisional analysis £m £m £m
• CRA in the Retail & Commercial divisions continued to increase as a proportion of the Core portfolio, accounting for 71% of the Core CRA (2012 - 69%).
• The increase in CRA in ‘other’ predominantly related to Group
• At the year end, Non-Core accounted for 8% of total CRA (2012 10 %) as asset disposals and run-offs continued. Some 50% of the reduction in Non-Core was in the property sector as the Group continued to reduce its concentration in this sector, in particular commercial real estate.
Sector and geographical regional analyses The table below details CRA by sector and geographical region. Sectors are based on the Group’s sector concentration framework. Geographical region is based on the location of the customer’s operations (or, in the case of individuals, location of residence).
Personal 127,620 18,751 28,616 1,418 61 656 177,122 174,798 2,324 Banks 2,506 25,085 3,133 9,670 1,192 1,771 43,357 43,010 347 Other financial institutions 23,080 10,363 9,164 2,633 1,320 1,100 47,660 43,849 3,811 Sovereign (2) 55,041 8,685 18,203 3,394 37 687 86,047 84,726 1,321 Property 49,639 18,673 6,206 929 286 795 76,528 53,569 22,959 Natural resources 6,698 4,587 6,189 3,669 214 2,087 23,444 21,412 2,032 Manufacturing 8,843 4,962 6,208 2,278 120 1,397 23,808 23,276 532 Transport (3) 10,332 3,936 3,959 1,800 163 9,435 29,625 24,086 5,539 Retail and leisure 16,338 3,924 4,977 738 91 517 26,585 24,562 2,023 Telecoms, media and technology 3,356 2,591 3,401 1,403 29 491 11,271 9,810 1,461 Business services 16,527 2,733 6,053 757 1,233 206 27,509 26,518 991 319,980 104,290 96,109 28,689 4,746 19,142 572,956 529,616 43,340 2012 Personal 129,431 19,256 30,664 1,351 39 926 181,667 177,880 3,787 Banks 5,023 36,573 6,421 8,837 1,435 2,711 61,000 60,609 391 Other financial institutions 20,997 13,398 10,189 2,924 4,660 789 52,957 47,425 5,532 Sovereign (2) 38,870 26,002 14,265 2,887 64 1,195 83,283 81,636 1,647 Property 54,831 23,220 7,051 1,149 2,979 1,280 90,510 56,566 33,944 Natural resources 6,103 5,911 6,758 4,129 690 1,500 25,091 21,877 3,214 Manufacturing 9,656 5,587 6,246 2,369 572 1,213 25,643 24,315 1,328 Transport (3) 12,298 5,394 4,722 5,065 2,278 4,798 34,555 26,973 7,582 Retail and leisure 17,229 5,200 4,998 1,103 270 658 29,458 26,203 3,255 Telecoms, media and technology 4,787 3,572 3,188 1,739 127 346 13,759 10,815 2,944 Business services 17,089 3,183 5,999 581 780 154 27,786 26,190 1,596 316,314 147,296 100,501 32,134 13,894 15,570 625,709 560,489 65,220 2011 Personal 126,945 20,254 33,087 1,604 158 1,114 183,162 176,201 6,961 Banks 4,720 39,213 3,952 11,132 1,738 3,276 64,031 63,470 561 Other financial institutions 16,549 15,960 13,319 3,103 5,837 1,159 55,927 45,548 10,379 Sovereign (2) 21,053 31,374 31,391 3,399 78 1,581 88,876 87,617 1,259 Property 60,099 27,281 8,052 1,370 3,471 1,480 101,753 58,323 43,430 Natural resources 6,552 7,215 8,116 3,805 1,078 2,508 29,274 25,146 4,128 Manufacturing 9,583 7,391 7,098 2,126 1,011 1,381 28,590 26,525 2,065 Transport (3) 13,789 7,703 4,951 5,433 2,500 5,363 39,739 27,529 12,210 Retail and leisure 22,775 6,101 5,762 1,488 1,041 675 37,842 32,766 5,076 Telecoms, media and technology 5,295 4,941 3,202 1,944 139 609 16,130 12,180 3,950 Business services 17,851 3,719 6,205 910 629 206 29,520 26,830 2,690 305,211 171,152 125,135 36,314 17,680 19,352 674,844 582,135 92,709
Notes: (1) Comprises Central and Eastern Europe, the Middle East, Central Asia and Africa, and supranationals such as the World Bank. (2) Includes cash held at central banks. (3) Excludes net investment in operating leases in shipping and aviation portfolios as they are accounted for as property, plant and equipment. However, operating leases are included in the monitoring and management of these portfolios.
(2012 - 29%), sovereign 15% (2012 - 13%) exposure to banks and other financial institutions 16% (2012 - 18%), property 13% (2012 - 14%), and other corporate sectors 25% (2012 - 26%).
Europe, was primarily a result of reduced exposures to European central banks.
• UK exposure increased to 56% of CRA (2012 - 51%) because of a £16.2 billion rise in exposure to the Bank of England. This was offset predominantly by falls in Non-Core property (£7.5 billion) and Core personal and banking sectors, which fell £4.3 billion in total. Excluding sovereigns, UK Core exposure fell by 3%).
• The personal sector, excluding exposures in North America, fell by 2% due to reduced overdraft and lending exposure in the UK. This was offset by slightly increased UK mortgage exposure. Personal exposure in North America decreased disproportionately due to Non-Core exposures.
Limits and exposures are tightly controlled through the combination of the SNC framework, bespoke credit policies and country limits. Derivatives generated the largest exposure for banks (58% of credit risk assets in the banks sector), but a large portion of the exposures was collateralised. The increase in bank exposure in the Asia Pacific region was largely driven by short-term, trade finance related activities.
• Exposure to other financial institutions comprises a range of financial companies, the largest of which were funds (25%) securitisation vehicles (22%) and financial intermediaries (16%) including broker dealers and central counterparties (CCPs). The Core other financial institutions portfolio decreased by 8% in 2013. The Non-Core portfolio decreased by 31%.
• At the year end, the total exposure to CCPs was £4.1 billion (2012 - £3.2 billion). Regulatory initiatives to encourage the wider use of CCPs for clearing over-the-counter derivatives across the industry continue. The Group supports this move but recognises that its concentration risk to CCPs will continue to rise when it clears its own trades, as well as when it acts as a clearing broker for third parties. This increased concentration risk is being managed under a specific risk appetite and control framework. The Group’s CCP exposure remains dominated by a small number of well-established, high quality and reputable clearing houses.
• The majority of the Group’s property exposure was commercial real estate in Ireland and the UK (refer to Commercial real estate on pages 252 to 257 for further details). The remainder comprised lending to construction companies and building materials groups, which fell by £1.7 billion (15%), and housing associations, which increased by £0.9 billion (12%). A total of 59% of the Group’s Core property exposure was in UK Corporate (2012 - 60%) with Ulster Bank and US Retail & Commercial representing 10% and 9% respectively, unchanged from 2012.
• An increased number of clients suffered liquidity challenges during the year or failed to meet their minimum security covenant. This led to a commensurate rise in referrals to the Watchlist and transfers to the Global Restructuring Group. At 31 December 2013, 12% of the Group’s exposure to this sector was in the Watch Red category and loans in default amounted to £0.9 billion.
• The reduction in exposure in the retail and leisure sector was consistent with the Group’s strategies to re-balance the Core portfolios towards stronger customers in the sector while continuing to reduce the Non-Core book. The modest growth in North America was in line with agreed sector and region risk appetite.
• Exposure in the telecoms, media and technology sector fell by 18%
during the year, driven by divisional strategies to exit underperforming sub-sectors in the portfolio. Notably, media exposure fell 31% during the year.
• Exposure to healthcare of £9.5 billion at the year end (2012 - £9.9 billion) was included in the business services sector. The Group’s healthcare exposure was heavily biased towards the UK, which represented 68% of the exposure, unchanged from 2012.
Exposures are allocated to asset quality bands on the basis of statistically driven models, which produce an estimate of default rate. The variables included in the models vary by product and geography. For portfolios secured on residential property these models typically include measures of delinquency and loan to value as well as other differentiating characteristics such as bureau score, product features or associated account performance information.
2013 2012 2011 Core Non-Core Total Total Core Non-Core Total Total Core Non-Core Total Total AQ band
Probability of default range £m £m £m % £m £m £m % £m £m £m %
Note: (1) Largely comprises assets covered by the standardised approach, for which a probability of default equivalent to those assigned to assets covered by the internal ratings based approach is not available.
AQ10 risk assets AQ10 risk assets AQ10 risk assets AQ10 CRA by division £m % £m % £m %
UK Retail 4,462 3.9 4,998 4.4 5,097 4.6 UK Corporate 6,279 6.5 6,310 6.2 5,484 5.2 International Banking 572 0.9 612 0.9 1,736 2.4 Ulster Bank 9,198 27.8 8,236 24.1 6,305 16.7 US Retail & Commercial 536 1.0 633 1.2 646 1.1 Retail & Commercial 21,047 5.6 20,789 5.3 19,268 4.8 Markets 767 0.9 773 0.7 749 0.7 Core 21,814 4.1 21,562 3.8 20,017 3.4 Non-Core 20,743 47.9 22,845 35.0 25,020 27.0 42,557 7.4 44,407 7.1 45,037 6.7 *unaudited
Key points • Trends in the asset quality of the Group’s credit risk exposures during 2013 reflected the change in the proportion of assets in the sovereign sector and movements in the underlying asset quality of the portfolio. The Group’s overall asset quality for performing assets improved slightly year-on-year.
AQ1 band reflected the increase in the Group’s exposure to sovereigns, in line with the Group’s liquidity and capital management practices.
• Trends in the Group’s non-performing credit risk exposures in 2013 were predominantly driven by the Non-Core and Ulster Bank portfolios, with these two divisions accounting for 70% of the Group's AQ10 CRA.
• The personal sector accounted for 21% (2012 - 21%) of the Group’s
• In UK Retail non-performing assets continued to fall, principally as a result of lower flows of assets into non-performing across all portfolios, as well as write-downs of aged debt.
• The slight decrease in the level of AQ10 exposure in UK Corporate was driven primarily by reductions in the property sector, offset by increases in shipping. At the year end, shipping represented 12% of the AQ10 assets in UK Corporate (2012 - 8%).
When seeking to mitigate risk, at a minimum the Group considers the following: • The suitability of the proposed risk mitigation, particularly if restrictions apply; • The means by which legal certainty is to be established, including required documentation, supportive legal opinions and the steps needed to establish legal rights; • Acceptable methodologies for initial and subsequent valuation of collateral, the frequency of valuation and the advance rates given; • The actions it can take if the value of collateral or other mitigants is less than needed; • The risk that the value of mitigants and counterparty credit quality may deteriorate simultaneously; • The need to manage concentration risks arising from collateral types; and
Credit risk continued Risk mitigation continued Lending The types of collateral the Group takes to mitigate the credit risk arising from wholesale lending varies according to the nature of the counterparty and its assets. The most common types are: • Commercial real estate - The market value of the collateral typically exceeds the loan amount at origination date. The market value is defined as the estimated amount for which the asset could be sold in an arm’s length transaction by a willing seller to a willing buyer. In Ireland and, to a lesser extent, the UK, a lack of market data has made estimating the value of property difficult and so causes the Group to use a range of other types of information to value such collateral, including expert judgement and indices. For further information, regarding the Group’s commercial real estate portfolio refer to pages 252 to 257.
• Residential property - The Group takes collateral in the form of residential property to mitigate the credit risk arising from mortgages and home equity lending. The Group values residential property during the loan underwriting process by either appraising properties individually or using statistically valid models. The Group updates residential property values quarterly using the relevant residential property index, namely the Halifax Quarterly Regional House Price Index in the UK, the Case-Shiller Home Price Index in the US, the Central Statistics Office Residential Property Price Index in the ROI, and the Nationwide House Price Index in Northern Ireland.
• Receivables - These are amounts owed to the Group’s counterparties by their own customers. The Group values them after taking into account the quality of its counterparty’s receivable management processes and excluding any that are past due.
All collateral is assessed case-by-case to ensure that it will retain its value independently of the provider. The Group monitors the value of the collateral and, if there is a shortfall, will seek additional collateral.
Performing Non-performing Total Performing Non-performing Total Performing Non-performing TotalCommercial real estate loan-to-value ratio £m £m £m £m £m £m £m £m £m
(2) Other non-performing loans of £2.3 billion (2012 - £2.0 billion; 2011 - £2.5 billion) were subject to the Group’s standard provisioning policies. Other performing loans of £5.4 billion (2012 - £6.6 billion; 2011 - £9.2 billion) included general corporate loans, typically unsecured, to commercial real estate companies, and major UK house builders in addition to facilities supported by guarantees. The credit quality of these exposures was consistent with that of the performing portfolio overall.
(3) Weighted average by exposure. (4) 2012 LTV revised to reflect refinement to security value reporting implemented during 2013.
2013 2012 2011 Corporate risk elements in lending and potential problem loans Loans Provisions Loans Provisions Loans Provisions (excluding commercial real estate) £m £m £m £m £m £m
Credit risk continued Risk mitigation continued The table below shows LTVs for the Group’s residential mortgage portfolio split between performing (AQ1-AQ9) and non-performing (AQ10), with the average LTV calculated on a weighted value basis. Loan balances are shown as at the end of the year whereas property values are calculated using property index movements since the last formal valuation.
Loan-to-value ratio £m £m £m £m £m £m £m £m £m 2011
Average LTV on new originations during the year (3) 63% 74% 63%
Notes: (1) Includes residential mortgages and home equity loans and lines (refer to page 260 for a breakdown of balances). (2) Where no indexed LTV is held. (3) Average LTV weighted by value is calculated using the LTV on each individual mortgage and applying a weighting based on the value of each mortgage.
Counterparty credit risk The Group mitigates counterparty credit risk arising from both derivatives and repurchase agreements through the use of netting, collateral and the use of market standard documentation.
Reverse repurchase agreements 76.5 104.8 100.9 Securities received as collateral (1) (76.4) (104.7) (98.9)
Note: (1) In accordance with normal market practice, at 31 December 2013 £63.7 billion (2012 - £100.7 billion; 2011 - £95.4 billion) had been resold or re-pledged as collateral for the Group's own transactions.
Watchlist* There are three Watch classifications - Amber, Red and Black - reflecting progressively deteriorating conditions. Watch Amber customers are performing customers who show early signs of potential financial difficulty, or have other characteristics that warrant closer monitoring. Watch Red customers are performing customers who show signs of declining creditworthiness which requires active management usually by the Global Restructuring Group (GRG). Watch Black customers include risk elements in lending and potential problem loans.
Once on the Watchlist, customers are subject to heightened scrutiny. Depending on the severity of the financial difficulty and the size of the exposure, the customer relationship strategy is reassessed by credit officers, by specialist units in divisions or by GRG. In more material cases, a forum of experienced credit, portfolio management and remedial management specialists in the divisions or GRG may reassess the customer relationship strategy. In accordance with Group-wide policies, a number of mandatory actions are taken, including a review of the customer’s credit grade and facility and security documentation.
Other appropriate corrective action is taken when circumstances emerge that may affect the customer’s ability to service its debt. Such circumstances include deteriorating trading performance, imminent breach of covenant, challenging macroeconomic conditions, a late payment or the expectation of a missed payment.
For all Watch Red cases, the division is required to consult with GRG on whether the relationship should be transferred to GRG (for more information on GRG, refer to below). Watch Red customers that continue to be managed by the divisions tend to be those requiring subject matter expertise that is available in the divisions rather than in GRG.
At 31 December 2013, exposures to customers reported as Watchlist Red and managed in the divisions totalled £3.2 billion (2012 - £4.3 billion).
The following table shows a sector breakdown of CRA of Watch Red customers under GRG management: 2013 2012 2011 Core Non-Core Total Core Non-Core Total Core Non-Core Total
Watch Red CRA by current exposure £m £m £m £m £m £m £m £m £m
The decrease in Watch Red cases was driven predominantly by a lower flow of cases into GRG, repayments and movement of cases into Watch Black. The overall value of customers in default has however reduced during the year. For further information regarding the asset quality of the Group's portfolio refer to the Asset quality section on page 236.
Global Restructuring Group GRG manages the Group’s wholesale problem debt portfolio in cases where its exposure to the customer exceeds £1 million. In addition, GRG provides a specialist credit function, the Strategy Management Unit, for distressed bilateral lending where the exposure is between £250,000 and £1 million. The primary function of GRG is to restore customers to an acceptable credit condition and minimise losses to the Group.
The objective is to find a mutually acceptable solution, including repayment, refinancing or transfer to another bank if that is the customer’s preferred option. Once a solution is found, management of the loans may be transferred back to the performing divisions. If the business is not viable and a turnaround is not possible, insolvency may be an option.
Concessions granted where there is no evidence of financial difficulty, or where any changes to terms and conditions are within the Group’s usual risk appetite (for a customer new to the Group), or reflect improving credit market conditions for the customer, are not considered forbearance.
Types of wholesale forbearance Wholesale forbearance may involve the following types of concessions: • Payment concessions and loan rescheduling, including extensions in contractual maturity, may be granted to improve the customer’s liquidity. Concessions may also be granted on the expectation that the customer’s liquidity will recover when market conditions improve. In addition, they may be granted if the customer will benefit from access to alternative sources of liquidity, such as an issue of equity capital. These options are commonly used in commercial real estate transactions, particularly where a shortage of market liquidity rules out immediate refinancing and makes short-term collateral sales unattractive.
• Debt may be forgiven, or exchanged for equity, where the customer’s business or economic environment means that it cannot meet obligations and where other forms of forbearance are unlikely to succeed. Debt forgiveness is commonly used for stressed leveraged finance transactions. These are typically structured on the basis of projected cash flows from operational activities, rather than underlying tangible asset values. Provided that the underlying business model, strategy and debt level are viable, maintaining the business as a going concern is the preferred option, rather than realising the value of the underlying assets.
A temporary covenant waiver, a recalibration of covenants or a covenant amendment may be used to cure a potential or actual covenant breach. In return for this relief, the Group would seek to obtain a return commensurate with the risk that it is required to take. The increased return for the increased risk can be structured flexibly to take into account the customer’s circumstances, for example increased margin on a cash or payment in kind basis, and/or deferred return instruments.
Loans may be forborne more than once, generally where a temporary concession has been granted and circumstances warrant another temporary or permanent revision of the loan’s terms. All customers are assigned a PD and related facilities a LGD. These are re-assessed prior to finalising any forbearance arrangement in light of the loan’s amended terms. Where forbearance is no longer viable, the Group will consider other options such as the enforcement of security and/or insolvency proceedings.
The ultimate outcome of a forbearance strategy is unknown at the time of execution. It is highly dependent on the cooperation of the borrower and the continued existence of a viable business. The following are generally considered to be options of last resort: • Enforcement of security or otherwise taking control of assets - Where the Group holds collateral or other security interest and is entitled to enforce its rights, it may enforce its security or otherwise take ownership or control of the assets. The Group’s preferred strategy is to consider other possible options prior to exercising these rights.
As part of the Group’s ongoing review of forbearance reporting, the amounts shown as “Completed forbearance” relating to 2012 and 2013 now include loans granted covenant concessions only. These were disclosed by way of a note in 2012. While the Group considers these types of concessions qualitatively different from other forms of forbearance, they constitute a significant proportion of wholesale forbearance and were therefore included.
Wholesale forbearance during the year by arrangement type (2) % % %
Notes: (1) Provision coverage reflects impairment provision as a percentage of non-performing loans. (2) The total exceeds 100% as an individual case can involve more than one type of arrangement. (3) The main types of ‘other’ concessions include formal ‘standstill’ agreements and release of security.
Key points • A number of refinements have been made in 2013 to the reporting of wholesale forbearance as explained below: ° Change in reporting thresholds from £10 million to £3 million, increased forbearance reported by £1.7 billion.
° During ongoing portfolio reviews, a number of facilities totalling £2.3 billion were identified which were being managed in accordance with an agreed forbearance strategy but where the forbearance had not been formally documented. These have been included in the tables above, which has led to an increase in completed forbearance for 2013 and a corresponding decrease in loans which are “in process” for the purpose of forbearance (in process loans are explained below).
° Covenant only forbearance of £1.7 billion (2012 - £3.5 billion) has been included.
• Year-on-year analysis of forborne loans may be skewed by individual material cases during a given year. This is particularly relevant when comparing the value of forbearance completed in the property and transport sectors in 2013 with previous years.
• At 31 December 2013, loans totalling £9.4 billion (2012 - £13.7 billion) were granted credit approval for forbearance but where such forbearance had not yet been formally documented and which were not being managed in accordance with an agreed forbearance strategy. These loans are referred to as in process and are not included in the tables above. 84% of these were non-performing loans, with an associated provision coverage of 44%, and 16% were performing loans. The principal types of arrangements offered included payment concessions and loan rescheduling, covenant concessions, forgiveness of all or part of the outstanding debt and variations in margin.
• Loans forborne during 2012 and 2013 and outstanding at 31 December 2013 totalled £18.4 billion, of which £8.0 billion related to arrangements completed during 2012.
Retail Collections Collections functions in each of the Group’s retail businesses provide support and assistance to customers who are experiencing difficulties in meeting their obligations to the Group. Such customers may miss a payment on their loan or borrow more than their agreed limit, or contact the Group themselves asking for help. Dedicated support teams are also in place to identify and help customers who have not yet missed a payment but may be facing financial difficulty.
The collections function may use a range of tools to initiate contact with the customer, establish the cause of their financial difficulty and support them where possible. In the process, they may consider granting the customer forbearance.
Additionally, in the UK and Ireland, support is provided to customers with unsecured loans who establish a repayment plan with the Group through a debt advice agency or a self-help tool. Such “breathing space” suspends collections activity for a 30-day period to allow time for the repayment plan to be put in place. Arrears continue to accrue for customer loans granted breathing space.
Identification Customers who contact the bank directly because of financial difficulties, or who are already in payment arrears, may be granted forbearance. In the course of assisting customers, more than one forbearance treatment may be granted.
Types of retail forbearance Forbearance is granted principally to customers with mortgages and less extensively to customers with unsecured loans.
Mortgage portfolios Forbearance options include, but are not limited to, payment concessions, capitalisations of arrears, term extensions and temporary conversions to interest only.
• Payment concessions - A temporary reduction in, or elimination of, the periodic (usually monthly) loan repayment is agreed with the customer. At the end of the concessionary period, forborne principal and accrued interest outstanding is scheduled for repayment over an agreed period. Ulster Bank and RBS Citizens also offer payment concessions in the form of discounted interest rates that involve the forgiveness of some interest (further details below).
• Capitalisation of arrears - The customer repays the arrears over the remaining term of the mortgage and returns to an up-to-date position.
• Interest only conversions - The loan converts from principal and interest repayment to interest only repayment on a temporary basis (Ulster Bank only).
In UK Retail, interest only conversions have not been used to support customers in financial difficulty since 2009, and from 2012 have only been permitted on a very exceptional basis for residential mortgage customers who are up to date on payments. As a result interest only loans with permanent changes to terms are historical stock. In Ulster Bank, interest only conversions are offered to customers under financial stress and solely on a temporary basis.
• For unsecured portfolios in UK Retail, £121 million of balances (1%
of the total unsecured balances) were subject to forbearance at 2013 year end.
of the population was subject to forbearance at 31 December 2013.
In Ulster Bank, if a customer makes payments that reduce loan arrears below 90 days, the loan is transferred to the performing book. In addition, where a customer meets the original payment terms for six months and is expected to continue to do so, capitalisation may be agreed. In these cases the loan is also transferred to the performing book.
Mortgages granted forbearance are reviewed regularly to ensure that customers are meeting the agreed terms. Key metrics have been developed to record the proportion of loans that fail to meet the agreed terms over time, as well as the proportion of loans that return to performing with no arrears. Retail forbearance loans can be modified more than once.
Twelve month default rates are calculated for all mortgage forbearance types. In 2013, the average twelve month default rates were 8% for UK Retail, 18% for Ulster Bank and 13% for RBS Citizens.
The mortgage arrears information for retail accounts in forbearance and related provision are shown in the tables below.
Credit risk continued Early problem identification and problem debt management continued Forbearance arrangements The incidence of the main types of retail forbearance on the balance sheet are analysed below.
The table below shows forbearance agreed during the year analysed between performing and non-performing.
Performing forbearance 1,332 2,223 — 41 3,596 Non-performing forbearance 186 1,213 101 22 1,522 Total forbearance (1,2) 1,518 3,436 101 63 5,118 2012 Performing forbearance 1,809 2,111 88 18 4,026 Non-performing forbearance 184 1,009 71 2 1,266 Total forbearance (1,2) 1,993 3,120 159 20 5,292
Notes: (1) An individual case can include more than one type of arrangement. (2) Includes all arrangements agreed during the year (new customers and renewals) including those deals that have expired at year end. Balances are at year end.
Key points UK Retail • At 31 December 2013, forbearance balances where the forbearance treatment was provided in the last 24 months amounted to £2.0 billion. This represented a 14% reduction in the year.
• 5.5% of total mortgage assets (£5.4 billion) were subject to a forbearance arrangement agreed since January 2008. This represented an increase from 4.9% on 2012 (£4.8 billion). The rise was driven by an extension of the reporting definition to include legacy conversions to interest only repayment in cases where customers were previously on a combination of repayment types. Excluding this change in definition, forbearance stock remained stable.
• Approximately 84% of forbearance loans (2012 - 83%) were up to date with payments compared with approximately 97% of assets not subject to forbearance activity.
(term extensions, capitalisation of arrears, historic conversions to interest only). Temporary forbearance comprises payment concessions such as reduced or deferred payments with such arrangements typically agreed for a period of three to six months.
• The impairment provision cover on forbearance loans remained significantly higher than that on assets not subject to forbearance.
Ulster Bank • At 31 December 2013, 14.6% of total mortgage assets (£2.8 billion)
were subject to a forbearance arrangement (agreed since early 2009), an increase from 10.4% (£2.0 billion) at 31 December 2012. This reflected Ulster Bank’s proactive strategies to contact customers in financial difficulty to offer assistance.
• The majority of forbearance arrangements were less than 90 days in
• The remaining forbearance loans were temporary concessions accounting for 72%. Short to medium-term concessions are offered for periods of three months to five years and incorporate different levels of repayment based on the customer’s ability to pay.
Credit risk continued Early problem identification and problem debt management continued Recoveries Once a loan has been identified as impaired it is managed by divisional recoveries functions. Their goal is to collect the total outstanding and reduce the Group’s loss by maximising cash recovery while treating customers fairly. Where an acceptable repayment arrangement cannot be agreed with the customer, litigation may be considered. In UK Retail and Northern Ireland, no repossession procedures are initiated until at least six months following the emergence of arrears. In the Republic of Ireland, new regulations prohibit taking legal action for an extended period. Additionally, certain forbearance options are made available to customers managed by the recoveries function.
For both wholesale and retail exposures, days-past-due measures are typically used to identify evidence of impairment. In both corporate and retail portfolios, a period of 90 days past due is used. In sovereign portfolios, the period used is 180 days past due. Other factors are considered including: the borrower’s financial condition; a forbearance event; a loan restructuring; the probability of bankruptcy; or any evidence of diminished cash flows.
Provisioning methodology If there is objective evidence that an impairment loss has been incurred, the amount of the loss is measured as the difference between the asset carrying amount and the present value of the estimated future cash flows discounted at the financial asset’s original effective interest rate. The current net realisable value of the collateral will be taken into account in determining the need for a provision. No impairment provision is recognised in cases where amounts due are expected to be settled in full on realisation of the security. The Group uses one of the following three different methods to assess the amount of provision required: individual; collective; and latent.
Collectively assessed provisions Provisions on impaired credits below an agreed threshold are assessed on a portfolio basis, reflecting the homogeneous nature of the assets. The Group segments wholesale and retail portfolios according to product type, such as credit cards, personal loans and mortgages. The approach taken to assess impaired assets in collections differs from the approach taken to assess those in recoveries (refer to page 245 for further details on collections and refer to above for recoveries).
Provisions are determined based on a quantitative review of the relevant portfolio. They take account of the level of arrears, the value of any security, and historical and projected cash recovery trends over the recovery period. The provisions also incorporate any adjustments that may be deemed appropriate given current economic conditions. Such adjustments may be determined based on a review of the latest cash collections profile and operational processes used in managing exposures.
The Group’s retail businesses segment their performing loan books into homogeneous portfolios such as mortgages, credit cards or unsecured loans, to reflect their different credit characteristics. Latent provisions are computed by applying portfolio level LGDs, PDs and emergence periods. The wholesale calculation is based on similar principles but there is no segmentation into portfolios. PDs and LGDs are calculated on an individual basis.
Refer to pages 299 to 317 for analysis of impaired loans, related provisions and impairments.
Provisions for forborne wholesale loans are assessed in accordance with the Group’s normal provisioning policies (refer to Group impairment loss provisioning on page 250). The customer’s financial position and prospects as well as the likely effect of the forbearance, including any concessions granted, are considered in order to establish whether an impairment provision is required. Individual impairment assessments for wholesale loans are reassessed in the light of any revisions to the loan's terms.
All wholesale customers are assigned a PD and related facilities an LGD. These are re-assessed prior to finalising any forbearance arrangement in light of the loan’s amended terms and any revised grading incorporated in the calculation of the impairment loss provisions for the Group’s wholesale exposures.
The transfer of wholesale loans subject to forbearance from impaired to performing status follows assessment by relationship managers in GRG. When no further losses are anticipated and the customer is expected to meet the loan’s revised terms, any provision is written-off and the balance of the loan returned to performing status.
Retail Provisions are assessed in accordance with the Group’s provisioning policies (refer to Group impairment loss provisioning on page 250).
Non-Core UK Corporate 1,201 774 1,975 2,651 983 3,634 3,957 2,020 5,977 Ulster Bank 3,211 6,915 10,126 3,383 7,607 10,990 3,860 8,490 12,350 US Retail & Commercial 232 — 232 392 — 392 901 28 929 International Banking 6,980 15 6,995 11,260 154 11,414 14,689 336 15,025 11,624 7,704 19,328 17,686 8,744 26,430 23,407 10,874 34,281
Key points • In line with Group strategy, the overall gross lending exposure to commercial real estate (CRE) fell by £10.5 billion, or 17%, during 2013 to £52.6 billion. Gross lending exposure is now almost half of the exposure of four years ago. The overall mix of geography, subsector and investment and development remained broadly unchanged.
• The UK portfolio was focused on London and South East England.
Approximately 47% of the portfolio was held in these areas at 31 December 2013 (2012 - 43%).
< 1 year (1) 6,816 2,740 602 352 117 10,627 1-2 years 3,436 360 669 203 — 4,668 2-3 years 4,721 177 739 116 7 5,760 > 3 years 8,621 860 2,008 273 13 11,775 Not classified (2) 420 — — — — 420 24,014 4,137 4,018 944 137 33,250
AQ1-AQ2 AQ3-AQ4 AQ5-AQ6 AQ7-AQ8 AQ9 AQ10 TotalCommercial real estate portfolio by asset quality band £m £m £m £m £m £m £m
Ulster Bank Rest of the Group Group Performing Non-performing Total Performing Non-performing Total Performing Non-performing TotalCommercial real estate loan-to-value ratio £m £m £m £m £m £m £m £m £m
Bank. Total portfolio average LTV is quoted net of loans with minimal security given that the anticipated recovery rate is less than 10%. Provisions are marked against these loans where required to reflect the relevant asset quality and recovery profile.
Key points • The reductions in the higher LTV buckets for the performing book were offset by the growth in these buckets in the non-performing book. Ulster Bank Group accounted for the majority of this deterioration and has addressed this through an increase in provisions (refer to the section on RCR). Ulster Bank Group's provision as a percentage of REIL stood at 76% at 31 December 2013 (2012 - 57%). Valuations continued to be affected by difficult, although improving, market conditions, as well as refinements to the Group’s estimation approach.
• Interest payable on outstanding loans was covered 3.1x and 1.6x within UK Corporate and International Banking, respectively, at 31 December 2013 (2012 - 3.0x and 1.5x respectively). The US Retail & Commercial portfolio is managed on the basis of debt service coverage, which includes principal amortisation as well as interest payable. The average debt service coverage was 1.5x at 31 December 2013 (2012 - 1.3x). As a number of different approaches are used across the Group and across geographies to calculate interest coverage ratios, they may not be comparable for different portfolio types and legal entities.
Credit quality metrics relating to commercial real estate lending were as follows: Group Non-Core
Lending (gross) £52.6bn £63.0bn £74.8bn £19.3bn £26.4bn £34.3bn Of which REIL £20.1bn £22.1bn £22.9bn £14.3bn £17.1bn £18.8bn Provisions £13.2bn £10.1bn £9.5bn £10.6bn £8.3bn £8.2bn REIL as a % of gross loans to customers 38.2% 35.1% 30.6% 74.1% 64.8% 54.8%
Note: (1) Excludes property related lending to customers in other sectors managed by Real Estate Finance.
UK Retail 99,338 99,062 96,388 Ulster Bank 19,034 19,162 20,020 RBS Citizens 19,584 21,538 24,153 Wealth 8,701 8,786 8,468 146,657 148,548 149,029
UK Retail Ulster Bank RBS Citizens (1) Wealth Non- Non- Non- Non-
• As at 31 December 2013, approximately 43% of the portfolio consisted of fixed rate, 5% a combination of fixed and variable rates and the remainder were variable rate mortgages (including those on managed rates). The interest only proportion of the total portfolio was 26%.
• All new mortgage business is subject to a comprehensive assessment. This includes: i) an affordability test which includes a stressed interest rate that is higher than the customer pay rate; ii) credit scoring; iii) a maximum loan-to-value of 90% with the exception of the UK Government backed schemes Help-to-Buy (from the fourth quarter of 2013), New Buy and My New Home products where lending of up to 95% is provided; and iv) a range of policy rules that restrict the availability of credit to borrowers with higher risk characteristics, for example highly indebted and/or adverse payment behaviour on previous borrowings.
• The arrears rate (defined as more than three payments in arrears, excluding repossessions and shortfalls post property sale), fell to 1.3% (2012 - 1.5%). The number of properties repossessed in 2013 was 1,532 compared with 1,426 in 2012. Arrears rates remained sensitive to economic developments and benefited from the low interest rate environment.
December 2013, with 88% in the Republic of Ireland and 12% in Northern Ireland. At constant exchange rates, the portfolio decreased 2.5% from 31 December 2012 as a result of amortisation and limited growth due to low market demand.
• Refer to the Ulster Bank Group (Core and Non-Core) section on pages 265 to 267 for commentary on mortgage REIL and impairments.
RBS Citizens • RBS Citizens residential real estate portfolio was £19.6 billion at 31
December 2013 (2012 - £21.5 billion). The Core business comprised 91% of the portfolio. The real estate portfolio consisted of £5.9 billion (£5.6 billion Core vs. £0.3 billion Non-Core) of first lien residential mortgages (1% in second lien position) and £13.5 billion (£12.0 billion Core vs. £1.5 billion Non-Core) of home equity loans and lines (first and second liens). Home equity Core consisted of 49% in first lien position while Non-Core consisted of 95% in second lien position.
England, Mid Atlantic and Mid West regions. At 31 December 2013, the portfolio consisted of £16.4 billion (84% of the total portfolio) within footprint.
2013 2012 2011 Impairment Impairment Impairment charge as a % charge as a % charge as a %
Average of average Average of average Average of average loans and loans and loans and loans and loans and loans and receivables receivables receivables receivables receivables receivables £m % £m % £m %
UK Retail cards (1) 5,626 2.0 5,624 2.3 5,675 3.0 UK Retail loans (1) 5,761 1.6 6,513 2.5 7,755 2.8
Key points UK Retail • The UK personal lending portfolio comprised credit cards, unsecured loans and overdrafts, and totalled £13.8 billion at 31 December 2013 (2012 - £14.7 billion). Loans fell 12%.
• Auto loans originated through dealer networks totalled £5.5 billion at 31 December 2013 (2012 - £5.4 billion). The portfolio maintained strong credit fundamentals. New origination credit and collateral characteristics throughout 2013 remained equally strong as a result of the short balance life and the resulting low collateral risk.
Credit risk continued Key loan portfolios* continued Interest only retail loans The Group’s interest only retail loan portfolios include interest only mortgage lending in UK Retail, Ulster Bank, Wealth and RBS Citizens’ portfolios of home equity lines of credit (HELOC) and interest only mortgage portfolios.
The tables below analyse the Group’s interest only mortgage and HELOC portfolios (excluding mixed repayment mortgages) by type, by contractual year of maturity and by originating division.
Notes: (1) 2014 includes pre-2014 maturity exposure. (2) Includes £2.3 billion (2012 - £2.2 billion) of repayment mortgages that have been granted interest only concessions (forbearance). (3) Maturity date relates to the expiry of the interest only period. (4) 2013 includes pre-2013 maturity exposure.
Of the bullet loans that matured in the six months to 30 June 2013, 53% had been fully repaid by 31 December 2013. The unpaid balance totalled £51 million, 96% of which continued to meet agreed payment arrangements (including balances that have been restructured on a capital and interest basis within eight months of the contract date; customers are allowed eight months leeway for their investment plan to mature and cashed in to repay the mortgage). Of the £51 million unpaid balance, 56% of the loans had an indexed LTV of 70% or less with only 14% above 90%. Customers may be offered a short extension to the term of an interest only mortgage or a conversion of an interest only mortgage to one featuring repayment of both capital and interest, subject to affordability and characteristics such as the customer’s income and ultimate repayment vehicle. The majority of term extensions in UK Retail are classified as forbearance.
Ulster Bank Ulster Bank’s interest only mortgages require full principal repayment (bullet) at the time of maturity; or payment of both capital and interest from the end of the interest only period, typically seven years, so that customers meet their contractual repayment obligations. For bullet customers, contact strategies are in place to remind them of the need to repay principal at the end of the mortgage term.
Ulster Bank Group (Core and Non-Core) Overview At 31 December 2013, Ulster Bank Group accounted for 10% of the Group’s total gross loans to customers (2012 and 2011 - 10%) and 8% of the Group’s Core gross loans to customers (2012 and 2011 - 8%) Ulster Bank’s financial performance continued to be impacted by the challenging economic climate in Ireland, with impairments remaining elevated in the wholesale bank as a result of limited liquidity in the economy which continues to depress the property market and domestic spending. Additionally, in the fourth quarter of 2013 the Group announced a recovery strategy for loans transferring to RCR. This resulted in a significant increase in provisions as the move from a through the cycle strategy to a 3 year deleverage, reduced expected realisations.
The impairment charge of £4,793 million for 2013 (2012 - £2,340 million; 2011 - £3,717 million) was driven by a combination of new defaulting customers and higher provisions on existing defaulted cases due primarily to the above mentioned RCR strategy. Provisions as a percentage of risk elements in lending increased to 76% in 2013, from 57% in 2012, predominantly as a result of this change in strategy, combined with the deterioration in the value of the Non-Core commercial real estate development portfolio.
Non-Core The impairment charge for the year was £3,019 million (2012 - £976 million; 2011 - £2,333 million), with the commercial real estate sector accounting for £2,674 million (89%) of the total 2013 impairment charge, again reflecting the RCR strategy.
The table below analyses Ulster Bank Group’s loans, REIL, impairments and related credit metrics by sector.
Ulster Bank Group Mortgages 19,034 3,235 1,725 17.0 53 9.1 235 34 Commercial real estate - investment 6,630 5,294 3,313 79.8 63 50.0 1,430 104 - development 7,633 7,229 6,489 94.7 90 85.0 1,990 374 Other corporate 8,518 3,486 3,053 40.9 88 35.8 1,116 155 Other lending 1,236 194 187 15.7 96 15.1 22 39
Gross as a % of as a % of as a % of Impairment Amounts loans REIL Provisions gross loans REIL gross loans charge written-off
Key points • The commercial real estate lending portfolio for Ulster Bank Group
(Core and Non-Core) totalled £14.3 billion at 31 December 2013, of which £10.1 billion or 71% was in Non-Core. The geographic split of the total Ulster Bank Group commercial real estate portfolio remained similar to 2012 with 64% (2012 - 63%) in the Republic of Ireland, 26% (2012 - 26%) in Northern Ireland, 10% (2012 - 11%) in the UK (excluding Northern Ireland) and the balance (0.1%) in Rest of World (primarily Europe).
Key points • Commercial real estate continued to be the primary sector driving the Ulster Bank Group defaulted loan book. Exposure to the sector fell during 2013 by £1.0 billion, reflecting Ulster Bank’s continuing strategy to reduce concentration risk in this sector.
• The outlook for the property sector remains challenging. While there may be some signs of stabilisation in main urban centres, the outlook continues to be negative for secondary property locations on the island of Ireland.
Residential mortgages Mortgage lending portfolio analysis by country of location of the underlying security is set out below.
Balance sheet analysis 269 Financial assets 269 - Exposure summary 271 - Sector and geographic concentration 279 - Asset quality 284 Debt securities 293 Equity shares 296 Derivatives 299 REIL, provisions and AFS reserves
Balance sheet analysis Credit risk assets analysed on pages 231 to 237 are reported internally to senior management. However, they exclude certain exposures, primarily securities and reverse repurchase agreements and take account of legal netting agreements, that provide a right of legal set-off but do not meet the criteria for offset in IFRS. The tables that follow are therefore provided to supplement the credit risk assets analysis and other analysis to reconcile to the balance sheet. All the disclosures in this section are audited except those relating to RCR on pages 299 and 300.
Gross IFRS Carrying Balance sheet Real estate and other Credit mitigation and exposure offset (1) value (2) offset (3) Cash (4) Securities (5) residential (6) commercial (6) Enhancement (7) enhancement 2013 £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn
Notes: (1) Relates to offset arrangements that comply with IFRS criteria and transactions cleared through and novated to central clearing houses, primarily London Clearing House and US Government
Gross IFRS Carrying Balance sheet Exposure exposure offset (1) value offset (2) post offset 2012 £bn £bn £bn £bn £bn
Cash and balances at central banks 79.3 — 79.3 — 79.3
Other financial assets 1.1 — 1.1 — 1.1 2011 Cash and balances at central banks 79.4 — 79.4 — 79.4
Central and local government 247 8,643 70,267 — 4,049 578 83,784 (4,433) 79,351 Financial institutions - banks 26,557 27,640 7,869 688 200,091 82,661 345,506 (207,203) 138,303 - other (2) 49,156 35,948 33,219 2,538 69,851 4,859 195,571 (87,110) 108,461 Personal - mortgages — 148,533 — — — — 148,533 — 148,533 - unsecured — 28,160 — — — 6 28,166 — 28,166 Property — 62,292 225 326 2,794 — 65,637 (689) 64,948 Construction — 6,331 24 117 451 7 6,930 (1,370) 5,560 Manufacturing 466 21,377 735 2,168 1,265 43 26,054 (2,525) 23,529 Finance leases and instalment credit — 13,587 14 5 13 — 13,619 (17) 13,602 Retail, wholesale and repairs — 19,574 244 446 882 11 21,157 (1,962) 19,195 Transport and storage — 16,697 299 82 2,186 — 19,264 (866) 18,398 Health, education and leisure — 16,084 103 86 661 14 16,948 (853) 16,095 Hotels and restaurants — 6,942 5 57 218 — 7,222 (165) 7,057 Utilities — 4,960 176 285 3,271 23 8,715 (1,064) 7,651 Other 28 28,624 762 2,112 2,308 50 33,884 (2,776) 31,108 Total gross of provisions 76,454 445,392 113,942 8,910 288,040 88,252 1,020,990 (311,033) 709,957 Provisions — (25,225) (319) (99) — — (25,643) n/a (25,643)
• The banking sector continues to be one of the largest in the Group’s portfolio. The sector is well diversified geographically and by exposure with derivative exposures being largely collateralised. The sector continues to be tightly controlled through the combination of the single name concentration framework, bespoke credit policies and country limits. Exposures to the banking sector decreased by £14.8 billion during the year with decreases across, reverse repos lending, securities and derivatives being partially offset by increased cash holdings with central banks.
• Exposure to other financial institutions comprising traded and nontraded products is spread across a wide range of financial companies including insurance, securitisation vehicles, financial intermediaries including broker dealers and central counterparties, financial guarantors - monolines and credit derivative product companies - and funds comprising unleveraged, hedge and leveraged funds. The size of the portfolio decreased by £44.6 billion. Entities in this sector remain vulnerable to market shocks or contagion from the banking sector.
• Retail, wholesale and repairs sector decreased by £4.2 billion, reflecting the Group’s strategy to re-balance the Core portfolios towards stronger customers in the sector while at the same time continuing to reduce the Non-Core book.
US Central and local government 247 238 23,832 — 21 221 24,559 (12) 24,547 Financial institutions - banks 4,073 946 212 166 53,340 17,811 76,548 (53,339) 23,209 - other (2) 18,346 3,908 17,269 379 9,580 2,276 51,758 (13,778) 37,980 Personal - mortgages — 19,901 — — — — 19,901 — 19,901 - unsecured — 8,722 — — — — 8,722 — 8,722 Property — 4,279 — — 21 — 4,300 (7) 4,293 Construction — 313 2 13 2 — 330 — 330 Manufacturing — 6,117 299 9 131 — 6,556 (56) 6,500 Finance leases and instalment credit — 2,513 8 — 1 — 2,522 — 2,522 Retail, wholesale and repairs — 4,914 87 1 32 — 5,034 (6) 5,028 Transport and storage — 1,667 76 7 370 — 2,120 (141) 1,979 Health, education and leisure — 3,059 55 2 37 — 3,153 — 3,153 Hotels and restaurants — 369 4 7 1 — 381 — 381 Utilities — 638 32 1 149 — 820 (27) 793 Other 10 4,464 429 16 547 — 5,466 (20) 5,446 Total gross of provisions 22,676 62,048 42,305 601 64,232 20,308 212,170 (67,386) 144,784 Provisions — (850) (60) (12) — — (922) n/a (922)
RoW Central and local government — 677 11,760 — 119 235 12,791 (70) 12,721 Financial institutions - banks 3,364 6,766 777 72 14,625 1,997 27,601 (11,846) 15,755 - other (2) 11,517 1,669 60 51 3,784 331 17,412 (3,442) 13,970 Personal - mortgages — 577 — — — — 577 — 577 - unsecured — 1,073 — — — — 1,073 — 1,073 Property — 584 139 3 20 — 746 (1) 745 Construction — 348 — 3 35 — 386 (4) 382 Manufacturing — 2,902 2 9 129 — 3,042 (46) 2,996 Finance leases and instalment credit — 129 3 — 1 — 133 (1) 132 Retail, wholesale and repairs — 1,016 3 22 99 — 1,140 (27) 1,113 Transport and storage — 702 82 6 154 — 944 (17) 927 Health, education and leisure — 188 — 4 4 — 196 — 196 Hotels and restaurants — 60 — — — — 60 — 60 Utilities — 535 15 3 182 23 758 (10) 748 Other — 3,585 82 78 216 3 3,964 (79) 3,885 Total gross of provisions 14,881 20,811 12,923 251 19,368 2,589 70,823 (15,543) 55,280 Provisions — (261) — — — — (261) n/a (261)
Reverse Securities Other Balance Exposure repos Lending Debt Equity Derivatives financial assets sheet value Offset (1) post offset
Europe Central and local government — 891 5,684 — 54 2 6,631 (15) 6,616 Financial institutions - banks 375 3,151 4,016 8 55 23,181 30,786 (2) 30,784 - other (2) 20 1,690 7,222 309 95 134 9,470 — 9,470 Personal - mortgages — 17,836 — — — — 17,836 — 17,836 - unsecured — 1,905 — — — — 1,905 — 1,905 Property — 14,634 — 2 77 — 14,713 (5) 14,708 Construction — 1,132 — 6 — — 1,138 (21) 1,117 Manufacturing — 5,431 94 26 25 1 5,577 (9) 5,568 Finance leases and instalment credit — 464 — — — — 464 — 464 Retail, wholesale and repairs — 3,749 — 109 10 — 3,868 (22) 3,846 Transport and storage — 5,450 1 10 12 — 5,473 (5) 5,468 Health, education and leisure — 1,569 — 2 — — 1,571 (6) 1,565 Hotels and restaurants — 1,379 — — — — 1,379 (4) 1,375 Utilities — 1,492 6 112 65 20 1,695 — 1,695 Other — 5,309 39 201 44 32 5,625 (53) 5,572 Total gross of provisions 395 66,082 17,062 785 437 23,370 108,131 (142) 107,989 Provisions — (10,267) (438) — — — (10,705) n/a (10,705)
RoW Central and local government — 724 6,849 — 132 42 7,747 (91) 7,656 Financial institutions - banks 4,528 4,250 961 111 24,639 1,210 35,699 (23,453) 12,246 - other (2) 4,226 2,296 565 84 4,515 425 12,111 (3,893) 8,218 Personal - mortgages — 330 — — — — 330 — 330 - unsecured — 1,061 — — — — 1,061 — 1,061 Property — 512 219 8 53 — 792 — 792 Construction — 22 — 8 22 — 52 — 52 Manufacturing — 2,277 7 45 183 32 2,544 (9) 2,535 Finance leases and instalment credit — 142 1 — 13 — 156 — 156 Retail, wholesale and repairs — 1,751 6 63 137 — 1,957 (121) 1,836 Transport and storage — 386 94 11 481 — 972 (156) 816 Health, education and leisure — 387 — 4 13 — 404 — 404 Hotels and restaurants — 19 — — — — 19 — 19 Utilities — 617 27 19 178 — 841 — 841 Other 1 3,588 88 98 416 — 4,191 (188) 4,003 Total gross of provisions 8,755 18,362 8,817 451 30,782 1,709 68,876 (27,911) 40,965 Provisions — (318) — — — — (318) n/a (318)
UK Central and local government 2,130 8,037 77,831 — 5,282 548 93,828 (1,098) 92,730 Financial institutions - banks 25,204 29,793 1,950 1,562 258,321 40,396 357,226 (271,500) 85,726 - other (2) 39,154 35,381 25,954 1,676 43,327 3,259 148,751 (59,160) 89,591 Personal - mortgages — 106,388 — — — — 106,388 — 106,388 - unsecured — 22,008 — — — 24 22,032 (7) 22,025 Property — 60,041 278 137 4,332 — 64,788 (1,265) 63,523 Construction — 7,589 20 26 895 — 8,530 (1,115) 7,415 Manufacturing 254 10,983 499 1,908 2,259 — 15,903 (2,205) 13,698 Finance leases and instalment credit — 11,216 1 2 73 — 11,292 (16) 11,276 Retail, wholesale and repairs — 13,237 574 2,616 952 18 17,397 (1,647) 15,750 Transport and storage 436 12,155 145 67 2,217 — 15,020 (200) 14,820 Health, education and leisure — 12,291 72 8 756 — 13,127 (965) 12,162 Hotels and restaurants — 6,734 23 — 664 — 7,421 (178) 7,243 Utilities — 3,398 1,150 513 3,207 30 8,298 (450) 7,848 Other 126 19,116 2,395 4,704 4,105 593 31,039 (947) 30,092 Total gross of provisions 67,304 358,367 110,892 13,219 326,390 44,868 921,040 (340,753) 580,287 Provisions — (10,103) (1,170) (141) — — (11,414) n/a (11,414)
US Central and local government — 191 22,936 — 9 1 23,137 — 23,137 Financial institutions - banks 7,289 711 1,245 443 111,240 29,426 150,354 (108,060) 42,294 - other (2) 17,368 9,334 29,885 560 54,639 3,510 115,296 (60,556) 54,740 Personal - mortgages — 23,237 — — — — 23,237 — 23,237 - unsecured — 8,441 — — — — 8,441 — 8,441 Property — 3,783 26 23 38 — 3,870 — 3,870 Construction — 457 21 3 11 — 492 — 492 Manufacturing — 6,824 101 12 452 — 7,389 — 7,389 Finance leases and instalment credit — 2,471 17 — — — 2,488 — 2,488 Retail, wholesale and repairs — 5,073 52 — 63 — 5,188 — 5,188 Transport and storage — 2,769 26 1 1,084 — 3,880 — 3,880 Health, education and leisure — 3,034 74 4 93 — 3,205 — 3,205 Hotels and restaurants — 684 93 3 1 — 781 — 781 Utilities — 1,061 243 16 322 — 1,642 — 1,642 Other 29 5,574 695 103 1,436 — 7,837 — 7,837 Total gross of provisions 24,686 73,644 55,414 1,168 169,388 32,937 357,237 (168,616) 188,621 Provisions — (1,303) — — — — (1,303) n/a (1,303)
RoW Central and local government 117 683 11,414 — 190 92 12,496 — 12,496 Financial institutions - banks 6,605 4,965 2,886 135 30,700 2,849 48,140 (27,897) 20,243 - other (2) 1,956 4,147 268 100 — 592 7,063 — 7,063 Personal - mortgages — 702 — — — — 702 — 702 - unsecured — 1,511 — — — — 1,511 — 1,511 Property — 850 269 15 61 1 1,196 — 1,196 Construction — 69 9 2 22 — 102 — 102 Manufacturing — 2,717 7 13 1,052 306 4,095 — 4,095 Finance leases and instalment credit — 117 127 — 2 — 246 — 246 Retail, wholesale and repairs — 1,304 3 34 96 — 1,437 — 1,437 Transport and storage — 605 225 6 443 — 1,279 (35) 1,244 Health, education and leisure — 583 — 4 34 — 621 — 621 Hotels and restaurants — 25 — 2 — — 27 — 27 Utilities — 1,848 13 22 94 — 1,977 — 1,977 Other 12 3,355 127 259 861 2 4,616 — 4,616 Total gross of provisions 8,690 23,481 15,348 592 33,555 3,842 85,508 (27,932) 57,576 Provisions — (370) — — — — (370) n/a (370)
Notes: (1) This shows the amount by which the Group’s credit risk exposure is reduced through arrangements, such as master netting agreements and cash management pooling, which give the Group a legal right to set off the financial asset against a financial liability due to the same counterparty. In addition, the Group holds collateral in respect of individual loans and advances to banks and customers. This collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant, inventories and trade debtors; and guarantees of lending from parties other than the borrower. The Group obtains collateral in the form of securities in reverse repurchase agreements. Cash and securities are received as collateral in respect of derivative transactions.
(2) Loans made by the Group's consolidated conduits to asset owning companies are included within financial institutions - other.
Total AQ1 80,305 5,885 2,043 6,039 13,967 30,233 10,042 34,395 74,670 2,707 71,497 64,453 6,739 314,338 AQ2 1 4,744 4,930 672 10,346 996 1,899 17,695 20,590 192 69,949 28,717 2,940 132,735 AQ3 1,873 2,164 1,502 2,347 6,013 1,857 3,796 29,364 35,017 746 94,678 23,126 7,057 168,510 AQ4 479 9,864 1,451 7,031 18,346 10,642 1,894 99,258 111,794 470 39,157 40,984 4,430 215,660 AQ5 — 1,776 416 662 2,854 5,403 297 77,045 82,745 717 8,826 33,507 2,087 130,736 AQ6 — 1,823 1 157 1,981 82 38 39,324 39,444 59 1,487 14,138 1,426 58,535 AQ7 — 301 — 237 538 684 50 30,279 31,013 22 978 7,437 918 40,906 AQ8 3 — — 48 48 — 10 8,482 8,492 58 132 1,183 119 10,035 AQ9 — — — 34 34 — 41 16,944 16,985 — 641 1,020 317 18,997 AQ10 — — — — — — — 730 730 — 695 1,274 137 2,836 Past due — — — — — — — 9,068 9,068 620 — — — 9,688 Impaired — — — 70 70 — — 37,101 37,101 — — — — 37,171 Impairment provision — — — (63) (63) — — (25,162) (25,162) — — — — (25,225)
Balance sheet analysis continued Financial assets continued Cash and Settlement balances at Loans and advances balances and other Contingent central banks Banks (1) Customers financial assets Derivatives Commitments liabilities Total 2011 £m £m £m £m £m £m £m £m
Core AQ1 78,003 17,806 3,708 8,495 30,009 42,963 15,022 32,256 90,241 2,671 99,882 62,440 7,822 371,068 AQ2 12 3,556 4,566 514 8,636 710 704 10,551 11,965 185 108,107 20,207 2,792 151,904 AQ3 1,046 5,703 2,241 2,738 10,682 2,886 3,917 21,688 28,491 539 152,462 23,392 7,419 224,031 AQ4 100 6,251 1,761 2,729 10,741 14,079 2,144 99,771 115,994 1,202 57,650 39,832 5,648 231,167 AQ5 — 1,183 469 785 2,437 8,163 679 86,581 95,423 659 12,082 27,501 2,508 140,610 AQ6 — 282 39 356 677 86 50 36,891 37,027 73 1,476 13,140 1,353 53,746 AQ7 — 2 — 186 188 1,133 12 32,032 33,177 191 2,536 17,824 949 54,865 AQ8 — — — 68 68 4 2 10,731 10,737 8 247 5,607 146 16,813 AQ9 1 — — 93 93 — 7 14,958 14,965 137 979 1,088 93 17,356 AQ10 — — — — — — — 684 684 1 448 832 149 2,114 Past due — — — — — — 249 9,528 9,777 991 — — — 10,768 Impaired — — — 133 133 — — 17,418 17,418 — — — — 17,551 Impairment provision — — — (113) (113) — — (9,949) (9,949) — — — — (10,062)
Non-Core AQ1 39 — — 53 53 — — 2,683 2,683 1 396 304 51 3,527 AQ2 1 — — 19 19 — — 442 442 — 128 74 23 687 AQ3 — — — 171 171 — — 884 884 — 359 118 18 1,550 AQ4 59 — — 107 107 — — 3,712 3,712 24 474 247 215 4,838 AQ5 — — — 3 3 — — 1,834 1,834 — 713 194 98 2,842 AQ6 — — — 10 10 — — 2,055 2,055 — 296 351 27 2,739 AQ7 — — — 33 33 7 — 862 869 — 222 277 171 1,572 AQ8 — — — 23 23 — — 482 482 — 37 97 4 643 AQ9 — — — 11 11 — — 4,452 4,452 — 160 323 34 4,980 AQ10 — — — — — — — 43 43 — 390 295 73 801 Past due — — — — — — — 532 532 37 — — — 569 Impaired — — — 1 1 — — 18,737 18,737 — — — — 18,738 Impairment provision — — — (1) (1) — — (13,838) (13,838) — — — — (13,839)
• Derivatives decreased across all asset quality bands reflecting risk reduction within Markets and upwards shifts in major interest rate yield curves.
• Core past due loans to customers decreased £1.2 billion, with a reduction in Ulster Bank (£0.8 billion) and US Retail and Commercial (£1.2 billion) being offset by increases in UK Retail (£1.2 billion) as balances transferred from the impaired book.
• Impairment provisions increased £4.0 billion, mainly due to RCR and related change in strategy (£4.5 billion) partly offset by a decrease in UK Retail (£0.5 billion).
Central and local government Other financial Of which UK US Other Banks institutions Corporate Total ABS
Key points HFT • UK and US government bonds and US agency ABS decreased reflecting sales and continued focus on balance sheet reduction and capital management in Markets. The decrease in other government bonds primarily comprised reductions in Japanese, French, Belgian and Canadian bonds, partially offset by increases in Italian, German and Spanish bonds. Short positions in US government bonds decreased, reflecting reduced holdings and short positions in German government bonds increased reflecting focus on reduction in net exposure.
UK US Other Banks institutions Corporate Total Total ABS 2013 £m £m £m £m £m £m £m % £m
Core AAA — 18 13,106 1,434 7,722 162 22,442 20 6,391 AA to AA+ 13,210 23,812 7,847 446 16,518 138 61,971 55 20,747 A to AA- — — 4,200 1,657 1,131 290 7,278 7 1,080 BBB- to A- — — 7,572 3,761 2,562 854 14,749 13 4,876 Non-investment grade — — 406 341 2,015 340 3,102 3 2,077 Unrated — 2 6 230 1,407 372 2,017 2 1,245 13,210 23,832 33,137 7,869 31,355 2,156 111,559 100 36,416
UK US Other Banks institutions Corporate Total Total ABS 2011 £m £m £m £m £m £m £m % £m
Key points • AAA rated debt securities decreased as the UK and the Netherlands were downgraded from AAA to AA+ during the year and also reflected the Group’s reduced holding of debt securities.
Balance sheet analysis continued Debt securities continued Asset-backed securities Introduction The Group structures, originates, distributes and trades debt in the form of loan, bond and derivative instruments in all major currencies and debt capital markets in North America, Western Europe, Asia and major emerging markets. The carrying value of the Group's debt securities is detailed below.
The main categories of mortgages that serve as collateral to RMBS held by the Group are set out below and described in the Glossary on pages 549 to 556. The US market has more established definitions of differing underlying mortgage quality and these are used as the basis for the Group's RMBS categorisation.
US UK Europe RoW Total HFT DFV AFS LAR 2013 £m £m £m £m £m £m £m £m £m
Net exposure RMBS: government sponsored or similar 14,869 — 2,403 — 17,272 7,031 — 10,241 —
RMBS: government sponsored or similar 27,549 — 5,884 2 33,435 15,031 — 18,404 — RMBS: prime 1,201 3,487 1,541 484 6,713 1,090 567 4,977 79 RMBS: non-conforming 1,220 2,197 74 — 3,491 717 — 1,402 1,372 RMBS: sub-prime 1,847 427 94 2 2,370 2,183 — 22 165 MBS: covered bond 133 203 8,256 — 8,592 — — 8,592 — CMBS 1,623 1,562 883 1 4,069 2,001 — 862 1,206 CDOs 7,889 72 469 — 8,430 4,455 — 3,885 90 CLOs 5,019 156 1,055 — 6,230 1,294 — 4,734 202 ABS covered bond 21 71 948 4 1,044 — — 1,044 — Other ABS 2,085 1,844 1,746 992 6,667 1,965 17 2,389 2,296 48,587 10,019 20,950 1,485 81,041 28,736 584 46,311 5,410
Carrying value RMBS: government sponsored or similar 28,022 — 5,549 2 33,573 15,132 — 18,441 — RMBS: prime 1,035 3,038 1,206 466 5,745 872 558 4,243 72 RMBS: non-conforming 708 1,897 74 — 2,679 327 — 980 1,372 RMBS: sub-prime 686 144 72 2 904 737 — 9 158 MBS: covered bond 136 209 7,175 — 7,520 — — 7,520 — CMBS 1,502 1,253 635 1 3,391 1,513 — 716 1,162 CDOs 1,632 31 294 — 1,957 315 — 1,555 87 CLOs 4,524 98 719 — 5,341 882 — 4,280 179 ABS covered bond 19 70 953 4 1,046 — — 1,046 — Other ABS 1,715 947 1,525 966 5,153 1,038 — 1,945 2,170 39,979 7,687 18,202 1,441 67,309 20,816 558 40,735 5,200
Of which in Non-Core — 651 404 154 — 780 494 2,228 — 850 5,561
Of which in Non-Core — 837 477 308 — 830 1,656 4,227 — 1,861 10,196
Equity shares The table below analyses holdings of equity shares for eurozone countries and other countries with balances of more than £100 million by country, issuer and measurement classification. The HFT positions in Markets, primarily in run-off and recovery businesses, are used mainly for economic hedging of debt issuances and equity derivatives. The AFS portfolios include capital stock in the Federal Home Loan Bank (a government sponsored entity, included in other financial institutions) and the Federal Reserve Bank, which together amounted to £0.6 billion (2012 - £0.7 billion) that US Retail & Commercial are required to hold. The remaining AFS balances are individually small holdings in unlisted companies, mainly acquired through debt for equity transactions in GRG.
Other financial HFT short Other financial AFS Banks institutions (2) Corporate Total positions Banks institutions (2) Corporate Total Total reserves
Ireland — 73 22 95 — — 7 2 9 104 — Italy 7 1 26 34 (1) — 5 — 5 39 — Portugal — — 4 4 — — — — — 4 — Greece — — 1 1 — — — — — 1 — Eurozone periphery 11 74 109 194 (3) — 12 62 74 268 (6)
France 3 6 130 139 (2) 4 — 147 151 290 30 Luxembourg — 234 35 269 (34) — — 2 2 271 — Germany 9 42 181 232 (20) — — — — 232 — Other 11 18 117 146 (17) 4 3 — 7 153 1 Total eurozone 35 515 973 1,523 (78) 8 15 256 279 1,802 7
Notes: (1) Designated as at fair value through profit or loss balances are £400 million (2012 - £533 million; 2011 - £774 million), of which £105 million other financial institutions (2012 - £61 million; 2011 - £81 million) and £295 million corporate (2012 - £472 million; 2011 - £692 million). (2) Includes government sponsored entities.
GBP USD Euro Other Total Assets Liabilities Notional (1) Assets Liabilities Notional (1) Assets Liabilities Derivatives £bn £bn £bn £bn £bn £m £m £bn £m £m £bn £m £m
AQ1 8,647 AQ2 252 AQ3 1,713 AQ4 778 AQ5 885 AQ6 882 AQ7 782 AQ8 124 AQ9 184 AQ10 679 14,926
Key points • Net exposure decreased by 47% (liabilities decreased by 38%)
• Interest rate contracts’ fair value decreased due to significant upward shifts in major yield curves as the US Federal Reserve announced tapering of quantitative easing from early 2014. Continued participation in trade compression cycles contributed to a further reduction in exposures.
• Corporate uncollateralised derivatives, principally all in Markets, relate to large corporates who may have netting arrangements in place but do not have collateral posting capability. A significant proportion of the Group’s credit valuation adjustments and funding valuation adjustments relate to those uncollateralised derivatives.
The table below analyses the Group’s derivative notional and fair values by trading and settlement method.
Interest rate 2,203 22,565 10,821 35,589 65 217,976 79 208,619 Exchange rate 94 2 4,459 4,555 — 61,923 — 65,749 Credit — 30 223 253 — 5,306 — 5,388 Equity and commodity — 1 80 81 4 2,766 220 5,472 2012 Interest rate 2,388 15,864 15,231 33,483 13 363,441 55 345,510 Exchange rate 108 — 4,590 4,698 — 63,067 — 70,481 Credit — — 553 553 — 11,005 — 10,353 Equity and commodity 1 — 110 111 28 4,364 200 7,741 2011 Interest rate 2,653 16,377 19,697 38,727 3 422,550 5 406,779 Exchange rate 110 — 4,372 4,482 — 74,526 — 81,022 Credit — — 1,054 1,054 — 26,836 — 26,743 Equity and commodity 2 — 121 123 115 6,027 423 9,137
Client-led trading and residual risk 124.7 111.7 1.2 1.5 250.7 240.7 3.4 3.1 401.0 390.5 17.0 16.5
Credit hedging - trading book - rates 5.1 4.0 0.1 0.1 9.4 5.8 0.1 0.1 21.2 17.1 0.9 1.7
By counterparty Central government (APS) — — — — — — — — 131.8 — (0.2) —
Fair value: Notional: reference Credit protected protected Gross valuation Net Counterparty and assets assets exposure adjustment Hedges exposure credit risk RWAs £m £m £m £m £m £m £bn
Fair value: Notional: reference Credit protected protected Gross valuation Net Counterparty and assets assets exposure adjustment exposure credit risk RWAs £m £m £m £m £m £bn
REIL, provisions and AFS reserves Risk elements in lending (REIL) comprises impaired loans and accruing loans past due 90 days or more as to principal or interest. Impaired loans are all loans (including loans subject to forbearance) for which an impairment provision has been established; for collectively assessed loans, impairment loss provisions are not allocated to individual loans and the entire portfolio is included in impaired loans. Accruing loans past due 90 days or more comprise loans past due 90 days where no impairment loss is expected and those awaiting individual assessment. A latent provision is established for the latter.
REIL as a % Provisions Gross loans to of gross loans as a % Impairment Amounts Banks Customers REIL Provisions to customers of REIL charge written-off
UK Retail 695 113,599 4,569 2,629 4.0 58 529 599 UK Corporate 746 107,025 5,452 2,432 5.1 45 836 514 Wealth 1,545 17,074 248 109 1.5 44 46 15 International Banking 4,827 42,342 422 391 1.0 93 111 445 Ulster Bank 632 32,652 7,533 3,910 23.1 52 1,364 72 US Retail & Commercial 435 51,271 1,146 285 2.2 25 83 391 Retail & Commercial 8,880 363,963 19,370 9,756 5.3 50 2,969 2,036 Markets 16,805 29,787 396 305 1.3 77 25 109 Other 3,196 2,125 — 1 — — 1 — Core 28,881 395,875 19,766 10,062 5.0 51 2,995 2,145 Non-Core 477 56,343 21,374 11,200 37.9 52 2,320 2,121 Direct Line Group 2,036 881 — — — — — — Group 31,394 453,099 41,140 21,262 9.1 52 5,315 4,266
• UK Retail REIL continued to decrease due to the write-off of aged debt and the transfer of up-to-date mortgages to potential problem loans. Provision coverage remained broadly stable at 59%.
Sector and geographical regional analyses: Group The tables below analyse gross loans and advances to banks and customers (excluding reverse repos) and related credit metrics by sector and geography (by location of lending office) for the Group, Core and Non-Core. Credit metrics REIL Provisions Provisions Gross as a % of as a % as a % of Impairment Amounts loans REIL Provisions gross loans of REIL gross loans charge written-off
Finance leases and instalment credit 13,587 263 190 1.9 72 1.4 16 121 of which: UK - residential mortgages 110,515 1,900 319 1.7 17 0.3 39 180
Balance sheet analysis continued REIL, provisions and AFS reserves continued Sector and geographical regional analyses: Group continued Credit metrics REIL Provisions Provisions Gross as a % of as a % as a % of Impairment Amounts loans REIL Provisions gross loans of REIL gross loans charge written-off
Central and local government 9,742 — — — — — — —
Balance sheet analysis continued REIL, provisions and AFS reserves continued Sector and geographical regional analyses: Core Credit metrics REIL Provisions Provisions Gross as a % of as a % as a % of Impairment Amounts loans REIL Provisions gross loans of REIL gross loans charge written-off
Finance leases and instalment credit 10,355 139 89 1.3 64 0.9 23 31 of which: UK - residential mortgages 110,515 1,900 319 1.7 17 0.3 38 179
Finance leases and instalment credit 9,201 159 107 1.7 67 1.2 35 41 of which: UK - residential mortgages 109,511 2,440 457 2.2 19 0.4 122 32
Central and local government 8,359 — — — — — — —
Finance leases and instalment credit 8,440 172 110 2.0 64 1.3 31 68 of which: UK - residential mortgages 104,965 2,210 420 2.1 19 0.4 174 24
Sector and geographical regional analyses: Non-Core Credit metrics REIL Provisions Provisions Gross as a % of as a % as a % of Impairment Amounts loans REIL Provisions gross loans of REIL gross loans charge written-off
Central and local government 1,368 — — — — — — —
Finance leases and instalment credit 4,408 283 187 6.4 66 4.2 9 222 of which: UK - residential mortgages 19 — — — — — — —
Central and local government 1,383 — — — — — — —
Note: (1) Excludes balances in relation to Direct Line Group (loans to banks: 2012 - £2,036 million; 2011 - £2,559 million and loans to customers: 2012 - £881 million; 2011 - £873 million).
Balance sheet analysis continued REIL, provisions and AFS reserves continued Provisions and AFS reserves methodology The Group's consumer portfolios, which consist of high volume, small value credits, have highly efficient largely automated processes for identifying problem credits and very short timescales, typically three months, before resolution or adoption of various recovery methods. Corporate portfolios consist of higher value, lower volume credits, which tend to be structured to meet individual customer requirements.
Analyses of provisions are set out on pages 312 to 314.
Analyses of AFS debt securities and related AFS reserves are set out on page 316 and 317.
At 1 January 2013 4,569 5,452 248 422 7,533 1,146 396 — 19,766 21,374 41,140 Currency translation and other adjustments — 11 2 (11) 134 (21) 1 — 116 279 395 Disposal of subsidiaries — — — — — — — — — (89) (89) Additions 1,302 4,825 132 431 2,479 282 14 1 9,466 3,397 12,863 Transfers (1) (445) 418 — 133 — — — — 106 (1) 105 Transfers to performing book — (54) (3) (118) — — — — (175) (108) (283)
At 1 January 2013 2,622 6,907 11,399 418 28 21,374 Currency translation and other adjustments 8 67 206 (2) — 279 Disposal of subsidiaries — — (89) — — (89)
Retail Corporate Wealth Banking Bank Commercial Markets Core Non-Core Total £m £m £m £m £m £m £m £m £m £m
UK International Ulster US Retail Corporate Banking Bank & Commercial Other Total £m £m £m £m £m £m
REIL as a % of gross loans and advances (1) 5.3% 52.4% 9.4% 4.9% 38.2% 9.1% 4.4% 30.1% 8.6% Provisions as a % of REIL 56% 73% 64% 51% 52% 52% 50% 48% 49%
2013 2012 2011 Core Non-Core Total Core Non-Core Total Core Non-Core Total £m £m £m £m £m £m £m £m £m
UK UK International Ulster US Total Central Total Retail Corporate Wealth Banking Bank R&C (1) R&C (1) Markets items Core Non-Core Group £m £m £m £m £m £m £m £m £m £m £m £m
UK International Ulster US Corporate Banking Bank R&C (1) Other Total £m £m £m £m £m £m
Recoveries of amounts previously written-off 11 35 — 41 1 88 Charged to income statement - continuing operations 355 1,109 3,027 156 (1) 4,646
UK UK International Ulster US Total Central Total Retail Corporate Wealth Banking Bank R&C (1) R&C (1) Markets Items Core Non-Core RFS MI Group £m £m £m £m £m £m £m £m £m £m £m £m £m
Corporate Banking Bank R&C (1) Other Total £m £m £m £m £m £m
Recoveries of amounts previously written-off 21 38 4 63 4 130
Impairment charge analysis The table below analyses the impairment charge for loans and securities.
Central and local government 6,436 12,880 10,303 29,619 9,774 19,046 16,155 44,975 13,436 20,848 25,552 59,836 Banks 492 92 5,390 5,974 1,085 357 7,419 8,861 1,391 376 11,408 13,175 Other financial institutions 2,335 8,327 6,668 17,330 2,861 10,613 10,416 23,890 3,100 17,453 11,199 31,752 Corporate 21 71 92 184 1,318 719 1,130 3,167 1,105 131 1,299 2,535 Total 9,284 21,370 22,453 53,107 15,038 30,735 35,120 80,893 19,032 38,808 49,458 107,298
AFS gross unrealised losses The table below shows the fair value of available-for-sale debt securities that were in an unrealised loss position at 31 December and the related gross unrealised losses.
Less than 12 months More than 12 months Total Gross Gross Gross unrealised unrealised unrealised Fair value losses Fair value losses Fair value losses 2013 £m £m £m £m £m £m
Central and local government - UK 6,987 69 — — 6,987 69 2012 Central and local government - US 59 1 — — 59 1 2011 Central and local government - other 2,878 65 778 106 3,656 171
Sources of risk The Group is exposed to traded market risk through its trading activities and to non-traded market risk as a result of its banking activities. In many respects, it manages its traded and non-traded market risk exposures separately, as described in this section, largely in line with the regulatory definitions of the trading and non-trading books.
The primary objective of the Group’s trading activities is to provide a range of financing, risk management and investment services to its customers - including major corporations and financial institutions around the world. From a market risk perspective, the Group's trading activities are included within the following markets: currencies; emerging markets; rates; asset-backed products; and traded credit.
The Group undertakes transactions in financial instruments including debt securities, loans, deposits and equities, as well as securities financing and derivatives.
Some of these transactions involve trading or clearing financial instruments on an exchange, including interest rate swaps, futures and options. Holders of these instruments provide margin on a daily basis with cash or other security at the exchange.
• customer transactions and profits and losses in a currency that are not conducted in the functional currency of the transacting operation.
Market risk continued Sources of risk continued Linkage to balance sheet* The table below analyses the Group’s balance sheet by trading and non-trading business. Trading Non-trading Total business (1) business (2) Non-trading business 2013 £bn £bn £bn Primary risk factor
Liabilities Deposits by banks 35.3 19.2 16.1 Interest rate Customer deposits 414.4 9.7 404.7 Interest rate Repurchase agreements and stock lending 85.1 73.6 11.5 Interest rate Debt securities in issue 67.8 19.7 48.1 Interest rate Settlement balances 5.3 5.3 — Short positions 28.0 28.0 — Derivatives 285.5 283.4 2.1 Interest rate, foreign exchange Subordinated liabilities 24.0 — 24.0 Interest rate Other liabilities 23.3 — 23.3 Interest rate, credit spreads Total liabilities 968.7 438.9 529.8
Governance structure For general information on risk governance in the Group, see the Risk governance section on pages 176.
Risk management Frameworks and processes common to both traded and non-traded market risk management are described in this sub-section. Separate subsections on traded and non-traded market risk follow, which provide more detailed information specific to the management and measurement of these two risk types.
Risk appetite and limit framework* Market risk appetite is the level of market risk that the Group accepts when pursuing its business objectives, taking into account both projected and stressed scenarios. The Group has a comprehensive structure and controls in place aimed at ensuring that this appetite is not exceeded.
The Group’s qualitative market risk appetite is set out in policy statements. These define the governance, responsibilities, control framework and requirements for the identification, measurement, analysis, management and reporting of market risk arising from the Group’s trading and non-trading activities. These policies are also cascaded, as appropriate, to the Group’s legal entities, divisions and businesses to ensure there is a consistent control framework throughout.
The limit framework comprises not only Group limits but also legal entity, divisional and lower level limits and aims to capture all material market risks arising from the Group’s activities.
Limit breaches at the Group level require escalation by the head of traded market risk or the head of non-traded market risk, as appropriate, to the ERF and the Group CRO. Limit breaches at the divisional or legal entity level require escalation by the head of the relevant divisional market risk function to the head of traded market risk or the head of non-traded market risk, as appropriate.
For more information on valuation controls, refer to page 412. The validation of pricing models is discussed below.
The Group uses a variety of models to manage and measure market risk, as described below. These models comprise pricing models (used for valuation of positions) and risk models (for risk measurement and capital calculation purposes). They are developed in both divisional units and Group functions and are subject to independent review and sign-off.
The Group has a dedicated independent model review and challenge function - Group Risk Analytics (GRA) - which performs reviews of relevant models in two instances: (i) for new models or amendments to existing models and (ii) as part of its ongoing programme to assess the performance of these models.
GRA also reassesses the appropriateness of approved models following significant market or regulatory developments or portfolio changes. The mechanics of the review process are the same as those for new models.
The review process comprises the following steps: • The committees prioritise models for GRA review, considering the materiality of the risk booked against the model and an assessment of the degree of model risk, that is the valuation uncertainty arising from the choice of modelling assumptions.
• Ensuring model outputs are sufficiently conservative in areas where there is significant model uncertainty; • Confirming the applicability of tests for accuracy and stability; recalculating and ensuring that results are robust; and
Based on the review and findings from GRA, an internal model governance committee with appropriate delegated authority considers whether a model can be approved for use and whether any conditions need to be imposed, including those relating to the remediation of material issues raised through the review process. Once approved through internal governance, the new or amended model is implemented. Models used for regulatory reporting may additionally require PRA approval before implementation.
Traded market risk Risk management The governance framework, risk management principles and appetite and limit framework applicable to the Group’s management of market risk are covered by the discussion on page 176. More specific information on the Group’s management of traded market risk is provided below.
Divisional market risk functions also prepare daily risk reports that detail exposures against a more granular set of limits and triggers.
Mitigation To ensure approved limits are not breached and that the Group remains within its risk appetite, triggers at Group, legal entity and divisional levels have been set such that if exposures exceed a specified level, action plans are developed by the front office, Market Risk and Finance.
The Group's main measurement methods are VaR and SVaR. Risks that are not adequately captured by these model methodologies are captured by the Risks Not in VaR (RNIV) framework to ensure that the Group is adequately capitalised for market risk. In addition, stress testing is used to identify any vulnerabilities and potential losses in excess of VaR and SVaR.
Each of these methodologies and techniques is discussed in more detail below.
The Group’s internal traded VaR model captures all trading book positions including those approved by the regulator. In 2013, improvements were made to the risk sensitivities associated with funding valuation adjustments (FVAs), which resulted in a reduction in the hedge portfolio. At the point of implementation, the impact on RBS plc was a £9 million decrease in 1-day 99% regulatory VaR and an associated £42 million decrease in regulatory SVaR. The current internal VaR methodology does not include credit valuation adjustment (CVA) and FVA exposures as these are out of scope of the measure, although the Group is planning to include these in its internal VaR measure in 2014. For an explanation of the distinction between internal VaR and regulatory VaR, see page 330.
The risk factors presented above are sufficient to define the Group’s overall market risk exposures. In addition, the following risks, which are components of the above-mentioned risk factors, are also monitored by individual businesses to identify and address any material concentrations: • Basis risk, which is the risk that imperfect correlation between two instruments in a hedging strategy creates the potential for excess gains or losses, thus adding risk to the position; • Prepayment risk, which is the risk associated with early unscheduled return of principal on a fixed rate security; and